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. Non-banking investments include several limited partnership investments, including a 33% interest in The Meriwether Group, LLC ("MWG"). The Company's business activities are generally focused on passive investment activities and oversight of the activities of First Fed. 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 commercial bank serving Clallam, Jefferson, King, Kitsap, and Whatcom counties in Washington State, through its twelve full-service branches, three business centers and three administration centers. We offer a wide range of products and services focused on the lending, deposit and money movement needs of the communities we serve. To diversify our portfolio and increase interest income, we increased our origination of commercial real estate, multi-family real estate, and commercial business loans. We also increased our auto and consumer loans through originations, purchased auto loan programs, and purchased manufactured homes. We continue to originate one-to-four family residential mortgage loans, primarily for sale into the secondary market to generate noninterest gain on sale and servicing fee revenue and manage interest rate risk, or retain select loans in our portfolio to enhance interest income. Home equity, residential construction and commercial construction loans are also originated primarily in Western Washington. 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 policy, including fiscal stimulus, interest rate policy and open market operations, housing, and consumer protection. Deposit flows are influenced by various factors, including changes in market rates; sales and marketing efforts; interest rates paid by competitors; available alternative investments such as money market mutual funds, 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 both regional and national 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 impact 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, earnings from equity and partnership investments, and gains and losses from the sale of loans and securities.
An offset to net interest income is the provision for credit losses, which represents the periodic charge to operations required to adequately provide for probable losses inherent in our loan, unfunded commitments and investment portfolios through our allowance for credit losses. A recapture of previously recognized provision for credit losses may be added to net interest income if forecasted macroeconomic factors improve, underlying balances decrease, or recoveries of amounts previously charged off are received.
The noninterest expenses incurred in operating our business consist of salaries and employee benefit costs, occupancy and equipment expenses, professional fees, 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 growing and diversifying our loan portfolio, expanding our deposit product offerings, and enhancing our digital 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. Below are strategies we have implemented, or intend to implement, 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.
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The following represent our critical accounting policies:
Allowance for Credit Losses on Loans. The allowance for credit losses on loans ("ACLL") is a valuation account that is deducted from the amortized cost of loans receivable to present the net amount expected to be collected. The allowance is established through the provision for credit losses on loans, which is charged to income. Determining the amount of the ACLL necessarily involves a high degree of judgment. Management has adopted a discounted cash flow ("DCF") methodology for most of its segments to calculate the ACLL. For certain segments with smaller portfolios or where data is prohibitive to running a DCF calculation, management has elected to use a remaining life methodology. The Company also uses established metrics to estimate qualitative risk factors by segment based on the identified risk. The Company evaluates individual loans for expected credit losses when those loans do not share similar risk characteristics with loans evaluated using a collective (pooled) basis using either a collateral value or cash flow method. All of the factors used in these methodologies are susceptible to significant change. Management reviews and approves, at least quarterly, the level of the allowance and the provision for credit losses on loans based on anticipated future 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 credit losses on loans, future economic or other conditions may differ substantially from the assumptions used in making the evaluation. The FDIC and the DFI, as an integral part of their examination process, periodically review our ACLL 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 credit losses on loans to replenish the allowance, which would adversely affect earnings. Management considers the ACLL to be a critical accounting estimate. Our accounting policies are discussed in detail in Notes 1 and 4 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. Servicing rights are measured at fair value at each reporting date with the change reported in earnings. 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, 7 and 15 to the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" of this Form 10-K.
Income Taxes. Management makes estimates and judgments to calculate certain tax liabilities and to determine the recoverability of certain deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. We also estimate a valuation allowance for deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. These estimates and judgments are inherently subjective. In evaluating the recoverability of deferred tax assets, management considers all available positive and negative evidence, including past operating results, recent cumulative losses - both capital and operating - and the forecast of future taxable income, both capital gains and operating. In determining future taxable income, management makes assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require judgments about future taxable income and are consistent with the plans and estimates to manage our business. Any reduction in estimated future taxable income may require us to record a valuation allowance against deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on future earnings.
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.
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Comparison of Financial Condition at December 31, 2023 and December 31, 2022
Assets. Total assets increased $159.7 million, or 7.8%, to $2.2 billion at December 31, 2023, from $2.04 billion at December 31, 2022.
Total loans, excluding loans held for sale, increased $112.5 million, or 7.3%, during the year ended December 31, 2023. Multi-family and commercial real estate loans increased $79.5 million, or 12.4%, consisting mainly of an increase in multi-family real estate loans of $80.4 million as a result of new originations and $38.4 million of construction loans converting into permanent amortizing loans. Commercial real estate loans decreased $901,000 as payment activity exceeded new loan originations of $39.7 million and $10.1 million from construction loans converting into permanent amortizing loans. Auto and other consumer loans increased $10.2 million, or 4.3%, with the purchase of a pool of manufactured home loans as well as purchases of individual manufactured home loans and specialty auto loans. Commercial business loans increased $35.4 million primarily due to an increase in the Northpointe Bank Mortgage Participation Program of $9.5 million and purchases of $15.9 million of unsecured Bankers Healthcare Group loans in addition to advances on new and existing lines of credit and originations of amortizing commercial loans.
One-to-four family residential loans increased $34.9 million, or 10.2%, with $64.7 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 $64.0 million, or 33.0%, with $118.2 million converting into fully amortizing loans partially offset by draws on new and existing commitments. Undisbursed construction commitments totaled $55.4 million at December 31, 2023 compared to $120.7 million at December 31, 2022. Undisbursed construction commitments at December 31, 2023 included $27.9 million of mainly custom one-to-four family residential construction, $22.1 million of multi-family construction, and $5.5 million of commercial real estate construction. Our construction loans are geographically disbursed throughout the state of Washington with one commitment for a property in Oregon. We manage our construction lending primarily 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.
During the year ended December 31, 2023, the Company originated $221.9 million of loans, of which $156.9 million, or 70.80%, were originated in the Puget Sound region; $55.9 million, or 25.20%, in the Olympic Peninsula region; $5.7 million, or 2.60%, in other areas in Washington; and $3.5 million, or 1.60%, in other states. The Company also purchased loans totaling $83.1 million with the largest concentration of these loans located in California.
Loans receivable, excluding loans held for sale, consisted of the following at the dates indicated:
(In thousands)
Real Estate:
Consumer:
Less:
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Our allowance for credit losses on loans increased $1.4 million, or 8.6%, during the year ended December 31, 2023, as a result of our transition from the incurred loss model to CECL and loan growth. Asset quality declined with increases in past due, nonaccrual and classified assets compared to the total loan portfolio. Management continues to closely monitor economic conditions for potential weaknesses that could expose the loan portfolio to losses. The allowance for credit losses on loans as a percentage of total loans was 1.05% at December 31, 2023 and 1.04% at December 31, 2022. We believe our allowance for credit losses on loans is adequate to cover inherent losses in the loan portfolio.
Nonperforming loans increased $16.9 million, or 939.8%, during the year ended December 31, 2023 to $18.6 million. This increase was mainly the result of increases in nonperforming commercial construction of $15.0 million, one-to-four family of $890,000, commercial business of $877,000 and auto and other consumer of $211,000, partially offset by decreases in home equity loans of $73,000 and commercial real estate of $25,000. Nonperforming loans to total loans was 1.12% at December 31, 2023, an increase from 0.12% at December 31, 2022.
At December 31, 2023, 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 $18.2 million, or 107.7%, to $35.1 million at December 31, 2023, from $16.9 million at December 31, 2022. The change in classified loans was mainly the result of a downgrade of a commercial loan relationship totaling $9.3 million involving several commercial real estate and business loans along with downgrades of a $3.6 million SBA loan and a $104,000 commercial business loan during the fourth quarter of 2023. A $15.0 million construction loan, which became a classified loan in the fourth quarter of 2022, and the $9.3 million commercial loan relationship account for 69% of the classified loan balance at December 31, 2023. The Bank continues to work with its borrowers to facilitate satisfactory repayment.
Cash and cash equivalents increased by $77.6 million, or 170.1%, to $123.2 million as of December 31, 2023, compared to $45.6 million at December 31, 2022, as a portion of the proceeds from the sale of investment securities in the fourth quarter of 2023 were held in interest-bearing cash.
Total investment securities decreased $31.0 million, or 9.5%, to $295.6 million at December 31, 2023, from $326.6 million at December 31, 2022. The year-over-year decrease was the result of sales and normal amortization during the year, partially offset by purchases and an improved portfolio market value. During 2023, we repositioned the investment portfolio by selling $44.8 million of available-for-sale securities yielding 2.4% for a total loss of $5.4 million during the period, and purchased $21.1 million of available-for-sale securities yielding 6.7%. The decrease in unrealized loss of $10.3 million relates mainly to a $5.4 million improvement in unrealized losses driven by a decrease in long-term interest rates and $4.9 million of realized losses related to the securities sale.
The estimated average life of the total investment securities portfolio was 7.7 years as of December 31, 2023, compared to 8.2 years as of December 31, 2022, and the average repricing term was approximately 6.3 years as of December 31, 2023, compared to 7.1 years as of December 31, 2022, based on the interest rate environments at those times. Expected duration of the portfolio has decreased to 4.8 years as of December 31, 2023, compared to 5.1 years as of December 31, 2022. 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 $139.3 million at December 31, 2023, a decrease of $29.6 million, or 17.5% from $169.0 million at December 31, 2022. Municipal bonds are the second largest segment, totaling $87.8 million at December 31, 2023, a decrease of $10.3 million, or 10.5%, from $98.1 million at December 31, 2022. The sale of investment securities during the fourth quarter of 2023 resulted in a shift in the investment mix from mortgage-backed securities, municipal bonds and U.S. Treasury notes toward more U.S. agency and corporate asset-backed securities. Other investment securities totaled $68.5 million at December 31, 2023, an increase of $9.0 million, or 15.0% from $59.6 million at December 31, 2022.At December 31, 2023, the investment portfolio contained 52.0% of amortizing securities, compared to 50.8% at December 31, 2022. 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 may purchase investment securities as a source of additional interest income and in lieu of carrying higher cash balances. 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 to $14.8 million at December 31, 2023, compared to $14.3 million at December 31, 2022, from contributions to existing commitments totaling $608,000 during 2023. Prepaid expenses and other assets decreased $1.5 million to $26.9 million at December 31, 2023, compared to $28.3 million one year ago. The decrease was mainly due to the $1.5 million write-off of the Quil commitment receivable in the fourth quarter of 2023, when the Company determined that Quil was no longer a going concern. Net deferred tax assets decreased $1.0 million from the prior year end as a result of an increase in the fair market value of the investment portfolio.
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Liabilities. Total liabilities increased $154.7 million, or 8.2%, to $2.04 billion at December 31, 2023, from $1.88 billion at December 31, 2022, with increases in deposits and borrowings used mainly to fund loan growth.
Deposit account balances increased $112.6 million, or 7.2%, to $1.68 billion at December 31, 2023 from $1.56 billion at December 31, 2022. Money market accounts decreased $110.8 million and transaction accounts decreased $87.1 million, while savings accounts increased $41.2 million. Retail CDs increased $195.6 million, or 78.9%, to $443.4 million and Brokered CDs increased $73.8 million, or 55.1%, to $207.6 million at December 31, 2023. We believe the current rate environment contributed to greater competition for deposits across the industry during 2023. Our focus continues to be on increasing core customer deposits, with an emphasis on small-to-medium sized business deposits, and maintaining a stable source of funding to reduce interest expense as a percentage of liabilities.
Borrowings increased $35.6 million, or 12.5%, to $320.9 million at December 31, 2023, from $285.4 million at December 31, 2022, as the Bank utilized FHLB overnight funds to maintain on balance sheet liquidity.
Equity. Total shareholders' equity increased $1.8 million, or 1.1%, to $163.3 million at December 31, 2023, from $161.6 million at December 31, 2022. The increase during the year resulted from a $7.9 million reduction in accumulated other comprehensive loss related to an improved unrealized market value of available for sale securities, net of tax, net income of $2.3 million, and an increase of $2.1 million related to share-based compensation plans. These increases were partially offset by a one-time decrease of $3.0 million upon the adoption of CECL, $2.7 million in dividends paid in 2023 and share repurchases of $1.1 million. During the year ended December 31, 2023, we repurchased 87,895 shares of common stock at an average cost of $12.95 per share, pursuant to the Company's 2020 stock repurchase plan.
Comparison of Results of Operations for the Years Ended December 31, 2023 and 2022
General. The Company generated a return on average assets of 0.11%, and a return on average equity of 1.43%, for the year ended December 31, 2023, compared to 0.79% and 9.09%, respectively, for the year ended December 31, 2022. Net income decreased $13.4 million, or 85.4%, compared to 2022. Net interest income declined as increases to interest expense outpaced increases to interest income. Noninterest income was down due to a loss on sale of securities of $5.4 million as well as lower loan and deposit fee, servicing rights and loan sale income. Noninterest expense was lower due to decreased compensation, advertising, data processing, and occupancy expenses. We earned $0.26 per common and diluted share for the year ended December 31, 2023, compared to $1.71 per common and diluted share for the year ended December 31, 2022. The decrease in earnings per share was the result of the decrease in net income as the Bank recognized a loss on sale of securities to reposition the portfolio by paying down higher cost funding and investing in higher yielding loans and securities.
Net Interest Income. Net interest income decreased $8.4 million, or 12.1%, to $61.4 million for the year ended December 31, 2023, from $69.9 million for the year ended December 31, 2022, mainly as the result of additional interest expense related to higher costs on both deposit and advance balances as well as an increase in the average balances of CDs and advances.
The increase in interest income was largely attributable to changes in loans receivable with an average balance increase of $145.5 million, at an average yield of 5.31%, for the year ended December 31, 2023 compared to an average yield of 4.74%, for the year ended December 31, 2022. The interest income earned from higher yields was offset by higher interest-bearing liability costs which increased to 2.42% for the year ended December 31, 2023 compared to 0.73% for the year ended December 31, 2022. This resulted in a 66 basis point decrease in our net interest margin to 3.13% for the year ended December 31, 2023, from 3.79% for the year ended December 31, 2022.
The $1.8 million net increase in interest income from the volume of interest earning assets was offset by the net increase in interest costs of $10.3 million as changes in rates outpaced increases in yields. As noted above, loans receivable was the main contributor to the increase in interest income with $6.9 million due to an increase in average volume and $9.1 million due higher rates. The increase to the cost of average interest-bearing liabilities for the year ended December 31, 2023 was due primarily to costs from higher rates paid of $24.6 million and increased average balances of $4.3 million on advances, certificates of deposit and money market accounts.
Interest Income. Interest income increased $20.5 million, or 25.5%, to $100.9 million for the year ended December 31, 2023 from $80.4 million for the comparable period in 2022, primarily due to an increase in the average balance of and higher yields on loans receivable. Interest and fees on loans receivable increased $16.0 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 $2.4 million to $13.3 million for the year ended December 31, 2023, compared to $10.9 million for the year ended December 31, 2022. The increase in interest income on investment securities was driven by an increase in the average yield during the year of 108 basis points due to the repricing of variable rate securities and slower prepayment activity reducing 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 $29.0 million, or 275.3%, for the year ended December 31, 2023, compared to the prior year, with increases in borrowing costs and deposit costs of $7.1 million and $21.8 million, respectively. Borrowing costs increased 207 basis points, mainly due to higher rates paid on overnight and short-term borrowings, combined with an increase of $86.0 million in the average balance outstanding. Deposit costs increased due to higher funding costs and an increase of $116.8 million in the average balance of interest-bearing deposits, as we utilized brokered certificates of deposits. The average cost of all interest-bearing deposit products increased 159 basis points to 2.01% for the year ended December 31, 2023 from 0.42% for the year ended December 31, 2022. The average balances of savings and CD accounts increased year-over-year, while lower cost transaction and money market average account balances declined.
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 Credit Losses. The total provision for credit losses decreased $212,000 to $1.3 million during the year ended December 31, 2023, compared to $1.5 million for 2022. A recapture of provision for credit losses on unfunded commitments due to the significant decrease in unfunded construction loan commitments from the initial balance recorded upon the adoption of CECL on January 1, 2023, was recorded during 2023. A higher provision for credit losses on loans compared to 2022 is reflective of loan growth, a change to the life-of-loan loss methodology and an increase in net charge-offs during 2023, which partially offset the unfunded commitments recapture.
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The following table details activity and information related to the allowance for credit losses on loans and reserve for unfunded commitments for the periods shown:
Year Ended December 31,
(Dollars in thousands)
Provision for credit losses on loans $ 2,357 $ 1,535
Charge offs net of recoveries (3,172 ) (543 )
Recapture of provision for credit losses on unfunded commitments $ (1,034 ) $ —
Reserve for unfunded commitments 817 325
Noninterest Income. Noninterest income decreased 61.1% to $4.0 million for the year ended December 31, 2023, from $10.3 million for the year ended December 31, 2022. The decrease compared to the prior year was primarily due to a $5.4 million loss on sale of investment securities during 2023. One-time increases to other income include a gain on sale of Visa, Inc. Class B common stock of $470,000 and $950,000 received from the Splash loan program as a partial reimbursement of program losses incurred by the Bank during 2023. Saleable mortgage loan production and related gains continued to be impacted by higher market rates on mortgage loans compared to the prior year. Fee income in 2023 was impacted by a decrease in late fees on commercial loans. In 2022, a one-time increase was recorded for a BOLI death benefit payment of $1.5 million.
The following table provides an analysis of the changes in the components of noninterest income for the periods shown:
Year Ended December 31, Increase (Decrease)
(Dollars in thousands)
Noninterest Expense. Noninterest expense decreased to $61.5 million for the year ended December 31, 2023, from $62.3 million for the year ended December 31, 2022. The year-over-year decrease reflects lower compensation expense, primarily due to lower Bank commissions, payroll taxes, and medical insurance expenses along with a $1.5 million reduction related to Quin Ventures compensation. Other one-time noninterest expenses recorded during 2023 included the Quil commitment receivable write-off of $1.5 million, a write-off of Fannie Mae and Freddie Mac investor accounting related items totaling $725,000, and an accrual for a civil money penalty proposed by the FDIC of $718,000. The FDIC proposed assessing a civil money penalty in connection with the concerns detailed in a consent order entered into by the Bank during 2023.
Quin Ventures non-compensation expenses included for the year ended December 31, 2023, totaled $320,000 compared to $2.7 million in the year ended December 31, 2022, as a result of decreases in advertising, depreciation and data processing expenses. The full amount of Quin Ventures activity was reported in noninterest income and noninterest expense under the controlling interest method of accounting. The proportional noncontrolling interest amount was then subtracted from net income. This resulted in noncontrolling interest net losses of $160,000 and $2.1 million being added back to net income for the years ended December 31, 2023 and 2022, respectively.
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The following table provides an analysis of the changes in the components of noninterest expense for the periods shown:
Year Ended December 31, Increase (Decrease)
(Dollars in thousands)
Provision for Income Tax. The provision for income tax for the year ended December 31, 2023, was $549,000 compared to $2.9 million for the year ended December 31, 2022, reflecting differences in pre-tax income. The effective tax rate increased over the prior year as a result of the permanent tax exclusion of BOLI noninterest income, including the BOLI death benefit, in 2022.
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Average Balances, Interest and Average Yields/Cost
The following table sets 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, 2023 and 2022. Income and all average balances are daily average balances. Nonaccrual loans have been included in the table as loans carrying a zero yield.
Year Ended December 31,
Interest-earning assets: (Dollars in thousands)
Interest-bearing liabilities:
Other noninterest-bearing liabilities 37,967 36,666
Net interest rate spread 2.71 3.63
(1) The average loans receivable, net balances include nonaccrual loans.
(2) Interest earned on loans receivable includes net deferred costs of $561,000 for the year ended December 31, 2023, and net deferred fees of $1.7 million, including $377,000 of deferred fee income from SBA Paycheck Protection Plan loans, for the year ended December 31, 2022.
(3) Includes interest-bearing deposits at other financial institutions.
(4) Cost of all deposits, including noninterest-bearing demand deposits, was 1.66% and 0.33% for the years ended December 31, 2023 and 2022.
(5) Net interest income divided by average interest-earning assets.
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Rate/Volume Analysis
The following table presents 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 component, 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.
Increase (Decrease) Due to Total Increase
Volume Rate (Decrease)
(In thousands)
Interest-earning assets:
Interest-bearing liabilities:
Interest-bearing demand deposits $ (15 ) $ 674 $ 659
Subordinated debt, net 1 — 1
(1) Includes net deferred fee income.
(2) 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.
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, 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.
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.
The Bank employs 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 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 400 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 Bank's balance sheet became more liability sensitive in 2023 due to slower loan prepayment speeds, driven by higher interest rates and deposit migration from non-maturity deposits to certificates of deposits with shorter average lives.
The following table presents the change in the present value of First Fed’s equity at December 31, 2023, 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, 2023, is as follows:
Basis Point Change Projected Net Interest Income
in Interest Rates $ Amount $ Change % Change
(Dollars in thousands)
Management makes assumptions about 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 our analysis. 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 forgoing the table.
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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, 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 holdings of 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, 2023, cash and cash equivalents totaled $123.2 million and securities classified as available-for-sale had a market value of $295.6 million. We have pledged loan collateral with principal balances totaling $896.2 million to support borrowings from the FHLB of $275.0 million, with a remaining borrowing capacity of $589.5 million. We have also pledged collateral of $6.6 million and $15.2 million, respectively, to the Federal Reserve Bank of San Francisco to secure discount window and Bank Term Funding Program advances; the Company has performed periodic borrowing tests on these lines with the Federal Reserve; however, no such funds were borrowed as of December 31, 2023. First Northwest maintains a $20.0 million line of credit with NexBank, with an available borrowing capacity of $13.5 million at year end, 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, 2023, we had $220,000 in loan commitments outstanding and an additional $148.2 million in undisbursed loans, including undisbursed construction commitments, and standby letters of credit. The Company also had unfunded partnership commitments totaling $3.7 million.
Customer CDs due within one year as of December 31, 2023, totaled $349.4 million, or 53.7% of total CDs. Brokered CDs due within one year as of December 31, 2023, totaled $146.2 million, or 22.5% of total CDs. Management believes a significant portion of our customer CDs 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 seek other sources of funds, which may include borrowings and brokered deposits. We also 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. Depending on market conditions, we may pay higher rates on borrowings or brokered deposits than we currently pay on standard certificates of deposit or promotional rate offerings. However, rates on these sources of funds may also be less than what the market demands for customer deposits. We believe relationships 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 sufficient short- and 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 60% of deposit account balances held by consumers, 28% held by business and public fund depositors, and 12% in brokered deposits. The average deposit account balance, excluding brokered and public fund accounts, was $27,000 at December 31, 2023. We estimate that 20-25% of our retail customer deposit balances are over the $250,000 FDIC insurance limit, representing less than 5% of deposit customers. Management believes that maintaining a diversified deposit base is an important factor in managing liquidity.
The Company is a separate legal entity from the Bank and relies on dividends from its subsidiary, First Fed Bank, the NexBank line of credit and future investment redemptions for liquidity to pay its operating expenses and other financial obligations. At December 31, 2023, the Company (on an unconsolidated basis) had liquid assets of $500,000.
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, 2023, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows.
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Commitments and Off-Balance Sheet Arrangements
The following table summarizes our commitments and contingent liabilities with off-balance sheet risks as of December 31, 2023:
Amount of Commitment Expiration
(In thousands)
Commitments to originate loans:
Fixed-rate loans $ 220 $ — $ — $ — $ 220
Unfunded commitments under existing maritime loans — — — 1,650 1,650
Standby letters of credit — — — 200 200
Unfunded commitments under partnership agreements 3,659 — — — 3,659
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 12 of the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data," of this Form 10-K for additional information regarding First Northwest Bancorp and First Fed’s regulatory capital requirements.
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, 2023, 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, 2023, the Bank and consolidated Company exceeded all regulatory capital requirements, and the Bank was considered "well capitalized" under FDIC regulatory capital guidelines.
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The following table provides the capital requirements and actual results at December 31, 2023.
Actual Minimum Capital Requirements Minimum Required to be Well-Capitalized
Amount Ratio Amount Ratio Amount Ratio
(Dollars in thousands)
Tier I leverage capital (to average assets)
Common equity tier I (to risk-weighted assets)
Tier I risk-based capital (to risk-weighted assets)
Total risk-based capital (to risk-weighted assets)
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data presented in this report have been prepared according to generally accepted accounting principles in the United States, which require the measurement of financial and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs and the effect that general inflation may have on both short-term and long-term interest rates. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than do general levels of inflation. Although inflation expectations do affect interest rates, interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
Recent Accounting Pronouncements
See Note 1 of the Notes to Consolidated Financial Statements contained in Item 8, "Financial Statements and Supplementary Data," of this Form 10-K.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information contained under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk and Asset and Liability Management" of this Form 10-K is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements Page
Notes to Consolidated Financial Statements 88
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Report of Independent Registered Public Accounting Firm
The Shareholders and Board of Directors
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, 2023 and 2022, 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, 2023 and 2022, 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.
Change in Accounting Principle
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for credit losses effective January 1, 2023, due to the adoption of Accounting Standards Codification Topic 326, Financial Instruments - Credit Losses (Topic 326). The Company adopted the new credit loss standard using the modified retrospective approach such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles. The new credit loss standard is also communicated a a critical audit matter below.
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.
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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.
Allowance for Credit Losses on Loans
As described in Notes 1 and 4 to the consolidated financial statements, the Company's consolidated allowance for credit losses on loans (ACLL) balance was $17.5 million at December 31, 2023. The ACLL is a valuation account that is deducted from the amortized cost of loans receivable to present the net amount expected to be collected. Management's estimate of the ACLL uses relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.
We identified management’s application of historical losses including reasonable and supportable forecasts of future economic conditions in the discounted cash flow model, and management’s estimation of qualitative risk factors, which are both components of the ACLL calculation, as a critical audit matter. Baseline loss rates are calculated using peer institution data related to historical losses. Historical losses are adjusted for management’s consideration of the forecasted direction of the economic and business environment. The Company also considers other qualitative risk factors to adjust the estimated ACLL.
The primary procedures we performed to address this critical audit matter included:
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/s/ Moss Adams LLP
Everett, Washington
March 15, 2024
We have served as the Company's auditor since 2002.
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FIRST NORTHWEST BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
ASSETS
Investment securities available for sale, at fair value 295,623 326,569
Federal Home Loan Bank (FHLB) stock, at cost 13,664 11,681
Servicing rights on sold loans, at fair value 3,793 3,887
Goodwill and other intangible assets 1,086 1,089
LIABILITIES AND SHAREHOLDERS' EQUITY
Accrued expenses and other liabilities 35,973 32,344
Advances from borrowers for taxes and insurance 1,260 1,376
Commitments and Contingencies (Note 14)
Shareholders' Equity
Accumulated other comprehensive loss, net of tax (32,636 ) (40,543 )
Unearned employee stock ownership plan (ESOP) shares (7,253 ) (7,913 )
Noncontrolling interest in Quin Ventures, Inc. — (3,291 )
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 $ 84,614 $ 68,635
Interest-bearing deposits and other 2,126 375
INTEREST EXPENSE
PROVISION FOR CREDIT LOSSES
Provision for credit losses on loans 2,357 1,535
Recapture of provision for credit losses on unfunded commitments (1,034 ) —
Net interest income after provision for credit losses 60,109 68,328
NONINTEREST INCOME
Sold loan servicing fees and servicing rights mark-to-market 676 867
Net gain on sale of loans 438 824
Net (loss) gain on sale of investment securities (5,397 ) 118
Increase in cash surrender value of bank-owned life insurance, net 928 916
Income from death benefit on bank-owned life insurance, net — 1,489
NONINTEREST EXPENSE
Supplies, postage, and telephone 1,433 1,376
Regulatory assessments and state taxes 1,635 1,539
Income before provision for income taxes 2,675 16,343
Provision for income taxes 549 2,847
Net income attributable to parent $ 2,286 $ 15,645
Basic and diluted earnings per common share $ 0.26 $ 1.71
See accompanying notes to the consolidated financial statements.
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
For the Year Ended December 31,
Other comprehensive income (loss):
Net actuarial gains (losses) on defined benefit ("DB") plan assets 397 (509 )
Amortization of unrecognized DB plan prior service cost 150 147
Unrealized holding losses on derivatives (1,054 ) —
Income tax benefit related to unrealized holding losses on derivatives 226 —
Other comprehensive income (loss), net of tax 7,907 (40,831 )
Comprehensive income (loss) attributable to parent $ 10,193 $ (25,186 )
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 22,470 — — —
Restricted stock awards canceled (21,302 ) — (392 ) — (392 )
Other comprehensive loss, net of tax (40,831 ) (40,831 )
Reclassification resulting from change in accounting method, net of tax 425 425
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 )
Restricted stock award grants net of forfeitures 16,856 — — —
Restricted stock awards canceled (20,666 ) — (280 ) (280 )
Other comprehensive income, net of tax 7,907 7,907
Close out investment in Quin Ventures (3,451 ) 3,451 —
ESOP shares committed to be released 32 660 692
Cash dividends declared and paid ($0.28 per share) (2,700 ) (2,700 )
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 $ 2,126 $ 13,496
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization 1,612 1,960
Amortization of core deposit intangible 3 94
Amortization of debt issuance costs 78 78
Change in fair value of sold loan servicing rights 243 (13 )
Additions to servicing rights on sold loans, net (149 ) (54 )
Provision for credit losses on loans 2,357 1,535
Recapture of provision for credit losses on unfunded commitments (1,034 ) —
Deferred federal income taxes, net 134 (1,529 )
Allocation of ESOP shares 692 673
Share-based compensation expense 1,413 1,601
Gain on sale of loans, net (438 ) (824 )
Loss (gain) on sale of securities available for sale, net 5,397 (118 )
Increase in cash surrender value of life insurance, net (928 ) (916 )
Income from death benefit on bank-owned life insurance, net — (1,489 )
Origination of loans held for sale (25,612 ) (25,926 )
Change in assets and liabilities:
Increase in accrued interest receivable (1,151 ) (1,454 )
Decrease (increase) in prepaid expenses and other assets 1,293 (3,938 )
Increase in accrued interest payable 2,941 62
Increase in accrued expenses and other liabilities 2,270 3,104
Net cash provided by operating activities 17,875 15,902
Cash flows from investing activities:
Purchase of securities available for sale (20,330 ) (78,409 )
Proceeds from sales of securities available for sale 40,619 12,685
Early surrender of bank-owned life insurance policy 15 —
Purchase of premises and equipment, net (1,571 ) (2,914 )
Capital contributions to equity investments (608 ) (7,364 )
Capital disbursements from equity and partnership agreements 759 —
Capital contributions to historic tax credit partnerships — (1,829 )
Net cash used by investing activities (84,194 ) (237,647 )
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 increase (decrease) in deposits $ 112,637 $ (16,325 )
Proceeds from long-term FHLB advances 15,000 —
Repayment of long-term FHLB advances (15,000 ) —
Net (decrease) increase in line of credit (5,500 ) 12,000
Restricted stock awards canceled (280 ) (392 )
Repurchase of common stock (1,149 ) (5,439 )
Net increase (decrease) in cash and cash equivalents 77,573 (80,420 )
Cash and cash equivalents at beginning of period 45,596 126,016
Cash and cash equivalents at end of period $ 123,169 $ 45,596
Supplemental disclosures of cash flow information:
Cash paid for interest on deposits and borrowings $ 36,526 $ 10,453
Supplemental disclosures of noncash investing activities:
Change in unrealized loss on securities available for sale $ 10,287 $ (51,322 )
Change in unrealized loss on fair value hedge (1,054 ) —
Lease liabilities arising from obtaining right-of-use assets 152 —
Investment in Meriwether Group, LLC acquired through issuance of shares — 1,869
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, 2023, First Northwest had allocated 439,174 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. ("Quil"), 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 valued at $225,000 and recorded a $1.5 million commitment receivable. In June 2023, First Northwest determined that Quin Ventures was no longer a going concern. The Company wrote off the remaining investment in Quin Ventures through retained earnings in accordance with applicable non-controlling interest accounting methods. The noncontrolling interest in Quin Ventures balance was moved to retained earnings, with no change to total shareholders' equity as a result of the transaction. In December 2023, the Company determined that Quil was no longer a going concern, making the collectability of the receivable from and investment in Quil unlikely. As result, the related investment of $225,000 and commitment receivable of $1.5 million were written off during the fourth quarter of 2023, impacting other noninterest income and other noninterest expense, respectively.
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 and the Bank are collectively referred to as the "Company." For periods prior to June 30, 2023, Company references also include Quin Ventures.
First Northwest's business activities generally are limited to passive investment activities and oversight of its investments in First Fed and former controlling interest in Quin Ventures. Accordingly, the information set forth in this report, including the consolidated financial statements and related data, relates primarily to the Bank for balance sheet related disclosures and the Bank and Quin Ventures for income statement related disclosures.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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 credit losses, fair value of financial instruments, deferred tax assets and liabilities, and the valuation of collateral dependent 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 former controlling interest in Quin Ventures, Inc. All material intercompany accounts and transactions have been eliminated in consolidation. Through June 2023, First Northwest and POM shared equal ownership in Quin Ventures; however, it was previously determined that First Northwest had 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.
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, 2023 and 2022. First Fed was in compliance with its reserve requirements at December 31, 2023 and 2022.
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, 2023 and 2022. 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, 2023 and 2022.
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 the need for an allowance for credit losses on investment securities ("ACLI") on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For investment securities available for sale in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before the recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For investment securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACLI is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any decline in fair value that has not been recorded through an ACLI is recognized in other comprehensive income (loss). Changes in the ACLI are recorded as provision, or recapture of provision, for credit losses expense. Losses are charged against the allowance when management believes the uncollectibility of an investment security available for sale is confirmed or when either of the criteria regarding intent or requirement to sell is met. Accrued interest receivable on investment securities available for sale is excluded from the estimate of credit losses as interest accrued, but not received, is reversed timely in accordance with the policy for investment securities 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, 2023 and 2022, First Fed’s minimum investment requirement was approximately $13.7 million and $11.7 million, respectively. First Fed was in compliance with the FHLB minimum investment requirement at December 31, 2023 and 2022. 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 a loss on its FHLB stock at December 31, 2023 and 2022.
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 credit losses on loans (ACLL) and any deferred fees or costs. Interest on loans is calculated using the simple interest method based on the month end balance of the principal amount outstanding and is credited to income as earned. The estimated life is adjusted for prepayments.
Each loan segment and class inherently contains differing credit risk profiles depending on the unique aspects of that segment or class of loans. For example, borrowers tend to consider their primary residence and access to transportation for employment-related purposes as basic requirements; accordingly, many consumers prioritize making payments on real estate first-mortgage loans and vehicle loans. Conversely, second-mortgage real estate loans or unsecured loans may not be supported by sufficient collateral; thus, in the event of financial hardship, borrowers may tend to place less importance on maintaining these loans as current and the Bank may not have adequate collateral to provide a secondary source of repayment in the event of default. Notwithstanding the various risk profiles unique to each class of loan, management believes that the credit risk for all loans is similarly dependent on essentially the same factors, including the financial strength of the borrower, the cash flow available to service maturing debt obligations, the condition and value of underlying collateral, the financial strength of any guarantors, and other factors.
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Problem loans are monitored and a portion or all of the balance is charged off when collectability is sufficiently questionable that the Bank can no longer justify showing the loan as an asset on the balance sheet. To determine if a loan should be charged off, all possible sources of repayment are analyzed. Possible sources of repayment include the potential for future cash flow, the value of the Bank’s collateral, and the strength of co-makers or guarantors. When these sources do not add up to a reasonable probability that the loan can be collected, charge off is processed.
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 credit losses (applicable to 2023) - On January 1, 2023, the Company adopted Financial Accounting Standards Board ("FASB") ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology with a current expected credit loss ("CECL") methodology. The allowance for credit losses on loans ("ACLL") is a valuation account that is deducted from the amortized cost of loans receivable to present the net amount expected to be collected. Loans are charged against the allowance when management believes the collectability of a loan balance is unlikely. Subsequent recoveries, if any, are credited to the allowance. The Bank records the changes in the ACLL through earnings, as a provision for credit losses on the Consolidated Statements of Income. Accrued interest receivable on loans receivable is excluded from the estimate of credit losses. Instead, interest accrued, but not received, is reversed timely in accordance with the policy for loans receivable above.
The Company has identified segments of loans with similar risk characteristics for which it then applies one of two loss methodologies. Management has adopted a discounted cash flow ("DCF") methodology for most of its segments to calculate the ACLL. For certain segments with smaller portfolios or where data is prohibitive to running a DCF calculation, management has elected to use a remaining life methodology. The Company will evaluate individual loans for expected credit losses when those loans do not share similar risk characteristics with loans evaluated using a collective (pooled) basis. The allowance for individually evaluated loans is calculated using the collateral value method, which considers the likely source of repayment as the value of the collateral, less estimated costs to sell, or another method such as the cash flow method, which considers the contractual principal and interest terms and estimated cash flows available from the borrower to satisfy the debt. When the cash flow method is used, cash flows are discounted back by the effective interest rate and compared to the total recorded investment. If the present value of cash flows is less than the total recorded investment, a reserve is calculated.
For each loan segment collectively measured, the baseline loss rates are calculated using peer institution data from FFIEC Call Report filings. The Bank evaluates the historical period on a quarterly basis. The baseline loss rates are applied to each loan's estimated cash flows over the life of the loan to determine the baseline loss estimate for each loan. Estimated cashflows consider the principal and interest in accordance with the contractual term of the loan and estimated prepayments. Contractual cashflows are based on the amortized cost, as adjusted for balances guaranteed by governmental entities, such as the Small Business Administration ("SBA") or the United States Department of Agriculture ("USDA"), or the unguaranteed amortized cost. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: 1) management has a reasonable expectation at the reporting date that a modification agreement will be executed with an individual borrower or 2) the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company. Prepayments are established for each segment based on historical averages for the segments, which management believes is an accurate representation of future prepayment activity. Management reviews the adequacy of the prepayment period assumption on a quarterly basis.
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The CECL methodology includes consideration of the forecasted direction of the economic and business environment and its likely impact to the estimated allowance as compared to the historical losses over the reasonable and supportable time frame. Economic forecast models for the current period are uploaded to the model, which targets two forecasted macroeconomic factors, which are national gross domestic product ("GDP") and unemployment figures. Each of the forecasted DCF segments is impacted by these macroeconomic factors. Further, each of the macroeconomic factors is utilized differently by segment, including the application of lagged factors and various transformations such as percent change year over year.
The Bank uses the Federal Open Market Committee ("FOMC") forecast via an application programming interface with our CECL software. FOMC provides various forecast scenarios used to determine the loan portfolio’s expected credit loss. Based on known/knowable information at the measurement date, management has determined that the FOMC scenarios and the underlying assumptions most closely align with current and expected conditions. The Bank has elected to forecast the firstfour quarters of the credit loss estimate and revert on a straight-line basis as permitted in ASC 326-20-30-9. The Bank also considers other qualitative risk factors to adjust the estimated ACLL calculated by the above-mentioned model. While there are many factors available to incorporate into the quantitative model, the Bank has selected to use the most critical factors. Additional metrics will be included only if internal or external factors outside those considered in its historical losses or macroeconomic forecast indicate otherwise. The Bank has established metrics to estimate the qualitative risk factor by segment based on the identified risk.
In general, management's estimate of the ACLL uses relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. The allowance for credit losses on loans evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. While management utilizes its best judgment and information available to recognize losses on loans, future additions to the allowance may be necessary based on further declines in local and national economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s ACLL. Such agencies may require the Bank to make adjustments to the allowance based on their judgments about information available to them at the time of their examinations. The Company believes the ACLL at December 31, 2023, is appropriate given the above considerations.
Allowance for loan losses (applicable to 2022 and prior years) - Prior to the implementation of CECL, First Fed maintained 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 included 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 were also considered for calculation of the allowance. The appropriateness of the allowance for loan losses was estimated based upon these factors and trends identified by management at the time the consolidated financial statements were prepared.
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.
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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.
Allowance for credit losses on unfunded commitments (applicable to 2023) - The Bank estimates expected credit losses on unfunded, off-balance sheet commitments over the contractual period in which the Bank is exposed to credit risk from a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Company. The Bank has determined that no allowance is necessary for its home equity line of credit portfolio as it has the ability to unconditionally cancel the available lines of credit. The allowance methodology is similar to the ACLL, but additionally includes an estimate of the future utilization of the commitment as determined by historical commitment utilization. The credit risks associated with the unfunded commitments are consistent with the risks outlined for each loan class. The allowance is recognized in accrued expenses and other liabilities on the Consolidated Balance Sheets and is adjusted as a provision (reversal of provision) for credit losses on the Consolidated Statements of Income.
Reserve for unfunded commitments (applicable to 2022 and prior years) - 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 - Loan servicing rights are recorded at fair value when loans are originated and subsequently sold with the servicing rights retained. 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. 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 and servicing rights mark-to-market" includes sold loan servicing income and changes in fair value.
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 $1.6 million and $1.7 million at December 31, 2023 and 2022, 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 $13.2 million and $12.6 million at December 31, 2023 and 2022, 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. The SAFE investment converted to non-publicly traded stock in 2023.
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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Historic Tax Credit Investment - The Company holds an interest in an Historic Tax Credit investment ("HTC") partnership, also referred to as the Rehabilitation Credit, which met the National Park Service's requirements to qualify for a tax incentive on the rehabilitation of a certified historic structure. 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 5-year period upon the qualified rehabilitated building being placed in service and having met all the requirements.
The Company uses the deferral method to amortize the initial cost of the investment over the life of the related tax credit 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 HTC in "Prepaid expenses and other assets" on the Company’s Consolidated Balance Sheets. The maximum exposure to loss in the HTC is the amount of equity invested by the Company. The Company has evaluated the variable interests held by the Company in the HTC investment and determined that the Company does not have controlling financial interests in such investment and is not the primary beneficiary.
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, 2023 and 2022, was approximately $1.8 million and $1.9 million, respectively. Of these loans, no loans were repurchased during the years ended December 31, 2023 or 2022. There is an associated allowance of $9,000 at December 31, 2022, included in "accrued expenses and other liabilities" on the consolidated balance sheets related to these loans. No allowance is recorded for these loans under CECL at December 31, 2023.
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 Revenue Recognition (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 15). Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates.
Derivative instruments and hedging activities - FASB ASC 815, Derivatives and Hedging ("ASC 815"), provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Further, qualitative disclosures are required that explain the Company’s objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.
As required by ASC 815, the Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation.
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Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply, or the Company elects not to apply hedge accounting.
In accordance with the FASB’s fair value measurement guidance in ASU 2011-04, the Company made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.
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.
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
Summary of Credit Losses Adoption
On January 1, 2023, the Company adopted Financial Accounting Standards Board ("FASB") ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology with a current expected credit loss ("CECL") methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loans receivable and held-to-maturity securities. It also applies to off-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments. In addition, the CECL adoption made changes to the accounting for investment securities available for sale.
The Company adopted ASU 2016-13 using the modified retrospective method for all financial assets measured at amortized cost and unfunded commitments. This method resulted in recording a cumulative-effect adjustment as of the beginning of 2023 with no change to prior periods. The Company elected not to measure an ACL on accrued interest receivable on loans receivable or accrued interest receivable on investment securities available for sale as Company policy is to reverse interest income for uncollectible accrued interest receivable balances in a timely manner.
Results for the reporting period beginning after January 1, 2023, are presented under ASU 2016-13, while prior period amounts were not restated and continue to be reported in accordance with previously applicable GAAP. The accounting policies for prior periods are included in the Company's Annual Report on Form 10-K for the year ended December 31, 2022.
The accounting policies for all financial instruments impacted by the CECL adoption are as follows:
Investment Securities
A debt security is placed on nonaccrual status at the time any principal or payments become more than 90 days delinquent. Interest accrued, but not received for a security placed on nonaccrual, is reversed against interest income during the period that the debt security is placed on nonaccrual status.
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Allowance for Credit Losses on Investment Securities
Management evaluates the need for an ACL on investment securities ("ACLI") on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For investment securities available for sale in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before the recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For investment securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACLI is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any decline in fair value that has not been recorded through an ACLI is recognized in other comprehensive income (loss).
Changes in the ACLI are recorded as provision, or recapture of provision, for credit losses expense. Losses are charged against the allowance when management believes the uncollectibility of an investment security available for sale is confirmed or when either of the criteria regarding intent or requirement to sell is met.
Accrued interest receivable on investment securities available for sale is excluded from the estimate of credit losses as interest accrued, but not received, is reversed timely in accordance with the policy for investment securities above.
Loans Receivable
Loans receivable include loans originated and indirect loans purchased by the Bank as well as loans acquired in business combinations.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost. Amortized cost is the outstanding principal balance, net of purchased premiums and discounts, unearned discounts, and net deferred loan origination fees and costs. Accrued interest receivable for loans receivable is reported in prepaid expenses and other assets on the Consolidated Balance Sheets.
Allowance for Credit Losses on Loans
The ACL on loans ("ACLL") is a valuation account that is deducted from the amortized cost of loans receivable to present the net amount expected to be collected. Loans are charged against the allowance when management believes the collectability of a loan balance is unlikely. Subsequent recoveries, if any, are credited to the allowance. The Bank records the changes in the ACLL through earnings, as a provision for credit losses on the Consolidated Statements of Income. This accounting policy is discussed in detail previously in Note 1 with additional detail provided in Note 4 of the Notes to Consolidated Financial Statements.
Accrued interest receivable on loans receivable is excluded from the estimate of credit losses. Instead, interest accrued, but not received, is reversed timely in accordance with the policy for loans receivable above.
Allowance for Credit Losses on Unfunded Commitments
The Bank estimates expected credit losses on unfunded, off-balance sheet commitments over the contractual period in which the Bank is exposed to credit risk from a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Company. The Bank has determined that no allowance is necessary for its home equity line of credit portfolio as it has the ability to unconditionally cancel the available lines of credit.
The allowance methodology is similar to the ACLL, but additionally includes an estimate of the future utilization of the commitment as determined by historical commitment utilization. The credit risks associated with the unfunded commitments are consistent with the risks outlined for each loan class.
The allowance is recognized in accrued expenses and other liabilities on the Consolidated Balance Sheets and is adjusted as a provision (recapture of provision) for credit losses on the Consolidated Statements of Income.
Provision for Credit Losses
The provision for credit losses as presented in the Company's Consolidated Statements of Income includes the provision for credit losses on loans and the provision for credit losses on unfunded commitments.
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Summary of CECL Impact:
Investment Securities - As of December 31, 2022, the Company had no historical charge-off or recovery history and did not have any investment securities available for sale outstanding at the adoption date for which an other-than-temporary impairment was previously recorded. At the adoption date of ASU 2016-13, the unrealized losses present in the portfolio of investment securities available for sale were primarily due to higher market interest rates at that time making our lower coupon investments less attractive. The fair value of these securities was expected to recover as the securities approach their maturity dates. The basis of management’s conclusion was that at January 1, 2023, 23.9% of the investment securities were issued by or guaranteed by the United States government or its agencies, 30.0% were issued and guaranteed by State and local governments and the remainder of the portfolio was invested in at least investment-grade securities. As a result of the analysis, no allowance for credit losses on investment securities available for sale was recorded upon adoption. See Note 2 Investment Securities for more information.
Loan Receivable - ASU 2016-13 was applied prospectively and replaced the allowance for loan losses with the ACLL on the Consolidated Balance Sheet and replaced the related provision for loan losses with the provision for credit losses on loans as presented on the Consolidated Statements of Income, net of provision for credit losses on unfunded commitments.
The Bank recorded a pretax increase to the ACLL of $2.2 million to increase the reserve to the estimated credit losses at January 1, 2023 based on its CECL methodology as part of the cumulative-effect adjustment to beginning retained earnings. Upon adoption, the adjusted beginning balance of the ACLL as a percentage of loans receivable was 1.18% as compared to 1.04% at December 31, 2022 under the prior incurred loss methodology. At December 31, 2023, the ACLL as a percentage of loans receivable was 1.05%.
See Note 4 - Allowance for Credit Loss on Loans for more information.
Unfunded Commitments - ASU 2016-13 was applied prospectively and replaced the reserve for unfunded commitments with the ACL on unfunded commitments ("ACLUC") as included in accrued liabilities and other expenses on the Consolidated Balance Sheet and replaced the provision for unfunded commitments with the provision for credit losses on unfunded commitments as presented on the Consolidated Statements of Income, net of provision for credit losses on loans. Upon adoption, the Bank recorded a pretax increase in the beginning ACLUC of $1.5 million.
Overall CECL Impact Upon Adoption - The adoption of ASU 2016-13, included an increase to the ACLL of $2.2 million and an increase to the ACLUC of $1.5 million, which resulted in a pretax cumulative-effect adjustment of $3.7 million. The impact of this adjustment to beginning retained earnings on January 1, 2023 was $3.0 million, net of tax.
Other Recently Adopted Accounting Pronouncements
In March 2022, the FASB issued ASU 2022-02,Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. This ASU eliminates the accounting guidance for troubled debt restructured loans (“TDRs”) by creditors while enhancing disclosure requirements for certain loan refinancing and restructuring activity by creditors when a borrower is experiencing financial difficulty. Additionally, the ASU requires public business entities to disclose current-period gross write offs by year of origination for financing receivables and net investments in leases. This ASU is effective upon adoption of ASU 2016-13. On January 1, 2023, the Company adopted this ASU at the same time ASU 2016-13 was adopted. The Company recorded gross charge-offs of $3.3 million during the year ended December 31, 2023, and recoveries for the same period were $150,000. See table in Note 3 for additional information.
On March 28, 2022, the FASB issued Accounting Standards Update (ASU) 2022-01,Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method. The purpose of this updated guidance is to further align risk management objectives with hedge accounting results on the application of the last-of-layer method, which was first introduced in ASU 2017-12,Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. ASU 2022-01 is effective for public business entities for fiscal years beginning after December 15, 2022, with early adoption in the interim period, permitted. For entities who have already adopted ASU 2017-12, immediate adoption is allowed. ASU 2022-01 requires a modified retrospective transition method for basis adjustments in which the entity will recognize the cumulative effect of the change on the opening balance of each affected component of equity in the statement of financial position as of the date of adoption. The Company adopted this ASU on January 1, 2023 on a prospective basis; therefore, there was no impact to the consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In March 2020, the FASB issued ASU 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. This ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, which 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, the FASB issued ASU 2022-06, which deferred the sunset date for Topic 848 to December 31, 2024. The Company implemented a transition plan to identify and modify its loans and other financial instruments that were either directly or indirectly influenced by LIBOR. There was no material impact as a result of implementing these ASUs, transitioning away from LIBOR for its loan and other financial instruments effective July 1, 2023.
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Recently issued accounting pronouncements not yet adopted
In June 2022, the FASB issued ASU 2022-03,Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions. ASU 2022-03 clarifies that a contractual restriction on the sale of an equity security should not be considered in measuring fair value, nor should the contractual restriction be recognized and measured separately. Further, this ASU requires disclosure of the fair value of equity securities subject to contractual sale restrictions reflected in the balance sheet, the nature and remaining duration of the restriction(s), and the circumstances that could cause a lapse in the restriction(s). ASU 2022-03 is effective for the Company for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years, with early adoption permitted. The Company does not believe this ASU will have a material impact on its consolidated financial statements and related disclosures.
In March 2023, the FASB issued ASU 2023-02,Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method, a consensus of the Emerging Issues Task Force. ASU 2023-02 allows an entity the option to apply the proportional amortization method of accounting to other equity investments that are made for the primary purpose of receiving tax credits or other income tax benefits if certain conditions are met. Prior to this ASU, the application of the proportional amortization method of accounting was limited to investments in low-income housing tax credit structures. The proportional amortization method of accounting results in the amortization of applicable investments, as well as the related income tax credits or other income tax benefits received, being presented on a single line in the statements of income, income tax expense. Under this ASU, an entity has the option to apply the proportional amortization method of accounting to applicable investments on a tax-credit-program-by-tax-credit-program basis. In addition, the amendments in this ASU require that all tax equity investments accounted for using the proportional amortization method use the delayed equity contribution guidance in paragraph 323-740-25-3, requiring a liability to be recognized for delayed equity contributions that are unconditional and legally binding or for equity contributions that are contingent upon a future event when that contingent event becomes probable. Under this ASU, low-income housing tax credit investments for which the proportional amortization method is not applied can no longer be accounted for using the delayed equity contribution guidance. Further, this ASU specifies that impairment of low-income housing tax credit investments not accounted for using the equity method must apply the impairment guidance in Subtopic 323-10:Investments - Equity Method and Joint Ventures - Overall. This ASU also clarifies that for low-income housing tax credit investments not accounted for under the proportional amortization method or the equity method, an entity shall account for them under Topic 321:Investments - Equity Securities. The amendments in this ASU also require additional disclosures in interim and annual periods concerning investments for which the proportional amortization method is applied, including (i) the nature of tax equity investments, and (ii) the effect of tax equity investments and related income tax credits and other income tax benefits on the financial position and results of operations. ASU 2023-02 is effective for the Company for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years, with early adoption permitted. The Company is evaluating the effect that ASU 2023-02 will have on its consolidated financial statements and related disclosures.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In November 2023, the FASB issued ASU No.2023-07,Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures. This ASU enhances disclosures about significant segment expenses. The key amendments: (1) require that a public entity disclose on an annual and interim basis, significant segment expenses that are regularly provided to the chief operating decision maker ("CODM") and included within each reported measure of segment profit or loss, (2) require that a public entity disclose, on an annual and interim basis, an amount for other segment items by reportable segment and a description of its composition, (3) require that a public entity provide all annual disclosures about a reportable segment's profit or loss currently required by GAAP in interim periods as well, (4) clarify that if CODM uses more than one measure of a segment's profit or loss in assessing segment performance and deciding how to allocate resources, an entity may report one or more of those additional measures of segment profit, (5) require that a public entity disclose the title and position of the CODM and an explanation of how the CODM uses the reported measure of segment profit or loss in assessing segment performance and deciding how to allocate resources and (6) require that a public entity that has a single reportable segment provide all the disclosures required by the amendments in the ASU and all existing segment disclosures. This ASU is effective for public entities for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024. As the Company has one reportable segment, the requirements of this standard for such entities will apply beginning with the Company's annual report for the year ending December 31, 2024. The Company does not expect adoption of this ASU to have a material effect on the Company's consolidated financial statements.
In December 2023, the FASB issued ASU No.2023-09,Income Taxes (Topic 740): Improvements to Income Tax Disclosures. This ASU requires that public business entities disclose, on an annual basis, specific categories in the rate reconciliation and provide additional information for reconciling items that meet a quantitative threshold. The ASU requires all entities to disclose on an annual basis (1) the amount of income taxes paid, disaggregated by federal, state and foreign taxes and (2) the amount of income taxes paid disaggregated by individual jurisdictions in which income taxes paid is equal or greater than 5 percent of total income taxes paid. The ASU also requires that all entities disclose income (loss) from continuing operations before income tax expense (or benefit) disaggregated between domestic or foreign and income tax expense (or benefit) from continuing operations disaggregated by federal (national), state and foreign. This ASU is effective for public business entities for annual periods beginning after December 15, 2024. The Company does not expect adoption of the ASU to have a material effect on the Company's consolidated 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.
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, 2023, are summarized as follows:
(In thousands)
Available for Sale
Corporate issued asset-backed securities (ABS corporate) 5,370 — (84 ) 5,286
Corporate issued debt securities (Corporate debt) 56,515 — (5,061 ) 51,454
Mortgage-Backed Securities:
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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
Mortgage-Backed Securities
There were no securities classified as held-to-maturity at December 31, 2023 and 2022.
Accrued interest receivable on available-for-sale debt securities totaled $1.9 million and $2.0 million as of December 31, 2023 and 2022, respectively. Accrued interest receivable on securities is reported in accrued interest receivable on the Consolidated Balance Sheets and is excluded from the calculation of the allowance for credit losses on investment 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, 2023:
Less Than Twelve Months Twelve Months or Longer Total
(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
There were 6 available-for-sale securities with unrealized losses of less than one year, and 156 available-for-sale securities with an unrealized loss of more than one year at December 31, 2023. There were 113 available-for-sale securities with unrealized losses of less than one year, and 69 available-for-sale securities with an unrealized loss of more than one year at December 31, 2022. Management believes that the unrealized losses on our investment securities relate principally to the general change in interest rates, market liquidity and demand, and market volatility that has occurred since the initial purchase, and such unrecognized losses or gains will continue to vary with general interest rate level and market fluctuations in the future. We do not believe the unrealized losses on our securities are related to a deterioration in credit quality. 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 that it is unlikely that we will be required to sell these investments prior to a market price recovery or maturity. Based on the Company’s evaluation of these securities, no credit loss was recorded at December 31, 2023 or December 31, 2022.
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 300 300 — —
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Sales of available-for-sale securities were as follows:
For the Year Ended December 31,
(In thousands)
Gross gains — 128
Note 3 - Loans Receivable
The Company has defined its loan portfolio into three segments that reflect the structure of the lending function, the Company's strategic plan and the manner in which management monitors performance and credit quality. The three loan portfolio segments are: Real Estate Loans, Consumer Loans and Commercial Business Loans. These segments are further disaggregated into classes based on similar attributes and risk characteristics.
Loan amounts are net of unearned loan fees in excess of unamortized costs and premiums of $14.8 million and $13.2 million as of December 31, 2023 and 2022, respectively. Net loans do not include accrued interest receivable. Accrued interest receivable on loans was $6.0 million and $4.7 million as of December 31, 2023 and 2022, respectively, and was reported in accrued interest receivable on the consolidated balance sheets.
The amortized cost of loans receivable, net of ACLL, consisted of the following at the dates indicated:
(In thousands)
Real Estate:
Consumer:
Less:
(1) Allowance for credit losses on loans in 2023 reported using the CECL method and in 2022 reported using the incurred loss method.
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Loans, by the earlier of next repricing date or maturity, at the dates indicated:
(In thousands)