Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
First Northwest is a bank holding company and a financial holding company and is engaged in banking activities through its wholly owned subsidiary, First Fed Bank, as well as certain non-banking financial activities, including a controlling interest in Quin Ventures, Inc. and several limited partnership investments. The Company's business activities are generally focused on passive investment activities and oversight of the activities of First Fed and Quin Ventures. The Company has also entered into partnerships to strategically invest in fintech-related businesses, which may result in the development of additional investment opportunities.
First Fed is a community-oriented financial institution serving Clallam, Jefferson, King, Kitsap, and Whatcom counties in Washington State, through its twelve full-service branches and four business centers. We offer a wide range of products and services focused on the lending, deposit and money movement needs of the communities we serve. While we have a concentration of first lien one- to four-family mortgage loans, in order to diversify our portfolio and increase interest income, 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. 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 Fed 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 and bond markets, 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 Fed, 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, loan servicing income, and gains and losses from sales of loans and securities.
An offset to net interest income is the provision for loan losses, which represents the periodic charge to operations 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 the last three years include:
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 objectives:
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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 the 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 servicing rights on loans originated and subsequently sold into the secondary market. We stratify our capitalized servicing rights based on the type, term and interest rates of the underlying loans. Effective January 1, 2022, the Bank elected to measure servicing rights using the fair value method of accounting. Servicing rights are measured at fair value at each reporting date with the change reported in earnings. Prior to 2022, the amortization method was applied with servicing rights initially recognized at fair value and subsequent changes in value amortized over the estimated remaining life of the loans. 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, 6 and 14 to the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" of this Form 10-K.
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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.
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. In the absence of quoted market prices, management determines the fair value of the Company’s assets and liabilities using valuation models or third-party pricing services.
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, 2022 and December 31, 2021
Assets. Total assets increased $121.0 million, or 6.3%, to $2.04 billion at December 31, 2022, from $1.92 billion at December 31, 2021.
Total loans, excluding loans held for sale, increased $177.2 million, or 13.1%, during the year ended December 31, 2022. Multi-family and commercial real estate loans increased $108.1 million, or 20.2%, consisting mainly of an increase in multi-family real estate loans of $81.1 million as a result of new originations and $17.6 million of construction loans converting into permanent amortizing loans. The commercial real estate loans increase was due to new loan originations in addition to $12.2 million from construction loans converting into permanent amortizing loans. Auto and other consumer loans increased $40.0 million, or 21.9%, 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 decreased $2.8 million due to a decrease in the Northpointe Bank Mortgage Participation Program of $26.3 million as our participation in the program ended and $14.5 million in payoffs of SBA Paycheck Protection Program loans, partially offset by purchases of $8.1 million in secured equipment loans and $6.3 million of unsecured Bankers Healthcare Group loans in addition to advances on new and existing lines of credit.
One- to four-family residential loans increased $48.9 million, or 16.6%, with $40.5 million in construction loans converting to permanent amortizing loans during the year. We continue to focus on the origination of one- to four-family mortgage loans with the intention of retaining certain adjustable-rate loans that 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.
Construction and land loans decreased $30.1 million, or 13.4%, with draws on new and existing loans partially offset by $79.3 million converting into fully amortizing loans. Undisbursed construction commitments totaled $120.7 million at December 31, 2022 compared to $194.3 million at December 31, 2021. Undisbursed construction commitments at December 31, 2022 included $68.1 million of mainly custom one- to four-family residential construction, $38.7 million of multi-family construction, $13.0 million of commercial real estate construction, and $1.0 million of commercial acquisition-renovation construction. Our construction loans are geographically disbursed throughout the state of Washington with two commitments for properties in Idaho and 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. Internal staff monitor certain projects, which enhances fee income related to these loans.
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During the year ended December 31, 2022, the Company originated $548.3 million of loans, of which $122.8 million, or 22.4%, were originated in the Olympic Peninsula region; $356.7 million, or 65.1%, in the Puget Sound region; $46.4 million, or 8.5%, in other areas in Washington; and $22.2 million, or 4.1%, in other states. The Company also purchased loans totaling $96.1 million with the largest concentration of personal property located in California.
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 (15,957 ) (12,995 )
Our allowance for loan losses increased $1.0 million, or 6.6%, during the year ended December 31, 2022, as a result of loan growth. Asset quality has remained stable year over year despite the uncertain economic conditions as the Federal Reserve Board has attempted to curb inflation by increasing the Federal Funds Rate. Management continues to closely monitor these and other economic conditions. The allowance for loan losses as a percentage of total loans was 1.05% at December 31, 2022 and 1.11% at December 31, 2021. We believe our allowance for loan losses is adequate to cover inherent losses in the loan portfolio.
Nonperforming loans increased $409,000, or 29.6%, during the year ended December 31, 2022 to $1.8 million. This increase was mainly the result of increases in nonperforming one- to four-family of $463,000 and auto and other consumer of $60,000, partially offset by a decrease in home equity loans of $88,000. Nonperforming loans to total loans was 0.12% at December 31, 2022, an increase from 0.10% at December 31, 2021.
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At December 31, 2022, 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 $4.3 million, or 34.3%, to $16.9 million at December 31, 2022, from $12.6 million at December 31, 2021. The change in classified loans was mainly the result of one $14.0 million commercial multifamily construction loan being downgraded during the fourth quarter due to additional liens being placed on the property, and was partially offset by commercial real estate loan upgrades and payoffs. The Bank continued to work with its borrowers to facilitate satisfactory repayment.
Cash and cash equivalents decreased by $80.4 million, or 63.8%, to $45.6 million as of December 31, 2022, compared to $126.0 million at December 31, 2021, as excess cash was deployed into funding loans.
Total investment securities decreased $17.6 million, or 5.1%, to $326.6 million at December 31, 2022, from $344.2 million at December 31, 2021. The year-over-year decrease was the result of a decline in the market value of the portfolio, sales and normal amortization during the year, partially offset by purchases. During 2022, we purchased $78.7 million of available-for-sale securities. We also took advantage of market opportunities to manage duration by selling $11.9 million of available-for-sale securities for a total gain of $118,000 during the same period. The decline in market value of $51.3 million relates mainly to changes in interest rates and market liquidity, not to changes in credit quality. The estimated average life of the total investment securities portfolio was 8.2 years, and the average repricing term was approximately 5.7 years as of December 31, 2022, based on the interest rate environment at that time. We anticipate the investment portfolio will continue to provide additional interest income and act as a source of liquidity.
Mortgage-backed securities represent the largest portion of our investment portfolio and totaled $169.0 million at December 31, 2022, an increase of $29.0 million, or 20.7% from $140.0 million at December 31, 2021. Municipal bonds are the second largest segment, totaling $98.1 million at December 31, 2022, a decrease of $15.3 million, or 13.5%, from $113.4 million at December 31, 2021. Other investment securities, including U.S. and international government agencies and corporate debt securities, were $59.6 million at December 31, 2022, a decrease of $31.3 million, or 34.5% from $90.9 million at December 31, 2021.At December 31, 2022, the investment portfolio contained 50.8% of amortizing securities, compared to 49.8% at December 31, 2021. 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.
Equity and partnership investments increased $10.7 million to $14.3 million at December 31, 2022, compared to $3.6 million at December 31, 2021, as we expanded partnership and equity relationships to include the three Meriwether Group investments and JAM FINTOP. Prepaid expenses and other assets increased $20.2 million to $42.4 million at December 31, 2022, compared to $22.2 million one year ago. The increase was mainly due to an increase in deferred tax assets of $11.2 million resulting from the fair market value decrease in the investment portfolio, an increase in other prepaid expenses of $3.9 million, which includes long-term sponsorship agreements with two local not-for-profit organizations, and a receivable for a bank-owned life insurance ("BOLI") death benefit payment related to the passing of a former employee. In December 2022, Quin Ventures sold substantially all of its assets to Quil Ventures. As part of the sale transaction, the Company received a 5% ownership stake in Quil Ventures valued at $225,000 and recorded a $1.5 million commitment receivable.
Liabilities. Total liabilities increased $153.2 million, or 8.9%, to $1.88 billion at December 31, 2022, from $1.73 billion at December 31, 2021, mainly due to an increase in borrowings of $166.1 million, or 139.2%, to $285.4 million at December 31, 2022, from $119.3 million at December 31, 2021, used to fund loan growth.
Deposit account balances decreased $16.3 million, or 1.0%, to $1.56 billion at December 31, 2022 from $1.58 billion at December 31, 2021. Money market accounts decreased $124.8 million and transaction accounts decreased $32.3 million, while savings accounts increased $6.3 million. Certificates of deposit increased $134.4 million, or 54.4%, to $381.7 million at December 31, 2022. Included in certificates of deposit balances at year end were $133.9 million in brokered certificates of deposit. We believe the current rate environment has contributed to greater competition for deposits with higher rate products being offered to attract new funds. Additionally, the significant deposit balance increases in 2020 and 2021 from stimulus payments and PPP loans began to run off in 2022 as business and consumer post-pandemic spending increased, fueled in part by inflation. Our focus will continue to be on increasing core customer deposits, with an emphasis on small-to-medium sized business deposits, and maintaining a stable source of funding for our continued growth.
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Equity. Total shareholders' equity decreased $29.4 million, or 15.4%, to $161.6 million at December 31, 2022, from $191.0 million at December 31, 2021. The decrease during the year resulted from a $40.8 million change in accumulated other comprehensive loss related to the change in unrealized market value of available for sale securities, net of tax. Share repurchases of $5.9 million and $2.8 million in dividends paid in 2022 also contributed to the decrease in equity. These decreases were partially offset by net income of $15.7 million, an increase of $2.6 million related to share-based compensation plans and $1.9 million related to the issuance of common stock as consideration for the acquisition of 33% of The Meriwether Group, LLC. During the year ended December 31, 2022, we repurchased 356,343 shares of common stock at an average cost of $15.26 per share, pursuant to the Company's 2020 stock repurchase plan.
Comparison of Results of Operations for the Years Ended December 31, 2022 and 2021
General. The Company generated a return on average assets of 0.79%, and a return on average equity of 9.09%, for the year ended December 31, 2022, compared to 0.87% and 8.19%, respectively, for the year ended December 31, 2021. Net income increased $227,000, or 1.5%, compared to 2021. An increase in net interest income was offset by a decrease in noninterest income and increase in noninterest expense. Noninterest income was down due to significant declines in gain on sale of loans and gains on partnership investments. Noninterest expense was higher due to increased compensation, advertising, data processing, and occupancy expenses. The increases in expense were primarily related to Quin and expansion of the Bank's staffing levels and locations. We earned $1.71 per common and diluted share for the year ended December 31, 2022, compared to $1.63 per common and diluted share for the year ended December 31, 2021. The increase in earnings per share was the result of an increase in net income combined with lower weighted-average common shares outstanding of 9,082,032 in 2022, compared to 9,133,953 shares for the same period in 2021. The decrease in average shares year-over-year is due to our share repurchase program and restricted stock award forfeitures offset by restricted stock award grants.
Net Interest Income. Net interest income increased $11.6 million, or 19.8%, to $69.9 million for the year ended December 31, 2022, from $58.3 million for the year ended December 31, 2021, mainly as the result of additional interest income related to an increase in the average balances of loans receivable as well higher yields earned on both loans receivable and investment securities.
The average balance of loans receivable increased $208.9 million, at an average yield of 4.74%, for the year ended December 31, 2022 compared to an average yield of 4.44%, for the year ended December 31, 2021. The cost of interest-bearing liabilities increased to 0.73% for the year ended December 31, 2022 compared to 0.43% for the year ended December 31, 2021. The combination of increased loan receivable balances and higher rates resulted in a 28 basis point increase in our net interest margin to 3.79% at December 31, 2022, from 3.51% at December 31, 2021, as loans repriced faster than deposit costs.
Net interest income increased $11.6 million during the year ended December 31, 2022 compared to the year ended December 31, 2021, of which $7.0 million was the result of an increase in volume and $4.6 million due to changes in yields. As noted above, loans receivable was the main contributor to the increase in net interest income with $9.3 million due to an increase in average volume and $4.3 million due higher rates. The increase to the cost of average interest-bearing liabilities for the year ended December 31, 2022 was due primarily to increased average balances and higher rates paid on advances, certificates of deposit and money market accounts.
Interest Income. Interest income increased $16.7 million, or 26.2%, to $80.4 million for the year ended December 31, 2022 from $63.7 million for the comparable period in 2021, primarily due to an increase in the average balance of loans receivable. Interest and fees on loans receivable increased $13.6 million during the year, in part, as the Bank grew the loan portfolio through single-family, multi-family and commercial real estate lending as well as purchased auto and manufactured home loans. Loan yields also increased due to higher rates on new originations as well as the repricing of variable rate loans tied to the Prime Rate or other indices.
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Interest income on investment securities increased $2.5 million to $10.9 million for the year ended December 31, 2022 compared to $8.4 million for the year ended December 31, 2021. The increase in interest income on investment securities was driven by an increase in the average yield during the year of 81 basis points due to the repricing of variable rate securities as slowing prepayment activity reduced the amount of premium amortization during the period.
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 increased $5.1 million, or 95.7%, for the year ended December 31, 2022, compared to the prior year, with increases in borrowing costs of $3.3 million and deposit costs of $1.8 million. Borrowing rates increased 12.4%, or 29 basis points, mainly due to higher rates paid on overnight and short-term borrowings, combined with an increase of $118.1 million in the average balance outstanding. Deposit costs increased due to higher rates paid and an increase of $73.9 million, or 6.4%, in the average balance of interest-bearing deposits, as we utilized brokered certificates of deposits to offset the decline in customer balances. The average cost of all interest-bearing deposit products increased 13 basis points to 0.42% for the year ended December 31, 2022 from 0.29% for the year ended December 31, 2021. While the average balances of all deposit categories increased year-over-year, growth in lower costing transaction, savings and money market accounts outpaced higher costing certificates of deposit accounts.
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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)
Provision for Loan Losses. The provision for loan losses increased during the year ended December 31, 2022, compared to 2021. The higher provision is reflective of loan growth and an increase in net charge-offs. Credit quality metrics improved slightly resulting in a lower allowance to total gross loans compared to the prior year.
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 $ 1,535 $ 1,350
Charge offs net of recoveries (543 ) (73 )
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Noninterest Income. Noninterest income decreased 34.0% to $10.3 million for the year ended December 31, 2022, from $15.6 million for the year ended December 31, 2021. Decreases compared to the prior year were primarily due to lower gain on sale of mortgage loans, lower gains on investment security sales, a $1.1 million decrease to the change in market value of our limited partnership fintech investments included in "other income" and a decline in the value of the loan servicing rights asset. These decreases were partially offset by additional service fee income and the BOLI death benefit payment.
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)
Income from death benefit on bank-owned life insurance, net 1,489 — 1,489 100.0
Noninterest Expense. Noninterest expense increased to $62.3 million for the year ended December 31, 2022, from $54.4 million for the year ended December 31, 2021. The year-over-year increase reflects higher data processing and occupancy expenses associated with expanding our footprint with additional branch locations as well as higher professional fees, including legal and technology consulting fees.
Additional Quin expenses resulted in significant increases to advertising, compensation, depreciation and data processing expenses during the year ended December 31, 2022, totaling approximately $3.5 million. The full amount of Quin Ventures activity is reported in noninterest income and noninterest expense under the controlling interest method of accounting. The proportional noncontrolling interest amount is later subtracted from net income. This resulted in a noncontrolling interest net loss of $2.1 million being added back to net income for the year ended December 31, 2022. As of December 31, 2022, future additional expenses related to Quin are expected to be immaterial.
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. The provision for income tax for the year ended December 31, 2022, was $2.9 million compared to $3.2 million for the year ended December 31, 2021, reflecting differences in pre-tax income. The effective tax rate decreased over prior periods as a result of the permanent tax exclusion of BOLI noninterest income, including the BOLI death benefit.
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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, 2022 and 2021. 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:
Other noninterest-bearing liabilities 36,666 39,432
(1) The average loans receivable, net balances include nonaccrual loans.
(2) Includes interest-bearing deposits at other financial institutions.
(3) Cost of all deposits, including noninterest-bearing demand deposits, was 0.33% and 0.23% for the years ended December 31, 2022 and 2021.
(4) 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:
Interest-bearing liabilities:
Interest-bearing demand deposits $ 4 $ 90 $ 94
(1) Includes interest-bearing deposits 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-earning assets and interest-bearing liabilities in an effort to minimize the adverse effects of changes in the interest rate environment. Deposit accounts may reprice more quickly in response to changes in market interest rates because of their shorter maturities. 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, the London Interbank Offered Rate ("LIBOR"), or the Term Secured Overnight Financing Rate ("TSOFR") will also reprice higher when market interest rates increase. Increases in interest rates should beneficially affect our earnings when variable or adjustable interest-earning assets reprice at higher interest rates faster than it takes for deposit and borrowing costs to reprice higher. Decreases in interest rates may adversely affect earnings as variable and adjustable assets will reprice lower which will reduce interest income. Given the current low cost of funding there is little ability to reduce funding costs to offset the decrease in interest income. Additionally, lower rates may result in increased 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, further reducing interest income.
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 400 basis point increase or a 100 to 300 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 Fed’s equity at December 31, 2022, 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, 2022, 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 investment security principal and interest payments, deposit inflows, brokered deposits, 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, 2022, cash and cash equivalents totaled $45.6 million, and securities classified as available-for-sale, which provide additional potential sources of liquidity, had a market value of $326.6 million. We have pledged loan collateral to support borrowings from the FHLB of $234.0 million. We have also pledged collateral to the Federal Reserve Bank of San Francisco to secure discount window advances; the Company has performed periodic borrowing tests, however, no funds were borrowed as of December 31, 2022. First Northwest has a $20.0 million borrowing arrangement with NexBank which is secured by First Northwest's personal property assets (with certain exclusions), including all the outstanding shares of First Fed, cash, loans receivable, and limited partnership investments.
At December 31, 2022, we had $25,000 in loan commitments outstanding and an additional $226.6 million in undisbursed loans, including undisbursed construction commitments, and standby letters of credit.
Certificates of deposit due within one year of December 31, 2022 totaled $262.2 million, or 68.7% 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 changing rate environment. Management believes that a significant portion of our certificates of deposit will be renewed or rolled into new certificates of deposit given the current rate environment. If these maturing deposits are not renewed or rolled into other deposit products, 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.
First Fed has a diversified deposit base with approximately 62% of deposit account balances held by consumers, 29% held by business and public fund depositors, and 9% in brokered deposits. The average deposit account balance, excluding brokered and public fund accounts, was $29,000 at December 31, 2022. We estimate that 20-25% of our retail customer deposit balances are over the $250,000 FDIC insurance limit, representing less than 5% of depositors. Management believes that maintaining a diversified deposit base is an important factor in managing liquidity.
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The Company is a separate legal entity from the Bank and relies on dividends from its subsidiary, First Fed, and cash received from the issuance of subordinated debt for liquidity to pay its operating expenses and other financial obligations. At December 31, 2022, the Company (on an unconsolidated basis) had liquid assets of $1.0 million.
Off-Balance Sheet Activities
In the normal course of operations, First Fed 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, 2022, 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, 2022:
Amount of Commitment Expiration
(In thousands)
Commitments to originate loans:
Variable-rate loans $ 25 $ — $ — $ — $ 25
Unfunded commitments under partnership agreements 4,268 — — — 4,268
Capital Resources
First Northwest Bancorp is a financial holding company (a type of 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 Fed, 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 Fed 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 Fed is subject to capital requirements adopted by the Federal Reserve and the FDIC. See Item 1, "Business-How We Are Regulated," and Note 11 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 Fed’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 Fed 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, 2022, the conservation buffer was 2.5%.
Consistent with our goals to operate a sound and profitable organization, our policy for First Fed is to maintain its "well-capitalized" status in accordance with regulatory standards. At December 31, 2022, 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, 2022.
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.
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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.
Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements Page
Notes to Consolidated Financial Statements 96
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Report of Independent Registered Public Accounting Firm
To the Shareholders and 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, 2022 and 2021, the related consolidated statements of income, comprehensive income, 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 present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2022 and 2021, and the consolidatedresults 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 Opinion
These consolidated financial 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 audit to obtain reasonable assurance about whether the consolidated financial 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 in accordance with the standards of the PCAOB. 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 in accordance with the standards of the PCAOB. 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 opinion.
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 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.
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Allowance for Loan Losses
As described in Notes 1 and 3 to the consolidated financial statements, the Company's consolidated allowance for loan losses balance was $16 million at December 31, 2022. The allowance for loan losses is maintained to provide for estimated inherent losses based upon the Company's analysis of the known and inherent risk factors underlying 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 qualitative factor adjustments, which are a component of the allowance for loan losses calculation, as a critical audit matter. Qualitative factor adjustments are added to the historical loss rates and applied to the loan balances with similar risk characteristics to calculate the allowance for loan losses. The qualitative factor adjustments are comprised of subjective risk factor adjustments used to quantify an estimate of losses 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. In turn, auditing management's judgments regarding the determination of the qualitative factor adjustments applied to the allowance for loan losses involved a high degree of subjectivity.
The primary procedures we performed to address this critical audit matter included:
/s/ Moss Adams LLP
Everett, Washington
March 17, 2023
We have served as the Company's auditor since 2002.
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CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
ASSETS
Investment securities available for sale, at fair value 326,569 344,212
Federal Home Loan Bank (FHLB) stock, at cost 11,681 5,196
Servicing rights on sold loans, net — 3,282
Servicing rights on sold loans, at fair value 3,887 —
Equity and partnership investments 14,289 3,571
Goodwill and other intangible assets 1,089 1,183
LIABILITIES AND SHAREHOLDERS' EQUITY
Accrued interest payable 455 393
Accrued expenses and other liabilities 32,344 29,240
Advances from borrowers for taxes and insurance 1,376 1,108
Commitments and Contingencies (Note 13)
Shareholders' Equity
Accumulated other comprehensive (loss) income, net of tax (40,543 ) 288
Unearned employee stock ownership plan (ESOP) shares (7,913 ) (8,572 )
Noncontrolling interest in Quin Ventures, Inc. (3,291 ) (481 )
See accompanying notes to the consolidated financial statements.
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CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
For the Year Ended December 31,
INTEREST INCOME
Interest and fees on loans receivable $ 68,635 $ 55,029
Interest on investment securities 10,866 8,369
Interest-bearing deposits and other 375 83
INTEREST EXPENSE
Net interest income after provision for loan losses 68,328 56,948
NONINTEREST INCOME
Loan and deposit service fees 4,729 3,860
Sold loan servicing fees 867 946
Net gain on sale of investment securities 118 2,410
Increase in cash surrender value of bank-owned life insurance, net 916 965
Income from death benefit on bank-owned life insurance, net 1,489 —
NONINTEREST EXPENSE
Supplies, postage, and telephone 1,376 1,189
Regulatory assessments and state taxes 1,539 1,213
INCOME BEFORE PROVISION FOR INCOME TAXES 16,343 18,173
NET INCOME ATTRIBUTABLE TO PARENT $ 15,645 $ 15,418
Basic and diluted earnings per common share $ 1.71 $ 1.63
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 (loss) income:
Unrecognized defined benefit ("DB") plan prior service cost — (2,210 )
Income tax benefit related to DB plan prior service cost — 464
Amortization of unrecognized DB plan prior service cost (362 ) (134 )
Income tax benefit related to amortization of DB plan prior service cost 75 28
Other comprehensive (loss) income, net of tax (40,831 ) (5,154 )
COMPREHENSIVE (LOSS) INCOME ATTRIBUTABLE TO PARENT $ (25,186 ) $ 10,264
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 Interest Equity
Restricted stock award grants net of forfeitures 64,839 1 (1 ) —
Restricted stock awards canceled (19,548 ) — (352 ) — (352 )
Other comprehensive loss, net of tax (5,154 ) (5,154 )
ESOP shares committed to be released 271 658 929
Cash dividends declared and paid ($0.25 per share) (2,533 ) (2,533 )
Restricted stock award grants net of forfeitures 22,470 — — —
Restricted stock awards canceled (21,302 ) — (392 ) — (392 )
Other comprehensive loss, net of tax (40,831 ) (40,831 )
Quin Ventures asset sale in-substance distribution — — — — (661 ) (661 )
ESOP shares committed to be released 293 659 952
Cash dividends declared and paid ($0.28 per share) (2,787 ) (2,787 )
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
Net income before noncontrolling interest $ 13,496 $ 14,979
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization 1,960 1,432
Amortization of core deposit intangible 94 5
Amortization of deferred loan fees and purchased premiums, net 981 1,260
Amortization of debt issuance costs 78 57
Change in fair value of sold loan servicing rights (13 ) —
Additions to servicing rights on sold loans (54 ) (1,233 )
Amortization of servicing rights on sold loans — 108
Deferred federal income taxes, net (1,529 ) 63
Allocation of ESOP shares 673 675
Share-based compensation expense 1,601 2,294
Gain on sale of loans, net (824 ) (5,278 )
Gain on sale of securities available for sale, net (118 ) (2,410 )
Increase in cash surrender value of life insurance, net (916 ) (965 )
Income from death benefit on bank-owned life insurance, net (1,489 ) —
Change in assets and liabilities:
(Increase) decrease in accrued interest receivable (1,454 ) 1,677
Increase in prepaid expenses and other assets (3,938 ) (15,404 )
Increase in accrued interest payable 62 340
Increase in accrued expenses and other liabilities 3,104 6,218
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of securities available for sale (78,409 ) (152,930 )
Proceeds from sales of securities available for sale 12,685 109,829
(Purchase) redemption of FHLB stock (6,485 ) 781
Purchase of premises and equipment, net (2,914 ) (6,019 )
Capital contributions to equity investments (7,364 ) (584 )
Capital contributions to historic tax credit partnerships (1,829 ) —
Net cash acquired from branch acquisition — 63,545
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
Net (decrease) increase in deposits $ (16,325 ) $ 182,196
Proceeds from long-term FHLB advances — 40,000
Repayment of long-term FHLB advances — (10,000 )
Net increase (decrease) in short-term advances 154,000 (59,977 )
Proceeds from issuance of subordinated debt, net — 39,223
Net increase (decrease) in line of credit 12,000 —
Restricted stock awards canceled (392 ) (352 )
Repurchase of common stock (5,439 ) (5,979 )
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (80,420 ) 60,861
CASH AND CASH EQUIVALENTS, beginning of period 126,016 65,155
CASH AND CASH EQUIVALENTS, end of period $ 45,596 $ 126,016
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest on deposits and borrowings $ 10,453 $ 4,550
NONCASH INVESTING ACTIVITIES
Lease liabilities arising from obtaining right-of-use assets — 4,402
Investment in partnership acquired through issuance of shares 1,869 —
BUSINESS COMBINATION (See Note 17)
Fair value of assets acquired $ — $ 1,340
Fair value of liabilities assumed — 65,947
See accompanying notes to the consolidated financial statements.
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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 Fed Bank ("First Fed" or the "Bank") on January 29,2015, upon completion of the Bank's conversion from a mutual to stock form of organization (the "Conversion").
In connection with the Conversion, the Company issued an aggregate of 12,167,000 shares of common stock at an offering price of $10.00 per share for gross proceeds of $121.7 million. An additional 933,360 shares of Company common stock and $400,000 in cash were contributed to the First Federal Community Foundation ("Foundation"), a charitable foundation that was established in connection with the Conversion, resulting in the issuance of a total of 13,100,360 shares. The Company received $117.6 million in net proceeds from the stock offering of which $58.4 million were contributed to the Bank upon Conversion.
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, 2022, First Northwest had allocated 386,285 shares from the total shares purchased to participants.
In April 2021, First Northwest entered into an Amended and Restated Joint Venture Agreement (the "Joint Venture Agreement") with the Bank, Peace of Mind, Inc. ("POM"), and Quin Ventures, Inc. ("Quin" or "Quin Ventures"). First Northwest extended $8.0 million to Quin Ventures under a capital financing agreement and related promissory note and issued 29,719 shares of the Company's common stock to POM with a value of $500,000. Quin Ventures sold substantially all of its assets in December 2022 to Quil Ventures, Inc., at which time POM returned the 29,719 shares previously issued and the joint venture agreement was terminated. As part of the sale transaction, the Company received a 5% ownership stake in Quil Ventures valued at $225,000 and recorded a $1.5 million commitment receivable. First Northwest continues to maintain a controlling interest in Quin Ventures.
On October 31, 2021, the Bank converted from a State Savings Bank Charter to a State Commercial Bank Charter and was simultaneously renamed First Fed Bank from First Federal Savings and Loan Association of Port Angeles.
On August 5, 2022, First Northwest's election to be treated as a financial holding company became effective, allowing the Company to engage in non-banking activities that are financial in nature or incidental to financial activities.
First Northwest, the Bank, and Quin Ventures are collectively referred to as the "Company."
First Northwest's business activities generally are limited to passive investment activities and oversight of its investments in First Fed and Quin Ventures. 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 primarily in Western Washington State with offices in Clallam, Jefferson, Kitsap, King, and Whatcom counties. These services include deposit and lending transactions that are supplemented with borrowing and investing activities.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 Fed, and its controlling interest in Quin Ventures, Inc. All material intercompany accounts and transactions have been eliminated in consolidation. While First Northwest and POM share equal ownership in Quin Ventures, it has been determined that First Northwest has a controlling interest for financial reporting purposes under Accounting Standards Codification 810. As a result, 100% of Quin Ventures balances, excluding intercompany activity, are reported in the consolidated financial statements presented. The Quin Ventures net loss allocable to POM is shown on the financial statements thorough a noncontrolling interest adjustment where applicable.
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 Fed to credit risk. First Fed 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 deposit requirement was zero at both December 31, 2022 and 2021. First Fed was in compliance with its reserve requirements at December 31, 2022 and 2021.
Investment securities - Investments in debt securities are classified into one of three categories: (1) held-to-maturity, (2) available-for-sale, or (3) trading. First Fed had no trading securities at December 31, 2022 and 2021. Investment securities are categorized as held-to-maturity when First Fed has the positive intent and ability to hold those securities to maturity. First Fed had no held-to-maturity securities at December 31, 2022 and 2021.
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 on securities without call features are recognized in interest income using the level yield method over the period to maturity. Premiums on securities with call features are amortized to the earliest call date.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
Federal Home Loan Bank stock - First Fed’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 Fed 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, 2022 and 2021, First Fed’s minimum investment requirement was approximately $11.6 million and $5.2 million, respectively. First Fed was in compliance with the FHLB minimum investment requirement at December 31, 2022 and 2021. First Fed may request redemption at par value of any stock in excess of the amount First Fed 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 Fed did not recognize an OTTI loss on its FHLB stock at December 31, 2022 and 2021.
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.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 Fed 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 Fed 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.
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 and purchased premiums - 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. We may pay a purchase premium or receive a purchase discount on fully originated loans that we purchase. Premiums and discounts are capitalized at the time of purchase and amortized as an adjustment to the yield over the contractual life using the effective interest method.
Allowance for loan losses - First Fed 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. Qualitative factors such as economic, market, industry, and political changes are also considered for calculation of the allowance. 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.
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The ultimate recovery of loans is susceptible to future market factors beyond First Fed’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 Fed’s allowance for loan losses. Such agencies may require First Fed 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 Fed 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 Fed 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.
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 Fed, for reasons related to the borrower’s financial difficulties, grants a concession to the borrower that First Fed 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 Fed 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 Fed 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.
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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 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 was subject to a TDR classification. Modifications not meeting the criteria under the CARES Act or interagency guidance to be excluded from TDR classification were evaluated under the existing TDR framework. Loans subject to forbearance under the COVID-19 loan modification program were not reported as past due or placed on non-accrual status during the forbearance time period, and interest income continued 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.
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. These properties are initially recorded at the fair market value of the property less selling costs. Properties are subsequently evaluated for impairment. In-substance foreclosed properties are those properties for which the Bank has taken physical possession, regardless of whether formal foreclosure proceedings have taken place.
Loan servicing rights - Originated servicing rights are recorded when loans are originated and subsequently sold with the servicing rights retained. Servicing assets are initially capitalized at fair value with the income statement effect recorded in gains on sales of loans. Management uses a valuation model that calculates the present value of future cash flows to determine the fair value of servicing rights. 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. For the year ended December 31, 2021, the fair value of the servicing asset was amortized into noninterest income in proportion to, and over the period of, estimated future net servicing income. Effective January 1, 2022, the Bank elected to measure servicing rights using the fair value method of accounting.
Management assesses the fair value of loan 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 loan 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.
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Sold loan servicing income represents fees earned for servicing loans. Fees for servicing sold 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 "Sold loan servicing fees" includes sold loan servicing income and changes in fair value for the year ending December 31, 2022. For years prior to 2022, it includes sold loan servicing income, amortization of loan servicing rights, the effects of sold loan servicing run-off, and impairment, if applicable.
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
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.
Equity and partnership investments - Equity investments include amounts invested in non-publicly traded stock and simple agreements for future equity ("SAFE"). Partnership investments include limited partnerships in investment funds and other business ventures. Investments in non-publicly traded stock and SAFE are measured at cost, less impairment, plus or minus changes resulting from observable price changes in ordinary transactions for the identical or similar investment of the same issuer. The recorded balance of these equity investments was $1.7 million and $500,000 at December 31, 2022 and 2021, respectively. Partnership investments that do not result in consolidation of the investee are accounted for under the equity method of accounting; the recorded balance of these partnership investments was $12.6 million and $3.1 million at December 31, 2022 and 2021, respectively. Throughout the year we assess whether impairment indicators exist to trigger the performance of an impairment analysis. Changes in the fair value of partnership investments are recorded in other noninterest income.
Goodwill - Goodwill is recorded from a business combination as the difference in the purchase price and fair value of assets acquired and liabilities assumed. Goodwill has an indefinite useful life, and as such, is not amortized. The Company reviews goodwill for impairment annually, or more frequently if an indication of impairment exists between annual tests. Any impairment will be recorded as noninterest expense and corresponding reduction in intangible asset on the consolidated financial statements.
Core deposit intangible - A core deposit intangible ("CDI") asset is recognized from the assumption of core deposit liabilities in connection with the acquisition of deposits from another financial institution. The asset is valued by a third party and is amortized into noninterest expense over its estimated useful life. The CDI is evaluated for impairment annually with any additional decline recorded as noninterest expense on the Consolidated Income Statement.
Income taxes - First Fed 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.
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 discount rate used in determining the present value is the Company's incremental borrowing rate using the FHLB fixed advance rate based on the remaining lease term as of January 1, 2019, or the commencement date for subsequent leases. 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. We have lease agreements with lease and non-lease components, which are generally accounted for separately for real estate leases.
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Low-Income Housing Tax Credit Investment - The Company has an equity investment in a Low-Income Housing Tax Credit Investment ("LIHTC") partnership which is an indirect federal subsidy that finances low-income housing projects. As a limited liability investor in this partnership, the Company receives a tax benefit in the form of a tax deduction from partnership operating losses and a federal income tax credit. The federal income tax credit is earned over a 10-year period as a result of the investment properties meeting certain criteria and is subject to recapture for noncompliance with such criteria over a 15-year period.
The Company accounts for the LIHTC under the proportional amortization method and amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance on the Consolidated Statements of Income as a component of income tax expense. The Company reports the carrying value of the equity investment in the unconsolidated LIHTC in "Prepaid expenses and other assets" on the Company’s Consolidated Balance Sheets.
The maximum exposure to loss in the LIHTC is the amount of equity invested and credit extended by the Company. The Company has evaluated the variable interests held by the Company in the LIHTC investment and determined that the Company does not have controlling financial interests in such investment and is not the primary beneficiary.
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 Fed, (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 Fed 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 Fed sells mortgage loans with "life of the loan" recourse provisions, requiring First Fed to repurchase the loan at any time if it defaults. The remaining balance of such loans at December 31, 2022 and 2021, was approximately $1.9 million and $2.0 million, respectively. Of these loans, no loans were repurchased during the years ended December 31, 2022 or 2021. There is an associated allowance of $9,000 and $11,000 at December 31, 2022 and 2021, respectively, included in "accrued expenses and other liabilities" on the consolidated balance sheets related to these loans.
Off-balance-sheet credit-related financial instruments - In the ordinary course of business, First Fed 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 Fed 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.
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Components of noninterest income evaluated under Topic 606 - The Company recognizes revenue as it is earned and noted no impact to its revenue recognition policies as a result of the adoption of ASU 2014-09. The following is a discussion of key revenues within the scope of the new revenue guidance.
Deposit fees - The Company earns fees from its deposit customers for account maintenance, transaction-based activity and overdraft services. Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit accounts on a monthly basis. The performance obligation is satisfied and the fees are recognized on a monthly basis as the service period is completed. Transaction-based fees on deposit accounts are charged to deposit customers for specific services provided to the customer, such as non-sufficient funds fees, overdraft fees, and wire fees. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer. Deposit fees are included in Service Fees on the Consolidated Statements of Income.
Debit card interchange income - Debit and Automated Teller Machine ("ATM") interchange income represent fees earned when a debit card issued by the Company is used. The Company earns interchange fees from debit cardholder transactions through card networks. In addition, the Company earns interchange fees for use of its ATMs by customers of other banking institutions. Interchange fees are based on purchase volumes and other factors and are recognized as transactions occur. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholder's debit card. Certain expenses directly associated with the credit and debit card are netted against interchange income. Debit card interchange income is included in Service Fees on the Consolidated Statements of Income.
Third-party credit card interchange income - Third-party credit card interchange income represents fees earned when a credit card issued by the Bank through a third-party vendor is used. Similar to the debit card interchange, the Bank earns an interchange fee for each transaction made with a Bank-branded credit card. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholder's credit card. Certain expenses directly related to the third-party credit card interchange contract are netted against interchange income. Third-party credit card interchange income is included in Service Fees on the Consolidated Statements of Income.
Investment services revenue - Commissions received on the sale of investment related products is determined by a percentage of underlying instruments sold and is recognized when the sale is finalized. Investment services revenue is included in Other Income on the Consolidated Statements of Income.
Gains/losses on the sale of other real estate owned are included in non-interest expense and are generally recognized when the performance obligation is complete. This is typically at delivery of control over the property to the buyer at time of each real estate closing.
Fair value measurements - Fair values of financial instruments are estimated using relevant market information and other assumptions (Note 14). 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.
Segment information - First Fed 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.
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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 and unallocated ESOP shares reduce debt and accrued interest.
Earnings per Common Share - Earnings per share ("EPS") is computed using 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. Under the two-class method, basic EPS is computed by dividing earnings allocated to common shareholders by the weighted average number of common shares outstanding for the period. Earnings allocated to common shareholders represents net income reduced by earnings allocated to participating securities. ESOP shares that are committed to be released are outstanding for EPS calculation purposes, while unallocated ESOP shares are not considered outstanding for basic or diluted EPS calculations. Diluted EPS is computed by dividing net income by the weighted average common shares outstanding plus the number of additional common shares that would have been outstanding if unvested restricted stock awards were included unless those additional shares would have been anti-dilutive. For the diluted EPS computation, the treasury stock method is applied and compared to the two-class method and whichever method results in a more dilutive impact is utilized to calculate diluted EPS.
Recently adopted accounting pronouncements
In November 2019, the FASB issued Accounting Standards Update ("ASU") 2019-10,Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates. ASU 2019-10 defers the effective date of the current expected credit loss model (CECL) guidance issued in ASUs 2016-13,2019-04, and 2019-05. The effective date for smaller reporting companies was changed from the interim and annual periods beginning after December 15, 2020 to the interim and annual periods beginning after December 15, 2022. Early adoption is permitted for interim and annual periods beginning after December 15, 2018. The Company adopted this ASU and implemented CECL effective January 1, 2023.
In January 2021, the FASB issued ASU No.2021-01,Reference Rate Reform (Topic 848): Scope. ASU No.2021-01 clarifies that certain optional expedients and exceptions in ASC 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. ASU No.2021-01 also amends the expedients and exceptions in ASC 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. This ASU was effective upon issuance and generally can be applied through December 31, 2022. The adoption of ASU 2021-01 did not have a material impact on the Company’s financial statements.
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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.
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 evaluated the provisions of ASU No.2016-13, ASU No.2019-04 and ASU No.2019-05, to determine the potential impact on the Company’s consolidated financial statements. We estimate the implementation of these ASUs will increase the combined balances for the allowance for credit losses and unfunded commitment liability 15%-30% with a related decrease to equity on the Company's consolidated balance sheet. The Company's internal project management team reviewed models, worked with our third-party vendor, and implemented changes to processes and procedures to ensure the Company was fully compliant with the amendments at the adoption date. Early adoption was permitted for interim and annual periods beginning after December 15, 2018. The Company adopted this guidance effective January 1, 2023.
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Other ASUs not yet adopted
In March 2020, FASB issued ASU No.2020-04,Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. ASU 2020-04 provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference the London Inter-Bank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. This ASU is effective for all entities as of March 12, 2020 through December 31, 2022. On December 31, 2022, FASB issued ASU 2022-06 which deferred the sunset date for Topic 848 to December 31, 2024. The Company is implementing a transition plan to identify and modify its loans and other financial instruments that are either directly or indirectly influenced by LIBOR. The Company continues to evaluate ASU No.2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments, with no material expected impact on the Company's financial statements.
In March 2022, FASB issued ASU No.2022-01,Derivatives and Hedging (Topic815): Fair Value Hedging—Portfolio Layer Method. This update will allow non-prepayable financial assets to be included in a closed portfolio hedge using the portfolio method, rather than only prepayable assets. It also allows entities to hedge multiple layers rather than just a single layer of closed portfolio of financial assets or one or more beneficial interests secured by a portfolio of financial instruments. This ASU, which is effective for fiscal years beginning after December 15, 2022, is not expected to have a material impact on the Company's financial statements.
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 at December 31, 2022, are summarized as follows:
(In thousands)
Available for Sale
International agency issued bonds (Agency bonds) 1,955 — (253 ) 1,702
Corporate issued debt securities (Corporate debt) 60,700 — (5,201 ) 55,499
Mortgage-Backed Securities:
The amortized cost, gross unrealized gains and losses, and estimated fair value of securities classified as available-for-sale at December 31, 2021, 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, 2022:
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, 2021:
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, 2022, there were 182 investment securities with $48.6 million of unrealized losses and a fair value of approximately $323.8 million. At December 31, 2021, there were 76 investment securities with $2.5 million of unrealized losses and a fair value of approximately $156.4 million.
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Management believes that the unrealized losses on investment securities relate principally to the general change in interest rates and poor market liquidity, and not to changes in credit quality, that has occurred since the initial purchase. These 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, 2022 and 2021.
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:
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)
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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 (15,957 ) (12,995 )
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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 Fed 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, 2022
(In thousands)
ALLL:
Charge-offs — — — — — (1,025 ) — — (1,025 )
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FIRST NORTHWEST BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands)
Specific reserve 22 — — 1 4 5 — — 32
(1) Loans collectively evaluated for general reserves.
(2) Loans individually evaluated for specific reserves.
At or For the Year Ended December 31, 2021
(In thousands)
ALLL:
Charge-offs — — — — (12 ) (865 ) — — (877 )
(In thousands)
(1) Loans collectively evaluated for general reserves.
(2) Loans individually evaluated for specific reserves.
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FIRST NORTHWEST BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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:
Commercial real estate 50 149 — 60 —
Construction and land — 14 — 437 1
Home equity — — — 2 —
Auto and other consumer — 2 — 184 2
With an allowance recorded:
Commercial real estate — — — 5 —
Total impaired loans:
Commercial real estate 50 149 — 65 —
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FIRST NORTHWEST BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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:
Multi-family — — — 94 —
Construction and land — 24 — — —
Auto and other consumer — 77 — 29 7
With an allowance recorded:
Commercial real estate — — — 121 —
Total impaired loans:
Multi-family — — — 94 —
Interest income recognized on a cash basis on impaired loans for the years ended December 31, 2022 and 2021, was $141,000 and $162,000, respectively.
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