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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

First Northwest is a bank holding company which primarily engages in the business activity of its subsidiary, First Federal. First Federal is a community-oriented financial institution serving Clallam, Jefferson, Kitsap, Whatcom, and King counties in Washington State, through its Seattle lending center and ten full service branches. We offer a wide range of products and services focused on the financial security and payment needs of the communities we serve. While we have a concentration of first lien one- to four-family mortgage loans, we have increased our origination of commercial real estate, multi-family real estate, construction, and commercial business loans, and have increased our auto and consumer loans through originations, indirect auto lending, and purchased auto loan programs, in order to diversify our portfolio and increase interest income. We continue to originate one- to four-family residential mortgage loans and regularly sell conforming loans into the secondary market to increase noninterest income and manage interest rate risk or retain select loans in our portfolio to enhance interest income. We offer traditional consumer and business deposit products, including transaction accounts, savings and money market accounts and certificates of deposit for individuals, businesses and nonprofit organizations. Deposits are our primary source of funding for our lending and investing activities

First Federal is impacted by prevailing economic conditions as well as government policies and regulations concerning, among other things, monetary and fiscal affairs, including fiscal stimulus, interest rate policy and open market operations, housing and financial institutions. Deposit flows are influenced by various factors, including sales and marketing efforts, interest rates paid on competing deposits, available alternative investments such as the stock market, account maturities, government stimulus and unemployment programs, and the overall level of personal income and savings. Lending activities are influenced by prevailing interest rates and property values in our markets, the demand for funds, the number and quality of lenders employed by First Federal, and regional economic cycles.

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

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

The noninterest expenses we incur in operating our business consist of salaries and employee benefit costs, occupancy and equipment expenses, federal deposit insurance premiums and regulatory assessments, digital delivery and data processing expenses, advertising and promotion expenses, expenses related to real estate and personal property owned, state and local taxes, federal income tax, and other miscellaneous expenses.

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Our Business and Operating Strategy

Our operating strategy is focused on diversifying our loan portfolio, expanding our deposit product offerings, and enhancing our infrastructure. Certain highlights of our operations in recent years are as follows:

Our objective is to be an independent, high performing bank focused on meeting the needs of individuals, small businesses and community organizations throughout our market areas with exceptional service and competitive products. We intend to implement these strategies to achieve our objective:

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Critical Accounting Policies

We have certain accounting policies that are important to the assessment of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Our accounting policies are discussed in detail in Note 1 of the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" of this Form 10-K.

The following represent our critical accounting policies:

Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio as of balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: the likelihood of default; the loss exposure at default; the amount and timing of future cash flows on impaired loans; the value of collateral; and the determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews, and the Board of Directors approves, at least quarterly, the level of the allowance and the provision for loan losses based on past loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the evaluation. In addition, the FDIC and the DFI, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on their judgment about information available at the time of their examination. A large loss could deplete the allowance and require increased provisions for loan losses to replenish the allowance, which would adversely affect earnings. See Note 3 of the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" of this Form 10-K.

Mortgage Servicing Rights. We record mortgage servicing rights on loans originated and subsequently sold into the secondary market. We stratify our capitalized mortgage servicing rights based on the type, term and interest rates of the underlying loans. Mortgage servicing rights are initially recognized at fair value. The value is determined through a discounted cash flow analysis, which uses interest rates, prepayment speeds and delinquency rate assumptions as inputs. All of these assumptions require a significant degree of management judgment. If our assumptions prove to be incorrect, the value of our mortgage servicing rights could be negatively affected. See Notes 1 and 7 to the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" of this Form 10-K.

Income Taxes. Management makes estimates and judgments to calculate certain tax liabilities and to determine the recoverability of certain deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. We also estimate a valuation allowance for deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. These estimates and judgments are inherently subjective. In evaluating the recoverability of deferred tax assets, management considers all available positive and negative evidence, including past operating results, recent cumulative losses - both capital and operating - and the forecast of future taxable income, both capital gains and operating. In determining future taxable income, management makes assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require judgments about future taxable income and are consistent with the plans and estimates to manage our business. Any reduction in estimated future taxable income may require us to record a valuation allowance against deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on future earnings.

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Fair Value. Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates.

New Accounting Pronouncements

For a discussion of new accounting pronouncements and their impact on the Company, see Note 1 of the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" of this Form 10-K.

Comparison of Financial Condition at December 31, 2020 and December 31, 2019

Assets. Total assets increased $347.0 million, or 26.5%, to $1.65 billion at December 31, 2020, from $1.31 billion at December 31, 2019, primarily due to an increase in new deposits.

Total loans, excluding loans held for sale, increased $270.3 million, or 30.6%, during the year ended December 31, 2020. Multi-family and commercial real estate loans increased $107.2 million, or 30.5%, consisting mainly of an increase in multi-family real estate loans of $66.4 million. Auto and other consumer loans increased $16.1 million, or 14.4%, with the purchase of a pool of manufactured home loans as well as purchases of individual manufactured home loans and specialty auto loans. Commercial business loans increased $58.6 million through our partnership in the Northpointe Bank Mortgage Participation Program and the SBA Paycheck Protection Program.

One- to four-family residential loans increased $3.8 million, or 1.2%. We continue to focus on the origination of one- to four-family mortgages loans with the intention of retaining certain loans which may not be readily sold in the secondary market while selling the majority of our saleable production to the Federal Home Loan Mortgage Corporation ("Freddie Mac") and other investors. While we intend to continue lending on residential real estate at our Seattle lending center, we expanded that location to include commercial loan production as well. We developed a team of strong mortgage lenders in each of our market areas in order to meet our balance sheet and revenue goals.

Construction and land loans increased $86.4 million, or 232.4%. There was $155.1 million in undisbursed construction commitments at December 31, 2020 compared to $46.8 million at December 31, 2019. Undisbursed construction commitments at December 31, 2020 included $22.7 million of mainly custom one- to four-family residential construction; $98.1 million of multi-family construction; and $34.2 million of commercial real estate construction. Our construction loans are geographically disbursed throughout the state of Washington with one commitment for a property in Oregon. We manage our construction lending by utilizing a licensed third-party vendor to assist us in monitoring our construction projects and began utilizing internal staffing during 2019 to monitor certain projects, which we expect will enhance fee income related to these loans.

During the year ended December 31, 2020, the Company originated $871.3 million of loans, of which $610.3 million, or 70.0%, were originated in the Puget Sound region; $203.3 million, or 23.3%, in the Olympic Peninsula region; $29.7 million, or 3.4%, in other areas in Washington; and $28.0 million, or 3.2%, in Oregon. The Company also purchased loans totaling $88.3 million with the largest concentration of property located in California.

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

(In thousands)

Real Estate:

Consumer:

Less:

Premium on purchased loans, net (6,129 ) (4,514 )

Our allowance for loan losses increased $4.2 million, or 43.8%, during the year ended December 31, 2020, due in part to adjustments made to qualitative factors as the result of the COVID-19 pandemic as well as the result of loan growth. Asset quality has remained stable year over year despite the challenging economic conditions due to the pandemic. Management continues to closely monitor these conditions. The allowance for loan losses as a percentage of total loans was 1.2% at December 31, 2020 and 1.1% at December 31, 2019. There was no material change in our allowance for loan losses as a percentage of total loans during the year ended December 31, 2020 compared to 2019. We believe our allowance for loan losses is adequate to cover inherent losses in the loan portfolio.

Nonperforming loans increased $477,000, or 26.6%, during the year ended December 31, 2020 to $2.3 million. This increase was mainly the result of increases in nonperforming one- to four-family of $214,000 and multi-family loans of $284,000. Increased nonperforming loans in these categories is mainly attributable to a few loans and is not indicative of the portfolio. Nonperforming loans to total loans was 0.2% at both December 31, 2020 and December 31, 2019. Real estate owned and repossessed assets decreased $152,000, or 98.7%, as defaulted auto loans were sold. The allowance for loan losses as a percentage of nonperforming loans increased to 609.2% at December 31, 2019 from 536.1% at December 31, 2019 as result of the increase in nonperforming loans.

At December 31, 2020, substantially all restructured loans were performing in accordance with their modified payment terms and returned to accrual status. Classified loans, consisting solely of substandard loans, increased by $2.6 million, or 52.1%, to $7.5 million at December 31, 2020, from $5.0 million at December 31, 2019. The change in classified loans was mainly the result of an increase in substandard commercial real estate and one- to four-family loans, offset by improvements in commercial business loans during the year. The Bank continued to work with its borrowers to facilitate satisfactory repayment.

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In late March 2020, the Bank announced loan modification programs to support and provide relief for its borrowers during the COVID-19 pandemic. Loans subject to payment forbearance under the Bank's COVID-19 loan modification program are not reported as delinquent during the forbearance time period. For additional information, see "COVID-19 Loan Modifications" below.

The following table represents nonperforming assets and troubled debt restructurings ("TDRs") at the dates indicated.

(In thousands)

Nonaccrual loans:

Real estate loans:

One- to four-family $ 912 $ 698

Multi-family 284 —

Construction and land 26 29

Consumer loans:

Auto and other consumer 821 848

Real estate owned:

Construction and land — 62

Total real estate owned — 62

Repossessed automobiles and recreational vehicles 2 92

Total nonperforming assets $ 2,275 $ 1,950

TDR loans:

Multi-family — 107

Commercial real estate — 643

Commercial business loans — 263

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Total investment securities increased $48.7 million, or 15.4%, to $364.3 million at December 31, 2020, from $315.6 million at December 31, 2019. The year-over-year increase was the result of increased investment purchases, partially offset by sales, prepayment activity, and normal amortization during the year. The estimated average life of the total investment securities portfolio was 7.3 years, and the average repricing term was approximately 5.0 years as of December 31, 2020, based on the interest rate environment at that time. We anticipate the investment portfolio will continue to provide additional interest income, as well as a source of liquidity to fund loan growth and a means with which to manage interest rate risk. During the fourth quarter of 2019, all held to maturity investments were marked as available for sale in order to provide greater flexibility to navigate changes to the portfolio as market conditions change or business needs may warrant, particularly as it relates to the sale of investments.

Municipal bonds represent the largest portion of our investment portfolio and totaled $127.9 million at December 31, 2020, an increase of $88.6 million, or 225.5%, from $39.3 million at December 31, 2019. Mortgage-backed securities are the second largest segment totaling $89.3 million at December 31, 2020, a decrease of $79.2 million, or 47.0% from $168.5 million at December 31, 2019. Other investment securities, including U.S. government agencies, corporate and asset-backed securities, were $147.2 million at December 31, 2020, an increase of $39.4 million, or 36.5% from $107.8 million at December 31, 2019.At December 31, 2020, the investment portfolio contained 48.0% of amortizing securities, compared to 81.8% at December 31, 2019. The projected average life of our securities may vary due to prepayment activity, which, particularly in the mortgage-backed securities portfolio, is generally affected by changing interest rates. We continue to focus on growing our loan portfolio and improving our earning asset mix over the long term, as evidenced by net loan growth exceeding the rate of investments during the year. We may purchase investment securities as a source of additional interest income and in lieu of carrying higher cash balances at nominal interest rates. For additional information, see Note 2 of the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data," of this Form 10-K.

Liabilities. Total liabilities increased $337.5 million, or 29.9%, to $1.47 billion at December 31, 2020, from $1.13 billion at December 31, 2019, mainly due to deposit account balances increasing $331.9 million, or 33.1%, to $1.33 billion at December 31, 2020 from $1.00 billion at December 31, 2019. Certificates of deposit increased $689,000, or 0.2%, to $308.8 million at December 31, 2020. Included in certificates of deposit balances at year end were $89.6 million in brokered certificates of deposit. Transaction accounts increased $154.7 million and money market accounts increased $181.1 million as customers significantly increased their liquidity during the year. Our focus will continue to be on increasing our customer deposits and maintaining a stable source of funding for our continued growth.

Borrowings decreased $3.0 million, or 2.6%, to $110.0 million at December 31, 2020, from $112.9 million at December 31, 2019, as we continued to utilize brokered certificates of deposit during the year to manage our cost of funds and interest rate risk. At December 31, 2020, we had $50.0 million of long term FHLB advances and $60.0 million in short term advances maturing in three months or less.

Equity. Total shareholders' equity increased $9.5 million, or 5.4%, to $186.4 million at December 31, 2020, from $176.9 million at December 31, 2019. This increase during the year resulted from net income of $10.3 million, an increase of $7.0 million due to the change in accumulated other comprehensive loss related to the change in unrealized market value of available for sale securities, net of tax, and an increase of $1.3 million related to our stock-based compensation plans. These increases were partially offset by a decrease of $7.4 million related to our repurchase of shares and $2.2 million in dividends paid in 2020. During the year ended December 31, 2020, we repurchased 575,859 shares of common stock at an average cost of $12.87 per share, pursuant to the Company's 2017, 2019, and 2020 stock repurchase plans.

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Comparison of Results of Operations for the Years Ended December 31, 2020 and 2019

General. The Company had net income for the year ended December 31, 2020 of $10.3 million, compared to net income of $9.0 million for the year ended December 31, 2019, an increase of $1.3 million, or 14.7%. The increase in net income was primarily due to increases in net interest income and noninterest income. We earned $1.11 per common share and $1.10 per diluted share for the year ended December 31, 2020, compared to $0.92 per common share and $0.91 per diluted share for the year ended December 31, 2019. The increase in earnings per share year-over-year was the result of an increase in net income combined with lower weighted-average common shares outstanding of 9,348,874 basic and 9,380,294 diluted shares in 2020, compared to 9,845,021 basic and 9,923,110 diluted shares for the same period in 2019. The decrease in average shares year-over-year is due to our share repurchase program coupled with changes to our share-based compensation plans.

Net Interest Income. Net interest income increased $6.1 million, or 16.1%, to $44.0 million for the year ended December 31, 2020, from $37.9 million for the year ended December 31, 2019, mainly as the result of additional interest income related to the increase in the average balances of loans receivable and investment securities.

The average balance of loans receivable increased $104.7 million, at an average yield of 4.44%, for the year ended December 31, 2020 compared to an average yield of 4.64%, for the year ended December 31, 2019. This increase in the volume of loans receivable and resulting interest income during 2020, and a decrease in the interest-bearing liabilities to 0.70% for the year ended December 31, 2020 compared to 1.03% for the year ended December 31, 2019, resulted in a 7 basis point improvement in our net interest margin of 3.27% at December 31, 2020, and 3.20% at December 31, 2019.

Net interest income increased $6.1 million during the year ended December 31, 2020 compared to the year ended December 31, 2019, of which $6.5 million was the result of an increase in volume, partially offset by a $435,000 decrease due to changes in rates. As noted above, loans receivable was the main contributor to the increase in net interest income with $4.8 million due to an increase in average volumes offset by a decrease of $2.0 million due to decreases in rates. The decrease to the cost of average interest-bearing liabilities for the year ended December 31, 2020 was due primarily to lower rates paid on certificates of deposit and borrowings, the result of the utilization of brokered certificates of deposit and new long-term borrowing agreements during the year.

Interest Income. Interest income increased $2.4 million, or 4.8%, to $51.7 million for the year ended December 31, 2020 from $49.3 million for the comparable period in 2019, primarily due to an increase in the average balance of loans receivable. Interest and fees on loans receivable increased $2.9 million as a result.

Interest income on investment securities increased $1.6 million to $5.7 million for the year ended December 31, 2020 compared to $4.0 million for the year ended December 31, 2019. While the average balance of investment securities increased $106.3 million during the year to $227.3 million for the year ended December 31, 2020 compared to $121.0 million for the year ended December 31, 2019, the average yield decreased 83 basis points, resulting in higher interest income from the investment securities portfolio. The change in average yields on investment securities does not include the benefit of nontaxable income from municipal bonds. Interest income on mortgage-backed and related securities decreased $1.9 million to $2.7 million for the year ended December 31, 2020 from $4.6 million for the year ended December 31, 2019, commensurate with a decline in the average balance of $52.0 million and a decrease in average yield of 44 basis points.

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

Year Ended December 31,

(Dollars in thousands)

Interest Expense. Total interest expense decreased $3.7 million, or 32.5%, for the year ended December 31, 2020, compared to the prior year, with decreases in deposit costs of $1.6 million, or 19.8%, and borrowing costs of $2.1 million, or 66.3%. Deposit costs decreased due to the decrease in the interest rates and growth in non-maturity deposits. The average balance of interest-bearing deposits increased $151.6 million, or 18.8%, to $957.3 million for the year ended December 31, 2020 from $805.7 million for the year ended December 31, 2019, as we continued to target growth in deposits in new and existing market areas. Additionally, the bank experienced deposit growth due the significant inflow of deposits into the banking system during the pandemic due to government stimulus payments and changes to consumer and business savings and spending habits. During the year ended December 31, 2020, the cost of certificates of deposit decreased $1.1 million due to a decrease in the average rate paid of 64 basis points. The average rate paid on savings accounts decreased 40 basis points and the cost of money market and transaction accounts both decreased 7 basis points even though the average balance of all deposit accounts increased $151.6 million. The average cost of all interest-bearing deposit products decreased 33 basis points to 0.70% for the year ended December 31, 2020 from 1.03% for the year ended December 31, 2019. Borrowing costs decreased 66.3%, or 154 basis points, mainly due to lower rates paid on overnight and long-term borrowings.

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

Year Ended December 31,

(Dollars in thousands)

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Provision for Loan Losses. The provision for loan losses increased during the year ended December 31, 2020 compared to 2019, primarily due to loan growth and uncertainty caused by the pandemic, as compared to 2019.

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

Year Ended December 31,

(Dollars in thousands)

Provision for loan losses $ 5,046 $ 669

Charge offs net of recoveries (827 ) (574 )

Noninterest Income. Noninterest income increased $8.8 million, or 126.0%, for the year ended December 31, 2020 compared to the prior year, primarily due to income received from the gain on sale of mortgage loans as the volume of loans sold increased 405.2% from 136 loans sold in 2019 to 687 sold in 2020. Gain on sale of investments also increased in 2020 as we changed the mix of securities to improve earnings. The cash surrender value of bank-owned life insurance increased over the prior year due to additional investments in BOLI as well as a restructure that resulted in the recognition of market gains.

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

Year Ended December 31, Increase (Decrease)

(Dollars in thousands)

Noninterest Expense. Noninterest expense increased $8.3 million, or 25.2%, to $41.5 million for the year ended December 31, 2020, compared to $33.1 million for the year ended December 31, 2019, primarily due to increases in compensation and benefits as well as occupancy and equipment related to our growth. Included in the compensation and benefit increase was a $2.6 million increase in commissions paid on mortgage and commercial loan production, as well as one-time pandemic-related payments to staff. All categories increased as a direct result of expanding our lending and deposit activities. A one-time FHLB prepayment penalty of $210,000 was also incurred as we retired long-term debt to reduce interest expense in March 2020.

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

Year Ended December 31, Increase (Decrease)

(Dollars in thousands)

Provision for Income Tax. Our income tax expense increased $877,000 to $3.0 million for the year ended December 31, 2020 from $2.1 million for the year ended December 31, 2019, mainly due to an increase in income before taxes. An estimate for the penalty on the early surrender of the BOLI contract was also recorded in 2020.

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Average Balances, Interest and Average Yields/Cost

The following tables set forth, for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin (otherwise known as net yield on interest-earning assets), and the ratio of average interest-earning assets to average interest-bearing liabilities. Also presented is the weighted average yield on interest-earning assets, rates paid on interest-bearing liabilities and the resultant spread at December 31, 2020 and 2019. Income and all average balances are monthly average balances, which management deems to be not materially different than daily averages. Nonaccrual loans have been included in the table as loans carrying a zero yield.

At December 31, Year Ended December 31,

Interest-earning assets: (Dollars in thousands)

Interest-bearing liabilities:

Net interest margin (3) n/a 3.27 3.20

(1) The average loans receivable, net balances include nonaccrual loans.

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

(3) Net interest income divided by average interest-earning assets.

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Rate/Volume Analysis

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

Year Ended

Increase (Decrease) Due to Total Increase

Volume Rate (Decrease)

(In thousands)

Interest-earning assets:

Investment and mortgage-backed securities 2,127 (2,428 ) (301 )

FHLB stock (71 ) (6 ) (77 )

Interest-bearing liabilities:

Interest-bearing transaction accounts 17 (98 ) (81 )

Total interest-bearing liabilities $ 483 $ (4,207 ) $ (3,724 )

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

Asset and Liability Management and Market Risk

Risk Management Overview. Managing risk is an essential part of successfully managing a financial institution. Our Enterprise Risk Management Committee reports key risk indicators to the Board of Directors through the Audit Committee. The most prominent risk exposures management monitors are strategic, credit, interest rate, liquidity, operational, compliance, reputational, cybersecurity, and legal risk. We utilize the services of outside firms to assist us in our asset and liability management and our analysis of market risk.

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Interest Rate Risk Management. We manage the interest rate sensitivity of interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Except for certain adjustable-rate investment securities, home equity lines of credit, and commercial real estate loans that are tied to the prime rate, the twelve month constant maturity treasury, or the London Interbank Offered Rate ("LIBOR"), certain deposit accounts may reprice more quickly in response to changes in market interest rates because of their shorter maturities. Typically, decreases in interest rates beneficially affect our earnings in the short term when fixed-rate interest-earning assets stay at higher interest rates longer than it takes for deposit and borrowing costs to reset lower. However, decreases in interest rates adversely affect earnings due to prepayments and refinancing associated with loans and investment securities, particularly consumer and one- to four-family residential loans and MBS securities with no prepayment restrictions, which are then reinvested into lower yielding assets, reducing interest income. In contrast, First Federal has little or no long-term ability to reduce funding costs associated with deposits and borrowings.

We currently do not participate in hedging programs, interest rate swaps or other activities involving the use of derivative financial instruments to manage interest rate risk.

Interest Rate Sensitivity Analysis. Management uses an interest rate sensitivity analysis to review our level of interest rate risk. This analysis measures interest rate risk by computing changes in the present value of our cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. The present value of equity is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 to 300 basis point increase or a 100 basis point decrease in market interest rates with no effect given to any future steps that management might take to counter the impact of that interest rate movement. The following table presents the change in the present value of First Federal’s equity at December 31, 2020, that would occur in the event of an immediate change in interest rates based on management's assumptions.

Economic Value of Equity

Basis Point Change in Interest Rates $ Amount $ Change % Change EVE Ratio %

(Dollars in thousands)

Using the same assumptions as above, the sensitivity of our projected net interest income over a one-year period for the year ended December 31, 2020, is as follows:

Basis Point Change Projected Net Interest Income

in Interest Rates $ Amount $ Change % Change

(Dollars in thousands)

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Assumptions made by management relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios, among others. As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing tables. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, 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 may take longer to adjust to changes in market rates. Additionally, certain assets have features, such as rate caps or floors, which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table.

Liquidity Management

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

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

Our most liquid assets are cash and cash equivalents followed by available for sale securities. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At December 31, 2020, cash and cash equivalents totaled $65.2 million, and securities classified as available-for-sale, which provide additional potential sources of liquidity, had a market value of $364.3 million. We have pledged collateral to support borrowings from the FHLB of $110.0 million. We have also pledged collateral to the Federal Reserve Bank of San Francisco to secure discount window advances; no funds were borrowed as of December 31, 2020.

At December 31, 2020, we had $1.6 million in loan commitments outstanding and an additional $212.1 million in undisbursed loans, including undisbursed construction commitments, and standby letters of credit.

Certificates of deposit due within one year of December 31, 2020 totaled $185.8 million, or 60.2% of certificates of deposit. The large percentage of certificates of deposit that mature within one year reflects customers' hesitancy to invest their funds for longer periods in this low rate environment. Management believes, based on past experience, that a significant portion of our certificates of deposit will be renewed or rolled into new certificates of deposit given the current rate environment; however, should rates continue to stay at lower levels, balances could continue to shift into more liquid money market accounts over time. If these maturing deposits are not renewed or rolled into other deposit products, however, we will be required to seek other sources of funds, which may include borrowings and brokered deposits. We also can attract and retain deposits by adjusting the interest rates offered, including the offering of promotional rates on certificates of deposit to encourage the renewal or rollover of maturing certificates of deposit and mitigate the risk of loss of these deposits to our competitors. Depending on market conditions, we may also be required to pay higher rates on borrowings or brokered deposits than we currently pay on standard certificates of deposit or promotional rate offerings. We believe that business developed by our sales teams, including our commercial relationship managers, branch managers and members of our branch network, and the general cash flows from our existing lending and investment activities, will afford us enough long-term liquidity. For additional information, see the Consolidated Statements of Cash Flows included in Item 8, "Financial Statements and Supplementary Data," of this Form 10-K.

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The Company is a separate legal entity from the Bank and relies on dividends from its sole subsidiary, First Federal, and cash flows and sales of its investment portfolio for liquidity to pay its operating expenses and other financial obligations. At December 31, 2020, the Company (on an unconsolidated basis) had liquid assets of $8.7 million.

Off-Balance Sheet Activities

In the normal course of operations, First Federal engages in a variety of financial transactions that are not recorded in the financial statements. These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks. These transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. For the year ended December 31, 2020, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows.

Commitments and Off-Balance Sheet Arrangements

The following table summarizes our commitments and contingent liabilities with off-balance sheet risks as of December 31, 2020:

Amount of Commitment Expiration - Per Period

Total Amounts Committed Due in One Year

(In thousands)

Commitments to originate loans:

Unfunded commitments under lines of credit 57,001 57,001

Unfunded commitments under existing construction loans 155,113 155,113

Standby letters of credit 182 182

Capital Resources

First Northwest Bancorp is a bank holding company subject to regulation by the Federal Reserve. As a bank holding company, we are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. Our subsidiary, First Federal, is subject to minimum capital requirements imposed by the FDIC. Capital adequacy requirements are quantitative measures established by regulation that require us to maintain minimum amounts and ratios of capital.

First Federal is subject to meeting minimum capital adequacy requirements for common equity Tier 1 ("CET1") capital, Tier 1 risk-based capital, total risk-based capital, and tier 1 capital ("leverage"). Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by bank regulators that, if undertaken, could have a direct material effect on the Company’s financial statements.

First Federal is subject to capital requirements adopted by the Federal Reserve and the FDIC. See Item 1, "Business-How We Are Regulated," and Note 12 of the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data," of this Form 10-K for additional information regarding First Northwest Bancorp and First Federal’s regulatory capital requirements.

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In order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such actions, First Northwest Bancorp and First Federal must maintain CET1 capital at an amount greater than the required minimum levels plus a capital conservation buffer. This new capital conservation buffer requirement was phased in starting in January 2016 until fully implemented in the amount of 2.5% of risk-weighted assets in January 2019. As of December 31, 2020, the conservation buffer was 2.5%.

Consistent with our goals to operate a sound and profitable organization, our policy for First Federal is to maintain its "well-capitalized" status in accordance with regulatory standards. At December 31, 2020, the Bank and consolidated Company exceeded all regulatory capital requirements, and the Bank was considered "well capitalized" under FDIC regulatory capital guidelines.

The following table provides the capital requirements and actual results at December 31, 2020.

Actual Minimum Capital Requirements Minimum Required to be Well-Capitalized

Amount Ratio Amount Ratio Amount Ratio

(Dollars in thousands)

Tier I leverage capital (to average assets)

Common equity tier I (to risk-weighted assets)

Tier I risk-based capital (to risk-weighted assets)

Total risk-based capital (to risk-weighted assets)

Effect of Inflation and Changing Prices

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

Recent Accounting Pronouncements

See Note 1 of the Notes to Consolidated Financial Statements contained in Item 8, "Financial Statements and Supplementary Data," of this Form 10-K.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

The information contained under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk and Asset and Liability Management" of this Form 10-K is incorporated herein by reference.

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Item 8. Financial Statements and Supplementary Data

Index to Consolidated Financial Statements Page

Report of Independent Registered Public Accounting Firm 79

Notes to Consolidated Financial Statements 87

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Report of Independent Registered Public Accounting Firm

To the Shareholders and the Board of Directors of

First Northwest Bancorp and Subsidiary

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of First Northwest Bancorp and Subsidiary (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for the years then ended, and the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2020 and 2019, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinions

These consolidatedfinancial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidatedfinancial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidatedfinancial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinions.

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the consolidated financial

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statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Allowance for Loan Losses

As described in Notes 1 and 4 to the consolidated financial statements, the Company’s consolidated allowance for loan losses balance was $13.85 million at December 31, 2020. The allowance for loan losses is maintained to provide for estimated inherent losses based on evaluating known and inherent risks in the loan portfolio, and is based upon the Company’s analysis of the factors underlying the quality of the loan portfolio. These factors include, among others, changes in the size and composition of the loan portfolio, actual loan loss experience, current economic conditions, analysis of individual loans for which full collectability may not be assured, and determination of the discounted cash flows or determination of the existence and realizable value of the collateral and guarantees securing the loans.

We identified management’s estimation of the qualitative factor adjustment, which is used in the allowance for loan losses calculation, as a critical audit matter. The qualitative factor adjustment is comprised of qualitative factors used to estimate losses related to factors that are not captured in the historical loss rates, and are based on management’s evaluation of available internal and external data and involves significant management judgment. The qualitative factor adjustment is added to the historical loss rate to calculate the allowance for loan losses. Auditing management’s judgments regarding the determination of the qualitative factor adjustment applied to the allowance for loan losses involved a high degree of subjectivity.

The primary procedures we performed to address this critical audit matter include:

/s/ Moss Adams LLP

Everett, Washington

March 12, 2021

We have served as the Company’s auditor since 2002.

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FIRST NORTHWEST BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

ASSETS

Investment securities available for sale, at fair value 364,296 315,580

Federal Home Loan Bank (FHLB) stock, at cost 5,977 6,034

Mortgage servicing rights, net 2,120 871

Prepaid expenses and other assets 10,975 8,872

LIABILITIES AND SHAREHOLDERS' EQUITY

Accrued interest payable 53 373

Accrued expenses and other liabilities 23,303 14,392

Advances from borrowers for taxes and insurance 1,116 1,145

Commitments and Contingencies (Note 14)

Shareholders' Equity

Accumulated other comprehensive income (loss), net of tax 5,442 (1,539 )

Unearned employee stock ownership plan (ESOP) shares (9,230 ) (9,890 )

See accompanying notes to the consolidated financial statements.

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FIRST NORTHWEST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

For the Year Ended December 31,

INTEREST INCOME

Interest and fees on loans receivable $ 43,063 $ 40,166

Interest on mortgage-backed and related securities 2,701 4,606

Interest on investment securities 5,569 3,965

Interest-bearing deposits and other 94 244

INTEREST EXPENSE

Net interest income after provision for loan losses 38,912 37,196

NONINTEREST INCOME

Loan and deposit service fees 3,454 3,893

Mortgage servicing fees, net 137 176

Net gain on sale of investment securities 3,147 836

Increase in cash surrender value of bank-owned life insurance, net 1,826 708

NONINTEREST EXPENSE

Supplies, postage, and telephone 985 883

Regulatory assessments and state taxes 930 783

FDIC insurance premium 245 82

FHLB prepayment penalty 210 344

INCOME BEFORE PROVISION FOR INCOME TAXES 13,294 11,091

Basic earnings per common share $ 1.11 $ 0.92

Diluted earnings per common share $ 1.10 $ 0.91

See accompanying notes to the consolidated financial statements.

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

For the Year Ended December 31,

Other comprehensive income:

Unrealized holding gains arising during the period 11,984 4,905

Income tax provision related to unrealized holding gains (2,517 ) (1,053 )

Other comprehensive income, net of tax 6,981 3,192

See accompanying notes to the consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

(In thousands, except share data)

Shares Amount Capital Earnings Shares Net of Tax Equity

Restricted stock awards granted net of forfeitures 57,900 — — —

Restricted stock awards canceled (18,442 ) — (305 ) — (305 )

Other comprehensive income, net of tax 3,192 3,192

Cash dividends declared and paid ($0.13 per share) (1,414 ) (1,414 )

Restricted stock awards granted net of forfeitures 105,124 1 (1 ) —

Restricted stock awards canceled (13,719 ) — (178 ) — (178 )

Other comprehensive income, net of tax 6,981 6,981

Cash dividends declared and paid ($0.21 per share) (2,185 ) (2,185 )

See accompanying notes to the consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

For the Year Ended December 31,

CASH FLOWS FROM OPERATING ACTIVITIES

Adjustments to reconcile net income to net cash from operating activities:

Depreciation and amortization 1,375 1,339

Amortization of deferred loan fees, net (1,113 ) (1,267 )

Amortization of mortgage servicing rights 278 251

Additions to mortgage servicing rights (1,564 ) (75 )

Deferred federal income taxes, net (1,131 ) 313

Allocation of ESOP shares 475 868

Gain on sale of loans, net (6,433 ) (1,077 )

Gain on sale of securities available for sale, net (3,147 ) (836 )

Increase in cash surrender value of life insurance, net (1,826 ) (708 )

Change in assets and liabilities:

(Increase) decrease in accrued interest receivable (3,035 ) 117

Increase in prepaid expenses and other assets (635 ) (4,108 )

Decrease in accrued interest payable (319 ) (148 )

Increase in accrued expenses and other liabilities 7,463 6,321

CASH FLOWS FROM INVESTING ACTIVITIES

Purchase of securities available for sale (305,713 ) (58,476 )

Proceeds from sales of securities available for sale 210,264 16,545

Redemption of FHLB stock 57 893

Purchase of bank-owned life insurance policy (6,500 ) —

Purchase of premises and equipment, net (1,818 ) (426 )

See accompanying notes to the consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

For the Year Ended December 31,

CASH FLOWS FROM FINANCING ACTIVITIES

Proceeds from long-term FHLB advances 30,000 15,000

Repayment of long-term FHLB advances (30,000 ) (25,000 )

Net decrease in short-term FHLB advances (2,953 ) (13,622 )

Net share settlement of stock awards (178 ) (305 )

Repurchase of common stock (7,413 ) (7,830 )

NET INCREASE IN CASH AND CASH EQUIVALENTS 16,416 22,416

CASH AND CASH EQUIVALENTS, beginning of period 48,739 26,323

CASH AND CASH EQUIVALENTS, end of period $ 65,155 $ 48,739

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

Cash paid during the period for:

Interest on deposits and borrowings $ 8,043 $ 11,596

NONCASH INVESTING ACTIVITIES

Unrealized gain on securities available for sale $ 8,837 $ 4,069

Lease liabilities arising from obtaining right-of-use assets $ 1,047 $ 3,919

See accompanying notes to the consolidated financial statements.

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FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 - Summary of Significant Accounting Policies

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

At the time of Conversion, the Bank established a liquidation account in an amount equal to its total net worth, approximately $79.7 million, as of June 30,2014, the latest statement of financial condition appearing in First Northwest's prospectus. The liquidation account is maintained for the benefit of eligible depositors who continue to maintain their accounts at the Bank after the Conversion. The liquidation account is reduced annually to the extent that eligible depositors have reduced their qualifying deposits. Subsequent increases will not restore an eligible holder’s interest in the liquidation account. In the event of a complete liquidation, each eligible depositor will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held. The liquidation account balance is not available for payment of dividends, and the Bank may not pay dividends if those dividends would reduce equity capital below the required liquidation account amount.

Pursuant to the Conversion, the Bank’s Board of Directors adopted an ESOP which purchased in the open market 8% of the common stock originally issued for a total of 1,048,029 shares. As of December 15,2015,1,048,029 shares, or 100.0% of the total, had been purchased. As of December 31, 2020, First Northwest had allocated 253,987 shares from the total shares purchased to participants.

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

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

Use of estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make assumptions. These assumptions result in estimates that affect the reported amounts of assets and liabilities, revenues and expenses, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to a determination of the allowance for loan losses, fair value of financial instruments, deferred tax assets and liabilities, and the valuation of impaired loans.

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Cash and cash equivalents - Cash and cash equivalents consist of currency on hand, due from banks, and interest-bearing deposits with financial institutions with an original maturity of three months or less. The amounts on deposit fluctuate and, at times, exceed the insured limit by the FDIC, which potentially subjects First Federal to credit risk. First Federal has not experienced any losses due to balances exceeding FDIC insurance limits.

Restricted assets - Federal Reserve Board regulations require maintenance of certain minimum reserve balances on deposit with the Federal Reserve Bank of San Francisco. The amount required to be on deposit was approximately $0 and $10.8 million at December 31, 2020, and 2019, respectively. First Federal was in compliance with its reserve requirements at December 31, 2020 and 2019.

Equity securities - Equity securities, except those accounted for under the equity method of accounting or those that result in consolidation of the investee, are carried at fair value. Changes in the fair value of investments in equity securities are recorded in other non-interest income.

Investment securities - Investment securities are classified into one of three categories: (1) held-to-maturity, (2) available-for-sale, or (3) trading. First Federal had no trading securities at December 31, 2020 and 2019. Investment securities are categorized as held-to-maturity when First Federal has the positive intent and ability to hold those securities to maturity.

Securities that are held-to-maturity are stated at cost and adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income.

Investment securities categorized as available for sale are generally held for investment purposes (to maturity), although unanticipated future events may result in the sale of some securities. Available-for-sale securities are recorded at fair value, with the unrealized holding gain or loss reported in other comprehensive income (OCI), net of tax, as a separate component of shareholders' equity. Realized gains or losses are determined using the amortized cost basis of securities sold using the specific identification method and are included in earnings. Dividend and interest income on investments are recognized when earned. Premiums and discounts are recognized in interest income using the level yield method over the period to maturity.

The Company reviews investment securities for other-than-temporary impairment (OTTI) on a quarterly basis. For debt securities, the Company considers whether management intends to sell a security or if it is likely that the Company will be required to sell the security before recovery of the amortized cost basis of the investment, which may be maturity. For debt securities, if management 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 as OTTI and charged against earnings. If management does not intend to sell the security and it is not likely that the Company will be required to sell the security, but management does not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, i.e. the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to OCI. Impairment losses related to all other factors are presented as separate categories within OCI. If there is an indication of additional credit losses, the security is re-evaluated according to the procedures described above.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Federal Home Loan Bank stock - First Federal’s investment in Federal Home Loan Bank of Des Moines (FHLB) stock is carried at cost, which approximates fair value. As a member of the FHLB system, First Federal is required to maintain a minimum investment in FHLB stock based on specific percentages of its outstanding mortgages, total assets, or FHLB advances. At December 31, 2020 and 2019, First Federal’s minimum investment requirement was approximately $5.9 million and $6.0 million, respectively. First Federal was in compliance with the FHLB minimum investment requirement at December 31, 2020 and 2019. First Federal may request redemption at par value of any stock in excess of the amount First Federal is required to hold. Stock redemptions are granted at the discretion of the FHLB.

Management evaluates FHLB stock for impairment based on its 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 compared with 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. Based on its evaluation, First Federal did not recognize an OTTI loss on its FHLB stock at December 31, 2020 and 2019.

Loans held for sale - Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value. Fair value is determined based upon market prices from third-party purchasers and brokers. Net unrealized losses, if any, are recognized through a valuation allowance by charges to earnings. Gains or losses on the sale of loans are recognized at the time of sale and determined by the difference between net sale proceeds and the net book value of the loan less the estimated fair value of any retained mortgage servicing rights.

Loans receivable - Loans are stated at the amount of unpaid principal, net of charge-offs, unearned income, allowance for loan loss (ALLL) and any deferred fees or costs. Interest on loans is calculated using the simple interest method based on the month end balance of the principal amount outstanding and is credited to income as earned. The estimated life is adjusted for prepayments.

Each loan segment and class inherently contains differing credit risk profiles depending on the unique aspects of that segment or class of loans. For example, borrowers tend to consider their primary residence and access to transportation for employment-related purposes as basic requirements; accordingly, many consumers prioritize making payments on real estate first-mortgage loans and vehicle loans. Conversely, second-mortgage real estate loans or unsecured loans may not be supported by sufficient collateral; thus, in the event of financial hardship, borrowers may tend to place less importance on maintaining these loans as current and the Bank may not have adequate collateral to provide a secondary source of repayment in the event of default. Notwithstanding the various risk profiles unique to each class of loan, management believes that the credit risk for all loans is similarly dependent on essentially the same factors, including the financial strength of the borrower, the cash flow available to service maturing debt obligations, the condition and value of underlying collateral, the financial strength of any guarantors, and other factors.

Loans are classified as impaired when, based on current information and events, it is probable that First Federal will be unable to collect the scheduled payments of principal and interest when due, in accordance with the terms of the original loan agreement. The carrying value of impaired loans is based on the present value of expected future cash flows discounted at each loan’s effective interest rate or, for collateral dependent loans, at fair value of the collateral, less selling costs. If the measurement of each impaired loan’s value is less than the recorded investment in the loan, First Federal recognizes this impairment and adjusts the carrying value of the loan to fair value through the allowance for loan losses. This can be accomplished by charging off the impaired portion of the loan or establishing a specific component to be provided for in the allowance for loan losses.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent, unless the credit is well secured and in process of collection. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash basis or cost recovery method until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. For those loans placed on non-accrual status due to payment delinquency, return to accrual status will generally not occur until the borrower demonstrates repayment ability over a period of not less than six months.

Loan fees - Loan origination fees and certain direct origination costs are deferred and amortized as an adjustment to the yield of the loan over the contractual life using the effective interest method. In the event a loan is sold, the remaining deferred loan origination fees and/or costs are recognized as a component of gains or losses on the sale of loans.

Allowance for loan losses - First Federal maintains a general allowance for loan losses based on evaluating known and inherent risks in the loan portfolio, including management’s continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, and current and anticipated economic conditions. When determining the appropriate historical loss and qualitative factors, management took into consideration the impact of the COVID-19 pandemic on such factors as the national and state unemployment rates and related trends, the amount of and timing of financial assistance provided by the government, consumer spending levels and trends, industries significantly impacted by the COVID-19 pandemic, and the Company's COVID-19 loan modification program. The appropriateness of the allowance for loan losses is estimated based upon these factors and trends identified by management at the time the consolidated financial statements are prepared. The reserve is an estimate based upon factors and trends identified by management at the time the financial statements are prepared.

The ultimate recovery of loans is susceptible to future market factors beyond First Federal’s control, which may result in losses or recoveries differing significantly from those provided in the consolidated financial statements. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review First Federal’s allowance for loan losses. Such agencies may require First Federal to recognize additional provisions for loan losses based on their judgment using information available to them at the time of their examination.

Allowances for losses on specific problem loans are charged to income when it is determined that the value of these loans and properties, in the judgment of management, is impaired. First Federal accounts for impaired loans in accordance with Accounting Standards Codification (ASC) 310-10-35,Receivables—Overall—Subsequent Measurement. A loan is considered impaired when, based on current information and events, it is probable that First Federal will be unable to collect all amounts due according to the contractual terms of the loan agreement.

When a loan has been identified as being impaired, the amount of the impairment is measured by using discounted cash flows, except when it is determined that the sole source of repayment for the loan is the operation or liquidation of the underlying collateral. In such cases, impairment is measured at current fair value generally based on a current appraisal of the collateral, reduced by estimated selling costs. When the measurement of the impaired loan is less than the recorded investment in the loan (including collected interest that has been applied to principal, net deferred loan fees or costs, and unamortized premiums or discounts), loan impairment is recognized by establishing or adjusting an allocation of the allowance for loan losses. Uncollected accrued interest is reversed against interest income.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

If ultimate collection of principal is in doubt, all cash receipts on impaired loans are applied to reduce the principal balance. The impairment amount for small balance homogeneous loans is calculated using the adjusted historical loss rate for the class and risk category related to each loan, unless the loan is subject to a troubled debt restructuring ("TDR").

A TDR is a loan for which First Federal, for reasons related to the borrower’s financial difficulties, grants a concession to the borrower that First Federal would not otherwise consider. The loan terms that have been modified or restructured due to the borrower’s financial difficulty include, but are not limited to, a reduction in the stated interest rate; an extension of the maturity; an interest rate below market; a reduction in the face amount of the debt; a reduction in the accrued interest; or extension, deferral, renewal, or rewrite of the original loan terms.

The restructured loans may be classified "special mention" or "substandard" depending on the severity of the modification. Loans that were paid current at the time of modification may be upgraded in their classification after a sustained period of repayment performance, usually six months or longer, and there is reasonable assurance that repayment will continue. Loans that are past due at the time of modification are classified "substandard" and placed on nonaccrual status.

TDR loans may be upgraded in their classification and placed on accrual status once there is a sustained period of repayment performance, usually six months or longer, and there is a reasonable assurance that repayment will continue. First Federal allows reclassification of a troubled debt restructuring back into the general loan pool (as a non-troubled debt restructuring) if the borrower is able to refinance the loan at then-current market rates and meet all of the underwriting criteria of First Federal required of other borrowers. The refinance must be based on the borrower’s ability to repay the debt and no special concessions of rate and/or term are granted to the borrower.

In March 2020, the Company announced loan modification programs to support and provide relief for its borrowers during the novel coronavirus of 2019 ("COVID-19") pandemic. The Company has followed the loan modification criteria within the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act"), which was signed into law on March 27, 2020, and interagency guidance from the federal banking agencies when determining if a borrower's modification is subject to a TDR classification. If it is determined that the modification does not meet the criteria under the CARES Act or interagency guidance to be excluded from TDR classification, the Company evaluates the loan modifications under its existing TDR framework. Loans subject to forbearance under the COVID-19 loan modification program are not reported as past due or placed on non-accrual status during the forbearance time period, and interest income continues to be recognized over the contractual life of the loans.

Reserve for unfunded commitments - Management maintains a reserve for unfunded commitments to absorb probable losses associated with off-balance sheet commitments to lend funds such as unused lines of credit and the undisbursed portion of construction loans. Management determines the adequacy of the reserve based on reviews of individual exposures, current economic conditions, and other relevant factors. The reserve is based on estimates and ultimate losses may vary from the current estimates. The reserve is evaluated on a regular basis and necessary adjustments are reported in earnings during the period in which they become known. The reserve for unfunded commitments is included in "Accrued expenses and other liabilities" on the consolidated balance sheets.

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Real estate owned and repossessed assets - Real estate owned and repossessed assets include real estate and personal property acquired through foreclosure or repossession and may include in-substance foreclosed properties. In-substance foreclosed properties are those properties for which the Bank has taken physical possession, regardless of whether formal foreclosure proceedings have taken place.

Mortgage servicing rights - Originated servicing rights are recorded when mortgage loans are originated and subsequently sold with the servicing rights retained. Servicing assets are initially recognized at fair value with the income statement effect recorded in gains on sales of loans and amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial asset. To determine the fair value of servicing rights, management uses a valuation model that calculates the present value of future cash flows. Assumptions used in the valuation model include market discount rates and anticipated prepayment speeds. In addition, estimates of the cost of servicing per loan, an inflation rate, ancillary income per loan, and default rates are used. The initial fair value relating to the servicing rights is capitalized and amortized into noninterest income in proportion to, and over the period of, estimated future net servicing income.

Management assesses impairment of the mortgage servicing rights based on recalculations of the present value of remaining future cash flows using updated market discount rates and prepayment speeds. Subsequent loan prepayments and changes in prepayment assumptions in excess of those forecasted can adversely impact the carrying value of the servicing rights. Impairment is assessed on a stratified basis with any impairment recognized through a valuation allowance for each impaired stratum. The servicing rights are stratified based on the predominant risk characteristics of the underlying loans: fixed-rate loans and adjustable-rate loans. The effect of changes in market interest rates on estimated rates of loan prepayments is the predominant risk characteristic for mortgage servicing rights. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds, and default rates and losses.

Mortgage servicing income represents fees earned for servicing loans. Fees for servicing mortgage loans are generally based upon a percentage of the principal balance of the loans serviced, as well as related ancillary income such as late charges. Servicing income is recognized as earned, unless collection is doubtful. The caption in the consolidated statement of income "Mortgage servicing fees, net" includes mortgage servicing income, amortization of mortgage servicing rights, the effects of mortgage servicing run-off, and impairment, if applicable.

Income taxes - First Federal accounts for income taxes in accordance with the provisions of ASC 740-10,Income Taxes, which requires the use of the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for their future tax consequences, attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

Premises and equipment - Premises and equipment are stated at cost less accumulated depreciation. Depreciation is recognized and computed on the straight-line method over the estimated useful lives as follows:

Years

Furniture, fixtures, and equipment 3 - 10

Software 3

Automobiles 5

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Leases - Operating lease right-of-use ("ROU") assets represent the Company's right to use the underlying asset during the lease term and operating lease liabilities represent the Company's obligation to make lease payments arising from the lease. ROU assets and operating lease liabilities are recognized at lease commencement based on the present value of the future lease payments using the Company's incremental borrowing rate. The Company does not capitalize short-term leases, which are leases with terms of twelve months or less. ROU assets and related operating lease liabilities are remeasured when lease terms are amended, extended, or when management intends to exercise available extension options.

Transfers of financial assets - Transfers of an entire financial asset, a group of financial assets, or a participating interest in an entire financial asset are accounted for as sales when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from First Federal, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) First Federal does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. The mortgage loans that are sold with recourse provisions are accounted for as sales until such time as the loan defaults.

Periodically, First Federal sells mortgage loans with "life of the loan" recourse provisions, requiring First Federal to repurchase the loan at any time if it defaults. The remaining balance of such loans at December 31, 2020 and 2019, was approximately $2.7 million and $5.0 million, respectively. Of these loans, no loans were repurchased during the years ended December 31, 2020 or 2019. There is an associated allowance of $11,000 and $19,000 at December 31, 2020 and 2019, respectively, included in "accrued expenses and other liabilities" on the consolidated balance sheets related to these loans.

Bank-owned life insurance - The carrying amount of life insurance approximates fair value. Fair value of life insurance is estimated using the cash surrender value, less applicable surrender charges. The change in cash surrender value is included in noninterest income.

Off-balance-sheet credit-related financial instruments - In the ordinary course of business, First Federal has entered into commitments to extend credit, including commitments under lines of credit, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.

Advertising costs - First Federal expenses advertising costs as they are incurred.

Comprehensive income (loss) - Accounting principles generally require that recognized revenue, expenses, and gains and losses be included in net income (loss). Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the consolidated balance sheets, such items, along with net income (loss), are components of comprehensive income (loss).

Dividend restriction - Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Company or by the Company to shareholders.

Fair value measurements - Fair values of financial instruments are estimated using relevant market information and other assumptions (Note 15). Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates.

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Segment information - First Federal is engaged in the business of attracting deposits and providing lending services. Substantially all income is derived from a diverse base of commercial, mortgage, and consumer lending activities and investments. The Company’s activities are considered to be a single industry segment for financial reporting purposes.

Employee Stock Ownership Plan - The cost of shares issued to the ESOP but not yet allocated to participants is shown as a reduction of shareholders' equity. Compensation expense is based on the market price of shares as they are committed to be released to participants' accounts. Dividends on allocated ESOP shares reduce retained earnings while dividends on unearned ESOP shares reduce debt and accrued interest.

Earnings per Common Share - Basic earnings per share ("EPS") is computed by dividing net income, reduced by earnings allocated to participating shares of restricted stock, by the weighted-average number of common shares outstanding during the period. As ESOP shares are committed to be released, they become outstanding for EPS calculation purposes. ESOP shares not committed to be released are not considered outstanding for basic or diluted EPS calculations. The basic EPS calculation excludes the dilutive effect of all common stock equivalents. Diluted earnings per share reflects the weighted-average potential dilution that could occur if all potentially dilutive securities or other commitments to issue common stock were exercised or converted into common stock using the treasury stock method.

According to the provisions of 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. Dividends paid on nonvested restricted stock award shares are not material.

Recently adopted accounting pronouncements

In February 2016, the FASB issued ASU No.2016-02,Leases. ASU 2016-02 is intended to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the balance sheet and disclosure of key information about leasing arrangements. The ASU requires a lessee to recognize on the balance sheet assets and liabilities for leases with lease terms of more than 12 months. Consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. The ASC requires that both capital and operating leases be recognized on the balance sheet. For public companies, this update is effective for interim and annual periods beginning after December 15, 2018. The adoption of ASU No.2016-02 effective January 1, 2019, resulted in a right-of-use asset and corresponding lease obligation liability of $3.9 million. The Corporation chose the effective date as the date of initial application. Consequently, prior period financial information has not been updated or restated. The right-of-use asset is included in other assets and the lease obligation liability is included in other liabilities on the December 31, 2020, consolidated balance sheet.

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In August 2018, FASB issued ASU No.2018-13,Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement, which removes, modifies, and adds certain disclosure requirements related to fair value measurements in ASC 820. This guidance eliminates certain disclosure requirements for fair value measurements: the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, an entity’s policy for the timing of transfers between levels of the fair value hierarchy and an entity’s valuation processes for Level 3 fair value measurements. This guidance also adds new disclosure requirements for public entities: changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements of instruments held at the end of the reporting period, and the range and weighted average of significant unobservable inputs used to develop recurring and nonrecurring Level 3 fair value measurements, including how the weighted average is calculated. Furthermore, this guidance modifies certain requirements which will involve disclosing: transfers into and out of Level 3 of the fair value hierarchy, purchases and issuances of Level 3 assets and liabilities, and information about the measurement uncertainty of Level 3 fair value measurements as of the reporting date. This guidance is effective for public companies in fiscal years beginning after December 15, 2019, with early adoption permitted. This ASU did not have a material impact on the Company's consolidated financial statements.

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

Recently issued accounting pronouncements not yet adopted

Credit Losses

In June 2016, the FASB issued ASU No.2016-13,Financial Instruments - Credit Loss, with subsequent amendments issued in ASU 2018-19, ASU 2019-04 and ASU 2019-05. This ASU updates the guidance on recognition and measurement of credit losses for financial assets. The new requirements, known as the current expected credit loss model (CECL) will require entities to adopt an impairment model based on expected losses rather than incurred losses. ASU No.2016-13 is now effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Upon adoption, the Company will change processes and procedures to calculate the allowance for loan losses, including changes in assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. In addition, the current accounting policy and procedures for other-than-temporary impairment on investment securities available for sale will be replaced with an allowance approach.

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

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

The Company is evaluating the provisions of ASU No.2016-13, ASU No.2019-04 and ASU No.2019-05, and will closely monitor developments and additional guidance to determine the potential impact on the Company’s consolidated financial statements. At this time, we cannot reasonably estimate the impact the implementation of these ASUs will have on the Company's consolidated financial statements. The Company's internal project management team continues to review models, work with our third-party vendor, and discuss changes to processes and procedures to ensure the Company is fully compliant with the amendments at the adoption date. Early adoption is permitted for interim and annual periods beginning after December 15, 2018. The Company plans to adopt this guidance on January 1, 2023.

In December 2019, FASB issued ASU No.2019-12,Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. ASU 2019-12 simplifies various aspects related to accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The standard also clarifies and amends existing guidance to improve consistent application. This ASU, which is effective for fiscal years beginning after December 15, 2020, is not expected to have a material impact on the Company's financial statements. Early adoption is permitted.

Reclassifications - Certain amounts in prior periods have been reclassified to conform to the current audited financial statement presentation with no effect on net income or shareholders' equity.

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Note 2 - Securities

The amortized cost, gross unrealized gains and losses, and estimated fair value of securities classified as available-for-sale and held-to-maturity at December 31, 2020, are summarized as follows:

(In thousands)

Available for Sale

Corporate issued asset-backed securities (ABS corporate) 29,661 37 (418 ) 29,280

U.S. Small Business Administration securities (SBA) 18,420 144 — 18,564

Mortgage-Backed Securities:

The amortized cost, gross unrealized gains and losses, and estimated fair value of securities classified as available-for-sale and held-to-maturity at December 31, 2019, are summarized as follows:

Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value

(In thousands)

Available for Sale

Mortgage-Backed Securities

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The following table shows the unrealized gross losses and fair value of the investment portfolio by length of time that individual securities in each category have been in a continuous loss position as of December 31, 2020:

Less Than Twelve Months Twelve Months or Longer Total

(In thousands)

Available for Sale

Mortgage-Backed Securities

The following table shows the unrealized gross losses and fair value of the investment portfolio by length of time that individual securities in each category have been in a continuous loss position as of December 31, 2019:

Less Than Twelve Months Twelve Months or Longer Total

(In thousands)

Available for Sale

Mortgage-Backed Securities

The Company may hold certain investment securities in an unrealized loss position that are not considered OTTI. At December 31, 2020, there were 36 investment securities with $1.5 million of unrealized losses and a fair value of approximately $99.4 million. At December 31, 2019, there were 62 investment securities with $3 million of unrealized losses and a fair value of approximately $198.8 million.

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

There were no OTTI losses during the years ended December 31, 2020 and 2019.

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

Amortized Cost Estimated Fair Value Amortized Cost Estimated Fair Value

(In thousands)

Mortgage-backed securities:

Due within one year $ 80 $ 84 $ — $ —

Due after five through ten years — — 6,261 6,257

All other investment securities:

Due within one year — — — —

Sales of available-for-sale securities were as follows:

For the Year Ended December 31,

(In thousands)

Gross losses (1,390 ) —

During the year ended December 31, 2019, the Bank changed the holding classification of the entire held to maturity portfolio to available for sale. The amortized cost of these securities was $37.6 million at the time of transfer.

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Note 3 - Loans Receivable

Loans receivable consist of the following at the dates indicated:

(In thousands)

Real Estate:

Consumer:

Less:

Premium on purchased loans, net (6,129 ) (4,514 )

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Loans, by the earlier of next repricing date or maturity, at the dates indicated:

(In thousands)

Adjustable-rate loans

Fixed-rate loans

The adjustable-rate loans have interest rate adjustment limitations and are generally indexed to multiple indices. Future market factors may affect the correlation of adjustable loan interest rates with the rates First Federal pays on the short-term deposits that have been primarily used to fund such loans.

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

At or For the Year Ended December 31, 2020

(In thousands)

ALLL:

Charge-offs — — — (5 ) — (992 ) — — (997 )

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NOTES TO CONSOLIDATED FINANCIAL STATEMENT

S

(In thousands)

(1) Loans collectively evaluated for general reserves.

(2) Loans individually evaluated for specific reserves.

At or For the Year Ended December 31, 2019

(In thousands)

ALLL:

Charge-offs — — — — — (884 ) (3 ) — (887 )

(In thousands)

(1) Loans collectively evaluated for general reserves.

(2) Loans individually evaluated for specific reserves.

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The following table presents a summary of loans individually evaluated for impairment by portfolio segment including the average recorded investment in and interest income recognized on impaired loans at or for the periods shown:

Year Ended

(In thousands)

With no allowance recorded:

Construction and land — 29 — 9 —

Auto and other consumer — 224 — — 13

Commercial business — — — 68 —

With an allowance recorded:

Multi-family — — — 119 —

Commercial business — — — 109 —

Total impaired loans:

Commercial business — — — 177 —

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The following table presents a summary of loans individually evaluated for impairment by portfolio segment including the average recorded investment in and interest income recognized on impaired loans at or for the periods shown:

Year Ended

(In thousands)

With no allowance recorded:

Construction and land — 33 — — —

Commercial business — — — — 4

With an allowance recorded:

Total impaired loans:

Interest income recognized on a cash basis on impaired loans for the years ended December 31, 2020 and 2019, was $256,000 and $318,000, respectively.

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

(In thousands)

One- to four-family $ 912 $ 698

Multi-family 284 —

Construction and land 26 29

Auto and other consumer 821 848

Past due loans - There were no loans past due 90 days or more and still accruing interest at December 31, 2020 and 2019.

The following table presents the recorded investment of past due loans, by class, as of December 31, 2020:

(In thousands)

Real Estate:

Consumer:

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The following table presents the recorded investment of past due loans, by class, as of December 31, 2019:

(In thousands)

Real Estate:

Consumer:

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

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

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

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The following table represents the internally assigned grade as of December 31, 2020, by class of loans:

Pass Watch Special Mention Substandard Total

(In thousands)

Real Estate:

Consumer:

The following table represents the internally assigned grade as of December 31, 2019, by class of loans:

Pass Watch Special Mention Substandard Total

(In thousands)

Real Estate:

Consumer:

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The following table represents the credit risk profile based on payment activity as of December 31, 2020, by class of loans:

Nonperforming Performing Total

(In thousands)

Real Estate:

Consumer:

The following table represents the credit risk profile based on payment activity as of December 31, 2019, by class of loans:

Nonperforming Performing Total

(In thousands)

Real Estate:

Consumer:

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The Coronavirus Aid, Relief, and Economic Security Act of 2020 signed into law on March 27, 2020, ("CARES Act") provided guidance around the modification of loans as a result of the COVID-19 pandemic, which outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term (i.e., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act and related regulatory guidance if they are less than 30 days past due on their contractual payments at the time a modification program is implemented. Through December 31, 2020, the Company had granted COVID-19 pandemic related temporary loan modifications on a total of 357 loans aggregating to $177.6 million. Loan modifications in accordance with the CARES Act and related regulatory guidance are still subject to an evaluation in regard to determining whether or not a loan is deemed to be impaired.

The following table is a summary of COVID-

19 modified loans that remain on deferral as of

December 31, 2020:

Count Balance Percent

(Dollars in Thousands)

Real Estate:

Construction and land 1 67 2.9

Consumer:

Home equity — — —

Commercial business loans — — —

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

(In thousands)

Allowance for loan losses related to TDR loans 26 41

Total nonaccrual TDR loans 108 81