FFNW-2014.6.30-10Q

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 June 30, 2014
 
 
or
[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
           For the transition period from ____________ to ____________
 
Commission File Number: 001-33652
 
 
FIRST FINANCIAL NORTHWEST, INC.
(Exact name of registrant as specified in its charter)
 
Washington
 
26-0610707
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
 
 
 
201 Wells Avenue South, Renton, Washington
 
98057
(Address of principal executive offices)
 
(Zip Code)
 
 
 
Registrant’s telephone number, including area code:
 
(425) 255-4400
 
 
 

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

YES    X   NO      

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).

YES    X   NO      

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

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 August 1, 2014, 15,730,979 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)
(Unaudited)

Part 1. Financial Information

Item 1. Financial Statements

 
June 30, 2014
 
December 31, 2013
Assets
 
 
 
 
 
Cash on hand and in banks
$
5,036

 
$
6,074

Interest-earning deposits
35,650

 
49,501

Investments available-for-sale, at fair value
128,844

 
144,364

Loans receivable, net of allowance of $11,951 and $12,994
676,455

 
663,153

Federal Home Loan Bank ("FHLB") stock, at cost
6,884

 
7,017

Accrued interest receivable
3,564

 
3,698

Deferred tax assets, net
11,427

 
14,835

Other real estate owned ("OREO")
10,114

 
11,465

Premises and equipment, net
17,024

 
17,291

Prepaid expenses and other assets
3,833

 
3,581

Total assets
$
898,831

 
$
920,979

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 
 
 
 
 
Interest-bearing deposits
$
565,211

 
$
601,446

Noninterest-bearing deposits
9,908

 
10,619

Advances from the FHLB
135,500

 
119,000

Advance payments from borrowers for taxes and insurance
1,583

 
1,846

Accrued interest payable
105

 
88

Other liabilities
4,040

 
3,625

Total liabilities
716,347

 
736,624

 
 

 
 
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
 
 
 
  15,730,979 at June 30, 2014, 16,392,139 shares at December 31, 2013
157

 
164

   Additional paid-in capital
159,495

 
166,866

Retained earnings, substantially restricted
32,724

 
29,220

Accumulated other comprehensive income (loss), net of tax
(582
)
 
(2,020
)
Unearned Employee Stock Ownership Plan ("ESOP") shares
(9,310
)
 
(9,875
)
Total stockholders' equity
182,484

 
184,355

Total liabilities and stockholders' equity
$
898,831

 
$
920,979

See accompanying selected notes to consolidated financial statements.

3

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

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Interest income
 
 
 
 
 
 
 
Loans, including fees
$
9,087

 
$
9,063

 
$
18,113

 
$
18,107

Investments available-for-sale
585

 
603

 
1,189

 
1,076

Interest-earning deposits
22

 
18

 
42

 
39

     Dividends on FHLB stock
1

 

 
3

 

Total interest income
$
9,695

 
$
9,684

 
$
19,347

 
$
19,222

Interest expense
 
 
 
 
 

 
 

Deposits
1,238

 
1,763

 
2,585

 
3,656

FHLB advances
279

 
116

 
530

 
372

Total interest expense
$
1,517

 
$
1,879

 
$
3,115

 
$
4,028

Net interest income
8,178

 
7,805

 
16,232

 
15,194

(Recapture of provision) provision for loan losses
(100
)
 
100

 
(600
)
 
100

Net interest income after (recapture of provision)
provision for loan losses
$
8,278

 
$
7,705

 
$
16,832

 
$
15,094

Noninterest income
 
 
 
 
 

 
 

Net (loss) gain on sale of investments
(20
)
 
1

 
(20
)
 
1

Other
108

 
154

 
176

 
258

Total noninterest income
$
88

 
$
155

 
$
156

 
$
259

Noninterest expense
 

 
 
 
 

 
 

Salaries and employee benefits
2,875

 
3,755

 
5,775

 
7,369

Occupancy and equipment
327

 
345

 
678

 
699

Professional fees
394

 
393

 
751

 
838

Data processing
159

 
176

 
332

 
338

Loss (gain) on sale of OREO property, net
36

 
(383
)
 
107

 
(1,015
)
OREO market value adjustments
92

 
76

 
288

 
221

OREO related expenses, net
78

 
151

 
139

 
485

Regulatory assessments
104

 
94

 
182

 
377

Insurance and bond premiums
88

 
121

 
176

 
235

Marketing
37

 
42

 
62

 
60

Prepayment penalty on FHLB advances

 

 

 
679

Other general and administrative
512

 
536

 
736

 
898

Total noninterest expense
$
4,702

 
$
5,306

 
$
9,226

 
$
11,184

Income before federal income tax provision (benefit)
3,664

 
2,554

 
7,762

 
4,169

            Federal income tax provision (benefit)
1,297

 
(13,809
)
 
2,750

 
(13,751
)
Net income
$
2,367

 
$
16,363

 
$
5,012

 
$
17,920

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.16

 
$
0.96

 
$
0.33

 
$
1.03

Diluted earnings per share
$
0.16

 
$
0.95

 
$
0.33

 
$
1.03


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 June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
2,367

 
$
16,363

 
$
5,012

 
$
17,920

 
 
 
 
 
 
 
 
Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
   Unrealized holding gains (losses) on available-for-
 
 
 
 
 
 
 
   sale securities
1,254

 
(1,960
)
 
2,193

 
(2,596
)
   Reclassification adjustment for net (gains) losses
 
 
 
 
 
 
 
   realized in income
20

 
(1
)
 
20

 
(1
)
Other comprehensive income (loss), before tax
1,274

 
(1,961
)
 
2,213

 
(2,597
)
   Income tax provision related to items of other
 
 
 
 
 
 
 
   comprehensive income
446

 

 
775

 

Other comprehensive income (loss), net of tax
$
828

 
$
(1,961
)
 
$
1,438

 
$
(2,597
)
Total comprehensive income
$
3,195

 
$
14,402

 
$
6,450

 
$
15,323


See accompanying selected notes to consolidated financial statements.



5

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
For the Six Months Ended June 30, 2014
(Dollars in thousands)
(Unaudited)

 
Shares
 
Common 
Stock
 
Additional 
Paid-in
Capital
 
Retained
Earnings
 
Accumulated Other Comprehensive Income (Loss),  net of tax
 
Unearned
ESOP
Shares
 
Total
Stockholders' Equity
Balances at December 31, 2013
16,392,139

 
$
164

 
$
166,866

 
$
29,220

 
$
(2,020
)
 
$
(9,875
)
 
$
184,355

Other comprehensive income

 

 

 
5,012

 
1,438

 

 
6,450

Cash dividend declared and paid ($0.10 per share)

 

 

 
(1,508
)
 

 

 
(1,508
)
Exercise of stock options
331,680

 
3

 
3,240

 

 

 

 
3,243

Repurchase and retirement of common stock
(992,840
)
 
(10
)
 
(10,813
)
 

 

 

 
(10,823
)
Compensation related to stock options and restricted stock awards

 

 
172

 

 

 

 
172

Allocation of 56,427 ESOP shares

 

 
30

 

 

 
565

 
595

Balances at June 30, 2014
15,730,979

 
$
157

 
$
159,495

 
$
32,724

 
$
(582
)
 
$
(9,310
)
 
$
182,484


See accompanying selected notes to consolidated financial statements.

6

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

 
Six Months Ended June 30,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
5,012

 
$
17,920

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 
(Recapture of provision) provision for loan losses
(600
)
 
100

OREO market value adjustments
288

 
221

Loss (gain) on sale of OREO property, net
107

 
(1,015
)
Loss (gain) on sale of investments
20

 
(1
)
Loss on sale of premises and equipment
11

 

Depreciation of premises and equipment
382

 
410

Net amortization of premiums and discounts on investments
750

 
966

Deferred federal income taxes (benefit)
2,633

 
(13,870
)
Allocation of ESOP shares
595

 
485

Stock compensation expense
172

 
970

Changes in operating assets and liabilities:
 
 
 

Prepaid expenses and other assets
(252
)
 
281

Net increase (decrease) in advance payments from
borrowers for taxes and insurance
(263
)
 
949

Accrued interest receivable
134

 
(149
)
Accrued interest payable
17

 
(120
)
Other liabilities
415

 
123

Net cash provided by operating activities
$
9,421

 
$
7,270

 
 
 
 
Cash flows from investing activities:
 

 
 

Capital expenditures related to OREO
(52
)
 
(38
)
Proceeds from sales of OREO properties
2,638

 
9,322

Proceeds from sales and call of investments
6,380

 
29,998

Principal repayments on investments
10,583

 
13,792

Purchases of investments

 
(45,078
)
Net increase in loans receivable
(14,332
)
 
(8,758
)
FHLB stock redemption
133

 
132

Purchases of premises and equipment
(126
)
 
(16
)
Net cash provided by (used for) investing activities
$
5,224

 
$
(646
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Net decrease in deposits
(36,946
)
 
(34,960
)
Advances from the Federal Home Loan Bank
16,500

 
74,000

Repayments of advances from the Federal Home Loan Bank

 
(83,066
)
Proceeds from stock options exercises
3,243

 
334

Repurchase and retirement of common stock
(10,823
)
 
(16,496
)
Dividends paid
(1,508
)
 
(658
)
Net cash used by financing activities
$
(29,534
)
 
$
(60,846
)
 
 
 
 
Continued
 
 
 

7

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

 
 
 
 
 
Six Months Ended June 30,
 
2014
 
2013
 
 
 
 
Net decrease in cash and cash equivalents
$
(14,889
)
 
$
(54,222
)
Cash and cash equivalents at beginning of period
55,575

 
87,741

Cash and cash equivalents at end of period
$
40,686

 
$
33,519

 
 
 
 
Supplemental disclosures of cash flow information:
 

 
 

Cash paid during the period for:
 

 
 

  Interest paid
$
3,098

 
$
4,148

  Federal income taxes paid
109

 
15

Noncash items:
 

 
 

Loans transferred to OREO, net of deferred loan fees and
allowance for loan losses
$
1,630

 
$
5,369

  Increase (decrease) in valuation allowance for investments
available for sale
2,213

 
(2,597
)
  Investment trades payable

 
2,676


See accompanying selected notes to consolidated financial statements.


8


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

Note 1 - Description of Business

First Financial Northwest, Inc. (“First Financial Northwest”), a Washington corporation, was formed on June 1, 2007 for the purpose of becoming the holding company for First Savings Bank Northwest (“First Savings Bank” or “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 Savings Bank. Accordingly, the information presented in the consolidated financial statements and related data, relates primarily to First Savings Bank. First Financial Northwest is a savings and loan holding company and is subject to regulation by the Federal Reserve Bank of San Francisco (“FRB”). First Savings Bank is regulated by the Federal Deposit Insurance Corporation (“FDIC”) and the Washington State Department of Financial Institutions (“DFI”).

First Savings Bank is a community-based savings bank primarily serving King, and to a lesser extent, Pierce, Snohomish and Kitsap counties, Washington through one full-service banking office located in Renton, Washington. First Savings 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, business, consumer loans and construction/land development. The Bank's current business strategy emphasizes commercial real estate, one-to-four family residential and multifamily lending.

As used throughout this report, the terms "we," "our," "us," or the "Company" refer to First Financial Northwest, Inc. and its consolidated subsidiary First Savings Bank Northwest, 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 consolidated financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC. In our opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the consolidated financial statements in accordance with GAAP have been included. All significant intercompany balances and transactions between the Company and its subsidiaries have been eliminated in consolidation. Operating results for the six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. 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 OREO and the underlying collateral of loans in the process of foreclosure, deferred tax assets 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 loans for our portfolio in our primary market area. Substantially all income is derived from a diverse base of commercial and residential real estate loans, consumer lending activities and investments.

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

Note 3 - Recently Issued Accounting Pronouncements

In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-11, Presentation of Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU No. 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, except to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such

9

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


purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. No new recurring disclosures are required. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2013 and are to be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The adoption of ASU No. 2013-11 did not have a material impact on the Company's consolidated financial statements.
In January 2014, the FASB issued ASU No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects. ASU 2014-01 permits an entity to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense (benefit). The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2014 and should be applied prospectively. The Company is currently reviewing the requirements of ASU No. 2014-01, but does not expect the ASU to have a material impact on the Company's consolidated financial statements.

In January 2014, the FASB issued ASU No. 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon foreclosure. ASU 2014-04 clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The ASU is effective for annual and interim reporting periods beginning on or after December 15, 2014 and can be applied with a modified retrospective transition method or prospectively. The Company is currently reviewing the requirements of ASU No. 2014-04, but does not expect the ASU to have a material impact on the Company's consolidated financial statements.

Note 4 - Investments

Investment securities available-for-sale are summarized as follows:
 
June 30, 2014
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value

(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
   Fannie Mae
$
42,286

 
$
898

 
$
(91
)
 
$
43,093

   Freddie Mac
23,707

 
532

 
(107
)
 
24,132

   Ginnie Mae
30,095

 
94

 
(243
)
 
29,946

Municipal bonds
642

 
1

 

 
643

U.S. Government agencies
17,155

 
105

 
(293
)
 
16,967

Corporate bonds
14,070

 
50

 
(57
)
 
14,063

Total
$
127,955

 
$
1,680

 
$
(791
)
 
$
128,844


10

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


 
December 31, 2013
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
   Fannie Mae
$
46,234

 
$
623

 
$
(625
)
 
$
46,232

   Freddie Mac
25,707

 
343

 
(194
)
 
25,856

   Ginnie Mae
34,403

 
63

 
(593
)
 
33,873

Municipal bonds
2,043

 
6

 
(199
)
 
1,850

U.S. Government agencies
23,222

 
123

 
(641
)
 
22,704

Corporate bonds
14,079

 
36

 
(266
)
 
13,849

Total
$
145,688

 
$
1,194

 
$
(2,518
)
 
$
144,364

 
The following table summarizes the aggregate fair value and gross unrealized loss by length of time those investments have been continuously in an unrealized loss position:
 
June 30, 2014
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
 
 
 
 
   Fannie Mae
$
8,761

 
$
(91
)
 
$

 
$

 
$
8,761

 
$
(91
)
   Freddie Mac
4,836

 
(107
)
 

 

 
4,836

 
(107
)
   Ginnie Mae
19,124

 
(239
)
 
1,059

 
(4
)
 
20,183

 
(243
)
Municipal bonds
500

 

 

 

 
500

 

U.S. Government agencies
8,197

 
(293
)
 

 

 
8,197

 
(293
)
Corporate bonds
5,944

 
(57
)
 

 

 
5,944

 
(57
)
Total
$
47,362

 
$
(787
)
 
$
1,059

 
$
(4
)
 
$
48,421

 
$
(791
)
 
December 31, 2013
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
 
 
 
 
   Fannie Mae
$
27,429

 
$
(625
)
 
$

 
$

 
$
27,429

 
$
(625
)
   Freddie Mac
8,704

 
(155
)
 
2,483

 
(39
)
 
11,187

 
(194
)
   Ginnie Mae
16,617

 
(278
)
 
12,730

 
(315
)
 
29,347

 
(593
)
Municipal bonds

 

 
1,201

 
(199
)
 
1,201

 
(199
)
U.S. Government agencies
7,702

 
(596
)
 
4,955

 
(45
)
 
12,657

 
(641
)
Corporate bonds
8,796

 
(266
)
 

 

 
8,796

 
(266
)
Total
$
69,248

 
$
(1,920
)
 
$
21,369

 
$
(598
)
 
$
90,617

 
$
(2,518
)

At June 30, 2014, the Company had one Ginnie Mae mortgage-backed security with a gross unrealized loss of $3,720 and a fair value of $1.1 million that had an unrealized loss for greater than one year. At December 31, 2013, there were 11 securities that had a total gross unrealized loss of $598,000 with a fair value of $21.4 million that had an unrealized loss for greater than one year. Management reviewed the financial condition of the entities issuing these securities at June 30, 2014 and December 31, 2013, and determined that an other-than-temporary impairment ("OTTI") was not warranted.


11

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


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 OTTI are written down to fair value. For equity securities, the write-down is recorded as a realized loss in noninterest income on the Company's Consolidated Income Statements. For debt securities, if the Company intends to sell the security or it is likely that the Company 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 the Company does not intend to sell the security and it is not likely that it will be required to sell the security but 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. For the three and six months ended June 30, 2014 and 2013, the Company did not have any OTTI losses on investments.

The amortized cost and estimated fair value of investments available-for-sale at June 30, 2014, 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.
 
June 30, 2014
 
Amortized Cost
 
Fair Value
 
(In thousands)
Due within one year
$
50

 
$
50

Due after one year through five years
10,820

 
10,813

Due after five years through ten years
15,281

 
15,178

Due after ten years
5,716

 
5,632

 
31,867

 
31,673

Mortgage-backed investments
96,088

 
97,171

Total
$
127,955

 
$
128,844


Under Washington state law, in order to participate in the public funds program the Company is required to pledge as collateral an amount equal to 100% of the public deposits held in the form of eligible securities. Investments with a market value of $17.7 million and $21.3 million were pledged as collateral for public deposits at June 30, 2014 and December 31, 2013, respectively, both of which exceeded the collateral requirements established by the Washington Public Deposit Protection Commission.

We sold $5.0 million of investments generating a gross loss of $20,000 during the three and six months ended June 30, 2014. For the three and six months ended June 30, 2013, we sold $30.0 million of investments resulting in a gross gain of $10,000 and a gross loss of $9,000.


12

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



Note 5 - Loans Receivable

Loans receivable are summarized as follows: 
 
June 30, 2014
 
December 31, 2013
 
(In thousands)
One-to-four family residential: 
 
 
 
   Permanent owner occupied
$
154,661

 
$
158,797

   Permanent non-owner occupied
117,404

 
121,877

 
272,065

 
280,674

Multifamily:
 
 
 

   Permanent
122,332

 
106,152

   Construction
7,445

 
12,360

 
129,777

 
118,512

Commercial real estate:
 
 
 

   Permanent
253,291

 
227,016

   Construction
6,100

 
19,905

   Land
1,601

 
1,831

 
260,992

 
248,752

Construction/land development: (1)
 
 
 

   One-to-four family residential
11,431

 
3,977

   Multifamily
12,858

 
12,491

   Commercial
956

 
6,726

   Land development
6,386

 
7,461

 
31,631

 
30,655

 
 
 
 
Business
897

 
1,142

Consumer
8,149

 
9,201

Total loans
703,511

 
688,936

 
 
 
 
Less:
 
 
 

   Loans in process ("LIP")
12,380

 
10,209

   Deferred loan fees, net
2,725

 
2,580

   ALLL
11,951

 
12,994

Loans receivable, net
$
676,455

 
$
663,153

___________
Excludes construction loans that will convert to permanent loans. The Company considers these loans to be "rollovers" in that one loan is originated for both the construction loan and permanent financing. These loans are classified according to the underlying collateral. At June 30, 2014, the Company had $6.1 million, or 2.3% of the total commercial real estate portfolio and $7.4 million, or 5.7% of its total multifamily portfolio in these rollover types of loans. At December 31, 2013, the Company had $19.9 million, or 8.0% of the total commercial real estate portfolio and $12.4 million, or 10.4% of the total multifamily portfolio in these rollover types of loans. At June 30, 2014 and December 31, 2013, $1.6 million and $1.8 million, respectively, of commercial real estate loans were not included in the construction/land development category because the Company classifies raw land or buildable lots (where we do not intend to finance the construction) as commercial real estate land loans.

At June 30, 2014 and December 31, 2013 there were no loans classified as held for sale.


13

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


The following tables summarize changes in the ALLL and loan portfolio by loan type and impairment method: 
 
At or For the Three Months Ended June 30, 2014
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial 
Real Estate
 
Construction/
Land
Development
 
Business
 
Consumer
 
Total
 
(In thousands)
ALLL:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
4,575

 
$
1,406

 
$
5,536

 
$
388

 
$
7

 
$
181

 
$
12,093

   Charge-offs
(57
)
 

 

 

 

 
(23
)
 
(80
)
   Recoveries
34

 

 

 

 
1

 
3

 
38

   Provision (recapture)
(175
)
 
27

 
86

 
(55
)
 
3

 
14

 
(100
)
Ending balance
$
4,377

 
$
1,433

 
$
5,622

 
$
333

 
$
11

 
$
175

 
$
11,951

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance by
   category:
 
 
 
 
 
 
 
 
 
 
 
 
 
General reserve
$
2,932

 
$
1,401

 
$
5,071

 
$
333

 
$
11

 
$
175

 
$
9,923

Specific reserve
1,445

 
32

 
551

 

 

 

 
2,028

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans: (1)
 
 
 
 
 
 
 
 
 
 
 
 
 

Total loans
$
272,065

 
$
129,639

 
$
259,701

 
$
20,680

 
$
897

 
$
8,149

 
$
691,131

General reserve (2)
225,319

 
127,225

 
249,818

 
20,680

 
897

 
8,106

 
632,045

Specific reserve (3)
46,746

 
2,414

 
9,883

 

 

 
43

 
59,086

____________ 
(1) Net of LIP.
(2) Loans collectively evaluated for impairment.
(3) Loans individually evaluated for impairment.


14

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


 
At or For the Six Months Ended June 30, 2014
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial 
Real Estate
 
Construction/
Land
Development
 
Business
 
Consumer
 
Total
 
(In thousands)
ALLL:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
5,141

 
$
1,377

 
$
5,881

 
$
399

 
$
14

 
$
182

 
$
12,994

   Charge-offs
(75
)
 

 
(311
)
 
(223
)
 

 
(24
)
 
(633
)
   Recoveries
34

 

 
151

 

 
1

 
4

 
190

   Provision (recapture)
(723
)
 
56

 
(99
)
 
157

 
(4
)
 
13

 
(600
)
Ending balance
$
4,377

 
$
1,433

 
$
5,622

 
$
333

0.345

$
11

 
$
175

0.158

$
11,951

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance by
   category:
 
 
 
 
 
 
 
 
 
 
 
 
 
General reserve
$
2,932

 
$
1,401

 
$
5,071

 
$
333

 
$
11

 
$
175

 
$
9,923

Specific reserve
1,445

 
32

 
551

 

 

 

 
2,028

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans: (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
Total loans
$
272,065

 
$
129,639

 
$
259,701

 
$
20,680

 
$
897

 
$
8,149

 
$
691,131

General reserve (2)
225,319

 
127,225

 
249,818

 
20,680

 
897

 
8,106

 
632,045

Specific reserve (3)
46,746

 
2,414

 
9,883

 

 

 
43

 
59,086

____________ 
(1) Net of LIP.
(2) Loans collectively evaluated for impairment.
(3) Loans individually evaluated for impairment.

15

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



 
At or For the Three Months Ended June 30, 2013
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial 
Real Estate
 
Construction/
Land
Development
 
Business
 
Consumer
 
Total
 
(In thousands)
ALLL:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
5,444

 
$
1,198

 
$
4,781

 
$
386

 
$
32

 
$
161

 
$
12,002

   Charge-offs
(150
)
 

 

 
(332
)
 

 
(55
)
 
(537
)
   Recoveries
533

 
208

 
2

 

 

 
5

 
748

   Provision
    (recapture)
(857
)
 
(106
)
 
736

 
291

 
(11
)
 
47

 
100

Ending balance
$
4,970

 
$
1,300

 
$
5,519

 
$
345

 
$
21

 
$
158

 
$
12,313

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance by
   category:
 
 
 
 
 
 
 
 
 
 
 
 
 
General reserve
$
3,825

 
$
1,232

 
$
5,035

 
$
345

 
$
21

 
$
158

 
$
10,616

Specific reserve
1,145

 
68

 
484

 

 

 

 
1,697

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans: (1)
 
 
 
 
 
 
 
 
 
 
 
 
 

Total loans
$
294,880

 
$
110,039

 
$
235,812

 
$
16,121

 
$
1,720

 
$
9,927

 
$
668,499

General reserve (2)
241,415

 
108,566

 
220,088

 
11,752

 
1,720

 
9,210

 
592,751

Specific reserve (3)
53,465

 
1,473

 
15,724

 
4,369

 

 
717

 
75,748

_____________ 
(1) Net of LIP.
(2) Loans collectively evaluated for impairment.
(3) Loans individually evaluated for impairment.

16

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



 
At or For the Six Months Ended June 30, 2013
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial 
Real Estate
 
Construction/
Land
Development
 
Business
 
Consumer
 
Total
 
(In thousands)
ALLL:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
5,562

 
$
1,139

 
$
5,207

 
$
437

 
$
30

 
$
167

 
$
12,542

   Charge-offs
(309
)
 
(346
)
 
(98
)
 
(332
)
 

 
(71
)
 
(1,156
)
   Recoveries
533

 
208

 
3

 
70

 

 
13

 
827

  Provision
    (recapture)
(816
)
 
299

 
407

 
170

 
(9
)
 
49

 
100

Ending balance
$
4,970

 
$
1,300

 
$
5,519

 
$
345

 
$
21

 
$
158

 
$
12,313

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance by
  category:
 
 
 
 
 
 
 
 
 
 
 
 
 
General reserve
$
3,825

 
$
1,232

 
$
5,035

 
$
345

 
$
21

 
$
158

 
$
10,616

Specific reserve
1,145

 
68

 
484

 

 

 

 
1,697

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans: (1)
 
 
 
 
 
 
 
 
 
 
 
 
 

Total loans
$
294,880

 
$
110,039

 
$
235,812

 
$
16,121

 
$
1,720

 
$
9,927

 
$
668,499

General reserve (2)
241,415

 
108,566

 
220,088

 
11,752

 
1,720

 
9,210

 
592,751

Specific reserve (3)
53,465

 
1,473

 
15,724

 
4,369

 

 
717

 
75,748

_____________ 
(1) Net of LIP.
(2) Loans collectively evaluated for impairment.
(3) Loans individually evaluated for impairment.

Nonperforming loans were $2.3 million and $4.0 million at June 30, 2014 and December 31, 2013, respectively. Foregone interest on nonperforming loans for the three months ended June 30, 2014 was $33,000, compared to $259,000 for the same quarter in 2013. Foregone interest for the six months ended June 30, 2014 was $79,000 compared to $553,000 for the six months ended June 30, 2013.
 
There were no funds committed to be advanced in connection with impaired loans at either June 30, 2014 or December 31, 2013.

We continually monitor our loan portfolio for delinquent loans and changes in the financial condition of our borrowers. When an issue is identified with one of our borrowers 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 our 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.

A loan is considered impaired when we have determined that we may be unable to collect payments of principal or interest when due under the terms of the original loan document. When identifying loans as impaired, management takes into consideration factors which include payment history and status, collateral value, financial condition of the borrower and the probability of collecting scheduled payments in the future. Minor payment delays and insignificant payment shortfalls typically do not result in a loan being classified as impaired. The significance of payment delays and shortfalls is considered by management on a case-by-case basis, after taking into consideration the circumstances surrounding the loan and the borrower, including payment history and the amounts of any payment shortfall, length and reason for delay and the likelihood of a return to stable performance. Impairment is measured on a loan-by-loan basis for all loans in the portfolio. We obtain annual updated appraisals for impaired collateral dependent loans that exceed $1.0 million and loans that have been transferred to OREO. In addition, we may order appraisals on properties not included within these guidelines when there are extenuating circumstances where we are not otherwise able to determine the fair value of the property.


17

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


The following tables present a summary of loans individually evaluated for impairment by loan type:
 
June 30, 2014
 
Recorded Investment (1)
 
Unpaid Principal Balance (2)
 
Related Allowance
 
(In thousands)
Loans with no related allowance:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
$
3,180

 
$
3,518

 
$

      Non-owner occupied
29,171

 
29,235

 

  Multifamily
222

 
262

 

   Commercial real estate
2,840

 
3,149

 

   Consumer
43

 
70

 

Total
35,456

 
36,234

 

Loans with an allowance:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
3,386

 
3,455

 
230

      Non-owner occupied
11,009

 
11,062

 
1,215

   Multifamily
2,192

 
2,192

 
32

   Commercial real estate
7,043

 
7,043

 
551

Total
23,630

 
23,752

 
2,028

Total impaired loans:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
6,566

 
6,973

 
230

      Non-owner occupied
40,180

 
40,297

 
1,215

   Multifamily
2,414

 
2,454

 
32

   Commercial real estate
9,883

 
10,192

 
551

   Consumer
43

 
70

 

Total
$
59,086

 
$
59,986

 
$
2,028

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

18

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


 
December 31, 2013
 
Recorded Investment (1)
 
Unpaid Principal Balance (2)
 
Related Allowance
 
(In thousands)
Loans with no related allowance:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
$
3,878

 
$
4,281

 
$

      Non-owner occupied
28,782

 
28,854

 

  Multifamily
233

 
264

 

   Commercial real estate
6,224

 
6,511

 

   Construction/land development
223

 
4,812

 

   Consumer
44

 
70

 

Total
39,384

 
44,792

 

Loans with an allowance:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
3,191

 
3,238

 
263

      Non-owner occupied
12,297

 
12,352

 
1,277

  Multifamily
2,208

 
2,208

 
85

   Commercial real estate
7,085

 
7,085

 
555

Total
24,781

 
24,883

 
2,180

Total impaired loans:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
7,069

 
7,519

 
263

      Non-owner occupied
41,079

 
41,206

 
1,277

   Multifamily
2,441

 
2,472

 
85

   Commercial real estate
13,309

 
13,596

 
555

   Construction/land development
223

 
4,812

 

   Consumer
44

 
70

 

Total
$
64,165

 
$
69,675

 
$
2,180

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

 

19

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


 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
 
Average Recorded Investment
 
Interest
Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
 
(In thousands)
Loans with no related allowance:
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
      Owner occupied
$
3,284

 
$
34

 
$
3,482

 
$
72

      Non-owner occupied
29,201

 
451

 
29,061

 
883

Multifamily
225

 

 
228

 

Commercial real estate
4,272

 
45

 
4,923

 
82

Construction/land development

 

 
74

 

Consumer
43

 
1

 
43

 
1

Total
37,025

 
530

 
37,811

 
1,038

 
 
 
 
 
 
 
 
Loans with an allowance:
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
      Owner occupied
3,392

 
40

 
3,325

 
79

      Non-owner occupied
11,178

 
149

 
11,551

 
306

Multifamily
2,196

 
37

 
2,200

 
71

Commercial real estate
7,055

 
94

 
7,065

 
181

Total
23,821

 
320

 
24,141

 
637

 
 
 
 
 
 
 
 
Total impaired loans:
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
      Owner occupied
6,676

 
74

 
6,807

 
151

      Non-owner occupied
40,379

 
600

 
40,612

 
1,189

Multifamily
2,421

 
37

 
2,428

 
71

Commercial real estate
11,327

 
139

 
11,988

 
263

Construction/land development

 

 
74

 

Consumer
43

 
1

 
43

 
1

Total
$
60,846

 
$
850

 
$
61,952

 
$
1,675




20

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


 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
 
(In thousands)
Loans with no related allowance:
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
      Owner occupied
$
5,136

 
$
28

 
$
5,004

 
$
58

      Non-owner occupied
29,161

 
419

 
30,880

 
849

Multifamily
2,050

 

 
3,350

 

Commercial real estate
8,355

 
69

 
8,946

 
135

Construction/land development
4,558

 

 
4,628

 

Consumer
725

 

 
736

 

Total
49,985

 
516

 
53,544

 
1,042

 
 
 
 
 
 
 
 
Loans with an allowance:
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
      Owner occupied
4,990

 
54

 
5,292

 
112

      Non-owner occupied
16,571

 
135

 
15,693

 
361

Multifamily
614

 
20

 
410

 
40

Commercial real estate
8,074

 
91

 
8,086

 
208

Total
30,249

 
300

 
29,481

 
721

 
 
 
 
 
 
 
 
Total impaired loans:
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
      Owner occupied
10,126

 
82

 
10,296

 
170

      Non-owner occupied
45,732

 
554

 
46,573

 
1,210

Multifamily
2,664

 
20

 
3,760

 
40

Commercial real estate
16,429

 
160

 
17,032

 
343

Construction/land development
4,558

 

 
4,628

 

Consumer
725

 

 
736

 

Total
$
80,234

 
$
816

 
$
83,025

 
$
1,763



21

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



Certain loan modifications or restructurings are accounted for as troubled debt restructured loans ("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, a concession is granted to the borrower that the Company would not otherwise consider. Once the loan is restructured, a current, well-documented credit evaluation of the borrower's financial condition and prospects for repayment are performed to assess the likelihood that all principal and interest payments required under the terms of the modified agreement will be collected in full. 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. The following is a summary of information pertaining to nonperforming assets and TDRs:
 
June 30, 2014
 
December 31, 2013
 
(In thousands)
Nonperforming assets: (1)
 

 
 

   Nonaccrual loans
$
1,845

 
$
3,027

   Nonaccrual TDRs
458

 
968

Total nonperforming loans
2,303

 
3,995

   OREO
10,114

 
11,465

Total nonperforming assets
$
12,417

 
$
15,460

 
 
 
 
Performing TDRs
$
56,783

 
$
60,170

Nonaccrual TDRs
458

 
968

Total TDRs
$
57,241

 
$
61,138

_____________
(1) There were no loans 90 days and greater past due and still accruing interest at June 30, 2014 or December 31, 2013.

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 after restructuring 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).

Nonaccrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual when they are 90 days delinquent or when, in management's opinion, the borrower is unable to meet scheduled payment obligations.

In order to return a nonaccrual loan to accrual status, each loan is evaluated on a case-by-case basis. The Company evaluates the borrower's financial condition to ensure that future loan payments are reasonably assured. The Company also takes into consideration the borrower's willingness and ability to make the loan payments, as well as historical repayment performance. The Company requires the borrower to make loan payments consistently for a period of at least six months as agreed to under the terms of the loan agreement before the Company will consider reclassifying the loan to accrual status.
 

22

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


The following table is a summary of nonaccrual loans by loan type: 
 
June 30, 2014
 
December 31, 2013
 
(In thousands)
One-to-four family residential
$
1,380

 
$
2,297

Multifamily
222

 
233

Commercial real estate
701

 
1,198

Construction/land development

 
223

Consumer

 
44

Total nonaccrual loans
$
2,303

 
$
3,995


The following tables represent a summary of the aging of loans by type: 
 
Loans Past Due as of June 30, 2014
 
 
 
 
 
30-59 Days
 
60-89 Days
 
90 Days and
Greater
 
Total Past
Due
 
Current
 
Total Loans (1) (2)
 
(In thousands)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential:
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
$
822

 
$
82

 
$
443

 
$
1,347

 
$
153,314

 
$
154,661

Non-owner occupied

 

 
167

 
167

 
117,237

 
117,404

Multifamily

 

 

 

 
129,639

 
129,639

Commercial real estate
328

 

 
600

 
928

 
258,773

 
259,701

Construction/land development

 

 

 

 
20,680

 
20,680

Total real estate
1,150

 
82

 
1,210

 
2,442

 
679,643

 
682,085

Business

 

 

 

 
897

 
897

Consumer
34

 
83

 

 
117

 
8,032

 
8,149

Total
$
1,184

 
$
165

 
$
1,210

 
$
2,559

 
$
688,572

 
$
691,131

 ________________ 
(1) There were no loans 90 days and greater past due and still accruing interest at June 30, 2014.
(2) Net of LIP.

 
Loans Past Due as of December 31, 2013
 
 
 
 
 
30-59 Days
 
60-89 Days
 
90 Days and
Greater
 
Total Past
Due
 
Current
 
Total Loans (1) (2)
 
(In thousands)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential:
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
$
923

 
$
337

 
$
575

 
$
1,835

 
$
156,962

 
$
158,797

Non-owner occupied

 

 
692

 
692

 
121,185

 
121,877

Multifamily

 

 

 

 
117,181

 
117,181

Commercial real estate
331

 

 
1,089

 
1,420

 
245,982

 
247,402

Construction/land development

 

 
223

 
223

 
22,904

 
23,127

Total real estate
1,254

 
337

 
2,579

 
4,170

 
664,214

 
668,384

Business

 

 

 

 
1,142

 
1,142

Consumer
103

 
34

 

 
137

 
9,064

 
9,201

Total
$
1,357

 
$
371

 
$
2,579

 
$
4,307

 
$
674,420

 
$
678,727

_________________ 
(1) There were no loans 90 days and greater past due and still accruing interest at December 31, 2013.
(2) Net of LIP.

23

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


 
Credit Quality Indicators. The Company utilizes a nine-point risk rating system and assigns a risk rating for all credit exposures. The risk rating system is designed to define the basic characteristics and identify risk elements of each credit extension. Credits risk rated 1 through 5 are considered to be “pass” credits. Pass credits include assets, such as cash secured loans with funds on deposit with the Bank, where there is virtually no credit risk. 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. Credits classified as special mention are risk rated 6 and 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. Substandard credits are risk rated 7. 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 the Company will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful are risk rated 8 and have all the weaknesses inherent in those credits classified as 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 risk rated 9 and are considered uncollectible and cannot be justified as a viable asset for the Company. There were no loans classified as doubtful or loss at June 30, 2014 and December 31, 2013.

        The following tables represent a summary of loans by type and risk category:
 
June 30, 2014
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction/ 
Land
Development
 
Business
 
Consumer
 
Total (1)
 
(In thousands)
Risk Rating:
 
 
 
 
 
 
 
 
 
 
 
 
 
   Pass
$
259,392

 
$
127,014

 
$
245,231

 
$
20,680

 
$
897

 
$
7,927

 
$
661,141

   Special mention
4,431

 
1,193

 
12,414

 

 

 

 
18,038

   Substandard
8,242

 
1,432

 
2,056

 

 

 
222

 
11,952

Total
$
272,065

 
$
129,639

 
$
259,701

 
$
20,680

 
$
897

 
$
8,149

 
$
691,131

 _____________ 
(1) Net of LIP.

 
December 31, 2013
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction /
Land
Development
 
Business
 
Consumer
 
Total (1)
 
(In thousands)
Risk Rating:
 
 
 
 
 
 
 
 
 
 
 
 
 
   Pass
$
265,511

 
$
114,525

 
$
229,149

 
$
22,904

 
$
1,142

 
$
8,934

 
$
642,165

   Special mention
5,825

 
1,203

 
15,134

 

 

 
1

 
22,163

   Substandard
9,338

 
1,453

 
3,119

 
223

 

 
266

 
14,399

Total
$
280,674

 
$
117,181

 
$
247,402

 
$
23,127

 
$
1,142

 
$
9,201

 
$
678,727

______________ 
(1) Net of LIP.
 

24

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


The following tables summarize the loan portfolio by type and payment activity:
 
June 30, 2014
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction /
Land
Development
 
Business
 
Consumer
 
Total (1)
 
(In thousands)
Performing (2)
$
270,685

 
$
129,417

 
$
259,000

 
$
20,680

 
$
897

 
$
8,149

 
$
688,828

Nonperforming (3)
1,380

 
222

 
701

 

 

 

 
2,303

Total
$
272,065

 
$
129,639

 
$
259,701

 
$
20,680

 
$
897

 
$
8,149

 
$
691,131

____________ 
(1) 
Net of LIP.
(2) 
There were $153.6 million of owner-occupied one-to-four family residential loans and $117.1 million of non-owner occupied one-to-four family residential loans classified as performing.
(3) 
There were $1.1 million of owner-occupied one-to-four family residential loans and $300,000 of non-owner occupied one-to-four family residential loans classified as nonperforming.
 
December 31, 2013
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction/
Land
Development
 
Business
 
Consumer
 
Total (1)
 
(In thousands)
Performing (2)
$
278,377

 
$
116,948

 
$
246,204

 
$
22,904

 
$
1,142

 
$
9,157

 
$
674,732

Nonperforming (3)
2,297

 
233

 
1,198

 
223

 

 
44

 
3,995

Total
$
280,674

 
$
117,181

 
$
247,402

 
$
23,127

 
$
1,142

 
$
9,201

 
$
678,727

_____________ 
(1) Net of LIP.    
(2) There were $157.3 million of owner-occupied one-to-four family residential loans and $121.1 million of non-owner occupied one-to-four family residential loans classified as performing.
(3) There were $1.5 million of owner-occupied one-to-four family residential loans and $817,000 of non-owner occupied one-to-four family residential loans classified as nonperforming.

The following table presents TDRs and their recorded investment prior to the modification and after the modification:
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
 
Number
of Loans
 
Pre-Modification Outstanding
Recorded
Investment
 
Post-Modification Outstanding
Recorded
Investment
 
Number
of Loans
 
Pre-Modification Outstanding
Recorded
Investment
 
Post-Modification Outstanding
Recorded
Investment
 
(Dollars in thousands)
TDRs that Occurred During the Period:
 
 
 
 
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
 
 
 
 
      Principal and interest with
interest rate concession
 

 

 
1

 
221

 
221

      Advancement of maturity date
4
 
772

 
772

 
4

 
772

 
772

   Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
      Interest-only payments with
interest rate concession
1
 
2,004

 
2,004

 
1

 
2,004

 
2,004

Total
5
 
$
2,776

 
$
2,776

 
6

 
$
2,997

 
$
2,997



25

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


 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
 
Number
of Loans
 
Pre-Modification Outstanding
Recorded
Investment
 
Post-Modification Outstanding
Recorded
Investment
 
Number
of Loans
 
Pre-Modification Outstanding
Recorded
Investment
 
Post-Modification Outstanding
Recorded
Investment
 
(Dollars in thousands)
TDRs that Occurred During the Period:
 
 
 
 
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
 
 
 
 
      Interest-only payments
with no interest rate
concession
2
 
$
682

 
$
685

 
2

 
$
682

 
$
685

      Principal and interest with
interest rate concession
2
 
1,620

 
1,590

 
2

 
1,620

 
1,590

      Advancement of maturity date
1
 
311

 
307

 
1

 
311

 
307

   Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
      Principal and interest
reamortized with no interest
rate concession
 

 

 
1

 
335

 
333

      Interest-only payments with
interest rate concession
2
 
3,484

 
3,484

 
2

 
3,484

 
3,484

Total
7
 
$
6,097

 
$
6,066

 
8

 
$
6,432

 
$
6,399


At June 30, 2014 and June 30, 2013, the Company had no commitments to extend additional credit to borrowers whose loan terms have been modified in TDRs. All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation of the ALLL.

The TDRs that occurred during the three and six months ended June 30, 2014 and 2013 were the result of advancing the maturity date of the loan or granting the borrower interest rate concessions and/or interest-only payments for a period of time ranging from one to three years. 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. TDRs resulted in no charge-offs to the ALLL for the three and six months ended June 30, 2014 and $85,000 and $89,000 for the three and six months ended June 30, 2013, respectively.


26

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


The following is a summary of loans that were modified as TDRs within the previous 12 months and for which there was a payment default during the three and six months ended June 30, 2014 and 2013: 

 
Types of Modification
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
 
Number of
Loans
 
No Interest
Rate Concession -
Modified
Payment
 
Interest
Rate
Concession
 
Advancement of
Maturity Date
 
Number of
Loans
 
No Interest
Rate Concession -
Modified
Payment
 
Interest
Rate
Concession
 
Advancement
of
Maturity
Date
 
(Dollars in thousands)
TDRs that Subsequently
   Defaulted:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   One-to-four family
      residential

 
$

 
$

$


 

 
$

 
$

 
$

   Commercial

 

 



 
1

 

 

430

430

Total

 
$

 
$

$


 
1

 
$

 
$

 
$
430


 
Types of Modification
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
 
Number of
Loans
 
No Interest
Rate Concession -
Modified
Payment
 
Interest
Rate
Concession
 
Advancement of
Maturity Date
 
Number of
Loans
 
No Interest
Rate Concession -
Modified
Payment
 
Interest
Rate
Concession
 
Advancement
of
Maturity
Date
 
(Dollars in thousands)
TDRs that Subsequently
   Defaulted:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   One-to-four family
      residential


$

 
$

$


 
1

 
$
70

 
$

 
$

   Commercial
1

 
333

 



 
2

 
333

 
940

333


Total
1

 
$
333

 
$

$


 
3

 
$
403

 
$
940

 
$



TDRs that default after they have been modified are typically evaluated individually on a collateral basis. Any additional impairment further reduces the ALLL.

Note 6 - Other Real Estate Owned

The following table is a summary of OREO: 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Balance at beginning of
period
$
11,609

 
$
16,310

 
$
11,465

 
$
17,347

   Loans transferred to
OREO
439

 
1,993

 
1,630

 
5,369

   Capitalized improvements
52

 
5

 
52

 
38

   Dispositions of OREO, net
(1,894
)
 
(4,006
)
 
(2,745
)
 
(8,307
)
   Market value adjustments
(92
)
 
(76
)
 
(288
)
 
(221
)
Balance at end of period
$
10,114

 
$
14,226

 
$
10,114

 
$
14,226

 

27

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


We sold $1.9 million of OREO during the second quarter of 2014, which was comprised of five properties and generated a net loss of $36,000. OREO includes properties acquired by the Company through foreclosure and deed in lieu of foreclosure. OREO at June 30, 2014 consisted of $898,000 in one-to-four family residential homes, $8.7 million in commercial real estate properties, and $536,000 in construction/land development projects.

Note 7 - Fair Value

Fair value is defined as 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 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 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):
 
Fair Value Measurements at June 30, 2014
 
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
$
43,093

 
$

 
$
43,093

 
$

Freddie Mac
24,132

 

 
24,132

 

Ginnie Mae
29,946

 

 
29,946

 

Municipal bonds
643

 

 
643

 

U.S. Government agencies
16,967

 

 
16,967

 

Corporate bonds
14,063

 

 
14,063

 

 Total
$
128,844

 
$

 
$
128,844

 
$


28

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


 
Fair Value Measurements at December 31, 2013
 
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
$
46,232

 
$

 
$
46,232

 
$

Freddie Mac
25,856

 

 
25,856

 

Ginnie Mae
33,873

 

 
33,873

 

Municipal bonds
1,850

 

 
1,850

 

U.S. Government agencies
22,704

 

 
22,704

 

Corporate bonds
$
13,849

 
$

 
$
13,849

 
$

 Total
$
144,364

 
$

 
$
144,364

 
$


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.    

The tables below present the balances of assets and liabilities measured at fair value on a nonrecurring basis at June 30, 2014 and December 31, 2013. 
 
Fair Value Measurements at June 30, 2014
 
Fair Value
Measurements
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant
Other
Observable
Inputs (Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
(In thousands)
Impaired loans (included in loans
 
 
 
 
 
 
 
   receivable, net) (1)
$
57,058

 
$

 
$

 
$
57,058

OREO
10,114

 

 

 
10,114

Total
$
67,172

 
$

 
$

 
$
67,172


(1)
Total fair value of impaired loans is net of $2.0 million of specific reserves on performing TDRs.

 
Fair Value Measurements at December 31, 2013
 
Fair Value
Measurements
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant
Other
Observable
Inputs (Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
(In thousands)
Impaired loans (included in loans
 
 
 
 
 
 
 
   receivable, net) (1)
$
61,985

 
$

 
$

 
$
61,985

OREO
11,465

 

 

 
11,465

Total
$
73,450

 
$

 
$

 
$
73,450


(1)    Total fair value of impaired loans is net of $2.2 million of specific reserves on performing TDRs

 

29

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


The fair value of impaired loans is calculated using the collateral value method or on a discounted cash flow basis. Inputs used in the collateral value method include appraised values, less estimated costs to sell. Some of these inputs may not be observable in the marketplace. Appraised values may be discounted based on management's historical knowledge, changes in market conditions from the time of valuation and/or management's expertise and knowledge of the borrower.

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

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at June 30, 2014 and December 31, 2013.
 
June 30, 2014
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Input(s)
 
Range (Weighted Average)
 
(Dollars in thousands)
Impaired Loans
$
57,058

 
Market approach
 
Appraised value discounted by market or borrower conditions
 
0% - 24.72%
(0.73%)
 
 
 
 
 
 
 
 
OREO
$
10,114

 
Market approach
 
Appraised value less selling costs
 
0% - 8.54%
(0.95%)

 
December 31, 2013
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Input(s)
 
Range (Weighted Average)
 
(Dollars in thousands)
Impaired Loans
$
61,985

 
Market approach
 
Appraised value discounted by market or borrower conditions
 
0% - 72.29%
(2.71%)
 
 
 
 
 
 
 
 
OREO
$
11,465

 
Market approach
 
Appraised value less selling costs
 
0% - 26.35%
(4.59%)

    
The carrying amounts and estimated fair values of financial instruments were as follows: 

30

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


 
June 30, 2014
 
 
 
Estimated
 
Fair Value Measurements Using:
 
Carrying Value
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
Financial Assets:
 
 
 
 
 
 
 
 
 
   Cash on hand and in banks
$
5,036

 
$
5,036

 
$
5,036

 
$

 
$

   Interest-earning deposits
35,650

 
35,650

 
35,650

 

 

   Investments available-for-sale
128,844

 
128,844

 

 
128,844

 

   Loans receivable, net
676,455

 
696,975

 

 

 
696,975

   FHLB stock
6,884

 
6,884

 

 
6,884

 

   Accrued interest receivable
3,564

 
3,564

 

 
3,564

 

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 

 
 

 
 

 
 

 
 
   Deposits
196,394

 
196,394

 
196,394

 

 

   Certificates of deposit
378,725

 
380,581

 

 
380,581

 

   Advances from the FHLB
135,500

 
135,404

 

 
135,404

 

   Accrued interest payable
105

 
105

 

 
105

 


 
December 31, 2013
 
 
 
Estimated
 
Fair Value Measurements Using:
 
Carrying Value
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
Financial Assets:
 
 
 
 
 
 
 
 
 
   Cash on hand and in banks
$
6,074

 
$
6,074

 
$
6,074

 
$

 
$

   Interest-earning deposits
49,501

 
49,501

 
49,501

 

 

   Investments available-for-sale
144,364

 
144,364

 

 
144,364

 

   Loans receivable, net
663,153

 
680,622

 

 

 
680,622

   FHLB stock
7,017

 
7,017

 

 
7,017

 

   Accrued interest receivable
3,698

 
3,698

 

 
3,698

 

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 

 
 

 
 

 
 

 
 
   Deposits
201,658

 
201,658

 
201,658

 

 

   Certificates of deposit
410,407

 
413,417

 

 
413,417

 

   Advances from the FHLB
119,000

 
118,610

 

 
118,610

 

   Accrued interest payable
88

 
88

 

 
88

 


Fair value estimates, methods, and assumptions are set forth below for the Company's financial instruments:

Financial instruments with book value equal to fair value: The fair value of financial instruments that are short-term or reprice frequently and that have little or no risk are considered to have a fair value equal to book value. These instruments include cash on hand and in banks, interest-earning deposits, FHLB stock, accrued interest receivable, accrued interest payable and investment transactions 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.

31

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



Loans receivable: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value of fixed-rate loans is estimated using discounted cash flow analysis, utilizing interest rates that would be offered for loans with similar terms to borrowers of similar credit quality. As a result of current market conditions, cash flow estimates have been further discounted to include a credit factor. The fair value of nonperforming loans is estimated using the fair value of the underlying collateral.

Liabilities: The fair value of deposits with no stated maturity, such as statement savings, NOW and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows using current interest rates for certificates of deposit with similar remaining maturities. The fair value of FHLB advances is estimated based on discounting the future cash flows using current interest rates for debt with similar remaining maturities.

Off balance sheet commitments: No fair value adjustment is necessary for commitments made to extend credit, which represents commitments for loan originations or for outstanding commitments to purchase loans. These commitments are at variable rates, are for loans with terms of less than one year and have interest rates which approximate prevailing market rates, or are set at the time of loan closing.

Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business. The fair value has not been estimated for assets and liabilities that are not considered financial instruments.


Note 8 - Federal Home Loan Bank Stock

At June 30, 2014, the Bank held $6.9 million of FHLB stock. FHLB stock is carried at par value ($100 per share) and does not have a readily determinable fair value. Ownership of FHLB stock is restricted to the FHLB and member institutions and can only be purchased and redeemed at par.

Management evaluates FHLB stock for impairment. The determination of whether this investment is impaired is based on the Bank's assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as: (1) the significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB and (4) the liquidity position of the FHLB.

Prior to 2014, the FHLB announced that the Federal Housing Finance Agency had granted it the authority to repurchase up to $25 million in excess capital stock per quarter and pay quarterly dividends, provided that the FHLB's financial condition - measured primarily by the ratio of market value of equity-to-par value of capital stock - does not deteriorate. As a result, the FHLB repurchased shares on a pro-rata basis from its shareholders, including 674 shares from the Bank, at par value during the second quarter of 2014 and 1,330 shares from the Bank for the six months ended June 30, 2014. For the three and six months ended June 30, 2013, the FHLB repurchased 659 and 1,318 shares, respectively, at par value, from the Bank.

During the second quarter and first six months of 2014 the Bank received $1,750 and $3,517 in dividends from the FHLB, respectively.

Note 9- Stock-Based Compensation

In June 2008, First Financial Northwest's shareholders approved the First Financial Northwest, Inc. 2008 Equity Incentive Plan (“Plan”). The Plan provides for the grant of stock options, restricted stock and stock appreciation rights.

Total compensation expense for the Plan was $87,000 and $489,000 for the three months ended June 30, 2014 and 2013, respectively, and the related income tax benefit was $30,000 and $171,000 for the three months ended June 30, 2014 and 2013, respectively.


32

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


Total compensation expense for the Plan was $172,000 and $970,000 for the six months ended June 30, 2014 and 2013, respectively, and the related income tax benefit was $60,000 and $340,000 for the six months ended June 30, 2014 and 2013, respectively.

Stock Options

The Plan authorizes the grant of stock options totaling 2,285,280 shares to Company directors, advisory directors, officers and employees. Option awards are 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 10 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 or the Bank. First Financial Northwest has a policy of issuing new shares from authorized but unissued common stock upon the exercise of stock options. At June 30, 2014, remaining options for 766,756 shares of common stock were available for grant under the Plan.

The fair value of each option award is estimated on the grant date using a Black-Scholes model that uses the following assumptions. The dividend yield is based on the current quarterly dividend in effect at the time of the grant. Historical employment data is used to estimate the forfeiture rate. The historical volatility of the Company's stock price over a specified period of time is used for the expected volatility assumption. First Financial Northwest bases the risk-free interest rate on the U.S. Treasury Constant Maturity Indices in effect on the date of the grant. First Financial Northwest elected to use the “Share-Based Payments” method permitted by the SEC to calculate the expected term. This method uses the vesting term of an option along with the contractual term, setting the expected life at the midpoint.
    
A summary of the Company’s stock option plan awards and activity for the three and six months ended June 30, 2014, follows: 

 
For the three months ended June 30, 2014
 
Shares
 
Weighted-Average Exercise Price
 
Weighted-Average Remaining Contractual Term in Years
 
Aggregate Intrinsic Value
 
Weighted-Average Grant Date Fair Value
Outstanding at April 1, 2014
1,141,535

 
$
9.48

 
 
 
$
839,668

 
$
2.13

Granted

 

 
 
 

 

Exercised
(269,680
)
 
9.78

 

 
232,398

 
1.92

Forfeited or expired

 

 

 

 

Outstanding at June 30, 2014
871,855

 
9.38

 
5.26

 
1,297,422

 
2.19

Expected to vest assuming a 3% forfeiture rate
 
 
 
 
 
 
 
 
 
    over the vesting term
865,855

 
9.38

 
5.23

 
1,288,392

 
2.18

 
 
 
 
 
 
 
 
 
 
Exercisable at June 30, 2014
671,855

 
9.39

 
4.25

 
996,422

 
1.90



33

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


 
For the six months ended June 30, 2014
 
Shares
 
Weighted-Average Exercise Price
 
Weighted-Average Remaining Contractual Term in Years
 
Aggregate Intrinsic Value
 
Weighted-Average Grant Date Fair Value
Outstanding at January 1, 2014
1,203,535

 
$
9.49

 


 
$
1,103,186

 
$
2.11

Granted

 

 
 
 

 

Exercised
(331,680
)
 
9.78

 

 
265,234

 
1.92

Forfeited or expired

 

 

 

 

Outstanding at June 30, 2014
871,855

 
9.38

 
5.26

 
1,297,422

 
2.19

Expected to vest assuming a 3% forfeiture rate
 
 
 
 
 
 
 
 
 
    over the vesting term
865,855

 
9.38

 
5.23

 
1,288,392

 
2.18

 
 
 
 
 
 
 
 
 
 
Exercisable at June 30, 2014
671,855

 
9.39

 
4.25

 
996,422

 
1.90


As of June 30, 2014, there was $512,000 of total unrecognized compensation cost related to nonvested stock options granted under the Plan. The cost is expected to be recognized over the remaining weighted-average vesting period of 3.77 years.

Restricted Stock Awards

The Plan authorizes the grant of restricted stock awards amounting to 914,112 shares to directors, advisory directors, officers and employees. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at the grant date. The restricted stock awards’ fair value is equal to the value on the grant date. Shares awarded as restricted stock vest ratably over a five-year period beginning at the grant date with 20% vesting on the anniversary date of each grant date. At June 30, 2014, remaining restricted stock awards for 74,478 shares were available to be awarded. Shares that have been awarded but have not yet vested totaled 97,000 as of June 30, 2014 and are held in a reserve account until they are vested.

A summary of changes in nonvested restricted stock awards for the three and six months ended June 30, 2014, follows: 







For the three months ended June 30, 2014
Nonvested Shares
 
Shares
 
Weighted-Average Grant Date  Fair Value
Nonvested at April 1, 2014
 
103,400

 
$
8.24

Vested
 
(6,400
)
 
4.03

Forfeited
 

 

Nonvested at June 30, 2014
 
97,000

 
8.52

 
 
 
 
 
Expected to vest assuming a 3% forfeiture rate over the vesting term
 
94,090

 
 




34

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


For the six months ended June 30, 2014
Nonvested Shares
 
Shares
 
Weighted-Average Grant Date  Fair Value
Nonvested at January 1, 2014
 
103,400

 
$
8.24

Vested
 
(6,400
)
 
4.03

Forfeited
 

 

Nonvested at June 30, 2014
 
97,000

 
8.52

 
 
 
 
 
Expected to vest assuming a 3% forfeiture rate over the vesting term
 
94,090

 
 


As of June 30, 2014, there was $655,000 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 3.42 years. The total fair value of shares vested for both quarters ended June 30, 2014 and 2013 was $26,000.

Note 10 - Federal Income Taxes

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

Under 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. Our policy is to evaluate our deferred tax assets on a quarterly basis and record a valuation allowance for our deferred tax asset if we do not have sufficient positive evidence indicating that it is more likely than not that some or all of the deferred tax asset will be realized. Each quarter, we consider positive and negative evidence, which includes cumulative losses in the most recent three year period and uncertainty regarding short-term future earnings. We further consider that GAAP places heavy emphasis on prior earnings in determining the realizable deferred tax asset. After reviewing and weighing these various factors, in 2010 we recorded a valuation allowance for the balance of the deferred tax asset in excess of the tax carryback refund potential. During 2013, management determined that a full valuation allowance was no longer appropriate and reversed all but $431,000 of the deferred tax asset valuation allowance as of December 31, 2013. In reaching this determination, management considered the scheduled reversal of deferred tax assets and liabilities, taxes paid in carryback years, available tax planning strategies and projected taxable income.

The Company has prepared federal tax returns through December 31, 2013, at which time the net operating loss carryforward was $21.3 million and will begin to expire in 2030.

Note 11 - Earnings Per Share

Per the provisions of FASB ASC 260, Earnings Per Share, nonvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and are included in the computation of EPS pursuant to the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. ESOP shares are considered outstanding for basic and diluted earnings per share when the shares are committed to be released. Certain of the Company's nonvested restricted stock awards qualify as participating securities.

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

35

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


dividing net earnings available to common shareholders by the weighted average number of common shares outstanding during the period, excluding participating nonvested restricted shares.

The following table presents a reconciliation of the components used to compute basic and diluted earnings per share for the periods indicated.
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(Dollars in thousands, except share data)
Net income
 
$
2,367

 
$
16,363

 
$
5,012

 
$
17,920

Less: Earnings allocated to participating
securities
 
$
(14
)
 
$

 
$
(30
)
 
$

Earnings allocated to common shareholders
 
$
2,353

 
$
16,363

 
$
4,982

 
$
17,920

 
 
 
 
 
 
 
 
 
Basic weighted-average common shares
outstanding
 
15,042,712

 
17,133,137

 
15,146,999

 
17,423,838

Dilutive stock options
 
56,546

 
26,528

 
56,392

 
23,869

Dilutive restricted stock grants
 
21,680

 

 
20,764

 

Diluted weighted-average common shares
outstanding
 
15,120,938

 
17,159,665

 
15,224,155

 
17,447,707

 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
0.16

 
$
0.96

 
$
0.33

 
$
1.03

Diluted earnings per share
 
$
0.16

 
$
0.95

 
$
0.33

 
$
1.03



Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. Options to purchase an additional 210,000 and 1,318,524 shares of common stock at June 30, 2014 and 2013, respectively, were not included in the computation of diluted earnings per share because the incremental shares under the treasury stock method of calculation resulted in them being antidilutive.

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

Forward-Looking Statements
Certain matters discussed in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to: the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs, that may be affected by deterioration in the housing and commercial real estate markets, and may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our reserves; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; results of examinations of us by the Federal Reserve Bank of San Francisco and our bank subsidiary by the Federal Deposit Insurance Corporation (“FDIC”), the Washington State Department of Financial Institutions, Division of Banks (“DFI”) or other regulatory authorities, including the possibility that any such

36


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; computer systems on which we depend could fail or experience a security breach; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our branch expansion strategy; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired or may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; costs and effects of litigation, including settlements and judgments; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, including the interpretation of regulatory capital or other rules, including as a result of Basel III; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (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 our filings with the U.S. Securities and Exchange Commission (“SEC”), including our Annual Report on Form 10-K for the year ended December 31, 2013 ("2013 Form 10-K"). Any of the forward-looking statements that we make in this Form 10-Q and in the other public reports and statements we make may turn out to be wrong because of the inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Because of these and other uncertainties, our actual future results may be materially different from those expressed in any forward-looking statements made by or on our behalf. Therefore, these factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. We undertake no responsibility to update or revise any forward-looking statements.

Overview

First Savings Bank is a wholly-owned subsidiary of First Financial Northwest and, as such, comprises substantially all of the activity for First Financial Northwest. First Savings Bank is a community-based savings bank primarily serving King and to a lesser extent, Pierce, Snohomish and Kitsap counties, Washington through our full-service banking office located in Renton, Washington. First Savings 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 development, business, and consumer loans. Our current business strategy emphasizes commercial real estate, one-to-four family residential, and multifamily lending.

Our primary source of revenue is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Changes in levels of interest rates affect our net interest income.

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

Our noninterest expenses consist primarily of salaries and employee benefits, occupancy and equipment, data processing, OREO-related expenses, professional fees, regulatory assessments and other general and administrative expenses. Salaries and employee benefits consist primarily of the salaries and wages paid to our employees, payroll taxes and expenses for retirement and other employee benefits. Occupancy and equipment expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of real estate taxes, depreciation expenses, maintenance and costs of utilities. 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.

Critical Accounting Policies

37



Our significant accounting policies are fundamental to understanding our results of operations and financial condition because they require that we use estimates and assumptions that may affect the value of our assets or liabilities and our financial results. These policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. These policies govern the ALLL, the valuation of OREO and foreclosed assets, and the calculation of deferred taxes, fair values and other-than-temporary impairments on the market value of investments. These policies and estimates are described in further detail in Part II, Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 1, Summary of Significant Accounting Policies with the 2013 Form 10-K. There have not been any material changes in the Company's critical accounting policies and estimates as compared to the disclosure contained in the Company's 2013 Form 10-K.

Comparison of Financial Condition at June 30, 2014 and December 31, 2013

Assets. Total assets were $898.8 million at June 30, 2014, a decrease of 2.4%, from $921.0 million at December 31, 2013. The following table details the changes in the composition of our assets at June 30, 2014 from December 31, 2013.
 
Balance at
June 30, 2014
 
Increase/(Decrease) from December 31, 2013
 
Percent Increase/(Decrease)
 
(Dollars in thousands)
Cash on hand and in banks                                           
$
5,036

 
$
(1,038
)
 
(17.1
)%
Interest-earning deposits                                           
35,650

 
(13,851
)
 
(28.0
)
Investments available-for-sale, at fair value
128,844

 
(15,520
)
 
(10.8
)
Loans receivable, net                                           
676,455

 
13,302

 
2.0

Premises and equipment, net
17,024

 
(267
)
 
(1.5
)
FHLB stock, at cost                                
6,884

 
(133
)
 
(1.9
)
Accrued interest receivable
3,564

 
(134
)
 
(3.6
)
Deferred tax assets, net
11,427

 
(3,408
)
 
(23.0
)
OREO
10,114

 
(1,351
)
 
(11.8
)
Prepaid expenses and other assets
3,833

 
252

 
7.0

Total assets                                
$
898,831

 
$
(22,148
)
 
(2.4
)%

Interest-earning deposits decreased 28.0% to $35.7 million at June 30, 2014, from $49.5 million at December 31, 2013. During the six months ended June 30, 2014, excess liquidity was used primarily to fund maturing certificates of deposit and the growth in loans receivable. Investments available-for-sale decreased 10.8%, to $128.8 million at June 30, 2014, from $144.4 million at December 31, 2013, primarily due to principal repayments. In addition, during the second quarter of 2014, we sold a $5.0 million adjustable rate agency security with a yield of 0.14%, reporting a $20,000 loss. Also contributing to the decrease, a $1.4 million tax exempt municipal security was called at par. The effective duration of the investment portfolio at June 30, 2014 is 2.6% as compared to 1.6% at June 30, 2013. 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.

Net loans receivable increased $13.3 million to $676.5 million at June 30, 2014 from $663.2 million at December 31, 2013, primarily due to a $12.2 million increase in commercial real estate loans, a $976,000 increase in construction/land development loans, and an $11.3 million increase in multifamily loans, partially offset by an $8.6 million decrease in one-to-four family residential loans and a $1.1 million decrease in consumer loans. Loan originations for the six months ended June 30, 2014 were $80.7 million; of which $29.5 million were in commercial real estate loans $17.8 million were in multifamily real estate loans and $16.7 million were in one-to-four family residential loans. Principal repayments for the loan portfolio during the six months ended June 30, 2014 were $66.3 million and loans transferred to OREO were $1.6 million. OREO decreased $1.4 million, to $10.1 million at June 30, 2014, from $11.5 million at December 31, 2013 as sales and write-downs of OREO exceeded transfers of loans into OREO during this six month period.


38


The following table details our five largest lending relationships at June 30, 2014:

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

 
$

 
$
18,249

 
$

 
$
18,249

Real estate builder
 
              51
 
12,862

 

 

 
2,115

 
14,977

Real estate investor
 
              34
 
8,427

 
3,933

 
1,680

 

 
14,040

Real estate investor
 
                7
 

 
13,734

 

 

 
13,734

Real estate builder(3)
 
                88
 
13,413

 

 
210

 

 
13,623

Total
 
              183
 
$
34,702

 
$
17,667

 
$
20,139

 
$
2,115

 
$
74,623

________
(1)
The composition of borrowers represented in the table may change between periods.
(2) 
Net of LIP.
(3) Of this amount, $12.9 million were considered impaired loans.

These relationships, which represent 10.8% of our loans, net of undisbursed funds, decreased $5.0 million from December 31, 2013. As of June 30, 2014, all five borrowers were current on their loan payments. We monitor the performance of these borrowing relationships very closely due to the concentration risk they possess in relation to the entire loan portfolio.

The ALLL decreased $1.0 million to $12.0 million at June 30, 2014 compared to $13.0 million at December 31, 2013. The ALLL represented 518.9% of nonperforming loans and 1.73% of total loans at June 30, 2014 compared to 325.3% and 1.91%, respectively, at December 31, 2013.     We believe that the ALLL as of June 30, 2014, was adequate to absorb the probable and inherent risks of loss in the loan portfolio at that date. While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will be proven correct in the future, that the actual amount of future losses will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. Future additions to the allowance may become necessary based upon changing economic conditions, the level of problem loans, business conditions, credit concentrations, increased loan balances, or changes in the underlying collateral of the loan portfolio. In addition, the determination of the amount of our ALLL is subject to review by bank regulators as part of the routine examination process, which may result in the establishment of additional loss reserves or the charge-off of specific loans against established loss reserves based upon their judgment of information available to them at the time of their examination.

Nonperforming assets continued to decrease, to $12.4 million at June 30, 2014 compared to $15.5 million at December 31, 2013. The following table presents a breakdown of our nonperforming assets and as a percent of total assets at the dates indicated:


39


 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
 
Six Month Increase/(Decrease)
 
One Year Increase/ (Decrease)
 
(Dollars in thousands)
Nonperforming loans:
 
 
 
 
 
 
 
 
 
   One-to-four family residential
$
1,380

 
$
2,297

 
$
5,709

 
$
(917
)
 
$
(4,329
)
   Multifamily
222

 
233

 
244

 
(11
)
 
(22
)
   Commercial real estate
701

 
1,198

 
3,520

 
(497
)
 
(2,819
)
   Construction/land development

 
223

 
4,369

 
(223
)
 
(4,369
)
   Consumer

 
44

 
717

 
(44
)
 
(717
)
Total nonperforming loans
2,303

 
3,995

 
14,559

 
(1,692
)
 
(12,256
)
 
 
 
 
 
 
 
 
 
 
OREO
10,114

 
11,465

 
14,226

 
(1,351
)
 
(4,112
)
Total nonperforming assets
$
12,417

 
$
15,460

 
$
28,785

 
$
(3,043
)
 
$
(16,368
)
 
 
 
 
 
 
 
 
 
 
Nonperforming assets as a percent of total assets
1.38
%
 
1.68
%
 
3.19
%
 
 
 
 

Nonperforming loans include loans to borrowers who are experiencing deteriorating financial conditions and there is doubt as to the ultimate recoverability of the full principal and interest due to the Bank in accordance with the terms of the loan agreement. Nonperforming loans decreased $1.7 million to $2.3 million at June 30, 2014, from $4.0 million at December 31, 2013. This decrease was the result of $1.1 million net increase of loans classified as nonperforming during the six months ended June 30, 2014, offset by $633,000 in net charge-offs, $215,000 in short sales, $265,000 in payoffs and principal reductions, and $1.6 million of loans transferred to OREO, net of charge-offs.

The three largest nonperforming loans in the loan portfolio at June 30, 2014 included a $601,000 commercial loan secured by a two-story office building in King County. The second largest nonperforming loan was a one-to-four family loan with a balance of $318,000, and is secured by a two-story single family residence in Pierce County. This property is owner occupied and payments are current. The third largest nonperforming loan was a multifamily loan with an outstanding balance of $222,000, secured by a two-story six-unit multifamily residence in Pierce County whose payments are also current.

OREO includes properties acquired by the Bank through foreclosure or deed in lieu of foreclosure. OREO decreased $1.4 million to $10.1 million at June 30, 2014 compared to $11.5 million at December 31, 2013 as sales and write-downs of OREO exceeded transfers of loans into OREO. We sold $2.7 million of OREO during the first six months of 2014, which was comprised of seven properties and generated a net loss on sale of $107,000. OREO at June 30, 2014 consisted of $8.7 million in commercial real estate properties, $898,000 in one-to-four family residential homes and $536,000 in construction/land development projects.

The three largest OREO properties at June 30, 2014 were two office/retail buildings valued at $3.5 million and $837,000, respectively, both located in Pierce County, and a land development project approved for 105 one-to-four family residential lots valued at $773,000 located in Kitsap County. The following table presents a breakdown of our OREO by county and number of properties at June 30, 2014:

40



 
County
 
Total OREO
 
Number of Properties
 
Percent
of
Total
OREO
 
King
 
Pierce
 
Whatcom
 
Kitsap
 
All
Other
 
 
 
 
(Dollars in thousands)
OREO:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   One-to-four family
      residential
$
314

 
$
584

 
$

 
$

 
$

 
$
898

 
5

 
8.9
%
   Commercial real estate (1)

 
7,000

 

 
773

 
907

 
8,680

 
12

 
85.8

   Construction/land
     development

 
223

 

 

 
313

 
536

 
2

 
5.3

Total OREO
$
314

 
$
7,807

 
$

 
$
773

 
$
1,220

 
$
10,114

 
19

 
100.0
%
_________
(1) Of the 12 properties classified as commercial real estate, eight are office/retail buildings; one is a mixed-use building,
and three are undeveloped lots.

We continue to focus our efforts on converting nonperforming loans to OREO through foreclosure or deeds in lieu of foreclosure and subsequently selling the properties. By taking ownership of these properties, we can convert nonearning assets into earning assets on a more timely basis. Our success in this area is reflected by the improved ratio of our nonperforming assets as a percent of total assets of 1.38% at June 30, 2014 compared to 3.19% at June 30, 2013.

As we work with our borrowers to help them through this difficult economic cycle, we explore all options available to minimize our risk of loss. At times, the best option for our customers and the Bank is to modify the loan for a period of time, usually one year or less. These modifications have included lowering the interest rate on the loan for a period of time and/or extending the maturity date of the loan or allowing interest only payments for a specific time frame. These modifications are granted only when there is a reasonable and attainable restructured loan plan that has been agreed to by the borrower and is in the Bank's best interest.

The following table presents a breakdown of our TDRs:


41


 
 
 
 
 
 
 
 
 
 
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
 
Six Month Increase/ (Decrease)
 
One Year Increase/ (Decrease)
 
(Dollars in thousands)
Nonperforming TDRs:
 
 
 
 
 
 
 
 
 
   One-to-four family
      residential
$
458

 
$
924

 
$
2,858

 
$
(466
)
 
$
(2,400
)
   Multifamily

 

 

 

 

   Commercial real estate

 

 

 

 

   Construction/land
      development

 

 

 

 

   Consumer

 
44

 
46

 
(44
)
 
(46
)
Total nonperforming TDRs
458

 
968

 
2,904

 
(510
)
 
(2,446
)
 
 
 
 
 
 
 
 
 
 
Performing TDRs:
 
 
 
 
 
 
 
 
 
   One-to-four family
      residential
45,366

 
45,851

 
47,756

 
(485
)
 
(2,390
)
   Multifamily
2,192

 
2,208

 
1,229

 
(16
)
 
963

   Commercial real estate
9,182

 
12,111

 
12,204

 
(2,929
)
 
(3,022
)
   Construction/land
     development

 

 

 

 

   Consumer
43

 

 

 
43

 
43

Total performing TDRs
56,783

 
60,170

 
61,189

 
(3,387
)
 
(4,406
)
Total TDRs
$
57,241

 
$
61,138

 
$
64,093

 
$
(3,897
)
 
$
(6,852
)
 
 
 
 
 
 
 
 
 
 
Percent of TDRs classified as performing
99.2
%
 
98.4
%
 
95.5
%
 
86.9
%
 
64.3
%

Our TDRs decreased $3.9 million to $57.2 million at June 30, 2014, compared to $61.1 million at December 31, 2013 as pay downs continue to outpace the addition of TDRs to our portfolio. Of the $57.2 million in TDRs at June 30, 2014, $56.8 million were performing and $458,000 were not performing according to their restructured payment terms. At June 30, 2014, there was no LIP in connection with these restructured and impaired loans.

The largest TDR relationship at June 30, 2014 totaled $12.9 million and was comprised of 85 one-to-four family residential rental properties located in King, Kitsap, Pierce and Thurston counties.

Deposits. During the first six months of 2014, deposits decreased $37.0 million to $575.1 million at June 30, 2014, compared to $612.1 million at December 31, 2013. Deposit accounts consisted of the following:

 
Balance at June 30, 2014
 
Increase/ (Decrease) from December 31, 2013
 
Percent Increase/(Decrease)
 
(Dollars in thousands)
Noninterest-bearing
$
9,908

 
$
(711
)
 
(6.7
)%
NOW
21,125

 
(4,346
)
 
(17.1
)
Statement savings
22,615

 
2,219

 
10.9

Money market
142,746

 
(2,426
)
 
(1.7
)
Certificates of deposit
378,725

 
(31,682
)
 
(7.7
)
 
$
575,119

 
$
(36,946
)
 
(6.0
)%
 


42



NOW accounts, money market and certificates of deposit accounts decreased $4.3 million, $2.4 million and $31.7 million, respectively, during the first six months of 2014 partially offset by an increase of $2.2 million in statement savings for the same period. The decrease in certificates of deposit was primarily the result of our strategy to utilize our excess liquidity, mainly cash, to reduce higher-cost deposits by competing less aggressively on deposit interest rates. We believe customers who were more interest rate sensitive elected to withdraw their funds to invest in higher yielding investment products, which contributed to the decline in our deposit balances. Included in the certificates of deposit balances at both June 30, 2014 and December 31, 2013 were $10.8 million in public funds. We did not have any brokered deposits at June 30, 2014 or December 31, 2013, however, management intends to utilize the brokered deposit market to support its operations going forward to assist with its interest rate risk management efforts or when market conditions exist that make such funds more cost effective.

Advances. We use advances from the FHLB as an alternative funding source to manage funding costs, reduce interest rate risk and to leverage our balance sheet. Total FHLB advances at June 30, 2014 were $135.5 million, an increase of $16.5 million from December 31, 2013. During the second quarter of 2014, we obtained advances of $10.0 million to fund a commercial real estate loan and $6.5 million to fund a multifamily loan that both qualified for interest rate discounts from the FHLB under its Community Investment Program, supporting loans for low to moderate income housing.

Stockholders’ Equity. Total stockholders’ equity decreased $1.9 million to $182.5 million at June 30, 2014 from $184.4 million at December 31, 2013. The decrease was primarily the result of the $10.8 million repurchase of 992,840 shares of common stock at an average price of $10.90 per share, and the payment of $1.5 million in cash dividends partially offset by net income of $5.0 million generated during the six months ended June 30, 2014 and an improvement of $1.4 million in accumulated other comprehensive loss, representing a decline in unrealized holding losses on available-for-sale securities. In April 2014, the Board of Directors authorized the repurchase of up to 1,645,414 shares of the Company’s common stock, or 10% of the Company’s outstanding shares, of which 652,574 shares remain authorized to be purchased through September 16, 2014, depending upon market conditions and other factors.
    

 
Comparison of Operating Results for the Three Months Ended June 30, 2014 and 2013

General. Net income for the three months ended June 30, 2014 was $2.4 million or $0.16 per diluted share as compared to net income of $16.4 million, or $0.95 per diluted share for the same period ended June 30, 2013. The decrease in net income was primarily due to the tax benefit from the reversal of $13.8 million of the deferred tax asset valuation allowance recognized in the second quarter of 2013. Pre-tax net income for the quarter ended June 30, 2014, however, was $1.1 million higher than the same period in the previous year. The increase was due in part to the $373,000 increase in net interest income due primarily to the $362,000 decrease in interest expense. A recapture from our provision for loan losses of $100,000 was recorded for the first three months of 2014 compared to a loan loss provision of $100,000 for the same period in 2013, reflecting the improvement in our risk profile over the last year. In addition, reductions in noninterest expense of $604,000, due to a decrease in salaries and employee benefits expense, significantly contributed to the improvement.
    
Net Interest Income. Net interest income for the quarter ended June 30, 2014 increased $373,000 to $8.2 million, as compared to $7.8 million for the same quarter in 2013. The increase was attributable to a $362,000 decrease in interest expense and an $11,000 increase in interest income. Average interest-earning assets increased $4.9 million to $846.5 million for the three months ended June 30, 2014, from the same quarter in 2013. During the three months ended June 30, 2014, our yield on interest-earning assets decreased two basis points while our cost of funds decreased 22 basis points. Our interest rate spread improved 20 basis points to 3.71% and our net interest margin improved 15 basis points to 3.86% for the three months ended June 30, 2014 as compared to the same period in 2013. The following table sets forth the effects of changes in rates and volumes on our net interest income:


43


 
Three Months Ended June 30, 2014
   Compared to June 30, 2013 Increase/(Decrease) Due to
 
Rate
 
Volume
 
Total
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
   Loan receivable, net
$
(206
)
 
$
230

 
$
24

   Investments available-for-sale
50

 
(68
)
 
(18
)
   Interest-earning deposits
1

 
3

 
4

   FHLB stock
1

 

 
1

Total net change in income on interest-earning assets
(154
)
 
165

 
11

 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
   NOW
(5
)
 
2

 
(3
)
   Statement savings
(2
)
 
1

 
(1
)
   Money market
12

 
(4
)
 
8

   Certificates of deposit
(319
)
 
(210
)
 
(529
)
   Advances from the FHLB
31

 
132

 
163

Total net change in expense on interest-bearing liabilities
(283
)
 
(79
)
 
(362
)
Net change in net interest income
$
129

 
$
244

 
$
373


Interest Income. Total interest income for the second quarter of 2014 of $9.7 million was an $11,000 increase over the second quarter of 2013.

The following table compares detailed average interest-earning asset balances, associated yields and resulting changes in interest and dividend income for the three months ended June 30, 2014 and 2013:
 
Three Months Ended June 30,
 
2014
 
2013
 
Increase/(Decrease) in Interest and Dividend Income
 
Average
Balance
 
Yield
 
Average
Balance
 
Yield
 
 
(Dollars in thousands)
Loans receivable, net                                           
$
673,339

 
5.40
%
 
$
656,368

 
5.52
%
 
$
24

Investments available-for-sale
133,701

 
1.75

 
150,811

 
1.60

 
(18
)
Interest-earning deposits                                           
32,493

 
0.27

 
27,213

 
0.26

 
4

FHLB stock                      
6,936

 
0.06

 
7,210

 

 
1

Total interest-earning assets                                                      
$
846,469

 
4.58
%
 
$
841,602

 
4.60
%
 
$
11


Interest income from net loans receivable was virtually unchanged at $9.1 million during the second quarter of both 2014 and 2013. A $17.0 million increase in average net loan receivables for the three months ended June 30, 2014 from the comparable period in 2013 resulted in a $230,000 increase in loan interest income attributable to volume that was mostly offset by a $206,000 decrease attributable to a 12 basis point reduction in the average yield earned.

Interest income from investments available-for-sale decreased $18,000 to $585,000 for the three months ended June 30, 2014, as compared to $603,000 for the same period in 2013. The average balance of investments available-for-sale for the three months ended June 30, 2014, decreased by $17.1 million compared to the same period in 2013, resulting in a $68,000 decrease in investment interest income. This decrease was partially offset by a $50,000 increase in investment interest income attributable to a 15 basis point increase in the average yield earned on investment securities. The increase in the average investment yield reflects the sales of low yielding, adjustable rate agency securities in 2013 and 2014, along with the subsequent purchase of higher yielding, predominately fixed rate securities.


44




Interest Expense. Total interest expense for the three months ended June 30, 2014 was $1.5 million, a decrease of $362,000 compared to $1.9 million for the three months ended June 30, 2013.

The following table details average balances, cost of funds and the resulting decrease in interest expense for the three months ended June 30, 2014 and 2013:
 
Three Months Ended June 30,
 
2014
 
2013
 
Increase/
(Decrease) in
Interest
Expense
 
Average
Balance
 
Cost
 
Average
Balance
 
Cost
 
 
(Dollars in thousands)
NOW                                
$
21,829

 
0.11
%
 
$
17,325

 
0.21
%
 
$
(3
)
Statement savings                                                      
22,465

 
0.11

 
18,666

 
0.15

 
(1
)
Money market
138,851

 
0.22

 
147,369

 
0.18

 
8

Certificates of deposit                                           
389,059

 
1.18

 
444,933

 
1.51

 
(529
)
Advances from the FHLB                                           
125,094

 
0.89

 
58,615

 
0.79

 
163

Total interest-bearing liabilities                                                      
$
697,298

 
0.87
%
 
$
686,908

 
1.09
%
 
$
(362
)

Interest expense on our money market accounts increased $8,000, primarily as a result of a four basis point increase in the average cost of these funds. The cost of our certificates of deposit decreased 33 basis points for a $319,000 decrease in interest expense, as compared to the second quarter of 2013, due to maturing certificates repricing to lower rates. The decline in interest expense was also the result of a $55.9 million decrease in the average balance of certificates of deposit, as a number of certificates of deposit were not renewed at maturity, resulting in a $210,000 reduction of interest expense.

Interest expense related to our FHLB advances increased $163,000, primarily due to a $66.5 million increase in average FHLB advances for the three months ended June 30, 2014 as compared to the same period last year. In addition, the average rate paid for these funds increased 10 basis points to 0.89% for the second quarter of 2014, as compared to 0.79% in the same quarter in 2013.

Provision for Loan Losses. Management recognizes that loan losses may occur over the life of a loan and that the ALLL must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Our methodology for analyzing the ALLL consists of two components: general and specific 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, 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.

During the quarter ended June 30, 2014, management evaluated the adequacy of the ALLL and concluded that a recapture of prior period provisions for loan loss in the amount of $100,000 was appropriate for the quarter, compared to a provision of $100,000 for the second quarter of 2013. The following items contributed to this recapture during the quarter ended June 30, 2014:

delinquent loans, loans over 30 days past due, decreased to $2.6 million at June 30, 2014, from $4.3 million and $8.1 million at December 31, 2013, and June 30, 2013, respectively;

nonperforming loans decreased to $2.3 million at June 30, 2014 from $4.0 million and $14.6 million at December 31, 2013 and June 30, 2013, respectively; and

nonperforming loans as a percent of total loans improved to 0.33% at June 30, 2014, compared to 0.59% and 2.18% at December 31, 2013, and June 30, 2013, respectively.

45



We continue to focus our efforts on converting nonperforming loans to OREO through foreclosure or deeds in lieu of foreclosure and selling the properties. By taking ownership of these properties, we can convert nonearning assets into earning assets on a more timely basis.

The following table summarizes selected financial data related to our ALLL and loan portfolio. All loan balances and ratios are calculated using loan balances that are net of LIP.
 
At or For the Three Months Ended June 30,
 
2014
 
2013
 
(Dollars in thousands)
(Recapture of provision) provision for loan losses
$
(100
)
 
$
100

Charge-offs
(80
)
 
(537
)
Recoveries
38

 
748

ALLL
11,951

 
12,313

ALLL as a percent of total loans, net of LIP
1.73
%
 
1.84
%
ALLL as a percent of nonperforming loans, net of LIP
518.93

 
84.57

Total nonperforming loans, net of LIP
$
2,303

 
$
14,559

Nonperforming loans as a percent of total loans, net LIP
0.33
%
 
2.18
%
Total loans receivable, net of LIP
$
691,131

 
$
668,499

Total loans originated
41,835

 
54,242


Noninterest Income. Noninterest income decreased $67,000 to $88,000 for the quarter ended June 30, 2014 from $155,000 for the same quarter in 2013. The following table provides a detailed analysis of the changes in the components of noninterest income:
 
Three Months Ended June 30, 2014
 
Increase/(Decrease) from June 30, 2013
 
Percent
Increase/(Decrease)
 
(Dollars in thousands)
Service fees on deposit accounts
$
29

 
$
(3
)
 
(9.4
)%
Loan service fees                                
47

 
(22
)
 
(31.9
)
Gain (loss) on sale of investments
(20
)
 
(21
)
 
(2,100.0
)
Servicing rights, net                                
1

 
5

 
(125.0
)
Other           
31

 
(26
)
 
(45.6
)
Total noninterest income                                           
$
88

 
$
(67
)
 
(43.2
)%

We recorded a $20,000 loss on sale of investments during the quarter ended June 30, 2014 as compared to $1,000 gain during the second quarter of 2013. Also, during the second quarter of 2014, loan prepayment fees were $26,000 due to early payoff of two multifamily loans and one commercial loan, as compared to $18,000 during the second quarter of 2013. In addition, noninterest income during the quarter ended June 30, 2013 included $27,000 in rental income from a property that has since been sold and loan service fees included $24,000 in escrow fee income from discontinued operations of a subsidiary. The cost savings realized by discontinuing the escrow operations of the subsidiary is greater than the foregone escrow fee income.

Noninterest Expense. Noninterest expense decreased $604,000 to $4.7 million for the second quarter of 2014 from $5.3 million for the comparable quarter in 2013.

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

46


 
Three Months Ended June 30, 2014
 
Increase/(Decrease) from June 30, 2013
 
Percent
Increase/(Decrease)
 
(Dollars in thousands)
Salaries and employee benefits
$
2,875

 
$
(880
)
 
(23.4
)%
Occupancy and equipment                                           
327

 
(18
)
 
(5.2
)
Professional fees                                
394

 
1

 
0.3

Data processing                                
159

 
(17
)
 
(9.7
)
Loss on sales of OREO property, net                                
36

 
419

 
(109.4
)
OREO market value adjustments
92

 
16

 
21.1

OREO related expenses, net
78

 
(73
)
 
(48.3
)
Regulatory assessments
104

 
10

 
10.6

Insurance and bond premiums                                           
88

 
(33
)
 
(27.3
)
Marketing
37

 
(5
)
 
(11.9
)
Other general and administrative
512

 
(24
)
 
(4.5
)
Total noninterest expense                                           
$
4,702

 
$
(604
)
 
(11.4
)%

The decrease in noninterest expense for the second quarter of 2014, compared to the same period in 2013, was primarily a result of an $880,000 decrease in salary and employee benefits. A portion of this savings was due to freezing of the defined benefit plan in 2013, resulting in a decreased expense of $293,000 for the second quarter of 2014. In addition, stock compensation expense declined $402,000 as compared to the same period last year as the largest group of participants became fully vested in our 2008 equity incentive plan between June 30, 2013 and September 30, 2013.

Federal Income Tax Expense. Our normal expected statutory income tax rate is 35%. We recorded a $1.3 million federal income tax expense for the quarter ended June 30, 2014 as a result of our net income. During the quarter ended June 30, 2013, we determined that maintaining the full valuation allowance was no longer appropriate and reversed most of the valuation allowance, resulting in a tax benefit of $13.8 million. Our effective tax rate was 35.4% for the three months ended June 30, 2014.

Comparison of Operating Results for the Six Months Ended June 30, 2014 and 2013

General. Net income for the six months ended June 30, 2014 was $5.0 million, or $0.33 per diluted share, as compared to net income of $17.9 million or $1.03 per diluted share for the comparable period in 2013. The decrease in net income was primarily due to the partial reversal of $13.8 million of the deferred tax asset valuation allowance in the second quarter of 2013. Pre-tax net income for the six months ended June 30, 2014, however, increased $3.6 million as compared to the same period in 2013. Net interest income increased $1.0 million due primarily to a $913,000 decrease in interest expense. A recapture from our provision for loan losses of $600,000 was recorded for the first six months of 2014 compared to a loan loss provision of $100,000 for the same period in 2013, reflecting the improvement in our risk profile over the last year. In addition, noninterest expense decreased $2.0 million for the six months ended June 30, 2014 as compared to the same period last year, primarily due to a $1.6 million decrease in salaries and employee benefits expense.

Net Interest Income. Net interest income for the six months ended June 30, 2014 increased $1.0 million to $16.2 million, as compared to $15.2 million for the same period in 2013. The increase was attributable to a $913,000 decrease in interest expense and a $125,000 increase in interest income. During the six months ended June 30, 2014, our yield on interest-earning assets decreased one basis point while our cost of funds decreased 28 basis points. Our interest rate spread for the six months ended June 30, 2014 increased 27 basis points to 3.66% while our net interest margin increased 21 basis points to 3.82% as compared to the same period in 2013. The following table sets forth the effects of changes in rates and volumes on our net interest income:


47


 
 
Six Months Ended June 30, 2014 Compared to June 30, 2013
Increase/(Decrease) Due to
 
 
Rate
 
Volume
 
Total
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
   Loan receivable, net
 
$
(500
)
 
$
506

 
$
6

   Investments available-for-sale
 
203

 
(90
)
 
113

   Interest-earning deposits
 

 
3

 
3

   FHLB stock
 
3

 

 
3

Total net change in income on interest-earning assets
 
(294
)
 
419

 
125

 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
   NOW
 
(6
)
 
5

 
(1
)
   Statement savings
 
(4
)
 
3

 
(1
)
   Money market
 

 
(18
)
 
(18
)
   Certificates of deposit
 
(629
)
 
(422
)
 
(1,051
)
   Advances from the FHLB
 
(416
)
 
574

 
158

Total net change in expense on interest-bearing liabilities
 
(1,055
)
 
142

 
(913
)
Net change in net interest income
 
$
761

 
$
277

 
$
1,038


Interest Income. Total interest income for the first six months of 2014 increased $125,000, to $19.3 million from $19.2 million, for the first six months of 2013.
   
The following table compares detailed average interest-earning asset balances, associated yields and resulting changes in interest and dividend income for the six months ended June 30, 2014 and 2013:
 
Six Months Ended June 30,
 
2014
 
2013
 
Increase/(Decrease) in Interest and Dividend Income
 
Average
Balance
 
Yield
 
Average
Balance
 
Yield
 
 
(Dollars in thousands)
Loans receivable, net                                           
$
671,834

 
5.39
%
 
$
653,676

 
5.54
%
 
$
6

Investments available-for-sale
138,063

 
1.72

 
150,912

 
1.43

 
113

Interest-earning deposits                                           
32,776

 
0.26

 
30,528

 
0.26

 
3

FHLB stock                      
6,968

 
0.09

 
7,240

 

 
3

Total interest-earning assets                                                      
$
849,641

 
4.55
%
 
$
842,356

 
4.56
%
 
$
125


Interest income from net loans receivable increased $6,000 to $18.1 million during the first six months of 2014, as compared to the same period in 2013, as the 15 basis points decrease in the average yield earned was more than offset by an increase in the average balance of $18.1 million.

Interest income from investments available-for-sale increased $113,000 to $1.2 million for the six months ended June 30, 2014, as compared to the comparable period in 2013. Although the average balance of investments decreased $12.8 million, resulting in $90,000 decrease in interest income, this decline was offset by a yield increase of 29 basis points, resulting in increased interest income of $203,000. The increase in the average investment yield reflects the sales of low yielding, adjustable rate agency securities in 2013 and 2014, along with the subsequent purchase of higher yielding, predominately fixed rate securities.

Interest Expense. Total interest expense for the six months ended June 30, 2014 was $3.1 million, a decrease of $913,000 compared to $4.0 million for the six months ended June 30, 2013.

48


The following table details average balances, cost of funds and the resulting decrease in interest expense for the six months ended June 30, 2014 and 2013:
 
Six Months Ended June 30,
 
2014
 
2013
 
Increase/
(Decrease) in
Interest
Expense
 
Average
Balance
 
Cost
 
Average
Balance
 
Cost
 
 
(Dollars in thousands)
NOW                                
$
21,919

 
0.13
%
 
$
16,893

 
0.18
%
 
$
(1
)
Statement savings                                                      
22,407

 
0.13

 
18,486

 
0.17

 
(1
)
Money market
138,508

 
0.20

 
152,888

 
0.20

 
(18
)
Certificates of deposit                                           
396,315

 
1.22

 
451,603

 
1.54

 
(1,051
)
Advances from the FHLB                                           
122,063

 
0.87

 
47,871

 
1.55

 
158

Total interest-bearing liabilities                                                      
$
701,212

 
0.89
%
 
$
687,741

 
1.17
%
 
$
(913
)

The average balance of our money market accounts decreased $14.4 million, which resulted in a decrease of $18,000 in interest expense, as compared to the same period last year. The average cost for money market accounts remained constant at 20 basis points for the six month period ended June 30, 2014 and the same period last year. The cost of our certificates of deposit decreased 32 basis points as compared to the first six months of 2013 due to maturing certificates repricing to lower rates, resulting in a $629,000 decrease in interest expense,. Interest expense declined an additional $422,000 as a result of a $55.3 million decrease in the average balance of certificates of deposit, as a number of certificates of deposit were not renewed at maturity.

Interest expense related to FHLB advances increased $158,000 for the six months ended June 30, 2014, as compared to the same period in 2013. The average balance of FHLB advances increased $74.2 million, resulting in a $574,000 increase in interest expense which was partially offset by a $416,000 decrease in the cost of FHLB advances due to a 68 basis point reduction in the average rate paid during the six months ended June 30, 2014, as compared to the same period last year .

Provision for Loan Losses.

During the six months ended June 30, 2014, management evaluated the adequacy of the ALLL and concluded that a recapture of prior period provisions for loan loss in the amount of $600,000 was appropriate, compared to a provision of $100,000 for the six months ended June 30, 2013. The following items contributed to this recapture during the six months ended June 30, 2014:

the risk rating of loans with principal balances totaling $12.3 million were upgraded during the first quarter of 2014 as a result of an improvement in their respective risk profiles, reducing the amounts allocated for future loan losses relating to these loans;

delinquent loans, loans over 30 days past due, decreased to $2.6 million at June 30, 2014, from $4.3 million and $8.1 million from December 31, 2013, and June 30, 2013, respectively;

nonperforming loans decreased to $2.3 million at June 30, 2014 from $4.0 million and $14.6 million from December 31, 2013 and June 30, 2013, respectively; and

nonperforming loans as a percent of total loans improved to 0.33% at June 30, 2014, compared to 0.59% and 2.18% at December 31, 2013, and June 30, 2013, respectively.

The following table summarizes selected financial data related to our ALLL and loan portfolio. All loan balances and ratios are calculated using loan balances that are net of LIP.

49


 
At or For the Six Months Ended June 30,
 
2014
 
2013
 
(Dollars in thousands)
(Recapture of provision) provision for loan losses
$
(600
)
 
$
100

Charge-offs
(633
)
 
(1,156
)
Recoveries
190

 
827

ALLL
11,951

 
12,313

ALLL as a percent of total loans, net of LIP
1.73
%
 
1.84
%
ALLL as a percent of nonperforming loans, net of LIP
518.93

 
84.57

Total nonperforming loans, net of LIP
$
2,303

 
$
14,559

Nonperforming loans as a percent of total loans, net LIP
0.33
%
 
2.18
%
Total loans receivable, net of LIP
$
691,131

 
$
668,499

Total loans originated
80,719

 
82,794


Noninterest Income. Noninterest income decreased $103,000 to $156,000 for the six months ended June 30, 2014 from $259,000 for the first six months ended June 30, 2013. The following table provides a detailed analysis of the changes in the components of noninterest income:
 
Six Months Ended June 30, 2014
 
Increase/(Decrease) from June 30, 2013
 
Percent
Increase/(Decrease)
 
(Dollars in thousands)
Service fees on deposit accounts
$
44

 
$
(5
)
 
(10.2
)%
Loan service fees                                
68

 
(36
)
 
(34.6
)
Gain on sale of investments
(20
)
 
(21
)
 
(2,100.0
)
Servicing rights, net                                
3

 
11

 
(137.5
)
Other           
61

 
(52
)
 
(46.0
)
Total noninterest income                                           
$
156

 
$
(103
)
 
(39.8
)%
    
The decrease in noninterest income for the six months ended June 30, 2014 from the comparable period in 2013 was principally the result of a decrease in rental income of $47,000 from a rental property that has since been sold. The decrease during the six months ended June 30, 2014 was also a result of a $46,000 decline in loan service fees for escrow services provided by a subsidiary in 2013 that are no longer offered and a $20,000 net loss on the sale of a security as compared to net gains of $1,000 on the sales of investments during the same period in 2013.

Noninterest Expense. For the six months ended June 30, 2014, noninterest expense decreased $2.0 million to $9.2 million from $11.2 million for the same period in 2013.

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

50


 
Six Months Ended June 30, 2014
 
Increase/(Decrease) from June 30, 2013
 
Percent
Increase/(Decrease)
 
(Dollars in thousands)
Salaries and employee benefits
$
5,775

 
$
(1,594
)
 
(21.6
)%
Occupancy and equipment                                           
678

 
(21
)
 
(3.0
)
Professional fees                                
751

 
(87
)
 
(10.4
)
Data processing                                
332

 
(6
)
 
(1.8
)
Loss on sales of OREO property, net                                
107

 
1,122

 
(110.5
)
OREO market value adjustments
288

 
67

 
30.3

OREO related expenses, net
139

 
(346
)
 
(71.3
)
Regulatory assessments
182

 
(195
)
 
(51.7
)
Insurance and bond premiums                                           
176

 
(59
)
 
(25.1
)
Marketing
62

 
2

 
3.3

Prepayment penalty on FHLB advances

 
(679
)
 
(100.0
)
Other general and administrative
736

 
(162
)
 
(18.0
)
Total noninterest expense                                           
$
9,226

 
$
(1,958
)
 
(17.5
)%

The decrease in noninterest expense for the six months ended June 30, 2014 compared to the same period in 2013 was primarily due to a $1.6 million decrease in salaries and employee benefits due to an $800,000 decrease in stock compensation expense as the largest group of participants became fully vested in our 2008 equity incentive plan; a $450,000 decrease in compensation as a result of reduced salaries and benefits due to staffing reductions and other improved efficiencies; and a $293,000 decrease due to freezing of the defined benefit plan in 2013. In addition, OREO related expenses decreased $346,000 as the number of OREO properties declined from 31 properties at June 30, 2013 to 19 properties as of June 30, 2014. Noninterest expense also benefitted from the absence of prepayment penalties on FHLB advances as we incurred $679,000 in penalties from the prepayment of a high costing FHLB advance during the first six months of 2013. These decreases were partially offset by a $1.1 million change in gain on sales OREO property, net, to a $107,000 net loss on the sale of seven OREO properties during the six months ended June 30, 2014 compared to a net gain of $1.0 million on the sale of 29 OREO properties during the first six months of 2013.

Federal Income Tax Expense. As a result of our net income, we recorded a $2.8 million federal income tax expense for the six months ended June 30, 2014. During the six months ended June 30, 2013, we determined that maintaining the full valuation allowance was no longer appropriate and reversed most of the valuation allowance, resulting in a tax benefit of $13.8 million for the six months ended June 30, 2013. Our effective tax rate was 35.4% for the six months ended June 30, 2014.



Liquidity

We are required to have enough cash flow in order to maintain sufficient liquidity to ensure a safe and sound operation. We maintain cash flows above the minimum level believed to be adequate to meet the requirements of normal operations, including potential deposit outflows. On a daily basis, we review and update cash flow projections to ensure that adequate liquidity is maintained.

Our primary sources of funds are customer deposits, loan and investment repayments, maturing investment securities and advances from the FHLB. These funds, together with equity, are used to make loans, acquire investment securities and other assets, and fund continuing operations. At June 30, 2014, certificates of deposit scheduled to mature in one year or less totaled $237.5 million. Management's policy is to maintain deposit rates at levels that are competitive with other local financial institutions, although recently we have been less aggressive in competing for certificates of deposit and public funds in order to reduce our cost of funds. Historically, we have been able to retain a significant amount of the deposits as they mature. While maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by the level of interest rates, economic conditions and competition. We measure our liquidity based on our ability to fund our assets and to meet liability obligations when they come due. Liquidity (and funding) risk occurs when funds cannot be raised at

51


reasonable prices or in a reasonable time frame to meet our normal or unanticipated obligations. We regularly monitor the mix between our assets and our liabilities to manage effectively our liquidity and funding requirements.

When deposits are not readily available and/or cost effective to provide the funds for our assets, we use alternative funding sources. These sources include, but are not limited to: advances from the FHLB, wholesale funding, brokered deposits, federal funds purchased and dealer repurchase agreements, as well as other short-term alternatives. These funding sources are generally collateral dependent. We may also liquidate assets to meet our funding needs. At June 30, 2014, the Bank maintained credit facilities with the FHLB totaling $223.8 million with an outstanding balance of $135.5 million. At June 30, 2014, we also had available a total of $50.0 million credit facilities with other financial institutions, with no balance outstanding. For additional information, see the Consolidated Statements of Cash Flows in Item 1 of this Form 10-Q.

Beginning in the third quarter of 2014, management intends to utilize the national brokered deposit market to assist in its funds acquisition and interest rate risk management efforts. While most retail certificate of deposit offerings provide the depositor with an option to withdraw their funds prior to maturity, subject to an early withdrawal penalty, acquiring certificates of deposit in the brokered market (wherein the depositor does not have the option of withdrawing the funds before the end of the term except in the case of death or adjudication of incompetence of a depositor) greatly reduces such early redemption risks. This strategy may include, but is not necessarily limited to, raising longer term deposits (with terms greater than three years) that will also assist the Bank in its interest rate risk management efforts In addition, management may elect to offer callable brokered deposits, wherein the Bank has the option to redeem the deposit prior to maturity, in a further attempt to improve the benefits of raising funds in the brokered deposit market compared to terms that are offered in its local markets. With these redemption limitations and call features, these brokered deposits are typically higher costing compared to deposits without such features and may also be higher costing than our retail certificate of deposit offerings. Consequently, our overall cost of certificates of deposits may increase. In addition, utilizing brokered deposits might result in increased regulatory scrutiny as such deposits are not viewed as favorably as core retail deposits and there can be no assurance that the Bank will be allowed to include brokered deposits in its deposit mix in the future. While management will attempt to weigh the benefits of brokered deposits against the costs and risks, there can be no assurance that its conclusions will necessarily be aligned with those of its regulators.

First Financial Northwest is a separate legal entity from the Bank and, on a stand-alone level, must provide for its own liquidity and pay its own operating expenses and cash dividends. First Financial Northwest's primary sources of funds consist of dividends from the Bank, although there are regulatory restrictions on the ability of the Bank to pay dividends. At June 30, 2014, the Company (on an unconsolidated basis) had liquid assets of $3.9 million.

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. We believe that our current liquidity position and our expected operating results are sufficient to fund all of our existing commitments.


Commitments and Off-Balance Sheet Arrangements

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and the unused portions of lines of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. Commitments to extend credit and lines of credit are not recorded as an asset or liability by us until the instrument is exercised. At June 30, 2014 and December 31, 2013, we had no commitments to originate loans for sale.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the loan agreement. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer's creditworthiness on a case-by-case basis. The amount of the collateral obtained, if deemed necessary by us upon 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 originate loans, to advance additional amounts pursuant to outstanding lines of credit and to disburse funds related to our construction loans at June 30, 2014.

52


 
 
 
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                                                      
$
17,749

 
$
17,749

 
$

 
$

 
$

Unused portion of lines of credit                                                      
20,555

 
2,395

 
8,652

 
8,709

 
799

Undisbursed portion of construction loans
12,380

 
7,662

 
4,718

 

 

Total commitments
$
50,684

 
$
27,806

 
$
13,370

 
$
8,709

 
$
799


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.

Capital

At June 30, 2014, stockholders' equity totaled $182.5 million, or 20.3% of total assets. Our book value per share of common stock was $11.60 at June 30, 2014 compared to $11.25 at December 31, 2013. Consistent with our goal to operate a sound and profitable financial organization, we actively seek to maintain a “well-capitalized” institution in accordance with regulatory standards. As of June 30, 2014, the Bank exceeded all regulatory capital requirements. Regulatory capital ratios for the Bank only were as follows at June 30, 2014: Tier 1 leverage capital 18.91%; Tier 1 risk-based capital 28.05%; and Total risk-based capital 29.31%. The regulatory capital requirements to be considered well capitalized are 5%, 6% and 10%, respectively. The Bank met the financial ratios for “well-capitalized” status at June 30, 2014.


Item 3. Quantitative and Qualitative Disclosures about Market Risk

General. Our Board of Directors has approved an asset/liability management policy to guide management in maximizing net interest income by managing the differences in terms between interest-earning assets and interest-bearing liabilities while maintaining acceptable levels of liquidity, capital adequacy, interest rate sensitivity, credit risk and profitability. The policy established an Asset/Liability Management 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 ALCO 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

53


than our deposits. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.

We have utilized the following strategies in our efforts to manage interest rate risk:
we 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; and
we have added adjustable-rate securities to our investment portfolio.

How We Measure the Risk of Interest Rate Changes. We monitor our interest rate sensitivity on a quarterly basis to measure the change in net interest income as a percentage of net income in varying rate environments. 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 experience differs 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 25.5% of our total loans were comprised of adjustable-rate loans at June 30, 2014. At that date, $78.5 million, or 43.7% of these loans were at their floor, with a weighted-average interest rate of 4.4%. The inability of our loans to adjust downward can contribute to increased income in periods of declining interest rates. Also, 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. Furthermore, in the event of a significant change in interest rates, prepayment and early withdrawal levels would likely deviate from those assumed. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. We consider all these factors in monitoring our interest rate exposure.

The assumptions we use are based upon a combination of proprietary and market data that reflect historical results and current market conditions. These assumptions relate to interest rates, loan prepayments, deposit decay rates and the market value of certain assets under the various interest rate scenarios. We use market data to determine prepayments and maturities of loans, investments and borrowings and use our own assumptions on deposit decay rates. The exception to this is time deposits, which 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 demonstrated in the past that the tiering structure of our deposit accounts during changing rate environments results in relatively lower volatility and less than market rate changes in our interest expense for deposits. We tier our deposit accounts by balance and rate, whereby higher balances within an account earn higher rates of interest. Therefore, deposits that are not very rate sensitive (generally, lower balance tiers) are separated from deposits that are rate sensitive (generally, higher balance tiers). When interest rates rise, we do not have to raise interest rates proportionately on less rate sensitive accounts to retain these deposits. These assumptions are based upon our analysis of our customer base, competitive factors and historical experience.

Our income simulation model examines changes in net interest income in which interest rates were assumed to remain at their base level, instantaneously increase by 100, 200 and 300 basis points or decline immediately by 100 basis points. Reductions of rates by 200 and 300 basis points were not reported due to the very low rate environment. The current federal funds rate is 0.25% making a 200 and 300 basis point decrease impossible.

The following table illustrates the change in our net interest income at June 30, 2014 that would occur in the event of a gradual 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.
 

54


Net Interest Income Change at June 30, 2014
Basis Point Change in Rates
 
Net Interest Income
 
% Change
(Dollars in thousands)
+300
 
$
30,659

 
(2.17)%
+200
 
30,946

 
(1.25)
+100
 
31,238

 
(0.32)
 Base
 
31,339

 
(100)
 
30,146

 
(3.81)

The following table illustrates the change in our net portfolio value (“NPV”) at June 30, 2014 that would occur in the event of an immediate change in interest rates equally across all maturities, with no effect given to any steps that we might take to counter the effect of that interest rate movement.
Basis Point
 
 
 
 
 
 
 
Net Portfolio as % of
 
Market
Change in
 
Net Portfolio Value (2)
 
Portfolio Value of Assets
 
Value of
Rates (1)
 
Amount
 
$ Change (3)
 
% Change
 
NPV Ratio (4)
 
% Change (5)
 
Assets (6)
 
 
(Dollars in thousands)
+300

 
$
154,685

 
$
(42,327
)
 
(21.48
)%
 
18.47
%
 
(4.64
)%
 
$
837,266

+200

 
168,883

 
(28,129
)
 
(14.28
)
 
19.59

 
(3.08
)
 
862,079

+100

 
184,249

 
(12,763
)
 
(6.48
)
 
20.74

 
(1.40
)
 
888,530

 Base

 
197,012

 

 

 
21.58

 

 
912,884

(100
)
 
201,865

 
4,853

 
2.46

 
21.70

 
0.53

 
930,137

_____________ 
(1) The current federal funds rate is 0.25%, making a 200 and 300 basis point drop impossible.
(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 set forth above. Also, a change in U.S. Treasury rates in the designated amounts accompanied by a change in the shape of the Treasury yield curve would cause changes to the net portfolio value and net interest income other than those indicated above.

At June 30, 2014, we did not have any derivative financial instruments or trading accounts for any class of financial instruments, nor have we engaged in hedging activities or purchased off-balance sheet derivative instruments. Interest rate risk continues to be one of our primary risks as other types of risks, such as foreign currency exchange risk and commodity pricing risk do not arise in the normal course of our business activities and operations.

Item 4. Controls and Procedures

55



The management of First Financial Northwest, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Securities Exchange Act of 1934 (“Exchange Act”). A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that its objectives are met. Also, because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Additionally, in designing disclosure controls and procedures, our management was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. As a result of these inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Furthermore, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

(a)
Evaluation of Disclosure Controls and Procedures: An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer (Principal Financial Officer) and several other members of our senior management as of the end of the period covered by this report. Our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2014, our disclosure controls and procedures were effective in ensuring that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is (i) accumulated and communicated to our management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.

(b)
Changes in Internal Controls: In the quarter ended June 30, 2014, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II
Item 1. Legal Proceedings

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

Item 1A. Risk Factors

There have been no material changes to the risk factors previously disclosed in Part I, Item 1A of our 2013 Form 10-K.

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

(a)     Not applicable

(b)     Not applicable


(c)    The following table summarizes First Financial Northwest's common stock repurchases during the second quarter of 2014:

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Period
 
Total Number of Shares Purchased
 
Average Price Paid per Share
 
Total Number of Shares Repurchased as Part of Publicly Announced Plan
 
Maximum Number of Shares that May Yet Be Repurchased Under the Plan
April 1, 2014 - April 30, 2014
 

 
$

 

 
1,645,414

May 1, 2014 - May 31, 2014
 
809,340

 
10.86

 
809,340

 
836,074

June 1, 2014 - June 30, 2014
 
183,500

 
11.08

 
183,500

 
652,574

 
 
992,840

 
$
10.90

 
992,840

 
652,574

 
 
 
 
 
 
 
 
 

On April 24, 2014, the Company announced that its Board of Directors has authorized the repurchase of up to 1,645,414 shares of the Company's common stock, or 10% of the Company's outstanding shares. The shares may be purchased through September 16, 2014, depending upon market conditions and other factors. For the six months ended June 30, 2014, the Company purchased 992,840 shares of the Company's common stock at an average cost of $10.90 per share.


Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

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

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3.1

 
Articles of Incorporation of First Financial Northwest (1)
3.2

 
Bylaws of First Financial Northwest (1)
4.0

 
Form of stock certificate of First Financial Northwest (1)
10.1

 
Amended Employment Agreement between First Savings Bank Northwest and Joseph W. Kiley III (11)
10.2

 
Form of Change in Control Severance Agreement for Executive Officers (1)
10.3

 
Form of First Savings Bank Employee Severance Compensation Plan (1)
10.4

 
Form of Supplemental Executive Retirement Agreement entered into by First Savings Bank with Joseph W. Kiley III (1)
10.5

 
Form of Financial Institutions Retirement Fund (1)
10.6

 
Form of 401(k) Retirement Plan (4)
10.7

 
2008 Equity Incentive Plan (5)
10.8

 
Forms of incentive and non-qualified stock option award agreements (6)
10.9

 
Form of restricted stock award agreement (6)
10.10

 
Memorandum of Understanding with the FDIC and DFI (7)
10.11

 
Settlement Agreement and Mutual Release with the Stilwell Group (8)
10.12

 
Amendment No. 1 to the Settlement Agreement and Releases with the Stilwell Group (9)
10.13

 
Amendment No. 2 to the Settlement Agreement and Releases with the Stilwell Group (80
10.14

 
Offer Letter, dated June 27, 2013, between First Savings Bank Northwest and Richard P. Jacobson (11)
10.15

 
Employment Agreement between First Savings Bank Northwest and Richard P. Jacobson (13)
31.1

 
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2

 
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32

 
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
101.0

 
The following materials from First Financial Northwest’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Income Statements; (3) Consolidated Statements of Comprehensive Income; (4) Consolidated Statements of Stockholders' Equity; (5) Consolidated Statements of Cash Flows; and (6) Selected Notes to Consolidated Financial Statements.*

*Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
 _____________
(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 March 22, 2012.
(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 Quarterly Report on Form 10-Q for the quarter ended June 30, 2007, and incorporated herein by reference.
(5)
Filed as Appendix A to First Financial Northwest’s definitive proxy statement dated April 15, 2008.
(6)
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated July 8, 2008.
(7)
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated April 2, 2012.
(8)
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated December 20, 2012.
(9)
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated January 17, 2013.
(10)
Filed as an exhibit to First Financial Northwest's Current Report on Form 8-K dated February 26, 2013.
(11)
Filed as an exhibit to First Financial Northwest's Current Report on Form 8-K dated July 9, 2013.

 

58


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
FIRST FINANCIAL NORTHWEST, INC. 
 
 
 
 
 
Date: August 7, 2014
By: 
/s/Joseph W. Kiley III
 
 
Joseph W. Kiley III
 
 
President and Chief Executive Officer (Principal Executive Officer)
Date: August 7, 2014
By: 
/s/Richard P. Jacobson
 
 
Richard P. Jacobson
 
 
Chief Financial Officer (Principal Financial Officer)
 
 
 
Date: August 7, 2014
By: 
/s/Christine A. Huestis
 
 
Christine A. Huestis
 
 
Vice President and Controller (Principal Accounting Officer)

59




Exhibit Index

Exhibit No.
 
Description
31.1

 
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2

 
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32

 
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
101

 
The following materials from First Financial Northwest’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Income Statements; (3) Consolidated Statements of Comprehensive Income; (4) Consolidated Statements of Stockholders' Equity; (5) Consolidated Statements of Cash Flows; and (6) Selected Notes to Consolidated Financial Statements.*
*Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.



60