Our deposit composition reflects a mixture of various deposit products. We rely on marketing activities, customer service, and the availability of a broad range of products and services to attract and retain customer deposits.
The following table sets forth information regarding our certificates of deposit and other deposits at December 31, 2017.2022. Certificates of deposit are categorized by their original term.
|
| | | | | | | | | | | | | | | | | | | | | | | |
| Within One Year | | After One Year Through Two Years | | After Two Years Through Three Years | | After Three Years Through Four Years | | Thereafter | | Total |
| (In thousands) |
0.00 - 1.00% | $ | 66,028 |
| | $ | 11,058 |
| | $ | 2,314 |
| | $ | 956 |
| | $ | 5 |
| | $ | 80,361 |
|
1.01 - 2.00% | 99,904 |
| | 147,470 |
| | 38,700 |
| | 26,913 |
| | 3,496 |
| | 316,483 |
|
2.01 - 3.00% | — |
| | 3,800 |
| | 2,570 |
| | 3,177 |
| | 2,468 |
| | 12,015 |
|
Retail certificates of deposit, fair value adjustment | (49 | ) | | (30 | ) | | (16 | ) | | (9 | ) | | (3 | ) | | (107 | ) |
Total | $ | 165,883 |
| | $ | 162,298 |
| | $ | 43,568 |
| | $ | 31,037 |
| | $ | 5,966 |
| | $ | 408,752 |
|
The following table sets forthprovides the amountuninsured portion by account of our jumbo certificates of deposit at December 31, 2022, by their remaining maturity as of December 31, 2017.period.
| | | | | | | | |
Maturity Period | | Certificates of Deposit |
| | (In thousands) |
Three months or less | | $ | 6,100 | |
Over three months through six months | | 8,070 | |
Over six months through twelve months | | 33,325 | |
Over twelve months | | 40,643 | |
Total | | $ | 88,138 | |
|
| | | | |
Maturity Period | | Certificates of Deposit |
| | (In thousands) |
Three months or less | | $ | 33,248 |
|
Over three months through six months | | 17,786 |
|
Over six months through twelve months | | 53,493 |
|
Over twelve months | | 141,438 |
|
Total | | $ | 245,965 |
|
Deposit Flow. Deposits by Type. The following table sets forth the deposit balances by the types of accounts we offered at the dates indicated.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2022 | | 2021 | | 2020 |
| Amount | | Percent of Total | | Amount | | Percent of Total | | Amount | | Percent of Total |
| (Dollars in thousands) |
Noninterest bearing | $ | 119,944 | | | 10.3 | % | | $ | 117,751 | | | 10.2 | % | | $ | 91,285 | | | 8.3 | % |
Interest-bearing demand | 96,632 | | | 8.3 | | | 97,907 | | | 8.5 | | | 108,182 | | | 9.9 | |
Savings | 23,636 | | | 2.0 | | | 23,146 | | | 2.0 | | | 19,221 | | | 1.8 | |
Money market | 542,388 | | | 46.4 | | | 624,543 | | | 54.0 | | | 465,369 | | | 42.5 | |
Certificates of deposit, retail: | | | | | | | | | | | |
0.00 - 1.00% | 79,978 | | | 6.8 | | | 176,376 | | | 15.2 | | | 93,570 | | | 8.6 | |
1.01 - 2.00% | 51,486 | | | 4.4 | | | 21,264 | | | 1.8 | | | 86,145 | | | 7.9 | |
2.01 - 3.00% | 92,335 | | | 7.8 | | | 57,509 | | | 4.9 | | | 180,733 | | | 16.5 | |
3.01 - 4.00% | 37,793 | | | 3.2 | | | 38,978 | | | 3.4 | | | 49,128 | | | 4.5 | |
4.01 - 5.00% | 962 | | | 0.1 | | | 0 | | — | | | | | — | |
| | | | | | | | | | | |
Total certificates of deposit, retail | 262,554 | | | 22.3 | | | 294,127 | | | 25.3 | | | 409,576 | | | 37.5 | |
Brokered deposits: | | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
3.01 - 4.00% | 15,680 | | | 1.3 | | | — | | | — | | | — | | | — | |
4.01% - 5.00% | 74,088 | | | 6.3 | | | — | | | — | | | — | | | — | |
Total certificates of deposit, brokered | 89,768 | | | 7.6 | | | — | | | — | | | — | | | — | |
Interest-bearing demand, brokered | 25,062 | | | 2.2 | | | — | | | — | | | — | | | — | |
Money market, brokered | 10,056 | | | 0.9 | | | — | | | — | | | — | | | — | |
Total brokered deposits | 124,886 | | | 10.7 | | | — | | | — | | | — | | | — | |
Total deposits | $ | 1,170,040 | | | 100.0 | % | | $ | 1,157,474 | | | 100.0 | % | | $ | 1,093,633 | | | 100.0 | % |
|
| | | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2017 | | 2016 | | 2015 |
| Amount | | Percent of Total | | Amount | | Percent of Total | | Amount | | Percent of Total |
| (Dollars in thousands) |
Noninterest bearing | $ | 45,434 |
| | 5.4 | % | | $ | 33,422 |
| | 4.7 | % | | $ | 29,392 |
| | 4.4 | % |
Interest-bearing demand | 38,224 |
| | 4.5 |
| | 18,532 |
| | 2.5 |
| | 16,261 |
| | 2.4 |
|
Statement savings | 28,456 |
| | 3.4 |
| | 28,383 |
| | 4.0 |
| | 28,327 |
| | 4.2 |
|
Money market | 318,636 |
| | 38.0 |
| | 204,998 |
| | 28.6 |
| | 211,436 |
| | 31.3 |
|
Certificates of deposit, retail: | | | | | | | | | | | |
0.00 - 1.00% | 79,323 |
| | 9.4 |
| | 124,710 |
| | 17.4 |
| | 154,011 |
| | 22.8 |
|
1.01 - 2.00% | 247,517 |
| | 29.5 |
| | 228,458 |
| | 31.8 |
| | 169,494 |
| | 25.1 |
|
2.01 - 3.00% | 6,531 |
| | 0.8 |
| | 3,349 |
| | 0.5 |
| | 206 |
| | — |
|
5.01 - 6.00% | — |
| | — |
| | 136 |
| | — |
| | 129 |
| | — |
|
Retail certificates of deposit, fair value adjustment | (107 | ) | | — |
| | — |
| | — |
| | — |
| | — |
|
Total certificates of deposit, retail | 333,264 |
| | 39.7 |
| | 356,653 |
| | 49.7 |
| | 323,840 |
| | 47.9 |
|
Certificates of deposit, brokered | | | | | | | | | | | |
0.00 - 1.00% | 1,038 |
| | 0.1 |
| | 1,038 |
| | 0.1 |
| | — |
| | — |
|
1.01 - 2.00% | 68,965 |
| | 8.2 |
| | 74,014 |
| | 10.3 |
| | 65,715 |
| | 9.7 |
|
2.01 - 3.00% | 5,485 |
| | 0.7 |
| | 436 |
| | 0.1 |
| | 436 |
| | 0.1 |
|
Total certificates of deposit, brokered | 75,488 |
| | 9.0 |
| | 75,488 |
| | 10.5 |
| | 66,151 |
| | 9.8 |
|
Total deposits | $ | 839,502 |
| | 100.0 | % | | $ | 717,476 |
| | 100.0 | % | | $ | 675,407 |
| | 100.0 | % |
Borrowings. Customer deposits are the primary source of funds for our lending and investment activities. We use advances from the FHLB and to a lesser extent federal funds (“Fed Funds”) purchased to supplement our supply of lendable funds, to meet short-term deposit withdrawal requirements and to provide longer term funding to better matchassist in the management of our interest rate risk by matching the duration of selected loan and investment maturities. In addition, at December 31, 2017 we had available a total of $35.0 million lines of credit between two other financial institutions as supplemental funding sources.
As a member of the FHLB, we are required to own capital stock in the FHLB and are authorized to apply for advances on the security of that stock and certain of our mortgage loans, provided that certain creditworthiness standards have been met. Advances are individually made under various terms pursuant to several different credit programs, each with its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. We maintain a credit facility with the FHLB that provides for immediately available advances, subject to acceptable collateral. At December 31, 2017,2022, our remaining FHLB credit capacity was $190.5$522.9 million and outstanding advances from the FHLB totaled $216.0$145.0 million.
The following table sets forth information regarding FHLB advances In addition, at December 31, 2022, we had supplemental funding sources of $70.4 million available at the endFRB and $75.0 million available between two correspondent financial institutions.
Other than our utilization of interest rate swaps, we do not currently participate in other hedging programs, stand-alone contracts for interest rate caps or floors or other activities involving the use of off-balance sheet derivative financial instruments, however, these options are evaluated on occasion. At both December 31, 2022, and during the periods indicated. The table includes both long-December 31, 2021, we had seven interest rate swaps with an aggregate notional amount of $95.0 million. At December 31, 2022, we had a fair value gain of $10.5 million as compared to a fair value gain of $1.5 million at December 31, 2021. In October 2021, a $50.0 million interest rate swap agreement matured and short-term borrowings.was partially replaced with two interest rate swap agreements with an aggregate notional amount of $25.0 million and original weighted-average term of 7.4 years. For additional information, see Item 1A.
|
| | | | | | | | | | | |
| At or for the Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
| (Dollars in thousands) |
Maximum amount of borrowings outstanding at any month end | $ | 231,500 |
| | $ | 251,500 |
| | $ | 135,500 |
|
Average borrowings outstanding | 192,227 |
| | 163,893 |
| | 133,527 |
|
Average rate paid during the year | 1.30 | % | | 0.87 | % | | 0.94 | % |
Balance outstanding at end of the year | $ | 216,000 |
| | $ | 171,500 |
| | $ | 125,500 |
|
Weighted-average rate paid at end of the year | 1.60 | % | | 0.87 | % | | 0.97 | % |
Risk Factors -“Risks Related to Market and Interest Rate Changes - If the interest rate swaps we entered into prove ineffective, it could result in volatility in our operating results, including potential losses, which could have a material adverse effect on our results of operations and cash flows,” Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management,” and Note 11 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
Subsidiaries and Other Activities
First Financial Northwest, Inc. First Financial Northwest has two wholly-owned subsidiaries, First Financial Northwestthe Bank and First Financial Diversified Corporation. First Financial Diversified Corporation currently holdspreviously held a loansmall portfolio of one‑to-four family residential, commercial real estate, and consumer loans. At December 31, 2017, First Financial Diversified’s netSubsequent to these loans receivable of $2.0 million represented less than one percent ofpaying off in 2019, the Company’s loan portfolio.company has had minimal activity.
First Financial Northwest Bank. First Financial NorthwestThe Bank is a community-based commercial bank. The Bankbank which primarily serves the greater Puget Sound region of King and to a lesser extent, Pierce, Snohomish and Kitsap Counties, Washington through our full-service banking office in Renton, Washington and eightfourteen additional branches in King, Pierce and Snohomish Counties, Washington. We are in the business of attracting deposits from the public and utilizing those deposits to originate loans.
Competition
The Bank operates in the highly competitive Puget Sound region of Western Washington. We face competition in originating loans and attracting deposits within our geographic market area. The competitive environment is impacted by changes in the regulatory environment, technology and product delivery systems as well as consolidation in the industry creating larger, more diversified competitors. We compete by striving to consistently deliverdelivering high-quality personal service to our customers seeking to achievethat results in a high level of customer satisfaction.
The Bank attracts deposits primarily through its branch office system. The competition is primarily from commercial banks, savings institutions and credit unions in the same geographic area. Based on the most current FDIC market share data dated June 30, 2017,2022, the top five banks in the Seattle-Tacoma-Bellevue metropolitan statistical area (comprised of Bank of America, Wells Fargo, JP Morgan Chase, Wells Fargo, US Bancorp and KeyBank) controlled over 70%72% of the deposit market. In addition to the FDIC insured competitors, credit unions, insurance companies and brokerage firms also compete for consumer deposit relationships. According to FDIC statistical market data, theThe Bank’s share of aggregate deposits in the market area wasis less than 1%.
Our competition for loans comes principally from commercial banks, mortgage brokers, thrift institutions, credit unions and finance companies. Several other financial institutions compete with us for banking business in our market area. These institutions have substantially more resources than the Bank and, as a result, are able to offer a broader range of services, such as trust departments and enhanced retail services. Among the advantages of some of these institutions are their ability to make larger loans, initiate extensive advertising campaigns, access lower cost funding sources, and allocate their investable assets in regions of highest yield and demand. The challenges posed by such large competitors may impact our ability to originate loans secure low cost deposits, and establish product pricing levels that support our net interest margin goals that may limit our future growth and earnings potential.
EmployeesHuman Capital
The Company continually strives to recruit the most talented, motivated employees in their respective fields. By providing opportunities for personal and professional growth coupled with an environment that values teamwork and work-life balance, we are able to attract and retain outstanding individuals. We pride ourselves on providing excellent benefits, competitive salaries and the opportunity for participation in the company's long-term success.
Workforce. At December 31, 2017,2022, we had 145151 full-time employees. Our employees are not represented by any collective bargaining group. We considerThe Company is committed to providing equality of opportunity in all aspects of employment through a comprehensive affirmative action plan that is updated annually. As of December 31, 2022, our workforce was 61.6% female and 38.4% male, and women held 55.0% of the Bank’s management roles. The average tenure of mid-level officers and managers is 3.8 years and the average tenure of executive / senior level officers is 8.2 years. The ethnicity of our workforce was 66.9% White, 23.8% Asian, 0.7% Black, 0.7% Native Hawaiian or Other Pacific Islander, 1.3% Two or More Races, and 6.6% undisclosed.
The following chart depicts the percentage of self-identified females and minorities in our workforce at December 31, 2022, by job classification as defined by the Equal Employment Opportunity Commission (“EEOC”):
| | | | | | | | | | | | | | | | | | | | |
Job Classification | | Female | | Minority (1) | | Distribution by EEOC Job Classification |
| | | | | | |
Executive / Senior level officers | | 46.2% | | 30.8% | | 8.6% |
Mid-level officers and managers | | 57.4 | | 23.4 | | 31.1 |
Professionals | | 46.7 | | 40.0 | | 19.9 |
Sales workers | | 55.6 | | 44.4 | | 6.0 |
Technicians | | — | | 25.0 | | 2.6 |
Administrative support | | 85.4 | | 16.7 | | 31.8 |
Total | | 61.6% | | 26.5% | | 100.0% |
__________
(1) Includes employees self-disclosed as Asian, Black, Native Hawaiian or Other Pacific Islander, or Two or More Races.
Benefits. The Company provides competitive comprehensive benefits to employees. The Company values the health and well-being of its employees and strives to provide programs to support this. Benefit programs available to eligible employees may include 401(k) savings plan, profit-sharing plan, ESOP, health and life insurance, employee relationsassistance program, paid holidays, paid time off, and other leave as applicable. Effective January 1, 2023, the Company made changes to its 401(k) plan to qualify as a Safe Harbor plan. Under the revised plan, employee contributions up to 5% will be good.matched 100% by the Company and said matching contributions will be immediately vested to the employee. Separately, in an effort to replace the ESOP benefits that matured in 2022, the Company introduced a profit-sharing plan beginning in 2023, wherein a contribution will be made to every employee’s retirement account in an amount ranging from 5% to 8% annually, based on the Company’s profitability.
Board of directors. The Company’s board of directors is comprised of the Company’s Chief Executive Officer and Chief Financial Officer and six non-employee directors. The non-employee directors are represented by 50% female and 17% minority.
Response to COVID-19 pandemic. The Company will continue to monitor any federal or Washington state mandates and make adjustments to support employees and prioritize employee safety.
Training and education. The Company recognizes that the skills and knowledge of its employees are critical to the success of the organization, and promotes training and continuing education as an ongoing function for employees. The Bank’s compliance training program provides annual training courses to assure that all employees and officers know the rules applicable to their jobs.
How We Are Regulated
The following is a brief description of certain laws and regulations that are applicable to First Financial Northwest and First Financial Northwestthe Bank. On March 31, 2015, First Financial Northwest rescinded the 10(1) election made by First Financial Northwest Bank and converted from a registered savings and loan holding company to a bank holding company. As a bank holding company, First Financial Northwest is subject to examination and supervision by, and is required to file certain reports with the FRB. First Financial Northwest also is subject to the rules and regulations of the SEC under the federal securities laws. First Financial NorthwestThe Bank, which changed its charter from a Washington-chartered savings bank to a Washington-chartered commercial bank effective on February 11, 2016, is subject to regulation and oversight by the DFI, the applicable provisions of Washington law and by the regulations of the DFI adopted thereunder. First Financial NorthwestThe Bank also is subject to regulation and examination by the FDIC, which insures its deposits to the maximum extent permitted by law.
The laws and regulations affecting depository institutions and their holding companies have changed significantly, particularly in connection with the enactment of the Dodd-Frank Act. Among other changes, the Dodd-Frank Act established the Consumer Financial Protection Bureau (“CFPB”) as an independent bureau of the Federal Reserve. The CFPB assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations and has authority to impose new requirements. In addition, the regulations governing us may be amended from time to time by the respectiverelevant legislative bodies and regulators. Any such legislationlegislative action or regulatory changes in the future could adversely affect us. We cannot predict whether any such changes may occur.
Regulation and Supervision of First Financial Northwest Bank
General. As a state-chartered commercial bank, First Financial Northwestthe Bank is subject to applicable provisions of Washington state law and regulations of the DFI in addition to federal law and regulations of the FDIC applicable to state banks that are not members of the Federal Reserve.Reserve System. State law and regulations govern First Financial Northwestthe Bank’s ability to take deposits and pay interest, to make loans on or invest in residential and other real estate, to make consumer loans, to invest in securities, to offer various banking services to its customers and to establish branch offices. Under state law, commercial banks in Washington also generally have all of the powers that federal commercial banks have under federal laws and regulations. First Financial NorthwestThe Bank is subject to periodic examination by and reporting requirements of the DFI.
Insurance of Accounts and Regulation by the FDIC. First Financial Northwest The Bank’s deposits are insured up to $250,000 per separately insured depositordeposit ownership right or category by the Deposit Insurance Fund (“DIF”) of the FDIC. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions.
The FDIC assesses deposit insurance premiums quarterly on each FDIC-insured institution applied to its deposit base, which is its average consolidated total assets minus its Tier 1 capital. No institution may pay a dividend if it is in default on its federal deposit insurance assessment. Total base assessment rates currently range from 3 to 30 basis points subject to certain adjustments.
Extraordinary growth in insured deposits during the first and second quarters of 2020 caused the DIF reserve ratio to decline below the statutory minimum of 1.35 percent.In September 2020, the FDIC Board of Directors adopted a Restoration Plan to restore the reserve ratio to at least 1.35 percent within eight years, absent extraordinary circumstances, as required by the Federal Deposit Insurance Act.The Restoration Plan maintained the assessment rate schedules in place at the time and required the FDIC to update its analysis and projections for the deposit insurance fund balance and reserve ratio at least semiannually. In the semiannual update for the Restoration Plan in June 2022, the FDIC projected that the reserve ratio was at risk of not reaching the statutory minimum of 1.35 percent by September 30, 2028, the statutory deadline to restore the reserve ratio.Based on this update, the FDIC Board approved an Amended Restoration Plan, and concurrently proposed an increase in initial base deposit insurance assessment rate schedules uniformly by 2 basis points, applicable to all insured depository institutions. In October 2022, the FDIC Board finalized the increase with an effective date of January 1, 2023, applicable to the first quarterly assessment period of 2023.The revised assessment rate schedules are intended to increase the likelihood that the reserve ratio of the DIF reaches the statutory minimum level of 1.35 percent by September 30, 2028
Management cannot predict what FDIC assessment rates will be in the future. In a banking industry emergency, the FDIC may also impose a special assessment. The Bank paid $399,000 in FDIC assessments for the year ending December 31, 2022.
As insurer, the FDIC is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. The FDIC also may prohibit any insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the deposit insurance fund.DIF. The FDIC also has the authority to initiatetake enforcement actions against commercial institutionsbanks and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices orsavings associations. Management is in an unsafe or unsound condition.
The Dodd-Frank Act requires the FDIC’s deposit insurance assessments to be based on assets instead of deposits. The FDIC has issued rules which specify that the assessment base for a bank is equal to its total average consolidated assets less average tangible equity capital. Currently, the FDIC’s base assessment rates are 3 to 30 basis points and are subject to certain adjustments. For institutions with less than $10 billion in assets, rates are determined based on supervisory ratings and certain financial ratios. No institution may pay a dividend if it is in default on its federal deposit insurance assessment.
In addition, federally insured institutions are required to pay a Financing Corporation (“FICO”) assessment in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. For the quarter ended December 31, 2017, the FICO assessment rate was 0.54 basis points (annualized) of the assessment base, computed on assets. These assessments will continue until the bonds mature in the years 2017 through 2019. For 2017, the Bank incurred approximately $491,000 in FDIC and FICO assessment expense.
The FDIC may terminate the deposit insurance of any insured depository institution, including First Financial Northwest Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. We are not aware of any practice, condition or violation that might lead toexisting circumstances which would result in termination of First Financial Northwest Bank’sthe Bank's deposit insurance.
A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. There can be no prediction as to what changes in insurance assessment rates may be made in the future.
Standards for Safety and Soundness. TheEach federal banking regulatory agencies have prescribed, by regulation,agency, including the FDIC, has adopted guidelines for all insured depository institutionsestablishing general standards relating to:to internal controls, information systems and internal audit systems,systems; loan documentation,documentation; credit underwriting,underwriting; interest rate risk exposure,exposure; asset growth,growth; asset quality, earningsquality; earnings; and compensation, fees and benefits. TheIn general, the guidelines set forth the safetyrequire, among other things, appropriate systems and soundness standards that the federal banking agencies usepractices to identify and address problems at insured depository institutions before capital becomes impaired. Each insured depository institution must implement a comprehensive written information security program that includes administrative, technicalmanage the risks and physical safeguards appropriateexposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the institution’s size and complexity and the nature and scope of its activities. The information security program also must be designed to ensure the security and confidentiality of customer information, protect against any unanticipated threatsservices performed by an executive officer, employee, director, or hazards to the security or integrity of such information, protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer and ensure the proper disposal of customer and consumer information. Each insured depository institution must also develop and implement a risk-based response program to address incidents of unauthorized access to customer information in customer information systems.principal shareholder. If the FDIC determines that an institution fails to meet any of these guidelines, it may require an institution to submit to the FDIC an acceptable plan to achieve compliance. We areManagement of the Bank is not aware of any conditions relating to these safety and soundness standards thatwhich would require submission of a plan of compliance by First Financial Northwest Bank.compliance.
Capital Requirements. Federally insured financial institutions, such as First Financial Northwestthe Bank, and their holding companies, are required to maintain a minimum level of regulatory capital.
Effective January 1, 2015 (with some changes phased in over several years), First Financial Northwest and First Financial Northwest
The Bank becameis subject to new capital regulations adopted by the Federal Reserve and the FDIC, which establish minimum required ratios for a common equity Tier 1 capital (“CET1”), capital to risk-based assets ratio, a Tier 1 capital andto risk-based assets ratio, a total capital to risk-based assets ratio and a Tier 1 capital to total assets leverage ratio. The capital standards require the leverage ratio; set out risk-weights for assets and certain off-balance sheet items for purposesmaintenance of the risk-based capital ratios, require an additional capital conservation buffer over the minimum risk-based ratios’ and define what qualifies as capital for purposes of meeting the capital requirements. These regulations implement the regulatory capital reforms required by the Dodd-Frank Act and the “Basel III” requirements.
Under the capital regulations, thefollowing minimum capital ratios are: (1)ratios: (i) a CET1 capital ratio of 4.5% of risk-weighted assets; (2); (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets; (3)6%; (iii) a total risk-based capital ratio of 8.0% of risk-weighted assets;8%; and (4)(iv) a Tier 1 leverage ratio (theof 4%. Consolidated regulatory capital requirements identical to those applicable to subsidiary banks generally apply to bank holding companies.However, the Federal Reserve has provided a “Small Bank Holding Company” exception to its consolidated capital requirements, and bank holding companies with less than $3.0 billion of consolidated assets are not subject to the consolidated holding company capital requirements unless otherwise directed by the Federal Reserve.
The Economic Growth, Regulatory Relief and Consumer Protection Act (“EGRRCPA”), enacted in May 2018, required the federal banking agencies, including the FDIC, to establish for institutions with assets of less than $10 billion a “community bank leverage ratio” or “CBLR” of between 8 to 10%.Institutions with capital meeting or exceeding the ratio and otherwise complying with the specified requirements (including off-balance sheet exposures of 25% or less of total assets and trading assets and liabilities of 5% or less of total assets) and electing the alternative framework are considered to comply with the applicable regulatory capital requirements, including the risk-based requirements. The CBLR was established at 9% Tier 1 capital to total average total adjusted assets) of 4.0%. CET1 generally consists of common stock, retained earnings, accumulated other comprehensive income (“AOCI”) unless an institution has elected to exclude AOCI from regulatory capital, and certain minority interests, all subject to applicable regulatory adjustments and deductions. Tier 1 capital generally consists of CET1 and noncumulative perpetual preferred stock. Tier 2 capital generally consists of other preferred stock and subordinated debt meeting certain conditions plus an amount of the allowance for loan and lease losses up to 1.25% of assets. Total capital is the sum of Tier 1 and Tier 2 capital.
There are a number of changes in what constitutes regulatory capital compared to the rules in effect prior toassets, effective January 1, 2015, some of which are subject to transition periods. These changes include the phasing-out of certain instruments as2020. A qualifying capitalinstitution may opt in and eliminate or significantly reduce the use of hybrid capital instruments, especially trust preferred securities, as regulatory capital. Mortgage servicing assets and deferred tax assets over designated percentages of CET1 are deducted from capital. In addition, Tier 1 capital includes AOCI, which includes all unrealized gains and losses on available for sale debt and equity securities. However, because of our asset size, we were eligible for the one-time option of permanently opting out of the inclusioncommunity bank leverage ratio framework on its quarterly call report.An institution that temporarily ceases to meet any qualifying criteria is provided with a two-quarter grace period to again achieve compliance. Failure to meet the qualifying criteria within the grace period or maintain a leverage ratio of unrealized gains and losses on available for sale debt and equity securities in8% or greater requires the institution to comply with the generally applicable capital requirements. Although the Bank qualified to make this election, as of December 31, 2022, management has not elected to use the CBLR as the Bank’s margin above the current minimum levels to be well-capitalized is greater than our capital calculations. We elected this option inmargin would be under the first quarter of 2015.CBLR.
For purposes of determining risk-based capital, assets and certain off-balance sheet items are risk-weighted from 0% to 1,250%, depending on the risk characteristics of the asset or item. The new regulations make certain changes in the risk-weighting of assets to better reflect credit risk and other risk exposure compared to the earlier capital rules. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and for non‑residential mortgage loans that are 90 days past due or otherwise in nonaccrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable (currently set at 0%); and a 250% risk weight (up from 100%) for mortgage servicing and deferred tax assets that are not deducted from capital.
In addition to the minimum CET1, Tier 1, and total capital ratios, the capital regulations require a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order
to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses. The phase-in of the capital conservation buffer requirement began on January 1, 2016 when a buffer greater than 0.625% of risk-weighted assets was required, which increases each year until the buffer requirement is fully implemented on January 1, 2019.
To be considered “well capitalized,” a depository institution must have a Tier 1 risk-based capital ratio of at least 8%, a total risk-based capital ratio of at least 10%, a CET1 capital ratio of at least 6.5% and a leverage ratio of at least 5%, and not be subject to an individualized order, directive or agreement under which its primary federal banking regulator requires it to maintain a specific capital level. As of December 31, 2017,2022, First Financial Northwest Bank met the requirements to be “well capitalized” and met the fully phased-in capital conservation buffer requirement.
The table below sets forth First Financial Northwestthe Bank’s capital position at December 31, 20172022 and 2016,2021, based on FDIC thresholds to be well-capitalized.
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2022 | | 2021 |
| Amount | | Ratio | | Amount | | Ratio |
| (Dollars in thousands) |
Bank equity capital under GAAP | $ | 150,370 | | | | | $ | 149,563 | | | |
| | | | | | | |
Tier 1 leverage capital | $ | 156,147 | | | 10.31 | % | | $ | 147,816 | | | 10.34 | % |
Tier 1 leverage capital requirement | 75,722 | | | 5.00 | | | 71,489 | | | 5.00 | |
Excess | $ | 80,425 | | | 5.31 | % | | $ | 76,327 | | | 5.34 | % |
| | | | | | | |
Common equity tier 1 | $ | 156,147 | | | 14.37 | % | | $ | 147,816 | | | 14.23 | % |
Common equity tier 1 capital requirement | 70,641 | | | 6.50 | | | 67,536 | | | 6.50 | |
Excess | $ | 85,506 | | | 7.87 | % | | $ | 80,280 | | | 7.73 | % |
| | | | | | | |
Tier 1 risk-based capital | $ | 156,147 | | | 14.37 | % | | $ | 147,816 | | | 14.23 | % |
Tier 1 risk-based capital requirement | 86,942 | | | 8.00 | | | 83,121 | | | 8.00 | |
Excess | $ | 69,205 | | | 6.37 | % | | $ | 64,695 | | | 6.23 | % |
| | | | | | | |
Total risk-based capital | $ | 169,755 | | | 15.62 | % | | $ | 160,840 | | | 15.48 | % |
Total risk-based capital requirement | 108,678 | | | 10.00 | | | 103,901 | | | 10.00 | |
Excess | $ | 61,077 | | | 5.62 | % | | $ | 56,939 | | | 5.48 | % |
|
| | | | | | | | | | | | | |
| December 31, |
| 2017 | | 2016 |
| Amount | | Ratio | | Amount | | Ratio |
| (Dollars in thousands) |
Bank equity capital under U.S. Generally Accepted Accounting Principles (“GAAP”) | $ | 123,023 |
| | | | $ | 118,346 |
| | |
| | | | | | | |
Tier 1 leverage capital | $ | 122,090 |
| | 10.20 | % | | $ | 119,652 |
| | 11.17 | % |
Tier 1 leverage capital requirement | 59,843 |
| | 5.00 |
| | 53,558 |
| | 5.00 |
|
Excess | $ | 62,247 |
| | 5.20 | % | | $ | 66,094 |
| | 6.17 | % |
| | | | | | | |
Common equity tier 1 | $ | 122,090 |
| | 12.52 | % | | $ | 119,652 |
| | 14.36 | % |
Common equity tier 1 capital requirement | 63,379 |
| | 6.50 |
| | 54,163 |
| | 6.50 |
|
Excess | $ | 58,711 |
| | 6.02 | % | | $ | 65,489 |
| | 7.86 | % |
| | | | | | | |
Tier 1 risk-based capital | $ | 122,090 |
| | 12.52 | % | | $ | 119,652 |
| | 14.36 | % |
Tier 1 risk-based capital requirement | $ | 78,006 |
| | 8.00 | % | | $ | 66,662 |
| | 8.00 | % |
Excess | $ | 44,084 |
| | 4.52 | % | | $ | 52,990 |
| | 6.36 | % |
| | | | | | | |
Total risk-based capital | $ | 134,292 |
| | 13.77 | % | | $ | 130,078 |
| | 15.61 | % |
Total risk-based capital requirement | 97,507 |
| | 10.00 |
| | 83,328 |
| | 10.00 |
|
Excess | $ | 36,785 |
| | 3.77 | % | | $ | 46,750 |
| | 5.61 | % |
The FDIC also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of particular risks or circumstances. Management of First Financial Northwest Bank believes that, under the current regulations, First Financial Northwest Bank will continue to meet its minimum capital requirements in the foreseeable future.
For a complete description of First Financial Northwestthe Bank’s required and actual capital levels on December 31, 2017,2022, see Note 14 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
The FASB has adopted a new accounting standard for GAAP that will be effective for us for our first fiscal year beginning after December 15, 2022. This standard, referred to as Current Expected Credit Loss, or CECL, requires FDIC-insured institutions and their holding companies (banking organizations) to recognize credit losses expected over the life of certain financial assets. CECL covers a broader range of assets than the current method of recognizing credit losses and generally results in earlier recognition of credit losses. Upon adoption of CECL, a banking organization must record a one-time adjustment to its credit loss allowances as of the beginning of the fiscal year of adoption equal to the difference, if any, between the amount of credit loss allowances under the current methodology and the amount required under CECL. For a banking organization, implementation of CECL is generally likely to reduce retained earnings, and to affect other items, in a manner that reduces its regulatory capital.
The federal banking regulators (the Federal Reserve, the Office of the Comptroller of the Currency and the FDIC) have adopted a rule that gives a banking organization the option to phase in over a three-year period the day-one adverse effects of CECL on its regulatory capital.
Prompt Corrective Action. Federal statutes establish a supervisory framework for FDIC-insured institutions based on five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution’s category depends upon where its capital levels are in relation to relevant capital measures. The well-capitalized category is described above. An institution that is not well capitalized is subject to certain restrictions on brokered deposits, including restrictions on the rates it can offer on its deposits, generally. To be considered adequately capitalized, an institution must have the minimum capital ratios described above. Any institution which is neither well capitalized nor adequately capitalized is considered undercapitalized. The previously referenced final rule establishing an elective “community bank leverage ratio” regulatory capital framework provides that a qualifying institution whose capital
exceeds the community bank leverage ratio and opts to use that framework will be considered “well capitalized” for purposes of prompt corrective action.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by First Financial
Northwestthe Bank to comply with applicable capital requirements would, if unremedied, result in progressively more severe restrictions on its activities and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels and, ultimately, the appointment of the FDIC as receiver or conservator. Banking regulators will take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for their review may be dependent on compliance with capital requirements.
At December 31, 2017, First Financial Northwest2022, the Bank was categorized as “well capitalized” under the prompt corrective action regulations of the FDIC. For additional information, see Note 14 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
Federal Home Loan Bank System. First Financial Northwest The Bank is a member of the FHLB of Des Moines, one of 11 regional FHLBs that administer the home financing credit function of savings institutions. The FHLBs are subject to the oversight of the Federal Housing Finance Agency (“FHFA”) and each FHLB serves as a reserve or central bank for its members within its assigned region. The FHLBs are funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System and makesmake loans or advances to members in accordance with policies and procedures established by the Board of Directors of the FHLB, which are subject to the oversight of the FHFA. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing. See “Business – Deposit Activities and Other Sources of Funds – Borrowings.”
As a member, the Bank is required to purchase and maintain stock in the FHLB of Des Moines based on the Bank's asset size and level of borrowings from the FHLB. At December 31, 2017,2022, the Bank held $9.9$7.5 million in FHLB stock that was in compliance with the holding requirements. The Bank purchased 708 shares of additional stock in March 2017 as a result of the increase in assets as of December 31, 2016. In addition, activity stock was purchased and sold throughout 2017 in response to increases or payoffs to our outstanding advances. At December 31, 2017, the Bank had a net increase in activity stock held of 17,800 shares for the year. The FHLB pays dividends quarterly, and First Financial Northwestthe Bank received $296,000$318,000 in dividends during the year ended December 31, 2017.2022.
The FHLBs continue to contribute to low- and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have adversely affected the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of First Financial Northwestthe Bank’s FHLB stock may result in a decrease in net income and possibly capital.
Commercial Real Estate Lending Concentrations. The federal banking agencies have issued guidance on sound risk management practices for concentrations in commercial real estate lending. The particular focus is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be sensitive to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is not to limit a bank’s commercial real estate lending but to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance directs the FDIC and other federal bank regulatory agencies to focus their supervisory resources on institutions that may have significant commercial real estate loan concentration risk. A bank that has experienced rapid growth in commercial real estate lending, has notable exposure to a specific type of commercial real estate loan, or is approaching or exceeding the following supervisory criteria may be identified for further supervisory analysis with respect to real estate concentration risk:
•Total reported loans for construction, land development and other landrepresent 100% or more of the bank’s total regulatory capital; or
•Total commercial real estate loans (as defined in the guidance) represent 300% or more of the bank’s total regulatory capital and the outstanding balance of the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months.
The guidance provides that the strength of an institution’s lending and risk management practices with respect to such concentrations will be taken into account in supervisory guidance on evaluation of capital adequacy. As of December 31, 2017, First Financial Northwest2022, the Bank’s aggregate recorded loan balances for construction, land development and land loans were 108.6%53.1% of regulatory
capital. In addition, at December 31, 2017, First Financial Northwest2022, the Bank’s loans on commercial real estate, as defined by the FDIC, were 514.0%346.9% of regulatory capital.
Activities and Investments of Insured State-Chartered Financial Institutions. Federal law generally limits the activities and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. An insured state bank is not prohibited from, among other things, (1) acquiring or retaining a majority interest in a subsidiary, (2) investing
as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank’s total assets, (3) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors’, trustees’ and officers’ liability insurance coverage or bankers’ blanket bond group insurance coverage for insured depository institutions and (4) acquiring or retaining the voting shares of a depository institution owned by another FDIC-insured institution if certain requirements are met.
Under the law of Washington State, has enacted a law regarding financial institution parity. Primarily, the law affords Washington state‑chartered commercial banks the same powers as Washington state-chartered savings banks and provides that Washington chartered commercialsavings banks may exercise any of the powers that the Federal Reserve has determined to be closely related to the business of bankingWashington-chartered commercial banks, national banks and the powers of nationalfederally-chartered savings banks, subject to the approval of the Director of the DFI in certain situations. Finally, the law provides additional flexibility forIn addition, Washington state-chartered commercial and savings banks with respect to interest rates on loans and other extensions of credit. Specifically, they may charge the maximum interest rate allowable for loans and other extensions of credit by federally-chartered financial institutions to Washington residents.
Environmental Issues Associated With Real Estate Lending. The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) is a federal statute that generally imposes strict liability on all prior and present “owners and operators” of sites containing hazardous waste. However, Congress acted to protect secured creditors by providing that the term “owner and operator” excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this “secured creditor exemption” has been the subject of judicial interpretations that have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan. To the extent that legal uncertainty exists in this area, all creditors, including First Financial Northwestthe Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs that often are substantial and can exceed the value of the collateral property.
Federal Reserve System. The Federal Reserve requires that all depository institutions to maintain reserves onat specified levels against their transaction accounts, and non-personal time deposits. These reserves may be inprimarily checking accounts. In response to the form of cash or deposits with the regional Federal Reserve Bank. Interest-bearing demand accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to reserve requirements, as are any non-personal time deposits at a savings bank. As of December 31, 2017, First Financial Northwest Bank’s deposits withCOVID-19 pandemic, the Federal Reserve exceeded its Regulation Dreduced reserve requirements.requirement ratios to zero percent effective on March 26, 2020, to support lending to households and businesses. At December 31, 2022, the Bank was in compliance with the reserve requirements in place at that time.
Affiliate Transactions. First Financial Northwest and First Financial Northwestthe Bank are separate and distinct legal entities. First Financial Northwest (and any non-bank subsidiary of First Financial Northwest) is an affiliate of First Financial Northwestthe Bank. Federal laws strictly limit the ability of banks to engage in certain transactions with their affiliates. Transactions deemed to be a “covered transaction” under Section 23A of the Federal Reserve Act and between a bank and an affiliate are limited to 10% of the bank’s capital andplus surplus and, with respect to all affiliates, to an aggregate of 20% of the bank’s capital andplus surplus. Further, covered transactions that are loans and extensions of credit generally are required to be secured by eligible collateral in specified amounts. Federal law also requires that covered transactions and certain other transactions listed in Section 23B of the Federal Reserve Act between a bank and its affiliates be on terms as favorable to the bank as transactions with nonaffiliates. For additional information, see “– Regulation and Supervision of First Financial Northwest – Limitations on Transactions with Affiliates” below.
In addition, Sections 22(g) and (h) of the Federal Reserve Act place restrictions on loans to executive officers, directors and principal shareholders. Under Section 22(h), loans to a director, executive officer or greater than 10% shareholder of a bank and certain affiliated interests, generally may not exceed, together with all other outstanding loans to such person and affiliated interests, the bank’s loans to one borrower limit (generally equal to 15% of the institution’s unimpaired capital and surplus).plus surplus. Section 22(h) also requires that loans to directors, executive officers and principal shareholders be made on terms substantially the same as offered in comparable transactions to other persons unless the loans are made pursuant to a benefit or compensation program that (1) is widely available to employees of the institution and (2) does not give preference to any director, executive officer or principal shareholder, or certain affiliated interests, over other employees of the bank. Section 22(h) also requires prior board approval for certain loans. In addition, the aggregate amount of extensions of credit by a bank to all insiders cannot exceed the bank’s unimpaired capital andplus surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers. At December 31, 2017, First Financial Northwest2022, the Bank was in compliance with these restrictions.
Community Reinvestment Act. First Financial NorthwestThe Bank is subject to the provisions of the Community Reinvestment Act of 1977 (“CRA”), which require the appropriate federal bank regulatory agency to assess a bank’s performance under the CRA in
meeting the credit needs of the community serviced by the bank, including low and moderate income neighborhoods. The regulatory agency’s assessment of the bank’s record is made available to the public. Further, a bank’s CRA
performance must be considered in connection with a bank’s application, to among other things, establish a new branch office that will accept deposits, relocate an existing office or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. First Financial NorthwestAn unsatisfactory rating may be the basis for denial of certain applications. The Bank received a “satisfactory”an “outstanding” rating during its most recent CRA examination.
Dividends. The amount of dividends payable by First Financial Northwestthe Bank to First Financial Northwest depends upon First Financial Northwestthe Bank’s earnings and capital position, and is limited by federal and state laws, regulations and policies. According to Washington law, First Financial Northwestthe Bank may not declare or pay a cash dividend on its capital stock if it would cause its net worth to be reduced below (1) the amount required for liquidation accounts or (2) the net worth requirements, if any, imposed by the Director of the DFI. In addition, dividends may not be declared or paid if First Financial Northwestthe Bank is in default in payment of any assessments due to the FDIC. Dividends on First Financial Northwestthe Bank’s capital stock may not be paid in an aggregate amount greater than the aggregate retained earnings of First Financial Northwestthe Bank, without the approval of the Director of the DFI. Dividends payable by the Bank can be limited or prohibited if the Bank does not meet the capital conservation buffer requirement.
The amount of dividends actually paid during any one period is affected by First Financial Northwestthe Bank’s policy of maintaining a strong capital position. Federal law further restricts dividends payable by an institution that does not meet the capital conservation buffer requirement and provides that no insured depository institution may pay a cash dividend if it would cause the institution to be “undercapitalized,” as defined in the prompt corrective action regulations. Moreover, the federal bank regulatory agencies also have the general authority to limit the dividends paid by insured banks if such payments are deemed to constitute an unsafe and unsound practice.
Privacy Standards.Standards and Cybersecurity. The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (“GLBA”) modernized the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. First Financial Northwest Bank is subject toFederal banking agencies, including the FDIC, regulationshave adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards under the privacy protection provisionssupervision of the GLBA.board of directors.These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third parties in the provision of financial services. These regulations require First Financial Northwestthe Bank to disclose its privacy policy, including informing consumers of its information sharing practices and informing consumers of their rights to opt out of certain practices.In addition, other federal and state cybersecurity and data privacy laws and regulations may expose the Bank to risk and result in certain risk management costs. In addition, on November 18, 2021, the federal banking agencies announced the adoption of a final rule providing for new notification requirements for banking organizations and their service providers for significant cybersecurity incidents.Specifically, the new rule requires a banking organization to notify its primary federal regulator as soon as possible, and no later than 36 hours after, the banking organization determines that a “computer-security incident” rising to the level of a “notification incident” has occurred.Notification is required for incidents that have materially affected or are reasonably likely to materially affect the viability of a banking organization’s operations, its ability to deliver banking products and services, or the stability of the financial sector.Service providers are required under the rule to notify affected banking organization customers as soon as possible when the provider determines that it has experienced a computer-security incident that has materially affected or is reasonably likely to materially affect the banking organization’s customers for four or more hours.Compliance with the new rule was required by May 1, 2022.Non-compliance with federal or similar state privacy and cybersecurity laws and regulations could lead to substantial regulatory imposed fines and penalties, damages from private causes of action and/or reputational harm.
Anti-Money Laundering and Customer Identification. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act) was signed into law on October 26, 2001. The USA PATRIOT Act and the Bank Secrecy Act requires financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts, and, effective in 2018, the beneficial owners of accounts. Bank regulators are directed to consider a holding company’s effectiveness in combating money laundering when ruling on Bank Holding Company Act and Bank Merger Act applications.
Other Consumer Protection Laws and Regulations. The Dodd-Frank Act established the CFPBConsumer Financial Protection Bureau (“CFPB”) and empowered it to exercise broad regulatory, supervisory and enforcement authority with
respect to both new and existing consumer financial protection laws. First Financial NorthwestThe Bank is subject to consumer protection regulations issued by the CFPB, but as a financial institution with assets of less than $10 billion, First Financial NorthwestThe Bank is generally subject to supervision and enforcement by the FDIC with respect to its compliance with federal consumer financial protection laws and CFPB regulations.
First Financial NorthwestThe Bank is subject to a broad array of federal and state consumer protection laws and regulations that govern almost every aspect of its business relationships with consumers. While not exhaustive, these laws and regulations include the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Right to Financial Privacy Act, the Home Ownership and Equity Protection Act, the Consumer Leasing Act, the Fair Credit Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st Century Act, laws governing flood insurance, laws governing consumer protections in connection with the sale of insurance, federal and state laws prohibiting unfair and deceptive business practices and various regulations that implement some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans and providing other services. Failure to comply with these laws and regulations can subject First Financial Northwestthe Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil liability, criminal penalties, punitive damages and the loss of certain contractual rights.
Regulation and Supervision of First Financial Northwest
General. First Financial Northwest, as sole shareholder of First Financial Northwestthe Bank, is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to comprehensive regulation by the Federal Reserve under the Bank Holding Company Act of 1956, as amended (“BHCA”), and the regulations of the FRB. Accordingly, First Financial Northwest is required to file quarterlysemi-annual reports with the Federal Reserve and provide additional information as the Federal Reserve may require. The Federal Reserve may examine First Financial Northwest, and any of its subsidiaries, and charge First Financial Northwest for the cost of the examination. The Federal Reserve also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. First Financial Northwest is also required to file certain reports with, and otherwise comply with the rules and regulations of the SEC.
The Bank Holding Company Act. Under the BHCA, First Financial Northwest is supervised by the Federal Reserve. The Federal Reserve has a policy that a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary bank and may not conduct its operations in an unsafe or unsound manner. In addition, the Dodd-Frank Act and earlier Federal Reserve policy provide that a bank holding company should serve as a source of strength to its subsidiary bank by having the ability to provide financial assistance to its subsidiary bank during periods of financial distress to the bank. A bank holding company’s failure to meet its obligation to serve as a source of strength to its subsidiary bank will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve’s regulations or both. No regulations have yet been proposed by the Federal Reserve to implement the source of strength provisions required by the Dodd-Frank Act. First Financial Northwest and any subsidiaries that it may control are considered “affiliates” within the meaning of the Federal Reserve Act, and transactions between First Financial Northwestthe Bank and affiliates are subject to numerous restrictions. With some exceptions, First Financial Northwest and its subsidiaries are prohibited from tying the provision of various services, such as extensions of credit, to other services offered by First Financial Northwest or by its affiliates.
Acquisitions.The BHCA prohibits a bank holding company, with certain exceptions, from acquiring ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. Under the BHCA, the Federal Reserve may approve the ownership of shares by a bank holding company in any company, the activities of which the Federal Reserve has determined to be so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto. These activities include: operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers’ checks and U.S. Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers.
Regulatory Capital Requirements. Bank holding companies, like First Financial Northwest, are subject to capital adequacy requirements of the The Federal Reserve undermust approve the BHCA and the regulationsacquisition (or acquisition of the Federal Reserve. These capital requirements are the same as those applicable to First Financial Northwest Bank as described above. At December 31, 2017, First Financial Northwest exceeded all regulatory requirements for bank holding companies with $1.0 billion or more in assets.
The following table presents the regulatory capital ratios for First Financial Northwest as of December 31, 2017:
|
| | | | | | |
| Actual |
| Amount | | Ratio |
| (Dollars in thousands) |
Tier I leverage capital (to average assets) | $ | 141,660 |
| | 11.82 | % |
Common equity tier I (to risk-weighted assets) | 141,660 |
| | 14.50 |
|
Tier I risk-based capital (to risk-weighted assets) | 141,660 |
| | 14.50 |
|
Total risk-based capital (to risk-weighted assets) | 153,885 |
| | 15.75 |
|
Under the regulationscontrol) of the Federal Reserve,a bank or other FDIC-insured depository institution by a bank holding company, with consolidated assetsand the appropriate federal banking regulator must approve a bank’s acquisition (or acquisition of more than $1.0 billion, including First Financial Northwest, is “well capitalized” if it has a total risk-based capital ratiocontrol) of 10.0%another bank or more and a Tier 1 risk-based capital ratio of 8.0% or more, and is not be subject to an individualized order, directive or agreement under which theother FDIC-insured institution.
Federal Reserve requires it to maintain a specific capital level. As of December 31, 2017, First Financial Northwest met the requirements to be “well capitalized” and met the fully phased-in capital conservation buffer requirement.
Acquisition of Control. Control of a Bank Holding Company. Under federal law, a notice or application must be submitted to the Federal Reserveappropriate federal banking regulator if any person (including a company), or group acting in concert, seeks to acquire “control” of a bank holding company. An acquisition of control can occur upon the acquisition of 10% or more of the voting stock of a bank holding company or as otherwise defined by the Federal Reserve.federal regulations. In considering such a notice or application, the Federal Reserve takes into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that acquires control becomes subject to regulation as a bank holding company. Depending on circumstances, a notice or application may be required to be filed with appropriate state banking regulators and may be subject to their approval or non-objection.
Regulatory Capital Requirements. As discussed above, pursuant to the “Small Bank Holding Company” exception, effective August 30, 2018, bank holding companies with less than $3 billion in consolidated assets were generally no longer subject to the Federal Reserve’s capital regulations, which are generally the same as the capital regulations applicable to First Financial Northwest Bank. At the time of this change, First Financial Northwest was considered “well capitalized” (as defined for a bank holding company), with a total risk-based capital ratio of 10.0% or more and a Tier 1 risk-based capital ratio of 8.0% or more, and was not subject to an individualized order, directive or agreement under which the Federal Reserve requires it to maintain a specific capital level.
Restrictions on Dividends. The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies which expresses its view that a bank holding company must maintain an adequate capital position and generally should not pay cash dividends unless the company’s net income for the past year is sufficient to fully fund the cash dividends and that the prospective rate of earnings appears consistent with the company’s capital needs, asset quality, and overall financial condition. The Federal Reserve policy statement also indicates that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. As described above under “Capital Requirements,”Under Washington corporate law, First Financial Northwest generally may not pay dividends if after that payment it would not be able to pay its liabilities as they become due in the usual course of business, or its total assets would be less than its total liabilities.The capital conversionconservation buffer requirement discussed above can also restrict First Financial Northwest’s and the Bank’s ability to paylimit dividends. For additional information, see Item 1.A. “Risk Factors – Certain regulatory restrictions are imposed on usRisks Related to Regulatory and lack of complianceCompliance Matters-Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in monetary penalties and/fines or additional regulatory actions.” in Item 1.A. Risk Factors containedsanctions” in this report.
Stock Repurchases. A bank holding company, except for certain “well-capitalized” and highly rated bank holding companies, is required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding twelve months, is equal to 10% or more of its consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order or any condition imposed by, or written agreement with, the Federal Reserve.During the year ended December 31, 2017,2022, First Financial Northwest repurchased 326,80084,981 shares of its common stock.
Federal Securities Laws. First Financial Northwest’s common stock is registered with the SEC under Section 12(b) of the Securities Exchange Act of 1934, as amended (“Exchange Act”). We are subject to information, proxy solicitation, insider trading restrictions and other requirements under the Exchange Act.
The Dodd-Frank Act. Among other requirements, the Dodd-Frank Act requires public companies, like First Financial Northwest, to (i) provide their shareholders with a non-binding vote (a) at least once every three years on the compensation paid to executive officers and (b) at least once every six years on whether they should have a “say on pay” vote every one, two or three years; (ii) have a separate, non-binding shareholder vote regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments; (iii) provide disclosure in annual proxy materials concerning the relationship between the executive compensation paid and the financial performance of the issuer; and (iv) require companies to disclose the ratio of the Chief Executive Officer’s annual total compensation to the median annual total compensation of all other employees. For certain of these changes, the implementing regulations have not been promulgated, so the full impact of the Dodd-Frank Act on public companies cannot be determined at this time.
The federal banking agencies have issued final rules to implement the provisions of Section 619 of the Dodd-Frank Act commonly referred to as the Volcker Rule. The regulations contain prohibitions and restrictions on the ability of financial institutions holding companies and their affiliates to engage in proprietary trading and to hold certain interests in, or to have certain relationships with, various types of investment funds, including hedge funds and private equity funds. Management believes First Financial Northwest’s investment portfolio and investment strategies are in compliance with the various provisions of the Volcker Rule regulations.
Sarbanes-Oxley Act of 2002. As a public company that files periodic reports with the SEC under the Exchange Act, First Financial Northwest, is subject to the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”), which addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. Our policies and procedures have been updated to comply with the requirements of the Sarbanes-Oxley Act.
Taxation
Federal Taxation
General. First Financial Northwest and First Financial Northwest Bank areThe Company is subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to First Financial Northwest or First Financial Northwest Bank.the Company. The tax years still open for review by the Internal Revenue Service are 2014are 2019 through 2017.2022.
On December 22, 2017, the U.S. Government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits, and deductions for individuals and businesses. For businesses, the Tax Act reduces the corporate federal income tax rate from a maximum of 35% to a flat 21% rate. The corporate income tax rate reduction was effective January 1, 2018. The Tax Act required a revaluation the Company’s deferred tax assets and liabilities to account for the future impact of lower corporate income tax rates and other provisions of the legislation. As a result of the Company’s revaluation, the net deferred tax asset (“DTA”) was reduced through an increase to the provision for income tax. The revaluation of our DTA balance resulted in a one-time increase for the year ended December 31, 2017 to federal income tax of $807,000.
First Financial Northwest files a consolidated federal income tax return with First Financial Northwestthe Bank. Accordingly, any cash distributions made by First Financial Northwest to its shareholders are considered to be taxable dividends and not as a non-taxable return of capital to shareholders for federal and state tax purposes.
Method of Accounting. For federal income tax purposes, First Financial Northwestthe Company currently reports its income and expenses on the accrual method of accounting and uses a fiscal year ending on December 31 for filing its federal income tax return.
Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, called alternative minimum taxable income. The alternative minimum tax is payable to the extent such alternative minimum taxable income is in excess of an exemption amount. Net operating losses can offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. The Company’s alternative minimum tax credit carryforward was fully utilized during the year and had a zero balance at December 31, 2017.
Net Operating Loss Carryovers. A financial institution may carry backcarryforward net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. This provision applies to losses incurred in taxable years beginning after August 2009.indefinitely. The Company had no net operating loss carryforwards at December 31, 2017.2022.
Corporate Dividends-Received Deduction. First Financial Northwest may eliminate from its income dividends received from First Financial Northwestthe Bank as a wholly-owned subsidiary of First Financial Northwest that files a consolidated return with First Financial Northwestthe Bank. The corporate dividends-received deduction is 100%, or 80%, in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level of stock ownership of the payer of the dividend. Corporations that own less than 20% of the stock of a corporation distributing a dividend may deduct 70% of dividends received or accrued on their behalf.
For additional information regarding our federal income taxes, see Note 13 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
State Taxation
First Financial Northwest and its subsidiaries areThe Company is subject to a business and occupation tax imposed under Washington state law at the rate of 1.50%1.75% of gross receipts.receipts for the Bank, as gross receipts are greater than $1.0 million, and 1.50% for its other subsidiaries with gross receipts less than $1.0 million. In addition, various municipalities also assess business and occupation taxes at differing rates. Interest received on loans secured by first lien mortgages or deeds of trust on residential properties, rental income from properties, and certain investment securities are exempt from this tax. An audit by the Washington State Department of Revenue was completed for the years 2010 through 2013, resulting in no material tax revisions.
The Bank has purchased and originated loans in California, and is subject to the California income tax on revenue earned from these loans. Corporations doing business in California are subject to an annual minimum franchise tax of $800 or an income tax of 10.84% of net income.
Executive Officers of First Financial Northwest, Inc.
The business experience for at least the past five years for the executive officers of First Financial Northwest and its primary subsidiary First Financial Northwest Bankthe Company is set forth below.
Joseph W. Kiley III,, age 62, 67, has served as President and Chief Executive Officer of First Financial Northwest and First Financial Diversified since September 2013,2013; as director of First Financial and servedFirst Financial Diversified since December 2012; and as President, Chief Executive Officer Directorand director of First Financial Northwest Bank since September 2012, and Director of First Financial Northwest and First Financial Diversified since December 2012. He previously served as President, Chief Executive Officer, and Directordirector of Frontier Bank, F.S.B., located in Palm Desert, California, and its holding company, Western Community Bancshares, Inc. from 2010 to 2012. From 2007 to 2010, Mr. Kiley was a Director at California General Bank. From 2009 to 2011, Mr. Kiley served as the President, Chief Executive Officer and Director of Imperial Capital Bank, located in San Diego, California and its holding company, Imperial Capital Bancorp, Inc. Mr. Kiley has over 2530 years of executive experience at banks, thrifts and their holding companies that includedincludes, but is not limited to, serving as president, chief executive officer, chief financial officer, and director. Mr. Kiley holds a Bachelor of Science degree in Business Administration (Accounting) from California State University, Chico, and is a former California certified public accountant. Mr. Kiley is a member of the Renton Rotary Club, City of Renton Mayor’s Business Executive Forum, City of Renton Mayor’s Blue Ribbon Panel, and serves onpast Chair of the boardsBoard of directorsDirectors of the Renton Chamber of CommerceCommerce. He is a director and past Chairman of the Board of Directors of the Washington Bankers’Bankers Association. In addition, Mr. Kiley currently serves on the Board of Directors of the California Bankers Association and its Executive Committee and is a member of the Community Bankers Council of the American Bankers Association.
Richard P. Jacobson,, age 54, 59, has served as Chief Operating Officer of theFirst Financial Northwest Bank since July 2013, and as Chief Financial Officer of First Financial Northwest, First Financial Diversified, and the Bank since August 2013, and Chief Operating Officer of First Financial Northwest since September 2013. He was appointed as a director of First Financial, Northwest and First Financial NorthwestDiversified and the Bank effective September 2013. Mr. Jacobson served as a consultant to First Financial Northwest from April 2010 to April 2012, and from that time until July 2013, served2012. Subsequently, he worked as a mortgage loan originator in Palm Desert, California. PriorCalifornia from July 2012 to that,July 2013. Previously, he had been employed by Horizon Financial Corp,Corp. and Horizon Bank, Bellingham, Washington, since 1987,for 23 years, and had served as President, Chief Executive Officer and a director of Horizon Financial CorpCorp. and Horizon Bank from January 2008 to January 2010. Mr. Jacobson also served as Chief Financial Officer of Horizon Financial CorpCorp. and Horizon Bank from March 2000 until October 2008. Between 1985 and 2008, Mr. Jacobson served in several other positions at Horizon Financial Corp. and Horizon Bank and spent two years as a Washington Statestate licensed real estate appraiser from 1992 to 1994. Mr. Jacobson received his Bachelor’s degree in Business Administration (Finance) from the University of Washington. In addition, Mr. Jacobson graduated with honors from the American BankerBankers Association’s National School of Banking. Mr. Jacobson is a past president of the Whatcom County North Rotary clubClub and has served on the boards of his church, the United Way, Boys and Girls Club, and Junior Achievement.
Simon Soh, age 5358, iswas appointed Senior Vice President and Chief Credit Officer of First Financial Northwest Bank. Prior to his promotionBank in December 2019, a position he held on an interim basis since November 2019, and between August 2017 and December 2018. Mr. Soh served as Senior Vice President and Chief Lending Officer a position he held sincefrom October 2012.2012 to December 2019. From August 2010 until October 2012, Mr. Soh served as Vice President and Loan Production Manager of First Financial Northwest Bank, a position he held since August 2010.Bank. Prior to that, he was First Vice President and Commercial Lending Manager at East West Bank. In 1998, Mr. Soh was a founding member of Pacifica Bank in Bellevue, Washington that merged with United Commercial Bank in 2005, later becoming East West Bank in 2009. Mr. Soh has over 2930 years of experience in commercial banking.
Ronnie J. Clariza, age 3742, was appointed Senior Vice President and Chief Risk Officer and Senior Vice President of First Financial Northwest Bank in November 2013. Mr. Clariza previously served as Vice President and Risk Management Officer since May 2008, and prior to that, as Assistant Vice President and Compliance Officer, as well as serving in various other compliance and internal audit roles since he began with the Bank in 2003. Mr. Clariza is a graduate of the University of Washington where he received his Bachelor of Arts degree in Business Administration, Finance, and is a certified regulatory Compliance Officer. Mr. Clariza is an active member of the Education and Enterprise Risk Management and Government Relations Committees for the California Bankers and Washington Bankers’ Association.Bankers Associations, respectively. He washas also participated in numerous working groups for the American Bankers Association and previously served as a past member ofVolunteer Compliance Manager for the Seattle Children’s Hospital Guild Association as a Volunteer Compliance Manager.Association.
Dalen D. Harrison, age 58,63, was promoted to Chief Banking Officer of First Financial Northwest Bank in December 2019. She was appointed Senior Vice President in July 2014 and previously served as Chief Deposit Officer of First Financial Northwest Bank infrom March 2014 and Senior Vice President in July 2014.to December 2019. Ms. Harrison served as Senior Vice President and Director of Retail Banking at Peoples Bank in Bellingham, Washington from 2010 until 2014. Prior to that, she served as Vice President of Rainier Pacific Bank, Tacoma, Washington, from 1994 until 2010. Ms. Harrison received a Bachelor of Arts degree in Business Administration from StSaint Mary’s College in Moraga, California. Ms. Harrison has served on the boards of Rainier Pacific Foundation, First Place for Children, and Gig Harbor Rotary Foundation, Renton Downtown Partnership, and currently serves on the boards of the Renton Area Youth and Family Services and the Renton Downtown Partnership.Services.
Christine A. Huestis, age 52, is Vice President and Controller of First Financial Northwest and First Financial Northwest Bank. Prior to joining First Financial Northwest in October 2013, she was employed by Realty in Motion, LLC, a holding company for several mortgage default service companies in Bellevue, Washington. From 1999 until joining First Financial Northwest, Ms. Huestis held key accounting positions at affiliated companies within Realty in Motion, with her most recent position being that
of Controller. Ms. Huestis received a Bachelor of Science degree in Accounting from Central Washington University. She is a certified public accountant and is a member of the American Institute of Certified Public Accountants.
Item 1A. Risk Factors.
An investment in our common stock is subject to risks inherent in our business. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this report and our other filings with the SEC. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition, capital levels, cash flows, liquidity, results of operations and prospects. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements. The market price of our common stock could decline significantly due to any of these identified or other risks and you could lose some or all of your investment. This report is qualified in its entirety by these risk factors.
Risks Related to Macroeconomic Conditions
Our business may be adversely affected by downturns in the national economy and in the economies in our market areas.
Our loans are primarily to businesses and individuals in the state of Washington with 88.4%86.6% of loans to borrowers or secured by properties located in Washington and 11.6%13.4% of loans to borrowers or secured by properties in other states. Through our efforts to geographically diversify our loan portfolio, at December 31, 2022, our portfolio included $158.2 million, or 13.4% of loans to borrowers or secured by properties located in 47 other states and Washington, D.C., including $37.1 million, or 3.1% of loans, secured by properties or to borrowers in California. A decline in the national economy or the economies of the four counties which we consider to be our primary market area could have a material adverse effect on our business, financial condition, results of operations, and prospects. Weakness in the global economy hasand global supply chain issues have adversely affected many businesses operating in our markets that are dependent upon international trade. Continued changestrade and it is not known how tariffs being imposed on international trade may also affect these businesses. Changes in agreements or relationships between the United States and other countries may also affect these businesses.
While real estate values and unemployment rates have recently improved, aA deterioration in economic conditions in the market areas we serve, in particularas a result of inflation, a recession, the Puget Sound areaeffects of Washington State,COVID-19 variants or other factors, could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:
•loan delinquencies, problem assets and foreclosures may increase;
•we may increase our allowance for loan and lease losses;
•demand for our products and services may decline resulting in a decrease in our total loans or assets;
•collateral for loans, especially real estate, may decline in value, exposing us to increased risk of loss on existing loans, reducing customers’ borrowing power, and reducing the value of assets and collateral associated with existing loans;
•the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us; and
•the amount of our low-cost or noninterest-bearing deposits may decrease and the composition of our deposits may be adversely affected.
A decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse. Many of the loans in our portfolio are secured by real estate. Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively affect the borrower’s ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by various other factors, including changes in general or regional economic conditions, governmental rules or policies and natural disasters such as earthquakes and tornadoes. If we are required to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and profitability could be adversely affected.
Adverse changes in the regional and general economy could reduce our growth rate, impair our ability to collect loans and generally have a negative effect on our financial condition and results of operations.
External economic factors, such as changes in monetary policy and inflation, may have an adverse effect on our business, financial condition and results of operations.
Our financial condition and results of operations liquidity and cash flows are subject to interest rate risk.
Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions andaffected by credit policies of various governmental and regulatory agencies, and, in particular,monetary authorities, particularly the Federal Reserve Board. In an attempt to help the economy,Actions by monetary and fiscal authorities, including the Federal Reserve Board, could lead to inflation, deflation, or other economic phenomena that could adversely affect our financial performance. Inflation has kept interest rates low through its targeted Fed Funds rate. The Federal Reserve Board increasedrisen sharply since the targeted Fed Funds rateend of 2021 and throughout 2022 at levels not seen for over 40 years. Inflationary pressures are currently expected to remain elevated throughout 2023. Small to medium-sized businesses may be impacted more during 2017periods of high inflation as they are not able to 1.50% at December 31, 2017 and has indicated further increases are likely during 2018, subjectleverage economics of scale to economic conditions. Asmitigate cost pressures compared to larger businesses. Consequently, the Federal Reserve Board increases the Fed Funds rate, overall interest rates will likely rise, which may negatively impact both the housing markets by reducing refinancing activity and new home purchases and the U.S. economic recovery.
Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but these changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assetsbusiness customers to repay their loans may deteriorate, and liabilities and (iii) the average duration of our mortgage-backed securities portfolio and other interest-earning assets.
Changes in interest rates could also have a negativesome cases this deterioration may occur quickly, which would adversely impact on our results of operations by reducingand financial condition. Furthermore, a prolonged period of inflation could cause wages and other costs to the abilityCompany to increase, which could adversely affect our results of borrowers to repay their current loan obligations or by reducing our marginsoperations and profitability. Our net interest margin is the difference between the yield we earn onfinancial condition. Virtually all of our assets and the interest rate we pay for deposits and our other sources of funding. Changesliabilities are monetary in interest rates-up or down-could adversely affect our net interest margin and, asnature. As a result, our net interest income. Although the yield we earnrates tend to have a more significant impact on our assets and our funding costs tend toperformance than general levels of inflation or deflation. Interest rates do not necessarily move in the same direction or by the same magnitude as the prices of goods and services.
The economic impact of the COVID-19 pandemic could continue to affect our financial condition and results of operations.
The COVID-19 pandemic has adversely impacted the global and national economy and certain industries and geographies in responsewhich our clients operate.Given its ongoing and dynamic nature, it is difficult to changes in interest rates, one can rise or fall faster thanpredict the other, causing our net interest marginfull impact of the COVID-19 pandemic on the business of the Company, its clients, employees and third-party service providers.The extent of such impact will depend on future developments, which are highly uncertain.Additionally, the responses of various governmental and nongovernmental authorities and consumers to expand or contract. Our liabilities tendthe pandemic may have material long-term effects on the Company and its clients which are difficult to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract until the yields on interest-earning assets catch up. Changesquantify in the slope of the “yield curve”,near-term or the spread between short-term and long-term interest rates-could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend tolong-term.
We could be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets. Also, interest rate decreases can lead to increased prepayments of loans and mortgage-backed securities as borrowers refinance their loans to reduce borrowing costs. Under these circumstances, we are subject to reinvestment riska number of risks as we may have to redeploy such repayment proceeds into lower yielding investments, which would likely hurt our income.
A sustained increase in market interest rates could adversely affect our earnings. As athe result of the low interest rate environment, an increasing percentageCOVID-19 pandemic, any of our deposits have been comprised of deposits bearing no or a relatively low rate of interest and having a shorter duration than our assets. We would incur a higher cost of funds to retain these deposits in a rising interest rate environment. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected
In addition, a portion of our adjustable-rate loans have interest rate floors below which the loan’s contractual interest rate may not adjust. At December 31, 2017, 49.9% of our net loans were comprised of adjustable-rate loans. At that date, $185.4 million, or 37.1%, of these loans with an average interest rate of 4.1% were at their floor interest rate. The inability of our loans to adjust downward can contribute to increased income in periods of declining interest rates, although this result is subject to the risks that borrowers may refinance these loans during periods of declining interest rates. Also, when loans are at their respective floor, which is above the fully-indexed rate, there is a further risk that our interest income may not increase as rapidly as our cost of funds during periods of increasing interest rates and could have a material, adverse effect on our results of operations.
Changes in interest rates also affect the value of our interest-earning assets, including our securities portfolio. Generally, the fair value of fixed-rate securities fluctuates inversely with changes in interest rates. Unrealized gains and losses on securities available for sale are reported as a separate component of equity, net of tax. Decreases in the fair value of securities available for sale resulting from increases in interest rates could have an adverse effect on stockholders’ equity.
Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on ourbusiness, financial condition, liquidity, results of operations, any substantial, unexpectedability to execute our growth strategy, and ability to pay dividends.These risks include, but are not limited to, changes in demand for our products and services; increased loan losses or other impairments in our loan portfolios and increases in our allowance for loan and lease losses; a decline in collateral for our loans, especially real estate; unanticipated unavailability of employees; increased cyber security risks as employees work remotely; a prolonged changeweakness in market interest rateseconomic conditions resulting in a reduction of future projected earnings could havenecessitate a material adverse effectvaluation allowance against our current outstanding deferred tax assets; a triggering event leading to impairment testing on our financial conditiongoodwill or core deposit and results of operations. Also,customer relationships intangibles, which could result in an impairment charge; and increased costs as the Company and our interest rate risk modeling techniquesregulators, customers and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet or projected operating results. For further discussion of how changes in interest rates could impact us, see Item 7A. Quantitative and Qualitative Disclosures About Market Risk” for additional information about our interest rate risk management.vendors adapt to evolving pandemic conditions.
Risks Related to Our Lending
Our construction/land loans are based upon estimates of costs and the value of the completed project.
We make construction/land loans to contractors and builders primarily to finance the construction of single and multifamily homes, subdivisions, as well as commercial properties. We originate these loans whether or not the collateral property underlying the loan is under contract for sale. At December 31, 2017,2022, construction/land loans totaled $237.6$78.1 million, or 21.7%6.6% of our total loan portfolio, an increase of $28.6 million or 13.7% since December 31, 2016.portfolio. At December 31, 2017, $108.4 million were multifamily construction loans, $87.42022, $52.8 million were one-to-four family construction loans and $5.3$15.5 million were multifamily construction loans. We had no commercial construction loans.loans at that day. Land loans, which are loans made with land as security, totaled $36.4$9.8 million, or 3.3%0.8% of our total loan portfolio at December 31, 2017.2022. Land loans include land non-development loans for the purchase or refinance of unimproved land held for future residential development, improved residential lots held for speculative investment purposes, and lines of credit secured by land, and land development loans.
Construction/land lending involves additional risks when compared with permanent residential lending because funds are advanced upon the collateral for the project based on an estimate of costs that will produce a future value at completion. Because of theThe uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation on real property, make it is relatively difficult to evaluate accurately the total funds required to complete a project and the completed project loan-to-value ratio. Changes in the demand, such as for new housing and higher than anticipated building costs, may cause actual results to vary significantly from those estimated. For these reasons, this type of lending also typically involves higher loan principal amounts and is often concentrated with a small number of builders. A downturn in
housing, or the real estate market, could increase loan delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. Some of our builders have more than one loan outstanding with us and also have residential mortgage loans for rental properties with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss.
In addition, during the term of most of our construction loans, no payment from the borrower is required since the accumulated interest is added to the principal of the loan through an interest reserve. As a result, these loans often involve the disbursement of funds with repayment substantially dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of a completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. Because construction loans require active monitoring of the building process, including cost comparisons and on-site inspections, these loans are more difficult and costly to monitor. Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly increasing the end-purchasers’ borrowing costs, thereby reducing the overall demand for the project. Properties under construction are often difficult to sell and typically must be completed in order to be successfully sold which also complicates the process of working out problem construction loans. This may require us to advance additional funds and/or contract with another builder to complete construction. Furthermore, in the case of speculative construction loans, there is the added risk associated with identifying an end-purchaser for the finished project. Land loans also pose additional risk because of the lack of income being produced by the property and the potential illiquid nature of the collateral. These risks can also be significantly impacted by supply and demand conditions.
At December 31, 2017, $94.82022, $56.8 million of our construction/land loans were for speculative construction loans and $27.1 millionloans. All of our permanent multifamilyconstruction loans did not have a take-out commitment for a permanent loan with us or another lender.us. At December 31, 2017,2022, all of our construction/land loans were classified as performing.
Our level of commercial and multifamily real estate loans may expose us to increased lending risks.
While commercial and multifamily real estate lending may potentially be more profitable than single-family residential lending, it is generally more sensitive to regional and local economic conditions, making loss levels more difficult to predict. Collateral evaluation and financial statement analysis in these types of loans requires a more detailed analysis at the time of loan underwriting and on an ongoing basis. At December 31, 2017,2022, we had $361.8$407.9 million of commercial real estate loans, representing 33.0%34.4% of our total loan portfolio and $184.9$126.9 million of multifamily loans, representing 16.9%10.7% of our total loan portfolio. These loans typically involve higher principal amounts than other types of loans and some of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one-to-fourone‑to‑four family residential loan. Repayment on these loans is dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service that may be adversely affected by changes in the economy or local market conditions. For example, if the cash flow from the borrower’s project is reduced as a result of leases not being obtained or renewed, the borrower’s ability to repay the loan may be impaired. Commercial and multifamily loans also expose a lender to greater credit risk than loans secured by one-to-four family residential real estate because the collateral securing these loans typically cannot be sold as easily as residential real estate. In addition, many of our commercial and multifamily real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment that may increase the risk of default or non-payment.
A secondary market for most types of commercial and multifamily real estate loans is not readily available, so we have less opportunity to mitigate credit risk by selling part or all of our interest in these loans. As a result of these characteristics, if we foreclose on a commercial or multifamily real estate loan, our holding period for the collateral typically is longer than for one‑to‑four family residential loans because there are fewer potential purchasers of the collateral. Accordingly, charge-offs on commercial real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.
The level of our commercial real estate loan portfolio may subject us to additional regulatory scrutiny.
The FDIC, the Federal Reserve Board and the Office of the Comptroller of the Currency have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under this guidance, a financial institution that, like us, is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if,
among other factors (i) total reported loans for construction, land development, and other land represent 100% or more of total capital, or (ii) total reported loans secured by multifamily and non-farm residential properties, loans for construction, land development and other land, and loans otherwise sensitive to the general commercial real estate market, including loans to commercial real estate related entities, represent 300% or more of total capital. Based on the FDIC criteria, the Bank hashad a concentration in commercial real estate lending as total loans for multifamily, non-farm/non-residential, construction, land development and other land represented 514.0%346.9% of total risk-based capital at December 31, 2017.2022. The particular focus of the guidance is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be at greater risk to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance states that management should employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing. While we believe we have implemented policies and procedures with respect to our commercial real estate lending consistent with this guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to us.
Expansion of our business loans may expose the Company to greater risk of loss.
The Company’s strategic plan includes growth in originations of business loans that are collateralized by non-real estate assets. Our business loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The borrowers’ cash flow may prove to be unpredictable, and collateral securing these loans may fluctuate in value. Most often, this collateral is accounts receivable, inventory, or equipment. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Other collateral securing loans may depreciate over time, may be difficult to appraise, may be illiquid and may fluctuate in value based on the success of the business. Further, the borrowers’ ability to repay these loans may be impacted more from general economic conditions as compared to real estate secured loans.
Our non-owner occupied real estate loans may expose us to increased credit risk.
At December 31, 2017, $130.42022, $242.1 million, or 46.8%50.9% of our one-to-four family residential loan portfolio and 11.9%20.5% of our total loan portfolio, consisted of loans secured by non-owner occupied residential properties. At December 31, 2017, all of our non-owner occupied one-to-four family residential loans were performing in accordance with their repayment terms. Loans secured by non-owner occupied properties generally expose a lender to greater risk of non-payment and loss than loans secured by owner occupied properties because repayment of such loans depend primarily on the tenant’s continuing ability to pay rent to the property owner, who is our borrower, or, if the property owner is unable to find a tenant, the property owner’s ability to repay the loan without the benefit of a rental income stream. In addition, the physical condition of non-owner occupied properties is often below that of owner occupied properties due to lenient property maintenance standards that negatively impact the value of the collateral properties. Furthermore, some of our non-owner occupied residential loan borrowers have more than one loan outstanding with us. At December 31, 2017,2022, we had 78127 non-owner occupied residential loan relationships with an outstanding balance over $500,000 and an aggregate balance of $102.1$196.8 million. Consequently, an adverse development with respect to one credit relationship may expose us to a greater risk of loss compared to an adverse development with respect to an owner occupied residential mortgage loan.
Our business may be adversely affected by credit risk associated with residential property.
At December 31, 2017, $278.72022, $475.8 million, or 25.5%40.3% of our total loan portfolio, was secured by first liens on one‑to‑four family residential loans.properties. In addition, at December 31, 2017,2022, our home equity lines of credit totaled $8.0$7.7 million. A significant portion of our one‑to‑four family residential real estate loan portfolio consists of jumbo loans that do not conform to secondary market mortgage requirements, and therefore are not immediately salable to Fannie Mae or Freddie Mac because such loans exceed the maximum balance allowable for sale (generally $453,000$647,000 to $667,000 $891,000 for single‑family homes in our primary market area)areas in 2022). Jumbo one‑to‑four family residential loans may expose us to increased risk because of their larger balances, and because they cannot be immediately sold to government sponsored enterprises.
In addition, one-to-four family residential loans are generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. A decline in residential real estate values resulting from a downturn in the housing market may reduce the value of the real estate collateral securing these types of loans and increase our risk of loss if borrowers default on their loans. Recessionary conditions or declines in the volume of real estate sales and/or the sales prices coupled with elevated unemployment rates may result in higher than expected loan delinquencies or problem assets, and a decline in demand for our products and services. These
potential negative events may cause us to incur losses, adversely affect our capital and liquidity and damage our financial condition and business operations.
High loan-to-value ratios on a portion of our residential mortgage loan portfolio exposes us to greater risk of loss.
Some of our residential mortgage loans are secured by liens on mortgage properties in which the borrowers have little or no equity because of a decline in the value of the property subsequent to when the loans were originated. Residential loans with high loan-to-value ratios will be more sensitive to declining property values than those with lower loan-to-value ratios and, therefore, may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, such borrowers may be unable to repay their loans in full from the sale. As a result, these loans may experience higher rates of delinquencies, defaults and losses.
To meet our growth objectives we may originate or purchase loans outside of our market area which could affect the level of our net interest margin and nonperforming loans.
In order to achieve our desired loan portfolio growth, we have and may continue to opportunistically originate or purchase loans outside of our market area either individually, through participations, or in bulk or “pools”. We perform certain due diligence procedures and may re-underwrite these loans to our underwriting standards prior to purchase, and anticipate acquiring loans subject to customary limited indemnities, however, we may be exposed to a greater risk of loss as we acquire loans of a type or in geographic areas where management may not have substantial prior experience and which may be more difficult for us to monitor. Further, when determining the purchase price we are willing to pay to acquire loans, management will make certain assumptions about, among other things, how borrowers will prepay their loans, the real estate market and our ability to collect loans successfully and, if necessary, to dispose of any real estate that may be acquired through foreclosure. To the extent that our underlying assumptions prove to be inaccurate or the basis for those assumptions change (such as an unanticipated decline in the real estate market), the purchase price paid may prove to have been excessive, resulting in a lower yield or a loss of some or all of the loan principal. For example, if we purchase “pools” of loans at a premium and some of the loans are prepaid before we anticipate, we will earn less interest income on the acquired loans than expected. Our success in increasing our loan portfolio through loan purchases will depend on our ability to price the loans properly and on general economic conditions in the geographic areas where the underlying properties or collateral for the loans acquired are located. Inaccurate estimates or declines in economic conditions or real estate values in the markets where we purchase loans could significantly adversely affect the level of our nonperforming loans and our results of operations. At December 31, 2017,2022, our loan portfolio included $85.6$80.2 million, or 8.5%6.8% of total loans, net of LIP,located in counties within Washington State that are outside of our primary market area. In addition, our portfolio included $116.3$158.2 million, or 11.6%13.4% of total loans, in loans located outside of Washington State.
If the lead institutions on our loan participation agreements do not keep us informed about the changes in credit quality on the underlying loans in a timely manner, we could be subject to misstatement in our ALLL, or possibly losses on these loans.
The lead institution in our participation agreements is responsible for obtaining necessary credit information related to the underlying loans in these agreements. If there is credit deterioration on the loans in these agreements that results in a downgrade, and this information is not provided to us in a timely manner, we will not have the loans appropriately graded, which will result in an understatement of our ALLL. If the credit downgrade was significant, and our ALLL was not adequate, we could incur a loss on these loans. At December 31, 2022, we had $39.0 million in loan participations in which we were not the lead lender.
We engage in aircraft and classic and collectible car financing transactions, in which high-value collateral is susceptible to potential catastrophic loss. Consequently, if any of these transactions becomes non-performing,nonperforming, we could suffer a loss oron some or all of our value in the assets.
Because our primary focus for aircraft loans is on the asset value of the collateral, the collectability of an aircraft loanthese loans ultimately may be dependent on the value of the aircraft.underlying collateral. Aircraft values have from time to time experienced sharp decreases due to a number of factors including, but not limited to, the availability of used aircraft, decreases in passenger and air cargo demand, increases in fuel costs, government regulation and the comparative value of newly manufactured similar aircraft. AircraftClassic and collectible car values are similarly affected by availability and demand, however, due to the unique nature of these cars, the estimated value often does not align with listed values, therefore, approval of the loan is based on the borrower’s ability to repay. An aircraft, classic or collectible car as collateral also presents unique risks because it isof its high-value and being susceptible to rapid movement across different locations and potential catastrophic loss. Although the loan documentation for these transactions will include insurance covenants and other provisions to protect us against risk of loss, there can be no assurance that the insurance proceeds would be sufficient to ensure our full recovery of the aircraft loan. Moreover, a relatively small number of non-performing aircraftnonperforming loans could have a significant negative impact on the value of our loan portfolio. If we are required to liquidate a significant amountnumber of aircraft collateralaircrafts or classic or collectible cars during a period of reduced values, our financial condition and profitability could be adversely affected. At December 31, 2017, or2022, our loan portfolio included $12.5$53.7 million in classic and collectible car loans and $2.1 million in aircraft loans.
If interest rate swaps we entered into prove ineffective, it could result in volatility in our operating results, including potential losses, which could have a material adverse effect on our results of operations and cash flows.
We are exposed to the effects of interest rate changes as a result of the borrowings we use to maintain liquidity and fund our expansion and operations. To limit the impact of interest rate changes on earnings, prepayment penalties and cash flows and to lower overall borrowing costs while taking into account variable interest rate risk, we may borrow at fixed rates or variable rates depending upon prevailing market conditions. We may also enter into derivative financial instruments such as interest rate swaps in order to mitigate our interest rate risk on a related financial instrument.
Our interest rate contracts expose us to:
basis or spread risk, which is the risk of loss associated with variations in the spread between the interest rate contract and the hedged item;
credit or counter-party risk which is the risk of the insolvency or other inability of another party to the transaction to perform its obligations;
interest rate risk;
volatility risk which is the risk that the expected uncertainty relating to the price of the underlying asset differs from what is anticipated; and
liquidity risk.
If we suffer losses on our interest rate contracts, our business, financial condition and prospects may be negatively affected, and our net income will decline.
We record the swaps at fair value, and designate them as an effective cash flow hedge under ASC 815, Derivatives and Hedging. Each quarter, we measure hedge effectiveness using the “hypothetical derivative method” and record in earnings any gains or losses resulting from hedge ineffectiveness. The hedge provided by our swaps could prove to be ineffective for a number of reasons, including early retirement of the debt, as is allowed under the debt, or in the event the counterparty to the interest rate swaps were determined to not be creditworthy. Any determination that the hedge created by the swaps was ineffective could have a material adverse effect on our results of operations and cash flows and result in volatility in our operating results. In addition, any changes in relevant accounting standards relating to the swaps, especially ASC 815, Derivatives and Hedging, could materially increase earnings volatility.
As of December 31, 2017, we had invested in interest rate swaps with an aggregate notional amount of $50.0 million. At December 31, 2017, market value of our interest rate swaps was $1.5 million. For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management”.
Our allowance for loan lossesALLL may prove to be insufficient to absorb losses in our loan portfolio. Future additions to our ALLL, as well as charge-offs in excess of reserves, will reduce our earnings.
While conditionsOur business depends on the creditworthiness of our customers. As with most financial institutions, we maintain an ALLL to reflect potential defaults and nonperformance, which represents management's best estimate of probable incurred losses inherent in the housing and real estate markets and economic conditions in our market areas have recently improved, if slow economic conditions return or real estate values and sales deteriorate, we may experience higher delinquencies and credit losses. As a result, we could be required to increase our provision for loan losses and to charge-off additional loans in the future. If charge-offs in future periods exceed the ALLL, we may need additional provisions to replenish the ALLL.
portfolio.The determination of the appropriate level of the ALLL inherently involves a high degree of subjectivity and requires us to make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the ALLL, we review our loans and the loss and delinquency experience and evaluate economic conditions and make significant estimates of current credit risks and future trends, all of which may undergo material changes. If our estimates are incorrect, the ALLL may not be sufficient to cover losses inherent in our loan portfolio, resulting in the need for increases in our provision for loan losses.losses which is charged against income. Deterioration in economic conditions, new information regarding existing loans, identification of additional problem loans or relationships, and other factors, both within and outside of our control, may increase our loan charge‑offs and/or may otherwise require an increase in the ALLL. Management also recognizes that significant new growth in loan portfolios, new loan products and the refinancing of existing loans can result in portfolios comprised of unseasoned loans that may not perform in a historical or projected manner and will increase the risk that our allowance may be insufficient to absorb losses without significant additional provisions. In addition, bank regulatory agencies periodically review our allowance for loan and lease losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge‑offs based on their judgment about information available to them at the time of their examination. Any increases in the provision for loan losses will result in a decrease in net income and may have a material adverse effect on our financial condition, results of operations, and capital.
In addition, the Financial Accounting Standards Board has adopted newan accounting standard 2016-13 that will be effective for our first fiscal year after December 15, 2019. This standard referred to as Current Expected Credit Loss, or CECL, which will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for credit losses. This will change the current method of providing allowances for credit losses thatonly when they have been incurred and are probable, which may require us to increase our allowance for loan and lease losses, and may greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for credit losses. This accounting pronouncement will be applicable to us as of January 1, 2023. We are evaluating the impact the CECL accounting model will have on our accounting, but expect to recognize a one-time cumulative-effect adjustment to the allowance for loan and lease losses as of March 31, 2023, the first reporting period in which the new standard is effective. The federal banking regulators, including the Federal Reserve and the FDIC, have adopted a rule that gives a banking organization the option to phase in over a three-year period the day-one adverse effects of CECL on its regulatory capital. For more on this new accounting
standard, see Note 1 of the Notes to Consolidated Financial Statements - Recently Issued Accounting Pronouncements contained in Item 8 of this report.
Risks Related to Market and Interest Rate Changes
Our results of operations, liquidity and cash flows are subject to interest rate risk.
Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Since March 2022, in response to inflation, the Federal Open Market Committee (“FOMC”) of the Federal Reserve has increased the target range for the federal funds rate by 425 basis, including 125 basis points during the fourth calendar quarter of 2022, to a range of 4.25% to 4.50% as of December 31, 2022. As it seeks to control inflation without creating a recession, the FOMC has indicated further increases are to be expected during 2023. If the FOMC further increases the targeted federal funds rate, interest rates will likely continue to rise, which will positively impact our interest income, however, the increase in interest expense may be greater. In addition, higher rates may negatively impact the housing market, by reducing refinancing activity and new home purchases, and the U.S. economy.
We principally manage interest rate risk by managing the volume and mix of our earning assets and funding liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially affected.
Changes in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay their current loan obligations or by reducing our margins and profitability. Our net interest margin is the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding.
Changes in interest rates—up or down—could adversely affect our net interest margin and, as a result, our net interest income. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract. Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates increase, the yield we earn on our assets may not rise as fast as our funding costs, causing our net interest margin to contract. Changes in the slope of the “yield curve”—or the spread between short-term and long-term interest rates—could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates, however, at December 31, 2022, the yield curve was inverted with short-term rates above long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets. Also, interest rate decreases can lead to increased prepayments of loans and mortgage-backed securities as borrowers refinance their loans to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk as we may have to redeploy such repayment proceeds into lower yielding investments, which would likely hurt our income.
A sustained increase in market interest rates could adversely affect our earnings. As is the case with many banks our emphasis on increasing core deposits has resulted in an increasing percentage of our deposits being comprised of deposits bearing no or a relatively low rate of interest and having a shorter duration than our assets. We would incur a higher cost of funds to retain these deposits in a rising interest rate environment. If the interest rates paid on deposits and other real estate owned are not properly valuedborrowings increase at a faster rate than the interest rates received on loans and managedother investments, our net interest income, and therefore earnings, could be reduced.adversely affected.
Our inventoryIn addition, a portion of OREO property reduced from $2.3 million atour adjustable-rate loans have interest rate floors below which the loan’s contractual interest rate may not adjust. At December 31, 20162022, 62.2% of our net loans were comprised of adjustable-rate loans. At that date, $377.6 million, or 51.3%, of these loans with an average interest rate of 4.21% were at their floor interest rate. The inability of our loans to $483,000 at December 31, 2017. We use current property valuationsadjust downward can contribute to increased income in the formperiods of appraisals when a loan has been foreclosed and the property taken in as OREO. Subsequently, an evaluationdeclining interest rates, although this result is performed by our experienced lending staff during the asset’s holding period. Our net book value in the loan at the time of foreclosure and thereafter is comparedsubject to the updated marketrisks that borrowers may refinance these loans during periods of declining interest rates. Also, when loans are at their respective floor, which is above the fully-indexed rate, there is a further risk that our interest income may not increase as rapidly as our cost of funds during periods of increasing interest rates and could have a material adverse effect on our results of operations.
Changes in interest rates also affect the value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any excess in the asset’s net book value over its fair value. If our valuation process is incorrect,securities portfolio. Generally, the fair value of our investmentsfixed-rate securities fluctuates inversely with changes in OREO may not be sufficient to recover ourinterest rates. Unrealized gains and losses on securities available for sale are reported as a separate component of equity, net book value in such assets, resultingof tax. Decreases in the needfair value of securities available for additional write-downs. During 2017, we had $50,000sale resulting from increases in valuation write-downsinterest rates could have an adverse effect on stockholders’ equity.
Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our inventoryresults of OREO properties. We may also incur significant property management and legal expenses related to our OREO. Additional material write-downs or expenses relating to our OREOoperations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition, liquidity and results of operations. Also, our interest rate risk modeling techniques and assumptions may not fully predict or capture the impact of actual interest rate changes on our balance sheet or projected operating results. For further discussion of how changes in interest rates could impact us, see Part II, Item 7A. “Quantitative and Qualitative Disclosures About Market Risk" for additional information about our interest rate risk management.
Bank regulators periodically review our OREO and may require us to recognize additional write-downs. Any increaseIf interest rate swaps we entered into prove ineffective, it could result in volatility in our write-downs, as required by such regulators, mayoperating results, including potential losses, which could have a material adverse effect on our financial condition, results of operations and capital.cash flows.
We are exposed to the effects of interest rate changes as a result of the borrowings we use to maintain liquidity and fund our expansion and operations. To limit the impact of interest rate changes on earnings, prepayment penalties and cash flows and to lower overall borrowing costs while taking into account variable interest rate risk, we may borrow at fixed rates or variable rates depending upon prevailing market conditions. We may also enter into derivative financial instruments such as interest rate swaps in order to mitigate our interest rate risk on a related financial instrument.
Our interest rate contracts expose us to:
•basis or spread risk, which is the risk of loss associated with variations in the spread between the interest rate contract and the hedged item;
•credit or counter-party risk, which is the risk of the insolvency or other inability of another party to the transaction to perform its obligations;
•interest rate risk;
•volatility risk, which is the risk that the expected uncertainty relating to the price of the underlying asset differs from what is anticipated; and
•liquidity risk.
If we suffer losses on our interest rate contracts, our business, financial condition and prospects may be negatively affected, and our net income will decline.
We record the swaps at fair value and designate them as an effective cash flow hedge under Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging. Each quarter, we measure hedge effectiveness using the “hypothetical derivative method” and record in earnings any gains or losses resulting from hedge ineffectiveness. The hedge provided by our swaps could prove to be ineffective for a number of reasons, including early retirement of the debt, as is allowed under the debt, or in the event the counterparty to the interest rate swaps were determined to not be creditworthy. Any determination that the hedge created by the swaps was ineffective could have a material adverse effect on our results of operations and cash flows and result in volatility in our operating results. In addition, any changes in relevant accounting standards relating to the swaps, especially ASC 815, Derivatives and Hedging, could materially increase earnings volatility.
As of December 31, 2022, we had interest rate swaps outstanding with an aggregate notional amount of $95.0 million. At December 31, 2022, the fair value of our interest rate swaps was a $10.5 million gain. For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management”.
We may incur losses on our securities portfolio as a result of changes in interest rates.portfolio.
Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect of the securities, defaults by, or other adverse events affecting, the issuer or with respect to the underlying securities, instability in the capital markets and, as previously discussed, changes in market interest rates and continued instability in the capital markets.rates. Any of these factors, among others, could cause other-than-temporary impairments and realized and/or unrealized losses in future periods and declines in other comprehensive income, which could have a material effect on our business, financial condition and results of operations. As we are required to have sufficient liquidity to ensure a safe and sound operation, we may be required to sell securities at a loss if our liquidity position is not at a desirable level and all other sources of liquidity are exhausted. In an environment where other market participants are also liquidating securities, our loss could be materially higher than expected, significantly adversely impacting liquidity and capital levels. The process for determining whether impairment of a security is other-than-temporary usually requires complex, subjective judgments about the future financial performance and liquidity of the issuer and any collateral underlying the security to assess the probability of receiving all contractual principal and interest payments on the security. There can be no assurance that the declines in market value will not result in other-than-temporary impairments of these assets, and would lead to accounting charges that could have a material adverse effect on our net income and capital levels. For the year ended December 31, 2022, we did not incur any other-than-temporary impairments on our securities portfolio.
Conditions in the financial markets may limit our access to additional funding to meet our liquidity needs.
Liquidity is essentialRisks Related to our business, therefore, the inability to obtain adequate funding may negatively affect growth and, consequently, our earnings capability and capital levels. We rely on a number of different sources in order to meet our potential liquidity demands. We require sufficient liquidity to meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress. An inability to raise funds through deposits, borrowings, the sale of loans or investment securities, or other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the Washington markets in which our loans are concentrated, negative operating results, or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry and the continued uncertainty in credit markets. In particular, our liquidity position could be significantly constrained if we are unable to access funds from the FHLB Des Moines, the Federal Reserve Bank of San Francisco or other wholesale funding sources, or if adequate financing is not available at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources, our revenues may not increase proportionately to cover our costs. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could, in turn, have a material adverse effect on our business, financial condition and results of operations. Additionally, collateralized public funds are bank deposits of state and local municipalities. These deposits are required to be secured by certain investment grade securities to ensure repayment that, on the one hand, tends to reduce our contingent liquidity risk by making these funds somewhat less credit sensitive, but on the other hand, reduces standby liquidity by restricting the potential liquidity of the pledged collateral. Although these funds historically have been a relatively stable source of funds for us,Business Strategy
availability depends on the individual municipality’s fiscal policies and cash flow needs. At December 31, 2017 we had $21.5 million in public funds.
If limitations arise in our ability to utilize the national brokered deposit market or to replace short-term deposits, our ability to replace maturing deposits on acceptable terms could be adversely impacted.
First Financial Northwest Bank utilizes the national brokered deposit market for a portion of our funding needs. At December 31, 2017, the balance of brokered certificates of deposit was $75.5 million, with remaining maturities of 0.5 to 3 years. Under FDIC regulations, in the event we are deemed to be less than well-capitalized, we would be subject to restrictions on our use of brokered deposits and the interest rate we can offer on our deposits. If this happens, our use of brokered deposits and the rates we would be allowed to pay on deposits may significantly limit our ability to use deposits as a funding source. If we are unable to participate in this market for any reason in the future, our ability to replace these deposits at maturity could be adversely impacted.
Further, there may be competitive pressures to pay higher interest rates on deposits, which would increase our funding costs. If deposit clients move money out of the Bank deposits and into other investments (or into similar products at other institutions that may provide a higher rate of return), we could lose a relatively low cost source of funds, increasing our funding costs and reducing our net interest income and net income. Additionally, any such loss of funds could result in reduced loan originations, which could materially negatively impact our growth strategy and results of operations.
Our limited branch locations limit our ability to attract deposits and as a result, a large portion of our deposits are certificates of deposit, including “jumbo” certificates that may not be as stable as other types of deposits.
With nine branch locations in operation during 2017, our ability to compete with larger institutions for noninterest bearing deposits is limited as these institutions have a larger branch network providing greater convenience to customers. As a result, we are dependent on more interest rate sensitive deposits. At December 31, 2017, $333.3 million, or 39.7%, of our total deposits were retail certificates of deposit and, of that amount, $246.0 million were “jumbo” certificates greater than or equal to $100,000, with $84.3 million of these certificates greater than or equal to $250,000. In addition, deposit inflows are significantly influenced by general interest rates. Our money market accounts and jumbo certificates of deposit and the retention of these deposits are particularly sensitive to general interest rates, making these deposits traditionally a more volatile source of funding than other deposit accounts. In order to retain our money market accounts and jumbo certificates of deposit, we may have to pay a higher rate, resulting in an increase in our cost of funds. In a rising rate environment, we may be unwilling or unable to pay a competitive rate because of the resulting compression in our interest rate spread. To the extent that such deposits do not remain with us, they may need to be replaced with borrowings or other deposits that could increase our cost of funds and negatively impact our interest rate spread and financial condition.
Our branching strategy may cause our expenses to increase faster than revenues.
During 2017, we opened a new branch office in Bellevue, Washington and acquired four additional branch locations in Woodinville, Clearview, Smokey Point, and Lake Stevens, all in Washington.
Our current business strategy includes continued similar branch expansion in strategic areas to enhance our market presence. These offices arenew branches tend to be much smaller than traditional bank branch offices, utilizing the improved technology available with our new core data processor. This allows us to maintain management’s focus on efficiency, while working to expand the Bank’sour presence into new markets. The success of our expansion strategy into new markets, however, is contingent upon numerous factors, such as our ability to select suitable locations, assess each market’s competitive environment, secure managerial resources, hire and retain qualified personnel and implement effective marketing strategies. The opening of new offices may not increase the volume of our loans and deposits as quickly as or to the degree that we hope, and opening new offices will increase our operating expenses. On average, de novo branches do not become profitable until three to four years after opening. We currently expect to lease rather than own theany additional branch properties. Further, the projected time linetimeline and the estimated dollar amounts involved in opening de novo branches could differ significantly from actual results. The success of our acquired
branches is dependent on retention of existing customers’ deposits as well as expanding our market presence in these locations. We may not successfully manage the costs and implementation risks associated with our branching strategy. Accordingly, any new branch may negatively impact our earnings for some period of time until the branch reaches certain economies of scale. Finally, there is a risk that our new branches will not be successful even after they have been established or acquired.
Risks Related to Regulatory and Compliance Matters
Our Wealth Management segment is subject to a number of risks, including reputational risk.
Our Wealth Management segment derives the majority of its revenue from noninterest income. Success in this business segment is highly dependent on reputation. Our ability to attract wealth management clients is highly dependent upon external perceptions of this division’s level of service, trustworthiness, business practices and financial condition. Negative perceptions or publicity regarding these matters could damage the division’s and our reputation among existing customers and corporate clients, which could make it difficult for the wealth management line of business to attract new clients and maintain existing ones. Adverse developments with respect to the financial services industry or our operation may also negatively impact our reputation, or result in greater regulatory or legislative scrutiny or litigation against us. Although we monitor developments for areas of potential risk to the lines of business and our reputation and brand, negative perceptions or publicity could materially and adversely impact both revenue and net income.
We may be required to raise additional capital in the future, but that capital may not be available when it is needed, or it may only be available on unacceptable terms, which could adversely affect our financial condition and results of operations.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside of our control, and on our financial performance. Accordingly, we may not be able to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations and pursue our growth strategy could be materially impaired and our financial condition and liquidity could be materially and adversely affected. In addition, if we are unable to raise additional capital when required by our bank regulators, we may be subject to adverse regulatory action.
We operate in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations that are expected to increase our costs of operations.
As a state-chartered, federally insured commercial bank, First Financial Northwest Bank is currently subject to extensive examination, supervision and comprehensive regulation by the FDIC and the DFI and as a bank holding company First Financial Northwest is subject to examination, supervision and regulation by the Federal Reserve. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on an institution’s operations, reclassify assets, determine the adequacy of an institution’s ALLL and determine the level of deposit insurance premiums assessed.
Additionally, the Dodd-Frank Act has significantly changed the bank regulatory structure and will affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies have significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.
The Dodd-Frank Act created the CFPB with broad powers to supervise and enforce consumer protection laws and rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Financial institutions such as First Financial Northwest Bank with $10 billion or less in assets will continue to be examined for compliance with the consumer laws by their primary bank regulators but are subject to the rules of the CFPB.
The CFPB has issued a number of final regulations and changes to certain consumer protections under existing laws. These final rules, most of the provisions of which (including the qualified mortgage rule) generally prohibit creditors from extending mortgage loans without regard for the consumer’s ability-to-repay and add restrictions and requirements to mortgage origination and servicing practices. In addition, these rules limit prepayment penalties and require the creditor to retain evidence of compliance with the ability-to-repay requirement for three years. Compliance with these rules has increased our overall regulatory compliance costs and may require changes to our underwriting practices with respect to mortgage loans. This includes compliance with The Truth in Lending Act and the Real Estate Settlement Procedures Act Integrated Disclosure (TRID) rule, which combines certain disclosures that consumers receive in connection with applying for and closing a mortgage loan. Moreover, these rules may adversely affect the volume of mortgage loans that we underwrite and may subject us to increased potential liabilities related to such residential loan origination activities.
It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks. However, it is expected that at a minimum they will increase our operating and compliance costs, which could adversely affect key operating efficiency ratios. See - “How We are Regulated” contained in, Item I‑Business of this report.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions.
The USA PATRIOT Act and Bank Secrecy Acts and related regulations require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. During the last few years, several banking institutions have received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations. If our policies and procedures are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the denial of regulatory approvals to proceed with certain aspects of our business plan, including acquisitions.
Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
We may be adversely affected by changes in U.S. tax lawsIf our enterprise risk management framework is not effective at mitigating risk and regulations.
The Tax Act was signed into law in December 2017 reforming the U.S. tax code. The legislation includes lowering the 35% corporate income tax rateloss to 21%, modifying the U.S. taxation of income earned outside the U.S.us, we could suffer unexpected losses and limiting or eliminating various deductions, tax credits and/or other tax preferences. While we expect to benefit on a prospective net income basis from the decrease in corporate income tax rates, the legislation has resulted in an $807,000 decrease in the value of our deferred tax asset, which resulted in a material reduction to net income during the year ended December 31, 2017. In addition, the legislation could negatively impact our customers because it lowers the existing caps on mortgage interest deductions and limits the state and local tax deductions. These changes could make it more difficult for borrowers to make their loan payments, could also negatively impact the housing market, which could adversely affect our business and loan growth.
New or changing tax, accounting, and regulatory rules and interpretations could significantly impact strategic initiatives, results of operations cash flows,could be materially adversely affected.
Our enterprise risk management framework seeks to achieve an appropriate balance between risk and financial condition.
The banking industryreturn, which is extensively regulated. Federalcritical to optimizing stockholder value. We have established processes and state banking regulationsprocedures intended to identify, measure, monitor, report, analyze and control the types of risk to which we are subject. These risks include liquidity risk, credit risk, market risk, interest rate risk, operational risk, legal and compliance risk, and reputational risk, among others. We also maintain a compliance program designed primarily to protect the deposit insurance fundsidentify, measure, assess, and consumers, notreport on our adherence to benefit a company’s shareholders. These regulations may sometimes impose significant limitationsapplicable laws, policies and procedures. While we assess and improve these programs on operations. The significant federal and state banking regulationsan ongoing basis, there can be no assurance that affect us are described in this report under the heading “Item 1. Business- How We are Regulated”. These regulations,our risk management or compliance programs, along with the currently existing tax, accounting, securities, insurance,other related controls, will effectively mitigate all risk and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time. The current administration has indicated that it would like to see changes made to certain financial reform regulations, including the Dodd-Frank Act, which has resultedlimit losses in increased regulatory uncertainty, and we are assessing the potential impact on financial and economic markets and on our business. ChangesHowever, as with any risk management framework, there are inherent limitations to our risk management strategies as there may exist, or develop in federal policy and at regulatory agencies are expected to occur over time through policy and personnel changes, whichthe future, risks that we have not appropriately anticipated or identified. If our risk management framework proves ineffective, we could lead to changes involving the level of oversight and focus on the financial services industry. The nature, timing and economic and political effects of potential changes to the current legal and regulatory framework affecting financial institutions remain highly uncertain. Any new regulations or legislation, change in existing regulations or oversight, whether a change in regulatory policy or a change in a regulator’s interpretation of a law or regulation, could have a material impact on our operations, increase our costs of regulatory compliance and of doing business and or otherwise adversely affect ussuffer unexpected losses and our profitability. Further, changes in accounting standards can be both difficult to predict and involve judgment and discretion in their interpretation by us and our independent accounting firms. These changes could materially impact, potentially even retroactively, how we report ourbusiness financial condition and results of our operations as could our interpretation of those changes.
Our operations rely on numerous external vendors.
We rely on numerous external vendors to provide us with products and services necessary to maintain our day-to-day operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements under service level agreements. The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements because of changes in the vendor's organizational structure, financial condition, support for existing products and services or strategic focus or for any other reason, could be disruptivematerially adversely affected.
Risks Related to our operations, which in turn could have a material negative impact on our financial conditionCybersecurity, Data and results of operations. We also could be adversely affected to the extent such an agreement is not renewed by the third party vendor or is renewed on terms less favorable to us.Fraud
We are subject to certain risks in connection with our use of technology.
Our security measures may not be sufficient to mitigate the risk of a cyber-attack. Communications and information systems are essential to the conduct of our business, as we use such systems to manage our customer relationships, our general ledger and virtually all other aspects of our business. Our operations rely on the secure processing, storage, and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems, software, and networks may be vulnerable to breaches, fraudulent or unauthorized access, denial or degradation of service attacks, misuse, computer viruses, malware or other malicious code and cyber-attacks that could have a security impact. If one or more of these events occur, this could jeopardize our or our customers’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us. We could also suffer significant reputational damage.
We support the ability of our customers to transact business through multiple automated methods. As such, we may be susceptible to fraud performed through these technologies.
Security breaches in our internet banking activities could further expose us to possible liability and damage our reputation. Increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third party technologies (including browsers and operating systems), or other developments could result in a
compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our customers and underlying transactions. Any compromise of our security also could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. TheseAlthough we have developed and continue to invest in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, these precautions may not protect our systems from compromises or breaches of our security measures, and could result in significant legal liability and significantlosses to us or our customers, our loss of business and/or customers, damage to our reputation, the incurrence of additional expenses, disruption to our business, our inability to grow our online services or other businesses, additional regulatory scrutiny or penalties, or our exposure to civil litigation and possible financial liability, any of which could have a material adverse effect on our business.business, financial condition and results of operations.
Our security measures may not protect us from systemssystem failures or interruptions. While we have established policies and procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance that such events will not occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects of our data processing and other operational functions to certain third-party providers. While we select third-party vendors carefully, we do not control their actions. If our third-party providers encounter difficulties, including those resulting from breakdowns or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher transaction volumes, cyber-attacks and security breaches, or if we otherwise have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected, and our ability to deliver products and services to our customers and otherwise conduct business operations could be adversely impacted. Replacing these third-party vendors could also entail significant delay and expense. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
The occurrence of anyWe cannot assure you that such breaches, failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. We may require usnot be insured against all types of losses as a result of third party failures and insurance coverage may be inadequate to cover all losses resulting from breaches, system failures or other disruptions. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to identify alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all. Further, the occurrence of any systems failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny, or could expose us to legal liability. Any of these occurrences could have a material adverse effect on our financial condition and results of operations.
If our enterprise risk management framework is not effective at mitigating risk and loss to us, we could suffer unexpected losses and our results of operations could be materially adversely affected.
Our enterprise risk management framework seeks to achieve an appropriate balance between risk and return, which is critical to optimizing stockholder value. We have established processes and procedures intended to identify, measure, monitor, report, analyze and control the types of risk to which we are subject. These risks include liquidity risk, credit risk, market risk, interest rate risk, operational risk, legal and compliance risk, and reputational risk, among others. We also maintain a compliance program to identify measure, assess, and report on our adherence to applicable laws, policies and procedures. While we assess and improve these programs on an ongoing basis, there can be no assurance that our risk management or compliance programs, along with other related controls, will effectively mitigate all risk and limit losses in our business. However, as with any risk
management framework, there are inherent limitations to our risk management strategies as there may exist, or develop in the future, risks that we have not appropriately anticipated or identified. If our risk management framework proves ineffective, we could suffer unexpected losses and our business, financial condition and results of operations could be materially adversely affected.
We are subject to certain risks in connection with our data management or aggregation.
We are reliant on our ability to manage data and our ability to aggregate data in an accurate and timely manner to ensure effective risk reporting and management. Our ability to manage data and aggregate data may be limited by the effectiveness of our policies, programs, processes and practices that govern how data is acquired, validated, stored, protected and processed. While we continuously update our policies, programs, processes and practices, many of our data management and aggregation processes are manual and subject to human error or system failure. Failure to manage data effectively and to aggregate data in an accurate and timely manner may limit our ability to manage current and emerging risks, as well as to manage changing business needs.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
Our loansAs a bank, we are susceptible to businesses and individuals andfraudulent activity that may be committed against us or our deposit relationships and related transactions are subjectcustomers which may result in financial losses or increased costs to exposureus or our customers, disclosure or misuse of our information or our customer’s information, misappropriation of assets, privacy breaches against our customers, litigation, or damage to the risk of loss due toour reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other financial crimes.dishonest acts. Nationally, reported incidents of fraud and other financial crimes have increased. We have also experienced losses due to apparent fraud and other financial crimes. While we have policies and procedures designed to prevent such losses, there can be no assurance that such losses will not occur.
Risks Related to Our Business and Industry Generally
We rely on other companies to provide key components of our business infrastructure.
We rely on numerous external vendors to provide us with products and services necessary to maintain our day-to-day operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements under service level agreements. The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements because of changes in the vendor's organizational structure, financial condition, support for existing products and services or strategic focus or for any other reason, could be disruptive to our operations, which in turn could have a material negative impact on our financial condition and results of operations. We also could be adversely affected to the extent a service agreement is not renewed by the third-party vendor or is renewed on terms less favorable to us. Additionally, the bank regulatory agencies expect financial institutions to be responsible for all aspects of their vendors’ performance, including aspects which they delegate to third parties.
We will be required to transition from the use of the London Interbank Offered Rate ("LIBOR") in the future.
We have certain FHLB advances, loans, interest rate swaps and investment securities, indexed to LIBOR to calculate the interest rate. ICE Benchmark Administration, the authorized and regulated administrator of LIBOR, ended publication of the one-week and two-month USD LIBOR tenors on December 31, 2021 and the remaining USD LIBOR tenors will end publication in June 2023. Financial services regulators and industry groups have collaborated to develop alternate reference rate indices or reference rates. The transition to a new reference rate requires changes to contracts, risk and pricing models, valuation tools, systems, product design and hedging strategies. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR (with the exception of overnight repurchase agreements, which are expected to be based on the Secured Overnight Financing Rate, or SOFR). Uncertainty as to the nature of such potential changes, alternative reference rates, the elimination or replacement of LIBOR, or other reforms may adversely affect the value of, and the return on our loans, and our investment securities, and may impact the availability and cost of hedging instruments and borrowings., including the rates we pay on our subordinated debentures and trust preferred securities. The language in our LIBOR-based contracts and financial instruments has developed over time and may have various events that trigger when a successor rate to the designated rate would be selected. If a trigger is satisfied, contracts and financial instruments may give the calculation agent discretion over the substitute index or indices for the calculation of interest rates to be selected. The implementation of a substitute index or indices for the calculation of interest rates under our loan agreements with our borrowers or our existing borrowings may result in our incurring significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices, and may result in disputes or litigation with customers and creditors over the appropriateness or comparability to LIBOR of the substitute index or indices, which could have an adverse effect on our results of operations.
Ineffective liquidity management could adversely affect our financial results and condition.
Effective liquidity management is essential to our business. We require sufficient liquidity to meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress. An inability to raise funds through deposits, borrowings, the sale of loans or investment securities and other sources could have a substantial negative effect on our liquidity. We rely on customer deposits and at times, borrowings from the FHLB of Des Moines and certain other wholesale funding sources to fund our operations. Deposit flows and the prepayment of loans and mortgage-related securities are strongly influenced by such external factors as the direction of interest rates, whether actual or perceived, and the competition for deposits and loans in the markets we serve. Further, changes to the FHLB of Des Moines's underwriting guidelines for wholesale borrowings or lending policies may limit or restrict our ability to borrow, and could therefore have a significant adverse impact on our liquidity. Historically, we have been able to replace maturing deposits and borrowings if desired, however, we may not be able to replace such funds in the future if, among other things, our financial condition, the financial condition of the FHLB of Des Moines, or market conditions change. Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable could be impaired by factors that affect us specifically or the financial services industry or economy in general, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry or deterioration in credit markets. Additional factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated, negative operating results, or adverse regulatory action against us. Any decline in available funding in amounts adequate to finance our activities or on terms which are acceptable could adversely impact our ability to originate loans, invest in securities, meet our expenses, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could, in turn, have a material adverse effect on our business, financial condition and results of operations. In addition, in order to maintain adequate liquidity we may have to sell investment securities at a loss, which could adversely impact our financial condition and operations, including but not necessarily limited to lower earnings and capital levels.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed, or the cost of that capital may be very high.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. At some point, we may need to raise additional capital to support our growth or replenish future losses. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. Accordingly, we cannot make assurances that we will be able to raise additional capital if needed on terms that are acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations could be materially impaired and our financial condition and liquidity could be materially and adversely affected. In addition, any additional capital we obtain may result in the dilution of the interests of existing holders of our common stock. Further, if we are unable to raise additional capital when required by our bank regulators, we may be subject to adverse regulatory action.
We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects.
Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge of, and experience in, the community banking industry where First Financial Northwest Bank conducts its business. The process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing, and technical personnel and upon the continued contributions of our management and personnel. In particular, our success has been and continues to be highly dependent upon the abilities of key executives, including our President, and certain other employees. In addition, our success has been and continues to be highly dependent upon the services of our directors, many of whom are at or nearing retirement age, and we may not be able to identify and attract suitable candidates to replace such directors.
We participate in a multiple employer defined benefit pension plan for the benefit of our employees. If we were to withdraw from this plan, or if Pentegra, the multiple employer defined benefit pension plan sponsor, requires us to make additional contributions, we could incur a substantial expense in connection with the withdrawal or the request for additional contributions.
We participate in the Pentegra Defined Benefit Plan for Financial Institutions, a multiple employer pension plan for the benefit of our employees. Effective March 31, 2013, we did not allow additional employees to participate in this plan. On March 31, 2013, weplan and froze the future accrual of benefits under this plan with respect to those participating employees. In connection with our decision to freeze our benefit accruals under the plan, and since then, we considered withdrawing from the plan.
If we choose to withdraw from the plan, we could incur a substantial expense in connection with the withdrawal. The actual expense that would be incurred in connection with a withdrawal from the plan is primarily dependent upon the timing of the withdrawal, the total value of the plan’s assets at the time of withdrawal, general market interest rates at that time, expenses imposed on withdrawal, and other conditions imposed by Pentegra as set forth in the plan. If we choose to withdraw from the plan in the future, we could incur a substantial expense in connection with the withdrawal.
Even if we do not withdraw from the plan, Pentegra, as sponsor of the plan, may request that we make an additional contribution to the plan, in addition to contributions that we are regularly required to make, or obtain a letter of credit in favor of the plan, if our financial condition worsens to the point that it triggers certain criteria set out in the plan. If we fail to make the contribution or obtain the requested letter of credit, then we may be forced to withdraw from the plan and establish a separate, single employer defined benefit plan that we anticipate would be underfunded to a similar extent as under the multiple employer plan.
We rely on dividends from the Bank for substantially all of our revenue at the holding company level.
We are First Financial Northwest is an entity separate and distinct from our principal subsidiary, First Financial Northwestthe Bank, and derivederives substantially all of ourits revenue at the holding company level in the form of dividends from that subsidiary.the Bank. Accordingly, we are,First Federal Northwest is, and will be, dependent upon dividends from the Bank to pay the principal of and interest on ourits indebtedness, to satisfy ourits other cash needs and to pay dividends on ourits common stock. First Financial NorthwestThe Bank’s ability to pay dividends is subject to its ability to earn net income and to meet certain regulatory requirements.requirements, including the capital conservation buffer requirement. In the event the Bank is unable to pay dividends to us, weFirst Financial Northwest, it may not be able to pay dividends on ourits common stock or continue its stock repurchases.
If we fail to meet the expectations of our stakeholders with respect to our environmental, social and governance (“ESG”) practices, including those relating to sustainability, it may have an adverse effect on our reputation and results of operation.
Our reputation may also be negatively impacted by our diversity, equity and inclusion (“DEI”) efforts if they fall short of expectations. In addition, various private third-party organizations have developed ratings processes for evaluating companies on their approach to ESG and DEI matters. These ratings may be used by some investors to assist with their investment and voting decisions. Any unfavorable ratings may lead to reputational damage and negative sentiment among our investors and other stakeholders. Furthermore, increased ESG related compliance costs could result in increases to our overall operational costs. Failure to adapt to or comply with regulatory requirements or investor or stakeholder expectations and standards could negatively impact our reputation to do business with certain partners, and our stock repurchases. Also, our right to participateprice. New government regulations could also result in a distributionnew or more stringent forms of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors.ESG oversight and expanding mandatory and voluntary reporting, diligence, and disclosure.
Item 1B. Unresolved Staff Comments
First Financial Northwest has not received any written comments from the SEC regarding its periodic or current reports under the Securities Exchange Act of 1934, as amended, that are unresolved.amended.
Item 2. Properties
The corporate office for First Financial Northwest and First Financial Northwest Bankthe Company is located at 201 Wells Avenue South, Renton, Washington and is owned by us. The Bank’s full service retail operation is also at this location. As part of the Branch Acquisition in August 2017,In addition, the Bank purchasedowns a branch facility in Clearview,retail office located at 17424 SR 9, Snohomish, Washington. At December 31, 2017,2022, the Bank had seventhirteen leased locations in Washington currently in operation: Mill Creek, Edmonds, “The Landing” in Renton, Bellevue, Bothell, Woodinville, Smokey Point, and Lake Stevens. In addition, the Bank entered into a lease for a future branch location in Bothell, Washington, that is scheduled to open in the first quarter of 2018. In addition, the branch operations at Woodinville and Lake Stevens, are moving to new leased locations during the first quarter of 2018.Kent, Kirkland, University Place, Gig Harbor, and Issaquah. The lending division operations of First Financial Northwest Bank are at our owned location at 207 Wells Avenue South, Renton, Washington. This location is also the site for the operations of First Financial Northwest’s wholly-owned subsidiary, First Financial Diversified. The lease terms for our properties are for an initial term of three to five years with the option to extend for additional three to five year periods. In the opinion of management, all properties are adequately covered by insurance, are in a good state of repair and are appropriately designed for their present and future use. For additional information on our lease commitments, see Note 10- “Leases” of the Notes to Consolidated Financial Statements in Item 8 of this report.
Item 3. Legal Proceedings
From time to time, we are involved as plaintiff or defendant in various legal actions arising in the normal course of business. As of December 31, 2017,2022, we were not involved in any significant litigation and do not anticipate incurring any material liability as a result of any such litigation.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on The Nasdaq Stock Market LLC’s Global Select Market (“NASDAQ”), under the symbol “FFNW.” As of December 31, 2017,March 9, 2023, there were 10.7 million shares of common stock issued and outstanding and we had 554 were approximately 473 shareholders of record, excluding persons or entities that hold stockstock in nominee or “street name” accounts with brokers.
Dividends
First Financial Northwest BankAs of December 31, 2022, our board of directors had declared 39 consecutive quarterly cash dividends on our common stock. Our cash dividend payout policy is a wholly-owned subsidiaryreviewed regularly by management and the Board of First Financial Northwest. Under federal regulations, the dollar amount of dividends First Financial Northwest Bank may pay to First Financial Northwest depends upon its capital position and recent net income. Generally, if First Financial Northwest Bank satisfies its regulatory capital requirements, it may make dividend payments up to the limits prescribed by state law and FDIC regulations. See “Item 1. Business – How We Are Regulated – Regulation and Supervision of First Financial Northwest – Dividends” and Note 14 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
There were $2.8 million inDirectors. Any dividends declared and paid in the future would depend upon a number of factors, including capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic conditions. No assurances can be given that any dividends will be paid or that, if paid, will not be reduced or eliminated in future periods. Our
future payment of dividends may depend, in part, upon receipt of dividends from the Bank, which are restricted by federal regulations.
Stock Repurchases
The following table represents First Financial Northwest common shares repurchased during the yearsfourth quarter ended December 31, 2017 and 2016. The price range per share of our common stock presented below represents the highest and lowest sales prices for our common stock on the NASDAQ during each quarter of the two most recent fiscal years.2022.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Period | | Total Number of Shares Purchased | | Average Price Paid per Share | | Total Number of Shares Repurchased as Part of Publicly Announced Plan | | Maximum Number of Shares that May Yet Be Repurchased Under the Plan |
October 1 - October 31, 2022 | | — | | | $ | — | | | — | | | 456,000 | |
November 1 - November 30, 2022 | | — | | | — | | | — | | | 456,000 | |
December 1 - December 31, 2022 | | — | | | — | | | — | | | 456,000 | |
| | — | | | — | | | — | | | |
|
| | | | | | | | | | | |
| High | | Low | | Cash Dividends Declared and Paid |
2017 | | | | | |
First Quarter | $ | 21.29 |
| | $ | 17.38 |
| | $ | 0.06 |
|
Second Quarter | 17.68 |
| | 14.83 |
| | 0.07 |
|
Third Quarter | 17.78 |
| | 15.67 |
| | 0.07 |
|
Fourth Quarter | 17.91 |
| | 14.90 |
| | 0.07 |
|
| | | | | |
2016 | | | | | |
First Quarter | $ | 13.88 |
| | $ | 12.51 |
| | $ | 0.06 |
|
Second Quarter | 13.89 |
| | 12.55 |
| | 0.06 |
|
Third Quarter | 14.20 |
| | 12.88 |
| | 0.06 |
|
Fourth Quarter | 20.54 |
| | 14.06 |
| | 0.06 |
|
Stock Repurchases
The Company’s Board of Directors authorized the repurchase of shares of our common stock under two stock repurchase plans in 2017. Stock repurchases through the stock repurchase plans are made in accordance with a plan established under the guidelines specified under Rule 10b5-1 of the Securities Exchange Act of 1934 as administered through an independent broker. During 2017,On August 16, 2021, the Company did not repurchase any additional shares under the stock repurchase planannounced that began on September 16, 2016 and expired on March 17, 2017. On May 22, 2017, theits Board of Directors authorized the repurchase of up to 1,100,000476,000 shares of the Company’s stock between May 30, 2017 and November 30, 2017. At the completion of the repurchase period, the Company had repurchased under thiscommon stock. The August 2021 stock repurchase plan 326,800program expired on February 15, 2022, with 459,732 shares repurchased at an average price of $15.99$16.83 per share.
On February 15, 2022, the Company announced that its Board of Directors authorized the repurchase of up to 5% of the Company’s outstanding common stock, or approximately 455,000 shares. The following table representsFebruary 2022 stock repurchase program expired on September 16, 2022, with 61,913 shares repurchased at an average price of $16.22 per share. On October 3, 2022, the share repurchased duringCompany announced that its Board of Directors authorized the fourth quarter endedrepurchase of up to 456,000 shares of the Company common stock. The October 2023 stock repurchase program expires upon the earlier of March 17, 2023, or repurchase of the full amount of authorized shares. As of December 31, 2017.
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| | | | | | | | | | | | | |
Period | | Total Number of Shares Purchased | | Average Price Paid per Share | | Total Number of Shares Purchased as Part of Plan | | Maximum Number of Shares that May be Repurchased Under the Plan |
October 1 - October 31, 2017 (1) | | — |
| | $ | — |
| | — |
| | 786,800 |
|
November 1 - November 30, 2017 (1) | | 13,600 |
| | 15.99 |
| | 13,600 |
| | — |
|
December 1 - December 31, 2017 | | — |
| | — |
| | — |
| | — |
|
Total | | 13,600 |
| | 15.99 |
| | 13,600 |
| | — |
|
_______________
(1) Shares2022, there was no shares repurchased under the stock repurchase plan effective May 30, 2017 through November 30, 2017.this plan.
Equity Compensation Plan Information
The equity compensation plan information presented under subparagraph (d) in Part III, Item 12 of this report is incorporated herein by reference.
Performance Graph
The following graph compares the cumulative total shareholder return on First Financial Northwest’s Common Stock with the cumulative total return on the Russell 2000 Index, the SNL Micro CAP U.S. Bank Index, and the SNL Thrift Index, a peer group index. Last year, the stock performance graph contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2016 also included the NASDAQ Bank Index and for the first time, the SNL Micro CAP U.S. Bank Index, the intended replacement for the NASDAQ Bank Index. The Company believes that a better industry comparison is provided by our replacement of the NASDAQ Bank Index with the SNL Micro CAP U.S. Bank, which we believe provides a better peer group comparison of our Company.
The graph assumes that total return includes the reinvestment of all dividends and that the value of the investment in First Financial Northwest’s common stock and each index was $100 on December 31, 2012, and is the base amount used in the graph. The closing price of First Financial Northwest’s common stock on December 29, 2017 was $15.51.
|
| | | | | | | | | | | | | | | | | |
| Period Ended |
Index | 12/31/2012 | | 12/31/2013 | | 12/31/2014 | | 12/31/2015 | | 12/31/2016 | | 12/31/2017 |
First Financial Northwest, Inc. | 100.00 |
| | 138.95 |
| | 164.31 |
| | 194.25 |
| | 279.39 |
| | 223.03 |
|
Russell 2000 Index | 100.00 |
| | 138.82 |
| | 145.62 |
| | 139.19 |
| | 168.85 |
| | 193.58 |
|
SNL Thrift Index | 100.00 |
| | 128.33 |
| | 138.02 |
| | 155.20 |
| | 190.11 |
| | 188.72 |
|
SNL Micro Cap U.S. Bank | 100.00 |
| | 129.02 |
| | 146.32 |
| | 162.71 |
| | 200.04 |
| | 244.72 |
|
Item 6. Selected Financial DataReserved
The following table sets forth certain information concerning our consolidated financial position and results of operations at and for the dates indicated and has been derived from our audited consolidated financial statements. The information below is qualified in its entirety by the detailed information included elsewhere herein and should be read along with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8. “Financial Statements and Supplementary Data” included in this Form 10-K.
|
| | | | | | | | | | | | | | | | | | | |
| At or For the Year Ended December 31, |
| 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
FINANCIAL CONDITION DATA: | (In thousands, except share data) |
| | | | | | | | | |
Total assets | $ | 1,210,229 |
| | $ | 1,037,584 |
| | $ | 979,913 |
| | $ | 936,997 |
| | $ | 920,979 |
|
Investments available-for-sale | 132,242 |
| | 129,260 |
| | 129,565 |
| | 120,374 |
| | 144,364 |
|
Loans receivable, net (1) | 988,662 |
| | 815,043 |
| | 685,072 |
| | 663,938 |
| | 663,153 |
|
Deposits | 839,502 |
| | 717,476 |
| | 675,407 |
| | 614,127 |
| | 612,065 |
|
Advances from the FHLB | 216,000 |
| | 171,500 |
| | 125,500 |
| | 135,500 |
| | 119,000 |
|
Stockholders’ equity | 142,634 |
| | 138,125 |
| | 170,673 |
| | 181,412 |
| | 184,355 |
|
| | | | | | | | | |
OPERATING DATA: | | | | | | | | | |
| | | | | | | | | |
Interest income | $ | 47,644 |
| | $ | 41,709 |
| | $ | 37,197 |
| | $ | 38,689 |
| | $ | 38,539 |
|
Interest expense | 10,022 |
| | 7,507 |
| | 6,751 |
| | 6,241 |
| | 7,526 |
|
Net interest income | 37,622 |
| | 34,202 |
| | 30,446 |
| | 32,448 |
| | 31,013 |
|
Provision (recapture of provision) for loan losses | (400 | ) | | 1,300 |
| | (2,200 | ) | | (2,100 | ) | | (100 | ) |
Net interest income after provision (recapture of provision) for loan losses | 38,022 |
| | 32,902 |
| | 32,646 |
| | 34,548 |
| | 31,113 |
|
Noninterest income | 2,208 |
| | 2,651 |
| | 1,279 |
| | 498 |
| | 891 |
|
Noninterest expense | 26,809 |
| | 22,949 |
| | 19,878 |
| | 18,503 |
| | 21,082 |
|
Income before provision (benefit) for federal income taxes | 13,421 |
| | 12,604 |
| | 14,047 |
| | 16,543 |
| | 10,922 |
|
Provision (benefit) for federal income taxes | 4,942 |
| | 3,712 |
| | 4,887 |
| | 5,856 |
| | (13,543 | ) |
Net income | $ | 8,479 |
| | $ | 8,892 |
| | $ | 9,160 |
| | $ | 10,687 |
| | $ | 24,465 |
|
Basic earnings per share | $ | 0.82 |
| | $ | 0.75 |
| | $ | 0.67 |
| | $ | 0.72 |
| | $ | 1.47 |
|
Diluted earnings per share | $ | 0.81 |
| | $ | 0.74 |
| | $ | 0.67 |
| | $ | 0.71 |
| | $ | 1.46 |
|
___________________
(1) Net of ALLL, LIP and deferred loan fees and costs.
|
| | | | | | | | | | | | | | | | | | | |
| At or For the Year Ended December 31, |
KEY FINANCIAL RATIOS: | 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
Performance Ratios: | | | | | | | | | |
Return on average assets | 0.76 | % | | 0.88 | % | | 0.96 | % | | 1.17 | % | | 2.73 | % |
Return on average equity | 5.94 |
| | 5.55 |
| | 5.15 |
| | 5.85 |
| | 13.12 |
|
Dividend payout ratio | 32.93 |
| | 32.02 |
| | 35.57 |
| | 27.73 |
| | 8.11 |
|
Equity-to-assets ratio | 11.79 |
| | 13.31 |
| | 17.42 |
| | 19.36 |
| | 20.02 |
|
Interest rate spread | 3.47 |
| | 3.47 |
| | 3.23 |
| | 3.62 |
| | 3.49 |
|
Net interest margin | 3.60 |
| | 3.60 |
| | 3.38 |
| | 3.77 |
| | 3.68 |
|
Average interest-earning assets to average interest-bearing liabilities | 114.07 |
| | 117.11 |
| | 120.45 |
| | 121.15 |
| | 121.77 |
|
Efficiency ratio | 67.31 |
| | 62.27 |
| | 62.66 |
| | 56.37 |
| | 66.08 |
|
Noninterest expense as a percent of average total assets | 2.42 |
| | 2.27 |
| | 2.07 |
| | 2.03 |
| | 2.36 |
|
Book value per common share | $ | 13.27 |
| | $ | 12.63 |
| | $ | 12.40 |
| | $ | 11.96 |
| | $ | 11.25 |
|
Capital Ratios: (1) | | | | | | | | | |
|
Tier 1 leverage | 10.20 | % | | 11.17 | % | | 11.61 | % | | 11.79 | % | | 18.60 | % |
Common equity tier 1 | 12.52 |
| | 14.36 |
| | 16.36 | | n/a | | n/a |
Tier 1 capital ratio | 12.52 |
| | 14.36 |
| | 16.36 |
| | 18.30 |
| | 27.18 |
|
Total capital ratio | 13.77 |
| | 15.61 |
| | 17.62 |
| | 19.56 |
| | 28.44 |
|
Asset Quality Ratios: (2) | | | | | | | | | |
|
Nonperforming loans as a percent of total loans | 0.02 |
| | 0.10 |
| | 0.16 |
| | 0.20 |
| | 0.59 |
|
Nonperforming assets as a percent of total assets | 0.05 |
| | 0.31 |
| | 0.48 |
| | 1.13 |
| | 1.68 |
|
ALLL as a percent of total loans, net of LIP | 1.28 |
| | 1.32 |
| | 1.36 |
| | 1.55 |
| | 1.91 |
|
ALLL as a percent of nonperforming loans, net of LIP | 7,196.65 |
| | 1,276.34 |
| | 872.17 |
| | 783.50 |
| | 325.26 |
|
Net (recoveries) charge-offs to average loans receivable, net | (0.27 | ) | | (0.02 | ) | | (0.18 | ) | | 0.06 |
| | (0.08 | ) |
_______________
(1) Capital ratios are for First Financial Northwest Bank only.
(2) Loans are reported net of LIP.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis reviews our consolidated financial statements and other relevant statistical data for the years ending December 31, 2022 and 2021, and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the Consolidated Financial Statements and footnotes thereto that appear in Item 8 of this Form 10-K. The information contained in this section should be read in conjunction with these Consolidated Financial Statements and footnotes and the business and financial information provided in this Form 10-K. Unless otherwise indicated, the financial information presented in this section reflects the consolidated financial condition and results of operations of First Financial Northwest and its subsidiaries. For a discussion and review of our consolidated financial statements and other relevant statistical data for the years ending December 31, 2021 and 2020 see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Form 10-K for the fiscal year ended December 31, 2021.
Overview
First Financial Northwest Bank is a wholly-owned subsidiary of First Financial Northwest and, as such, comprises substantially all of the activity for First Financial Northwest. First Financial NorthwestThe Bank was a community-based savings bank until February 4, 2016, when the Bank converted to a Washington state chartered commercial bank reflecting the commercial banking services it now provides to its customers. The Bank primarily serves King, Snohomish, Pierce Snohomish and Kitsap counties, Washington through its full-service banking office and headquarters in Renton, Washington, as well as threeseven retail branches in King County, Washington, and five retail branches in Snohomish County, Washington. On August 25, 2017, the Bank completed the purchase of fourWashington, and two retail branches in WoodinvillePierce County, Washington at December 31, 2022. The Bank purchased four of these branches in King County, and Lake Stevens, Clearview, and Smokey Point in Snohomish County2017 and acquired $74.7 million in deposits.deposits (the “Branch
Acquisition”). The Branch Acquisition expanded our retail footprint and provided an opportunity to extend our unique brand of community banking into those communities. In addition, the Bank has received regulatory approval to open a new branch office at The Junction, a new, mixed use development in Bothell, Washington which is expected to open in the first quarter of 2018.
The Bank’s business consists predominantly of attracting deposits from the general public, combined with borrowing from the Federal Home Loan Bank of Des Moines (“FHLB”)FHLB and raising funds in the wholesale market, then utilizing these funds to originate one-to-four family residential, multifamily, commercial real estate, construction/land, business, and consumer loans.
The Bank’s strategic initiatives seek to diversify our loan portfolio and broaden growth opportunities with our current risk tolerance levels and asset/liability objectives. Our current business strategy emphasizes commercial real estate, construction, one-to-four family residential, and multifamily lending. With the current low interest rate environment, we are not aggressively pursuing longer term assets, but rather are focused on financing shorter term loans, in particular construction/land loans. During 2017,2022, loan originations, of new loansrefinances and refinancespurchases outpaced repayments of loans, resulting in an increase of $63.6 million in net loans receivable with a balance of $988.7 million$1.17 billion at December 31, 2017,2022. Originations of one-to-four family residential loans were $160.3 million in 2022, as compared to $815.0$124.2 million in 2021.
We have also geographically expanded our loan portfolio through loan purchases or loan participations of commercial and multifamily real estate loans, as well as consumer classic and collectible car loans, that are outside of our primary market area. Commercial and multifamily real estate purchases and participation in 2022 were $9.1 million, compared to $32.6 million in 2021. Consumer loans purchased in 2022 were $31.8 million, compared to $20.3 million in 2021.
Through our efforts to geographically diversify our loan portfolio outside of the State of Washington with direct loan originations, loan participations, or loan purchases, our portfolio includes $158.2 million of loans to borrowers or secured by properties located in 47 other states, plus Washington, D.C., with the largest concentrations at December 31, 2016. Recently, improvements2022, in California, Oregon, Texas, Florida, and Alabama of $37.1 million, $13.8 million, $9.4 million, $10.7 million and $8.0 million of loans, respectively.
The Bank has affiliated with an SBA partner to process our SBA loans while the economy, employment rates, stronger real estate prices, and a general lack of new housing inventory in certain areas inBank retains the Puget Sound region have resulted in our significantly increasing originations of construction loans for properties located in our market area. We anticipate that construction/land lending will continuecredit decisions. This enables us to be a strong element ofactive in lending to small businesses until our totalvolumes are high enough to support the investment in necessary infrastructure. When volumes support our becoming an SBA preferred lender, we will apply for that status which would provide the Bank with delegated loan portfolio in future periods. We will continueapproval as well as closing and most servicing and liquidation authority, enabling the Bank to take a disciplined approach in our construction/land lending by concentrating our efforts on residential loans to builders known to us, including multifamily loans to developers with proven success in this type of construction. Originations of construction/land loans decreased to $138.6 million in 2017 from $165.4 million in 2016. These short term loans typically mature in six to eighteen months.make loan decisions more rapidly. In addition, the funding is usually not fully disbursed at origination, thereby reducingBank plans to increase originations of the business loan portfolio, which may include business lines of credit, business term loans or equipment financing. In conjunction with the growth of business loans, the Bank seeks to service these customers with their business deposits as well.
Net income for the year ended December 31, 2022, was $13.2 million, or $1.45 per diluted share, compared to $12.2 million, or $1.29 per diluted share, for the year ended December 31, 2021. The primary contributor to this increase was a $3.4 million increase in net interest income as our increase in interest income exceeded the increase in interest expense. In addition, we recorded a recapture of the provision for loan losses of $400,000 in 2022, compared to a $300,000 provision for loan losses in 2021, primarily as a result of the net loans receivableimpact of changes in the short term. At December 31, 2017, construction/land loans netloan portfolio mix and changes in impairment status of LIP was $145.6 million, a 6.4% increase from $136.9 million at December 31, 2016.loans. Partially offsetting these improvements, noninterest income decreased $639,000 and noninterest expense increased $2.2 million.
Our primary source of revenue is interest income, which is the income that we earn on our loans and investments. Interest expense is the interest that we pay on our deposits and borrowings. Net interest income is the difference between interest income and interest expense. Changes in levels of interest rates affect interest income and interest expense differently and, thus, impacts our net interest income. First Financial NorthwestThe Bank is liability-sensitive,currently liability sensitive, meaning our interest-bearing liabilities reprice at a faster rate than our interest-earning assets. Despite increasingThe Bank had a modest improvement in the net interest ratesmargin over the last year, changesyear. Other than the FHLB stock, average yields of all interest-earning assets increased, primarily due to an increase in interest rates resulting from the compositionrising rate environment. For the same reasons, cost of our interest‑earning assets and interest-bearing liabilities enabled us to maintain our net interest rate spread and net interest margin at 3.47% and 3.60%, respectively, for both the years ended December 31, 2017 and 2016.
An offset to net interest income is the provision for loan losses, or the recapture of the provision for loan losses, that is required to establish the ALLLfunds also increased, but at a level that adequately provides for probable losses inherentslower pace than interest income. During 2022, the Bank supplemented its funding needs with higher cost brokered deposits as they were deemed the most appropriate alternative funding source, resulting in our loan portfolio. a $1.1 million increase in interest expense from those funds.
As our loan portfolio increases, or due to an increase for probable losses inherent in our loan portfolio, our ALLL may increase, resulting in a decrease to net interest income.income after the provision. Improvements in loan risk ratings, increases in property values, or receipt of recoveries of amounts previously charged off may partially or fully offset any required increase to ALLL due to loan growth or an increase in probable loan losses. During 2017, we had a recapture from the ALLL of $400,000 as compared to a provision for loan losses of $1.3 million forFor the year ended December 31, 2016. The2022, the Company recorded a recapture of provision for loan losses in 2017 was primarily a resultthe amount of $2.3 million in net recoveries received on previously charged-off loans partially offset by the provision necessary to support the $173.6 million growth in net loans receivable. Our total adversely classified loans decreased to $1.3 million at December 31, 2017 from $1.9 million at December 31, 2016. We will continue to monitor our loan portfolio and make adjustments to our ALLL as we deem necessary.$400,000.
Noninterest income is generated from various loan or deposit fees, increases in the cash surrender value of bank owned life insurance (“BOLI”), and revenue earned on our wealth management brokerage services. This incomeservices and is increased or partially offsetalso affected by any net gain or loss on sales of investment securities. Our noninterest income decreased $443,000$639,000 during the year ended December 31, 20172022, as compared to 2016. The decrease was2021, primarily attributable to a $567,000 loss on sale of investments and a $221,000$425,000 decrease in the noninterest income from our BOLI policies, partially offset by a $290,000 increase in deposit and loan related fees, and a $106,000 increase in wealth management revenue.prepayment penalties.
Our noninterest expenses consist primarily of salaries and employee benefits, professional fees, regulatory assessments, occupancy and equipment, and other general and administrative expenses. Salaries and employee benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement, and other employee benefits. OREO-related expenses consist primarily of maintenance and costs of utilities for the OREO inventory, market valuation adjustments, build-out expenses, gains and losses from OREO sales, legal fees, real estate taxes, and insurance related to the properties included in the OREO inventory. Professional fees include legal services, auditing and accounting services, computer support services, and other professional services in support of strategic plans. Occupancy and equipment expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of lease expenses, real estate taxes, depreciation expenses, maintenance, and costs of utilities. Also included in noninterest expense are changes to the Company’s unfunded commitment reserve which are reflected in general and administrative expenses. This unfunded commitment reserve expense can vary significantly each quarter, based on the amount believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities, and reflects changes in the amounts that the Company has committed to fund but has not yet disbursed. Our noninterest expenses increased $3.9$2.2 million during the year ended December 31, 20172022, as compared to 2016.2021. The increase was primarily attributable to a $2.4 million
$896,000 increase in salarysalaries and employee benefits, expenses,reflecting higher than normal vacancies in staffing during 2021, a $546,000 increase in data processing expenses, a $522,000$219,000 increase in occupancy and equipment, expenses,a $440,000 increase in professional fees, including a $183,000 examination fee that was not included in 2021, a $149,000 increase in marketing expense and a $730,000$574,000 increase in other general and administrative expenses in 2017 as comparedexpense, due to 2016.a number of factors, including increased subscriptions, travel and business development efforts.
Net income for the year ended December 31, 2017, was $8.5 million, or $0.81 per diluted share, compared to $8.9 million, or $0.74 per diluted share, for the year ended December 31, 2016. Following the passing of the Tax Act, we elected to restructure a portion of our investment portfolio. Specifically, we sold approximately $37.0 million in securities at a loss of $670,000, which was the primary reason for the $443,000 decline in noninterest income. The investments sold were all fixed rate securities, with the proceeds reinvested primarily into adjustable rate securities. Also relating to passage of the Tax Act, we recorded a charge of $807,000 through the federal income tax provision relating to changes to our net deferred tax asset valuation as a result of the new lower enacted corporate income tax rates, which, along with higher pre-tax net income, resulted in a $1.2 million increase in the federal income tax provision. These charges, combined with a $3.9 million increase in noninterest expense reflecting the growth in our operations over the last year, which was partially offset by a $3.4 million increase in net interest income, due primarily to the increase in net loans receivable and a $400,000 recapture of provision for loan losses, were the primary factors for the decrease in net income for the year ended December 31, 2017.
Business Strategy
Our long-term business strategy is to operate and grow First Financial Northwestthe Bank as a well-capitalized and profitable community bank, offering one-to-four family residential, commercial and multifamily, construction/land, consumer and business loans along with a diversified array of deposit and other products and services to individuals and businesses in our market areas. We intend to accomplish this strategy by leveraging our established name and franchise, capital strength, and loan production capability by:
•Capitalizing on our intimate knowledge of our local communities to serve the convenience and needs of customers, and delivering a consistent, high-quality level of professional service;
•Offering competitive deposit rates and developing customer relationships to diversify our deposit mix, growing lower cost deposits, attracting new customers, and expanding our footprint in the geographical area we serve;
•Utilizing wholesale funding sources, including but not limited to FHLB advances and acquiring deposits in the national brokered certificate of deposit market, to assist with funding needs and interest rate risk management efforts, as needed;
•Managing our loan portfolio to minimize concentration risk and diversify the types of loans within the portfolio;
•Managing credit risk to minimize the risk of loss and interest rate risk to optimize our net interest margin; and
•Improving profitability through disciplined pricing, expense control and balance sheet management, while continuing to provide excellent customer service.
Critical Accounting PoliciesEstimates
CriticalWe prepare our consolidated financial statements in accordance with GAAP. In doing so, we have to make estimates and assumptions. Our critical accounting policiesestimates are those estimates that involve a significant judgmentslevel of uncertainty at the time the estimate was made, and assumptions by management andchanges in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have or couldused in the current period, would have a material impact on our incomefinancial condition or results of operations.Accordingly, actual results could differ materially from our estimates. We base our estimates on past experience and other assumptions that we believe are reasonable under the carrying value of our assets. The following arecircumstances, and we evaluate these estimates on an ongoing basis. We have reviewed our critical accounting policies.estimates with the audit committee of our Board of Directors.
See Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for a summary of significant accounting policies and the effect on our financial statements.
Allowance for Loan and Lease Losses. Management recognizes that loan losses may occur over the life of a loan and that the ALLL must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Our methodology for analyzing the ALLL consists of two components: general and specific allowances. The general allowance is determined by applying factors to our various groups of loans. Management considers factors such as charge-off history, policy and underwriting standards, the current and expected economic conditions, borrower’s ability to repay, the regulatory environment, competition, geographic and loan type concentrations, policy and underwriting standards, nature and volume of the loan portfolio, management’s experience level, the level of problem loans, our loan review and grading systems, the value of underlying collateral, geographic and the level of problem loansloan type concentrations, and other external factors such as competition, legal, and regulatory requirements in assessing the ALLL. Specific allowances result when management performs an impairment analysis on a loan when it determines it is probablemanagement believes that all contractual amounts of principal and interest will not be paid as scheduled. TheBased on this impairment analysis, usually occurs when aif the recorded investment in the loan has been classified as substandard or placed on nonaccrual status. Ifis less than the market value of the collateral less costs to sell (“market value”) of the impaired loan is less than the recorded investment in the loan, impairment is recognized by establishing, a specific reserve is established in the ALLL for the loan or by adjusting an existing reserve amount.loan. The amount of the specific reserve is computed using current appraisals, listed sales prices, and other available information less costs to complete, if any, and costs to sell the property. This evaluationanalysis is inherently subjective as it requiresrelies on estimates that are susceptible to significant revision as more information becomes available or as future events differ from predictions. In addition, specific reserves may be created uponLoans classified as TDRs due to the borrower being granted a loan’s restructuring,
based onrate concession are analyzed by a discounted cash flow analysis,analysis. The amount of the specific reserve on these loans is calculated by comparing the present value of the anticipated repayments under the restructured terms to the outstanding principal balance ofrecorded investment in the loan.
Our Board of Directors’ Internal Asset Review Committee reviews and recommends for approval the allowance for loan and lease losses on a quarterly basis, and any related provision or recapture of provision for loan losses, and the full Board of Directors approves the provision or recapture after considering the Committee’s recommendations. The allowance is increased by the provision for loan losses which is charged against current period earnings. When analysis of the loan portfolio warrants, the allowance is decreased and a recapture of provision of loan losses is included in current period earnings.
We believe that the ALLL is a critical accounting estimate because it is highly susceptible to change from period‑to‑period requiring management to make assumptions about probable losses inherent in the loan portfolio. The impact of an unexpected large loss could deplete the allowance and potentially require increased provisions to replenish the allowance, thereby reducing earnings. For additional information see Item 1A. “Risk Factors – Risks Related to Our Lending - Our allowance for loan and lease losses may prove to be insufficient to absorb losses in our loan portfolio,” in this Form 10-K.
Valuation of OREO. Real estate properties acquired through foreclosure or by deed-in-lieu of foreclosure are recorded at the lower of cost or fair value less estimated costs to sell. Fair value is generally determined by management based on a number of factors, including third-party appraisals of fair value in an orderly sale. Accordingly, the valuation of OREO is subject to significant external and internal judgment. If the carrying value of the loan at the date a property is transferred into OREO exceeds the fair value less estimated costs to sell, the excess is charged to the ALLL. Management periodically reviews OREO values to determine whether the property continues to be carried at the lower of its recorded book value or fair value, net of estimated costs to sell. Any further decreases in the value of OREO are considered valuation adjustments and are charged to noninterest expense in the Consolidated Income Statements. Expenses and income from the maintenance and operations and any gains or losses from the sales of OREO are included in noninterest expense.
Deferred Taxes. Deferred tax assets arise from a variety of sources, the most significant being expenses recognized in our financial statements but disallowed in the tax return until the associated cash flow occurs, and write-downs in the value of assets for financial statement purposes that are not deductible for tax purposes until the asset is sold or deemed worthless.
When warranted, we record a valuation allowance to reduce our deferred tax assets to the amount that can be recognized in line with the relevant accounting standards. The level of deferred tax asset recognition is influenced by management’s assessment of our historic and future profitability profile. At each balance sheet date, existing assessments are reviewed and, if necessary, revised to reflect changed circumstances. In a situation where income is less than projected or recent losses have been incurred, the relevant accounting standards require convincing evidence that there will be sufficient future tax capacity. For additional information regarding our deferred taxes, see Note 13 of the Notes to Consolidated Financial Statements contained in Item 8.
Other-Than-Temporary Impairments Onon the Market Value of Investments. Declines in the fair value of available‑for‑sale or held-to-maturity investments below their cost that is deemed to be other-than-temporary results in a reduction in the carrying amount of such investments to their fair value. A charge to earnings and an establishment of a new
cost basis for the investment is made. Unrealized investment losses are evaluated at least quarterly to determine whether such declines should be considered other-than-temporary and therefore be subject to immediate loss recognition. Although these evaluations involve significant judgment, an unrealized loss in the fair value of a debt security is generally deemed to be temporary when the fair value of the investment security is below the carrying value primarily due to changes in interest rates and there has not been significant deterioration in the financial condition of the issuer. Other factors that may be considered in determining whether a decline in the value of a debt security is other-than-temporary include ratings by recognized rating agencies; the extent and duration of an unrealized loss position; actions of commercial banks or other lenders relative to the continued extension of credit facilities to the issuer of the security; the financial condition, capital strength and near-term prospects of the issuer and recommendations of investment advisers or market analysts. Therefore, deterioration of market conditions could result in impairment losses recognized within the investment portfolio.
Fair Value. FASB ASCFinancial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures, establishes a hierarchical disclosure framework associated with the level of pricing observability utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no pricing observability and a higher degree of judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the
transaction. See Note 76 of the Notes to Consolidated Financial Statements contained in Item 8 for additional information about the level of pricing transparency associated with financial instruments carried at fair value.
Derivatives and Hedge Accounting. The Bank recognizes its interest rate swapswaps as a cash flow hedge derivative instrument,instruments, and as such, reports the net fair value as an asset or liability. Fair value is based on dealer quotes, pricing models, discounted cash flow methodologies or similar techniques for which the determination of fair value may require significant management judgment or estimation. The derivative isderivatives are marked to itstheir fair value through other comprehensive income. Any ineffectiveness is recognized in earnings. The net gain or loss on the derivativederivatives is removed from equity and recognized in noninterest incomereclassified into earnings in the same periodincome statement line item that is used to present the corresponding loss or gain on theearnings effect of hedged cash flow is recognized in earnings.items.
Intangible Assets. The Company incurred goodwill and a core deposit intangible asset “(CDI”) through the Branch Acquisition during 2017. These assets were booked at fair value at the time of the acquisition. Goodwill will beis evaluated in the futureannually for impairment, annually during the fourth quarter, with any impairment recognized as noninterest expense. The core deposit intangibleCDI is amortized into noninterest expense.
Comparison of Financial Condition at December 31, 20172022 and December 31, 20162021
Assets. The following table details the changes in the composition of our assets at December 31, 20172022 from December 31, 2016.2021.
| | | | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2022 | | Balance at December 31, 2021 | | $ Change | | % Change |
| (Dollars in thousands) |
Cash on hand and in banks | $ | 7,722 | | | $ | 7,246 | | | $ | 476 | | | 6.6 | % |
Interest-earning deposits | 16,598 | | | 66,145 | | | (49,547) | | | (74.9) | |
Investments available-for-sale, at fair value | 217,778 | | | 168,948 | | | 48,830 | | | 28.9 | |
Investments held-to-maturity, at amortized cost | 2,444 | | | 2,432 | | | 12 | | | 0.5 | |
Loans receivable, net | 1,167,083 | | | 1,103,461 | | | 63,622 | | | 5.8 | |
FHLB stock, at cost | 7,512 | | | 5,465 | | | 2,047 | | | 37.5 | |
Accrued interest receivable | 6,513 | | | 5,285 | | | 1,228 | | | 23.2 | |
Deferred tax assets, net | 2,597 | | | 850 | | | 1,747 | | | 205.5 | |
Premises and equipment, net | 21,192 | | | 22,440 | | | (1,248) | | | (5.6) | |
BOLI | 36,286 | | | 35,210 | | | 1,076 | | | 3.1 | |
Prepaid expenses and other assets | 12,479 | | | 3,628 | | | 8,851 | | | 244.0 | |
Right of use asset (“ROU”), net | 3,275 | | | 3,646 | | | (371) | | | (10.2) | |
Goodwill | 889 | | | 889 | | | — | | | — | |
Core deposit intangible, net | 548 | | | 684 | | | (136) | | | (19.9) | |
Total assets | $ | 1,502,916 | | | $ | 1,426,329 | | | $ | 76,587 | | | 5.4 | % |
|
| | | | | | | | | | |
| Balance at December 31, 2017 | | Change from December 31, 2016 | | Percentage Change |
| (Dollars in thousands) |
Cash on hand and in banks | $ | 9,189 |
| | $ | 3,410 |
| | 59.0 | % |
Interest-earning deposits | 6,942 |
| | (18,631 | ) | | (72.9 | ) |
Investments available-for-sale, at fair value | 132,242 |
| | 2,982 |
| | 2.3 |
|
Loans receivable, net | 988,662 |
| | 173,619 |
| | 21.3 |
|
Premises and equipment, net | 20,614 |
| | 2,153 |
| | 11.7 |
|
FHLB stock, at cost | 9,882 |
| | 1,851 |
| | 23.0 |
|
Accrued interest receivable | 4,084 |
| | 937 |
| | 29.8 |
|
Deferred tax assets, net | 1,211 |
| | (1,931 | ) | | (61.5 | ) |
OREO | 483 |
| | (1,848 | ) | | (79.3 | ) |
BOLI | 29,027 |
| | 4,874 |
| | 20.2 |
|
Prepaid expenses and other assets | 5,738 |
| | 3,074 |
| | 115.4 |
|
Goodwill | 889 |
| | 889 |
| | n/a |
|
Core deposit intangible | 1,266 |
| | 1,266 |
| | n/a |
|
Total assets | $ | 1,210,229 |
| | $ | 172,645 |
| | 16.6 | % |
The $172.6$76.6 million increase in total assets during 20172022 was primarily a result of utilizing growth in our loan portfolio of $63.6 million, funded by growth in deposits, primarily brokered deposits, additional advances from the FHLB, and excess cash held at the Federal Reserve Bank of San Francisco to growFrancisco. Additional factors in our loan portfolio by $173.6 million.asset growth are described below.
Interest-earning deposits with banks. Our interest-earningInterest-earning deposits with banks, consisting primarily of funds held at the Federal Reserve Bank of San Francisco, decreased by $18.6$49.5 million from December 31, 20162021 to December 31, 20172022 primarily due to fund new loan originationsthe deployment of a portion of these funds into higher earning loans and investment securities during 2017.2022.
Investments available-for-sale. OurDuring 2022, investments available-for-sale increased by $3.0$49.0 million, or 2.3%29.0%, during 2017 as we continued to restructure our available‑for‑sale investment portfolio to transition our investment portfolio to securities with higher yields in order to enhance our interest income. Following the passing of the Tax Act, we elected to restructure a portion of our investment portfolio through the sale of certain fixed rate securities that were carried in an unrealized loss position and the purchase of primarily adjustable rateexcess liquidity was reinvested into higher yielding available-for-sale securities. During the year, we purchased $58.8 million of securities with an expected yield of 2.24%, partially funded by sales of $40.0 million with an average yield of 1.78%. The restructure discussed above resulted in an increase in the average yield of our available-for-sale investments to 2.61% in 2017 from 2.31% in 2016. Securities purchased included $15.1 million in fixed rate and $43.7 million in variable rate securities, comprised of $36.0 million in U.S. government agency bonds, $18.2 million in mortgage-backed securities, $3.0 million in corporate bonds and $1.6 million in municipal bonds.
The sales of investments available-for-sale generated a net loss of $567,000 for the year ended December 31, 2017. We also received calls or partial2022, we purchased $54.2 million of fixed rate securities and $41.8 million of variable rate securities. Purchases included $40.0 million of fixed rate U.S. Treasury bonds with maturities of approximately two years. In addition, the Bank purchased $37.8 million of mortgage-backed securities, $3.0 million of asset-backed securities, $10.0 million in corporate securities, and $5.2 million in Community Reinvestment Act qualified municipal and mortgage-backed securities. These purchases were partially offset by $11.1 million in proceeds from sales, calls and proceeds at maturity during 2017maturities of $731,000securities, generating a net gain of U.S. Government agency and municipal securities. In addition to the purchase and call activity, we received principal repayments of $10.7 million on our investments available-for-sale during 2017.$27,000.
The effective duration of our securities portfolio decreasedincreased slightly to 2.90%3.65% at December 31, 20172022, as compared to 4.00%3.54% at December 31, 2016.2021. Effective duration is a measure that attempts to quantifymeasures the anticipated percentage change in the value of an investment (or portfolio) in the event of a 100 basis point change in market yields. Since the Bank’s portfolio includes securities with embedded options (including call options on bonds and prepayment options on mortgage-backed securities), management believes that effective duration is an appropriate metric to use as a tool when analyzing the Bank’s investment securities portfolio, as effective duration incorporates assumptions relating to such embedded options, including changes in cash flow assumptions as interest rates change.
Loans receivable. Net loans receivable increased by $173.6$63.6 million during 20172022 to $988.7$1.17 billion. During the year ended December 31, 2022, one-to-four family loans increased $90.7 million as a resultand consumer loans, consistent with management’s strategy to increase the Bank’s portfolio of growth in all loan categories. The most significant classic and collectible car loans, increased $17.2 million. Partially offsetting these
increases, occurredwere decreases in multifamily loans with a $61.7of $3.3 million, or 50.0% increase and commercial real estate loans with a $58.1of $11.5 million, or 19.1% increase. Commercial real estate and one-to-four family residential loans continue to be the largest concentrations in our loan portfolio at 33.0% and 25.5%, respectively, of total loans. The growth in construction/land loans was less than other loan types, withof $15.3 million. In addition, business loans decreased $15.2 million, primarily due to a $10.1 million decrease in concentrationPPP loans, due to 21.7%the expiration of our total loan portfoliothe PPP in 2017 from 23.2%May 2021, and $4.0 million decrease in 2016. aircraft loans.
During 2017,2022, we supplemented our loan originations and participations by purchasing $76.2$40.6 million in loans, including $31.8 million of performing classic and collectible car loans, and $4.0 million of CRA qualified one-to-four family multifamily, commercial, and aircraft loans from other financial institutions. The loans wereloans. In addition, during 2022 we purchased at an average premium of 2.3% and are intended to be held to maturity. The majority of these purchased loans area $3.7 million loan secured by propertiesa commercial real estate property located in states across the country, reflectingNevada and a $1.1 million loan secured by a commercial real estate property located in New York. These out-of-state purchases reflect our efforts to geographically diversify our loan portfolio with loans meeting our investment and credit quality objectives.
The quality of our loan portfolio continued to improve during 2017 as our nonperforming loans decreased to $179,000 atAt December 31, 2017 from $858,000 at December 31, 2016.2022, the Bank had $193,000 of nonaccrual loans. Nonperforming loans as a percent of our total loans remained low atincreased to 0.02% and 0.10% at December 31, 2017 and 2016, respectively.2022, from 0.00% at December 31, 2021. Adversely classified loans, defined as substandard or below, decreasedincreased to $1.3$47.4 million at December 31, 2017,2022, from $1.9$34.2 million at December 31, 2016. 2021. The increase in our classified loans during the year ended December 31, 2022 was primarily the result of $47.4 million of loans downgraded to substandard. The downgrades included $45.5 million of commercial loans, $1.6 million in multifamily loan and $193,000 in consumer loans. All substandard loans at December 31, 2022, were classified as impaired and evaluated for a specific allowance. The Bank is monitoring these loans closely, all of which remain current on their payment obligations, and does not expect to incur any loss.
The following table presents a breakdown of our nonperforming assets:loans at the dates indicated. At both December 31, 2022 and 2021, we had no accruing loans 90 days or more past due or OREO.
| | | | | | | | | | | | | | | | | | | | | | |
| | December 31, | | $ Change | | |
| | 2022 | | 2021 |
| | (Dollars in thousands) |
Nonperforming loans: | | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Consumer | | $ | 193 | | | — | | | $ | 193 | | | |
Total nonperforming loans | | 193 | | | — | | | 193 | | | |
| | | | | | | | |
Total nonperforming assets | | $ | 193 | | | $ | — | | | $ | 193 | | | |
|
| | | | | | | | | | | | | | | |
| | December 31, | | Amount of Change | | Percent of Change |
| | 2017 | | 2016 |
| | (Dollars in thousands) |
Nonperforming loans: | | | | | | | | |
One-to-four family residential | | $ | 128 |
| | $ | 798 |
| | $ | (670 | ) | | (84.0 | )% |
Consumer | | 51 |
| | 60 |
| | (9 | ) | | (15.0 | ) |
Total nonperforming loans | | 179 |
| | 858 |
| | (679 | ) | | (79.1 | ) |
OREO | | 483 |
| | 2,331 |
| | (1,848 | ) | | (79.3 | ) |
Total nonperforming assets | | $ | 662 |
| | $ | 3,189 |
| | $ | (2,527 | ) | | (79.2 | )% |
We continued to focusThe Bank did not foreclose on reducing our nonperforming assets through loan work outsany properties during either 2022 or pursuing foreclosure. Foregone2021, as a result, we had no foregone interest during the year ended December 31, 2017 relating to nonperforming loans totaled $26,000.2022. There was no LIP related to nonperforming loans at December 31, 20172022 or 2016. OREO decreased to $483,000 at December 31, 2017 as we continued to sell our inventory2021. The level of foreclosed real estate. During 2017, we sold three properties for $1.9 million as compared to sales of two properties for $988,000 during 2016. We did not foreclose on any properties during either 2017 or 2016. The continued decline in our nonperforming assets reflects improvements in the qualitymodest risk profile of our loan portfolio and our commitment to promptly identify any problem loans and take prompt actions to turn nonperforming assets into performing assets.
Allowance for loan and lease losses. We believe that we use the best information available to establish the ALLL, and that the ALLL as of December 31, 20172022 was adequate to absorb the probable and inherent losses in the loan portfolio at that date. While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions, or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. Future additions to the allowance may become necessary based upon changing economic conditions, the level of problem loans, business conditions, credit concentrations, increased loan balances, or changes in the underlying collateral of the loan portfolio. In addition, the determination of the amount of our ALLL is subject
to review by bank regulators as part of the routine examination process that which may result in the establishment of additional loss reserves or the charge-off of specific loans against established loss reserves based upon their judgment of information available to them at the time of their examination.
The ALLL was $12.9$15.2 million, or 1.28%1.29% of total loans outstandingreceivable at December 31, 20172022, as compared to $11.0$15.7 million, or 1.32%1.40% of total loans outstandingreceivable at December 31, 2016. The ALLL represented 7,196.7% of nonperforming loans at December 31, 2017 compared to 1276.3% at December 31, 2016.2021. The following table details activity and information related to the ALLL for the years ended December 31, 20172022 and 2016. All loan balances and ratios are calculated using loan balances that are net of LIP.
2021.
| | | At or For the Years Ended December 31, | | At or For the Years Ended December 31, |
| 2017 | | 2016 | | 2022 | | 2021 |
| (Dollars in thousands) | | (Dollars in thousands) |
ALLL balance at beginning of year | $ | 10,951 |
| | $ | 9,463 |
| ALLL balance at beginning of year | $ | 15,657 | | | $ | 15,174 | |
(Recapture of provision) provision for loan losses | (400 | ) | | 1,300 |
| (Recapture of provision) provision for loan losses | (400) | | | 300 | |
Charge-offs | — |
| | (83 | ) | Charge-offs | (37) | | | — | |
Recoveries | 2,331 |
| | 271 |
| Recoveries | 7 | | | 183 | |
ALLL balance at end of year | $ | 12,882 |
| | $ | 10,951 |
| ALLL balance at end of year | $ | 15,227 | | | $ | 15,657 | |
ALLL as a percent of total loans, net of LIP | 1.28 | % | | 1.32 | % | |
| ALLL as a percent of total loans | | ALLL as a percent of total loans | 1.29 | % | | 1.40 | % |
ALLL as a percent of nonperforming loans | 7,196.65 |
| | 1,276.34 |
| ALLL as a percent of nonperforming loans | 7,889.78 | % | | — | % |
Total nonperforming loans | $ | 179 |
| | $ | 858 |
| Total nonperforming loans | $ | 193 | | | $ | — | |
Nonperforming loans as a percent of total loans | 0.02 | % | | 0.10 | % | Nonperforming loans as a percent of total loans | 0.02 | % | | — | % |
Total loans receivable, net LIP | $ | 1,002,694 |
| | $ | 828,161 |
| |
Total loans receivable | | Total loans receivable | $ | 1,182,159 | | | $ | 1,119,536 | |
Total loans originated | 331,166 |
| | 359,666 |
| Total loans originated | 271,403 | | | 308,454 | |
Intangible assets. As a result of ourthe Branch Acquisition the Bankin 2017, we recognized goodwill of $889,000 and a core deposit intangible (“CDI”)CDI of $1.3 million. Goodwill was calculated as the excess purchase price of the branches over the fair value of the assets acquired and liabilities assumed at August 25, 2017. The Company performed an impairment analysis at December 31, 2022, and determined that no impairment of goodwill and CDI existed. However, if adverse economic conditions or the decrease in the Company’s stock price and market capitalization were to be deemed sustained rather than temporary, it may significantly affect the fair value of our goodwill.
The CDI was provided by a third partythird-party valuation service and represents the fair value of the customer relationships that provide a low-cost source of funding. The analysis was performed on the acquired noninterest-bearing checking, interest-bearing checking, savings, and money market accounts. The initial ratio of CDI to the acquired balances of core deposits was 2.23%. This amount will amortizeis amortized into noninterest expense on an accelerated basis over ten years.years and had a balance of $548,000 at December 31, 2022.
Deposits. During the year ended December 31, 2017,2022, deposits increased $122.0$12.6 million from December 31, 2016.2021. Details of deposit balances and their concentrations are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2022 | | 2021 |
| (Dollars in thousands) |
Noninterest-bearing demand deposits | $ | 119,944 | | | 10.3 | % | | $ | 117,751 | | | 10.2 | % |
Interest-bearing demand | 96,632 | | | 8.3 | | | 97,907 | | | 8.5 | |
Savings | 23,636 | | | 2.0 | | | 23,146 | | | 2.0 | |
Money market | 542,388 | | | 46.4 | | | 624,543 | | | 54.0 | |
Certificates of deposit, retail | 262,554 | | | 22.3 | | | 294,127 | | | 25.3 | |
Brokered deposits (1) | 124,886 | | | 10.7 | | | — | | | — | |
Total deposits | $ | 1,170,040 | | | 100.0 | % | | $ | 1,157,474 | | | 100.0 | % |
|
| | | | | | | | | | | | | |
| December 31, |
| 2017 | | 2016 |
| (dollars in thousands) |
Noninterest-bearing demand deposits | $ | 45,434 |
| | 5.4 | % | | $ | 33,422 |
| | 4.7 | % |
Interest-bearing demand | 38,224 |
| | 4.6 |
| | 18,532 |
| | 2.5 |
|
Statement savings | 28,456 |
| | 3.4 |
| | 28,383 |
| | 4.0 |
|
Money market | 318,636 |
| | 38.0 |
| | 204,998 |
| | 28.6 |
|
Certificates of deposit, retail (1) | 333,264 |
| | 39.6 |
| | 356,653 |
| | 49.7 |
|
Certificates of deposit, brokered | 75,488 |
| | 9.0 |
| | 75,488 |
| | 10.5 |
|
Total deposits | $ | 839,502 |
| | 100.0 | % | | $ | 717,476 |
| | 100.0 | % |
____________ ____________________
(1) Retail certificates of deposit are shown net of $107,000 fair value adjustmentBrokered deposits at December 31, 2017 from acquired2022, were comprised of $89.8 million of certificate of deposits, $25.1 million of interest-bearing demand deposits and $10.0 million of money market deposits. There is no fair value adjustment at December 31, 2016.
The $12.6 million growth in retail deposits during 20172022 was primarily the result of our expansion from four branch locations to nine, withbrokered deposit growth as retail deposits declined in the additionrising rate environment, especially in the latter half of one de novo branch and acquisition of four other branches. The Branch Acquisition was executed to further shift our deposit mix by increasing core deposits and strengthen our liquidity position while providing access to contiguous markets. At the acquisition date, deposits were $74.7 million, consisting primarily of $32.7 million in moneyyear. Money market accounts and $15.6decreased by $82.2 million, in retail certificates of deposit. At December 31, 2017, we had retained 98% of the acquired deposits.
During 2017, we continued the work on shifting the mix of our deposit portfolio to be less reliant on certificates of deposit, as the Bank continued to focus its efforts on growing accounts with a lower cost of funds. Our efforts resulted in money market accounts increasing $113.6 million and checking accounts increasing $31.7 million while retail certificates of deposit decreased $23.4$31.6 million, during 2017. In addition, continuedand interest-bearing demand accounts decreased by $1.3
million. Partially offsetting to these decreases, was a $2.2 million increase in noninterest-bearing demand accounts, which increase was due primarily to growth in our wealth management services provided our customers with other long-term investment choices, resulting in a decrease in deposits (primarily maturing certificates of deposit) which converted to investmentbusiness checking accounts.
OurThe Bank’s strategic initiatives seek to diversify our loan portfolio of brokered certificates ofand broaden growth opportunities within our current risk tolerance levels and asset/liability objectives. When retail deposit remained at $75.5 million at December 31, 2017, unchanged from December 31, 2016. We may add tobalances do not meet our portfolio of thesefunding needs, we utilize brokered deposits, as a source of additionalthe national deposit marketplace and other wholesale funding in future periods. While brokered certificates of deposit may carry a higher cost than our retail certificates, their remaining maturity periods of six monthssources. These funds are used to 36 months, along with the enhanced call features of a majority of these deposits, assist us in our efforts to manage interest rate risk.fund loan origination and support other operation needs.
At December 31, 20172022 and December 31, 2016,2021, we held $21.5$61.0 million and $23.7$60.6 million in public funds, respectively, nearly all of which $20.1 million were retail certificates of deposit. These funds were secured at December 31, 20172022 with the Washington State Public Deposit Protection Commission by $14.2$21.0 million in pledged investment securities.
Advances. We use advances from the FHLB as an alternative funding source to manage interest rate risk, and to leverage our balance sheet. Throughout the year, we utilized FHLB federal fundssheet and to balancesupplement our funding needs with our total funding sources. Totaldeposits. FHLB advances at December 31, 20172022 were $216.0$145.0 million as compared to $171.5$95 million at December 31, 2016. During 2017, as part of our ongoing liquidity management efforts, we replaced a $20.0 million matured advance, and refinanced our existing $80.0 million member option variable-rate advance and $20.0 million of FHLB Fed Funds into a new $120.0 million three-year member option variable-rate advance that reprices quarterly and allows for prepayment without penalties on the repricing date.2021. At December 31, 2017, we had $24.52022, our FHLB advances consisted of $35.0 million of fixed-rate three-month advances that renew quarterly, $60.0 million of fixed-rate one-month advances that renew monthly, all of which are utilized in cash flow hedge agreements, as described below, and $50.0 million of overnight FHLB Fed Funds. Our averageadvances. The availability of overnight FHLB advances provides us flexibility to adjust the level of our borrowings as our funding needs change consistent with our asset/liability objectives. Average borrowings during 20172022 were $192.2$113.9 million. At December 31, 2017, $86.0 million2022, all of our FHLB advances including Fed Funds, were due to mature in 2018, with the remaining $130.0 million due to mature in one to three years.less than two months.
Cash Flow Hedge. As part of itsTo assist in managing interest rate risk, management efforts, the Bank entered into a five-year, $50 million notional, pay fixed, receive floatingseven interest rate swap agreements with qualified institutions designated as cash flow hedge orinstruments. The agreements have an aggregate notional amount of $95.0 million, with individual notional amounts ranging from $10.0 million to $15.0 million, a weighted-average remaining term of 3.9 years and a weighted-average fixed rate of 1.05%. The remaining maturity of these agreements is from 10 months to seven years. On October 25, 2021, a $50.0 million notional swap with a fixed rate of 1.34% matured and was partially replaced with two previously contracted forward-starting interest rate swap withagreements of $15.0 million and $10.0 million, effective on that date. These swaps had an original weighted-average term of 7.4 years and a qualified institution on October 25, 2016. weighted-average fixed rate of 0.80%.
Under the terms of the agreement,interest rate swap agreements, the Bank pays a fixed interest rate of 1.34% for five years and in return receives an interest payment based on the three-monthcorresponding LIBOR index, which resets quarterly.quarterly or monthly, depending on the hedge term. Concurrently, the Bank borrowed a $50 million fixed rate three-month FHLB advance that will be renewed quarterly or monthly, as designated by the hedge agreement, at the fixed interest rate at that time. Effectiveness of the interest rate swap is evaluated quarterly with any ineffectiveness recognized as a gain or a loss on the income statement in noninterest income. A change in the fair value of the cash flow hedge created by the interest rate swap agreements is recognized as an other asset or other liability on the balance sheet with the tax-effected portion of the change included in other comprehensive income. At December 31, 2017,2022, we recognized a $1.5$10.5 million fair value asset as a result of the increase in market value of the hedge agreement.interest rate swap agreements.
The Bank has confirmed our adherence to the International Swaps and Derivatives Association (“ISDA”) 2020 LIBOR Fallbacks Protocol (“Protocol”) to prepare for the cessation of LIBOR by June 30, 2023. The Protocol provides a mechanism for parties to bilaterally amend their existing derivatives transactions to incorporate ISDA’s fallback terms, providing for a clear transition from LIBOR to SOFR.
Stockholders’ Equity. Total stockholders’ equity increased $4.5 million, or 3.3% to $142.6$160.4 million at December 31, 20172022, from $138.1$157.9 million at December 31, 2016. The increase in2021. Increases to stockholders’ equity was primarily a resultfor the year ended December 31, 2022, included $13.2 million of $8.5net income and $1.9 million in net income partially offset by $2.8 million in shareholder dividends and the repurchase of 326,800 shares of stock at an aggregate cost of $5.3 million.stock-based compensation. In addition, the exercise of stock options andresulted in the issuance of restricted54,481 shares of common stock resulted in 136,986 shares being issued from authorized shares and ana $454,000 increase to stockholders’ equity of $1.2 million.additional paid-in capital.
The Company has elected to early adopt ASU 2018-02 and reclassified $41,000 of strandedThese increases were partially offset by a $7.4 million other comprehensive income as a result of the reduction in the tax rate in the corporate income rateloss from the enactmentdecrease in fair value of the Tax Act from 35% to 21%. The result wasour available-for-sale investments, partially offset by increases in value of our derivative portfolio. These increases were further offset by a $1.4 million decrease to accumulated other comprehensive incomeadditional paid-in-capital from the repurchase and retirement of 84,981 shares of First Financial Northwest common stock at an increase toaverage price of $16.43 per share. In addition, shareholder cash dividends of $0.48 per share were paid during 2022, reducing retained earnings with no net change in stockholders’ equity.by $4.3 million.
Comparison of Operating Results for the Years Ended December 31, 20172022 and December 31, 20162021
Net Interest Income. Net interest income in 20172022 was $37.6$48.4 million, a $3.4 million or 10.0%7.6% increase from $34.2$45.0 million in 20162021, due primarily to a $5.9$5.5 million increase in interest income partially offset by a $2.5$2.1 million increase in
interest expense. The increase in
terest expense. Interest interest income increased duringprimarily was due to the year ended December 31, 2017 primarily as a result of the growthincrease in average loans receivable and in particular, multifamily and commercial real estate loans. In addition, the average yield ofon interest-earning assets increased to 4.57%4.33% for the year ended December 31, 20172022 from 4.39%4.01% for the year ended December 31, 2016. The increase2021,a result of increases in averagemarket interest rates during the year and our deployment of excess liquidity into higher yielding assets. Average interest-earning assets wasincreased $26.8 million, partially funded by a $102.7$16.9 million increase in average interest-bearing liabilities. The average cost of these fundsinterest-bearing liabilities increased to 1.10%0.95% for the year ended December 31, 20172022 from 0.92%0.78% for the year ended December 31, 2016, primarily2021, as a result of the overall increaserising rate environment and the change in federal funds ratethe Company’s deposit mix. In 2022, we supplemented our funding needs by utilizing brokered deposits to fund asset growth and replace retail deposit withdrawals. The average balance of retail certificates of deposit declined $69.0 million during 2017. Although2022 compared to 2021. The average balances in money market accounts and saving accounts increased by $48.7 million and $2.1 million respectively. However, money market balances declined to $542.4 million at December 31, 2022 compared to $624.5 million at December 31, 2021, contributing to the total yield on assetsneed for brokered deposits and total costother wholesale funding alternatives. Average balance in interest-bearing demand accounts decreased $4.9 million while the average balance of fundsnoninterest bearing accounts increased during 2017,$12.7 million. The resulting impact was an improvement in our net interest rate spreadmargin to 3.53% for the year ended December 31, 2022, from 3.35% for the year ended December 31, 2021. For more information, see “Asset and net interest margin remained constant at 3.47%Liability Management and 3.60% year over year. Continued growth in higher yielding loans helped contribute to maintaining these ratios.Market Risk.”
The following table compares average interest-earning asset balances, associated yields, and resulting changes in interest and dividend income for the years ended December 31, 20172022 and 2016:2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2022 | | 2021 | | Change in Interest and Dividend Income |
| Average Balance | | Yield | | Average Balance | | Yield | |
| (Dollars in thousands) |
Loans receivable, net | $ | 1,128,835 | | | 4.69 | % | | $ | 1,098,772 | | | 4.57 | % | | $ | 2,765 | |
Investments | 203,148 | | | 2.76 | | | 176,110 | | | 1.83 | | | 2,379 | |
Interest-earning deposits | 30,176 | | | 1.28 | | | 60,482 | | | 0.12 | | | 314 | |
FHLB stock | 6,256 | | | 5.08 | | | 6,271 | | | 5.29 | | | (14) | |
Total interest-earning assets | $ | 1,368,415 | | | 4.33 | % | | $ | 1,341,635 | | | 4.01 | % | | $ | 5,444 | |
|
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | Change in Interest and Dividend Income |
| Average Balance | | Yield | | Average Balance | | Yield | |
| (Dollars in thousands) |
Loans receivable, net | $ | 878,449 |
| | 4.96 | % | | $ | 765,948 |
| | 4.99 | % | | $ | 5,389 |
|
Investments available-for-sale | 134,105 |
| | 2.61 |
| | 132,372 |
| | 2.31 |
| | 450 |
|
Interest-earning deposits | 22,194 |
| | 1.07 |
| | 45,125 |
| | 0.52 |
| | 2 |
|
FHLB stock | 8,914 |
| | 3.32 |
| | 7,714 |
| | 2.62 |
| | 94 |
|
Total interest-earning assets | $ | 1,043,662 |
| | 4.57 | % | | $ | 951,159 |
| | 4.39 | % | | $ | 5,935 |
|
During the year ended December 31, 2017,2022, interest income on net loans receivable increased $2.8 million due to increases in both the $5.4average yield and balance of loans. The average loan yield increased to 4.69% from 4.57% and the average balance of loans receivable increased $30.1 million for the year ended December 31, 2022, as compared to the year ended December 31, 2021, primarily due to loans originated or refinanced at higher rates or adjusted upward in this rising rate environment.
Interest income on investments available-for-sale increased $2.4 million during 2022, due to an increase in loan interest income was primarily the result ofaverage yield to 2.76% from 1.83% for the prior year and, to a $112.5lesser extent, a $27.0 million increase in the average balance of net loans receivable. Also contributing toinvestments. Approximately half of our investment portfolio was comprised of variable rate securities which repriced during the increase in loan interest income, repayments of previously charged off notes as part of an A/B note restructure contributed $495,000 in additional loan interest income.rising rate environment during 2022.
Interest income from investments available-for-saleon interest-earning deposits increased $450,000$314,000 during 2017the year ended December 31, 2022 compared to the prior year, as a combined result of a $1.7 million increase in the average balance of our investments and a 30116 basis point increase in the average yield to 2.61% from 2.31% during 2016. The increase in the average yield was a result of the restructuring of our investments portfolio through the sales of lower yielding investment securities and utilizing the proceeds received to purchase higher yielding, long-term investment securities.
Interest income on interest-earning deposits remained stable with a modest $2,000 increase during the year ended December 31, 2017. Although the average balance of these funds decreased by $22.9 million as they were converted into higher-yielding assets, the increase in average yield to 1.07%1.28% for the year ended December 31, 20172022, from 0.52%0.12% for the year ended December 31, 2016 more than2021, partially offset the declineby a reduction of $30.3 million in thetheir average balance. The rate increase was the result of increases in the Federal Reserve’s targeted federal funds rate during 2017.
The following table details average balances, cost of funds and the resulting increasechanges in interest expense for the years ended December 31, 20172022 and 2016:2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2022 | | 2021 | | Change in Interest Expense |
| Average Balance | | Cost | | Average Balance | | Cost | |
| (Dollars in thousands) |
Interest-bearing demand accounts | $ | 101,744 | | | 0.47 | % | | $ | 106,684 | | | 0.08 | % | | $ | 388 | |
Savings accounts | 23,823 | | | 0.03 | | | 21,715 | | | 0.03 | | | 1 | |
Money market accounts | 593,984 | | | 0.63 | | | 545,306 | | | 0.29 | | | 2,143 | |
Certificates of deposit, retail | 273,197 | | | 1.33 | | | 342,147 | | | 1.61 | | | (1,884) | |
Brokered deposits | 41,603 | | | 2.62 | | | — | | | — | | | 1,091 | |
FHLB advances and other borrowings | 113,890 | | | 1.70 | | | 115,466 | | | 1.39 | | | 331 | |
Total interest-bearing liabilities | $ | 1,148,241 | | | 0.95 | % | | $ | 1,131,318 | | | 0.78 | % | | $ | 2,070 | |
|
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | Change in Interest Expense |
| Average Balance | | Cost | | Average Balance | | Cost | |
| (Dollars in thousands) |
Interest-bearing demand accounts | $ | 25,267 |
| | 0.29 | % | | $ | 17,545 |
| | 0.17 | % | | $ | 43 |
|
Statement savings accounts | 28,160 |
| | 0.15 |
| | 29,221 |
| | 0.16 |
| | (5 | ) |
Money market accounts | 247,770 |
| | 0.72 |
| | 196,670 |
| | 0.44 |
| | 909 |
|
Certificates of deposit, retail | 345,981 |
| | 1.26 |
| | 335,496 |
| | 1.17 |
| | 428 |
|
Certificates of deposit, brokered | 75,488 |
| | 1.67 |
| | 69,392 |
| | 1.76 |
| | 41 |
|
Advances from the FHLB | 192,227 |
| | 1.30 |
| | 163,893 |
| | 0.86 |
| | 1,099 |
|
Total interest-bearing liabilities | $ | 914,893 |
| | 1.10 | % | | $ | 812,217 |
| | 0.92 | % | | $ | 2,515 |
|
Interest expense increased $2.5$2.1 million to $10.0$10.9 million for the year ended December 31, 20172022 from $7.5$8.8 million for the year ended December 31, 2016.2021. The increase in interest expense during 2017 was primarily a result of the increase in the average cost of interest-bearing deposits to 0.87% for the year ended December 31, 2022, as compared to 0.71% for the year ended December 31, 2021.
Interest expense on retail certificates of 10deposit decreased $1.9 million as a result of a $69.0 million decrease in the average balance of and a 28 basis pointspoint decrease in the average rate paid on these deposits. To compensate for the volume loss in retail certificates of deposit, the Bank utilized brokered deposits as an alternative funding source in 2022, which increased interest expense by $1.1 million in 2022 compared to 2021 when we had no brokered deposits. Brokered deposits had an average balance of $41.6 million and an average cost of 2.62% in 2022. Interest expense on money market accounts increased $2.1 million, primarily due to the average cost increasing to 0.63% in 2022 as compared to 0.29% in 2021 and, to a lesser extent, an increase of $48.7 million in average balance. Interest expense on interest-bearing demand deposits increased $388,000 due primarily to a 39 basis point increase in average cost.
Interest expense on FHLB advances and other borrowings increased $331,000 in 2022 compared to 2021 due to a 31 basis point increase in the average cost of our FHLB borrowings of 44 basis points. Also contributing to a lesser extent to the increase in interest expense, therate paid on advances, slightly offset by lower average balances of interest-bearing deposits and borrowings increased by $74.3 million and $28.3 million, respectively, in support of our asset growth.
The average cost of our retail deposits increased asbalance. As a result of the increaserate hikes in market interest rates that occurred during 2017. The2022, the average cost of brokered certificates of deposit decreased by nine basis points during 2017these advances increased to 1.70% for the year ended December 31, 2022 as a result ofcompared to 1.39% for the redemption of higher rate brokered certificates of deposit and subsequent replacement with lower rate brokered certificates of deposit during 2016.year ended December 31, 2021.
Provision for Loan Losses. OurWe recorded a recapture of the provision for loan losses wasof $400,000 for the year ended December 31, 2017 as2022, compared to a $300,000 provision for loan losses for the year ended December 31, 2021. This recapture, combined with a net charge off of $1.3$30,000, resulted in a $430,000 decrease in the ALLL and a decrease in the percentage of the ALLL to total loans to 1.29% at December 31, 2022, compared to 1.40% at December 31, 2021. The recapture of provision for loan losses in 2022 was primarily a result of $14.4 million of loans downgraded to substandard, resulting in these loans being removed from the calculation of the general allowance for loan and lease losses and instead being individually analyzed for required specific reserve, which indicated no additional specific reserve was needed. Changes in the composition of our loan portfolio, with $90.7 million growth in lower risk one-to-four family residential loans and a decline in higher risk construction/land loans with over $20.0 million of these loans converting to permanent multifamily loans also contributed to the recapture of provision in 2022.
In comparison, the provision for loan losses was $300,000 for the year ended December 31, 2021. This provision was primarily a result of a $2.1 million increase in net loans receivable and a change in the composition of our loan portfolio as $30.4 million in repaid PPP loans omitted from our loan loss analysis were replaced with other loans included in the analysis, offsetting the impact from decreased historical loss factors and qualitative factors for certain loan categories as the expected economic impact as a result of the COVID-19 pandemic to the credit quality of our loan portfolio has diminished in 2021. In addition, the provision for loan losses was impacted by the $31.6 million increase in substandard loans and the $14.7 million increase in impaired loans during 2021 evaluated for specific reserve and omitted from the general reserve calculations used to calculate the ALLL and provision for loan losses. Our individual evaluation of our impaired loans during 2021 indicated no additional specific reserve was needed.
Noninterest Income. Noninterest income decreased $639,000 to $3.2 million for the year ended December 31, 2016. The recapture of provision in 2017 was primarily the result of $2.3 million in net recoveries of previously charged off loans partially reduced by the provision for loan losses required as a result of the $173.6 million increase in net loans receivable. In comparison, the provision in 2016 was primarily the result of a $130.0 million increase in net loans receivable. The quality of our loan portfolio continued to improve as indicated by our credit metrics and that the loans evaluated individually for specific reserves decreased by $13.0 million. The related specific reserves declined to $135,000 at December 31, 20172022 from $309,000 at December 31, 2016.
In February, 2018, we received a $4.0 million payment from a borrower for the remaining balance of previously charged off loans, resulting in $3.1 million to recovery and the recognition of $914,000 of interest income. For additional information see Note 19 of the Notes to Consolidated Financial Statements included in Item 8 of this report.
Noninterest Income. Noninterest income decreased $443,000 to $2.2$3.9 million for the year ended December 31, 2017 from $2.7 million for the year ended December 31, 2016.2021. The following table provides a detailed analysis of the changes in the components of noninterest income:
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2022 | | Year Ended December 31, 2021 | | $ Change | | % Change |
| (Dollars in thousands) |
Gain on sale of investments, net | $ | 27 | | | $ | 32 | | | $ | (5) | | | (15.6) | % |
BOLI change in cash surrender value | 1,004 | | | 1,107 | | | (103) | | | (9.3) | |
Wealth management revenue | 312 | | | 494 | | | (182) | | | (36.8) | |
Deposit related fees | 936 | | | 872 | | | 64 | | | 7.3 | |
Loan related fees | 919 | | | 1,265 | | | (346) | | | (27.4) | |
Other | 49 | | | 92 | | | (43) | | | (46.7) | |
Total noninterest income | $ | 3,247 | | | $ | 3,862 | | | $ | (615) | | | (15.9) | % |
|
| | | | | | | | | | |
| Year Ended December 31, 2017 | | Change from December 31, 2016 | | Percentage Change |
| (Dollars in thousands) |
Deposit related fees | $ | 446 |
| | $ | 185 |
| | 70.9 | % |
Loan related fees | 776 |
| | 105 |
| | 15.6 |
|
Gain on sale of investments, net | (567 | ) | | (617 | ) | | (1,234.0 | ) |
BOLI change in cash surrender value | 623 |
| | (221 | ) | | (26.2 | ) |
Wealth management revenue | 919 |
| | 106 |
| | 13.0 |
|
Other | 11 |
| | (1 | ) | | (8.3 | ) |
Total noninterest income | $ | 2,208 |
| | $ | (443 | ) | | (16.7 | )% |
The largest change to our noninterest income was the $567,000 loss on sales of investments$346,000 decrease in loan related fees for the year ended December 31, 2017 as compared2022, primarily due to a $50,000 gain$425,000 decrease in fees collected on salethe early payoff of investmentscertain loans during the year ended December 31, 2022.
Wealth management revenue decreased by $182,000 in 2022. Beginning in early 2022, due to volatile capital markets and rising investor fears, our wealth management services experienced sales headwinds from investors seeking more conservative products and solutions, resulting in a decline in revenue versus 2021.
BOLI income decreased $103,000 for the year ended December 31, 2016. As a result of the
Tax Act, we opted to sell a selection of our investment securities that were in a loss position to receive the optimal tax benefit of the losses.
Our BOLI noninterest income decreased by $221,000 during 20172022, primarily due to the $4.2$161,000 in death benefit proceeds received in 2021 with no similar activity in 2022. The $1.0 million purchase in the second quarter of new policies that offset the premium against the increase in cash surrender value for the first year. For the year ended December 31, 2017, we recognized theBOLI income also included a net $623,000 increase in cash surrender value of these policies as noninterest income, which assists in offsetting expenses for employee benefits.policies.
Partially offsetting these losses, depositDeposit related fees increased by $185,000, primarily as a result of the increase in debit card transactions reflecting the increase in the number of our accounts as well as other deposit related services at our branch locations. Loan related fees increased by $105,000 as a result of a $166,000 increase in prepayment penalties duringwere $936,000 for the year ended December 31, 2017, partially2022, a $64,000 increase over the prior year, primarily from increased debit card usage in 2022. The increase in deposit related fees was fully offset by a $40,000 reductionthe $67,000 decrease in loan servicing fees and a $21,000 reduction in fees from interest rate swaps from commercial loan customers during the year. Interest rate swap fees are received on loans when certain commercial loan customers participate in an interest rate swap with a third party broker institution and the Bank receives a fee that is recognized as other noninterest income at the time the loan is originated. In addition, wealth management revenue continued growing with a $106,000 increase during 2017. Since inception of our wealth management services in 2015, this line of business has grown to $44.6 million of assets under management.income.
Noninterest Expense. Expense. Noninterest expense increased $3.9$2.2 million to $26.8$35.6 million for the year ended December 31, 20172022 from $22.9$33.4 million for the year ended December 31, 2016.2021. The following table provides a detailed analysis of the changes in the components of noninterest expense:
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2022 | | Year Ended December 31, 2021 | | $ Change | | % Change |
| (Dollars in thousands) |
Salaries and employee benefits | $ | 21,133 | | | $ | 20,237 | | | $ | 896 | | | 4.4 | % |
Occupancy and equipment | 4,776 | | | 4,557 | | | 219 | | | 4.8 | |
Professional fees | 2,339 | | | 1,899 | | | 440 | | | 23.2 | |
Data processing | 2,678 | | | 2,692 | | | (14) | | | (0.5) | |
Regulatory assessments | 403 | | | 456 | | | (53) | | | (11.6) | |
Insurance and bond premiums | 464 | | | 451 | | | 13 | | | 2.9 | |
Marketing | 303 | | | 154 | | | 149 | | | 96.8 | |
Other general and administrative | 3,495 | | | 2,921 | | | 574 | | | 19.7 | |
Total noninterest expense | $ | 35,591 | | | $ | 33,367 | | | $ | 2,224 | | | 6.7 | % |
|
| | | | | | | | | | |
| Year Ended December 31, 2017 | | Change from December 31, 2016 | | Percentage Change |
| (Dollars in thousands) |
Salaries and employee benefits | $ | 17,773 |
| | $ | 2,396 |
| | 15.6 | % |
Occupancy and equipment | 2,506 |
| | 522 |
| | 26.3 |
|
Professional fees | 1,809 |
| | (170 | ) | | (8.6 | ) |
Data processing | 1,457 |
| | 546 |
| | 59.9 |
|
OREO-related reimbursement of expenses, net | (67 | ) | | (361 | ) | | (122.8 | ) |
Regulatory assessments | 491 |
| | 71 |
| | 16.9 |
|
Insurance and bond premiums | 399 |
| | 50 |
| | 14.3 |
|
Marketing | 270 |
| | 76 |
| | 39.2 |
|
Other general and administrative | 2,171 |
| | 730 |
| | 50.7 |
|
Total noninterest expense | $ | 26,809 |
| | $ | 3,860 |
| | 16.8 | % |
For the year ended December 31, 2017, salaries and employee benefits increased by $2.4 million as comparedThe primary contributor to the previous year to $17.8 million as a result of normal wage increases and the hiring of 24 new full time positions in support of the growth in our operations, including new branches and new product lines. In addition, in response to the Tax Act, the Bank paid a special one-time bonus to all non-executive employees totaling $224,000 to share with our employees the expected future tax benefits the legislation provides.
Occupancy and equipment expense increased $522,000 to $2.5 million during 2017 as a result of the addition of five branch locations, expenses related to our automated teller machine (“ATM”) conversion and the upgrade of our main Renton branch. Lease expense increased by $165,000 and depreciation expense increased by $186,000 as we added one building, leasehold improvements and computer equipment to support the new branch operations. In support of our ATM conversion and Branch Acquisition, our data processing expense increased by $546,000 for 2017 as compared to 2016. The rate of the increase in data processing expense is expected to decline in future periods as we complete system conversion costs, although our core processor service fees will increase reflecting the expected increase in deposit accounts activity from the growth in customer accounts.
OREO related reimbursement of expense was $67,000, a $361,000 improvement over the previous year. Valuation expense to adjust our carrying value to market value decreased by $207,000 for the year ended December 31, 2017 as compared to the year ended December 31, 2016. In addition, sales of OREO properties resulted in a net gain of $110,000 in 2017 as compared to a net loss of $87,000 in 2016.
Other general and administrative expenses increased by $730,000 during the year ended December 31, 2017, primarily as a result of a $254,000 increase in the reserve for unfunded commitments due to a $20.5 million increase in our unfunded loans in process and $9.3 million increase in unfunded lines of credit. This reserve is held to absorb estimated probable losses of our unfunded lines of credit and construction loans and varies as a result of the timing of funding these loans. Other general and administrative expense increases included $103,000 for additional debit card operating expenses and $88,000 in additional deposit related expenses, both the result of increased customer volumes at our branch locations. With the addition of California loan activity and overall increase in loan income, the Bank incurred an $83,000 increase in state taxes. As a result of our Branch Acquisition, the Bank recognized CDI amortization expense of $53,000 during 2017.
Federal Income Tax Expense. We recorded a $4.9 million federal income tax provision for 2017, compared to $3.7 million for 2016. The Tax Act resulted in a revaluation of our DTA balance at the new corporate income tax rate of 21% rather than the 35% rate previously used, effective January 1, 2018. The reduction in our DTA balance resulted in a one-time $807,000 increase in federal income taxnoninterest expense for the year ended December 31, 2017. In addition, our federal income tax expense2022 compared to the prior year, was a $896,000 increase in salaries and employee benefits. The increase was due in part to a $944,000 net increase in salaries, payroll related taxes, commissions and employees incentives reflecting higher than normal vacancies in staffing in the year ago period. Also contributing to the increase, were employee benefit related expenses, including the 401(k) match contribution, which increased $145,000 from the prior year. Partially offsetting these increases was a decrease in stock-based
compensation of $262,000 primarily due to pretax net income increasing by $817,000the maturity of the Bank’s ESOP in 2022 that resulted in nine months of related expense recognition in 2022 versus 12 months in 2021.
Occupancy and equipment increased $219,000 for the year ended December 31, 2017 as2022 compared to the prior year, ended December 31, 2016.
Comparison of Financial Condition at December 31, 2016 and December 31, 2015
Assets. The following table details the changes in the composition of our assets at December 31, 2016 from December 31, 2015.
|
| | | | | | | | | | |
| Balance at December 31, 2016 | | Change from December 31, 2015 | | Percentage Change |
| (Dollars in thousands) |
Cash on hand and in banks | $ | 5,779 |
| | $ | 66 |
| | 1.2 | % |
Interest-earning deposits | 25,573 |
| | (74,425 | ) | | (74.4 | ) |
Investments available for sale, at fair value | 129,260 |
| | (305 | ) | | (0.2 | ) |
Loans receivable, net | 815,043 |
| | 129,971 |
| | 19.0 |
|
Premises and equipment, net | 18,461 |
| | 754 |
| | 4.3 |
|
FHLB stock, at cost | 8,031 |
| | 1,894 |
| | 30.9 |
|
Accrued interest receivable | 3,147 |
| | 179 |
| | 6.0 |
|
Deferred tax assets, net | 3,142 |
| | (1,414 | ) | | (31.0 | ) |
OREO | 2,331 |
| | (1,332 | ) | | (36.4 | ) |
Bank owned life insurance (“BOLI”) | 24,153 |
| | 844 |
| | 3.6 |
|
Prepaid expenses and other assets | 2,664 |
| | 1,439 |
| | 117.5 |
|
Total assets | $ | 1,037,584 |
| | $ | 57,671 |
| | 5.9 | % |
During 2016, total assets surpassed $1.0 billion withdue primarily to a $57.7 million$120,000 increase in total assets during the year. The increase was primarilyfacilities and equipment maintenance and a result of redirecting $74.4 million from lower-yielding interest-earning deposits, consisting primarily of funds held at the Federal Reserve Bank of San Francisco, to partially fund the $130.0 million growth in higher-yielding loans receivable.
Investments. Our investments available-for-sale remained stable during 2016 with a $305,000 or 0.2% decrease to $129.3 million at December 31, 2016 from $129.6 million at December 31, 2015. During 2016, we continued to restructure our available‑for‑sale investment portfolio to transition our investment portfolio to securities with longer maturity periods, higher yields, and primarily fixed rates in order to enhance our interest income. During the year, we purchased $44.6 million of securities with an expected yield of 2.99%, partially funded by sales of $25.9 million with an average yield of 1.68%. Restructuring of our investment portfolio during 2016 and 2015 resulted in an$65,000 increase in average yield of our available-for-sale investmentsdepreciation expense.
Professional fees increased $440,000, due to 2.31%a $162,000 increase in 2016 from 1.84%legal fees, a $100,000 increase in 2015. The purchases included $31.9 millionaudit and accounting service fees, along with $183,000 in fixed rateregulatory examination fees paid in 2022, with no comparable expense in 2021.
Marketing expense increased $149,000 during 2022, primarily due to increased marketing/promotional campaigns.
Other general and $12.0 million in variable rate securities. These consisted of $28.2 million in mortgage-backed securities, $10.0 million in corporate bonds, consisting of two subordinated debt instruments issued by well capitalized financial institutions located in southern California in the amounts of $5.0 million each, $4.0 million in U.S. government agency bonds and $1.7 million in municipal bonds. The sales of investments available-for-sale generated a net gain of $50,000 for the year ended December 31, 2016. We also received calls or partial calls of $438,000 of U.S. Government agency and municipal securities. In additionadministrative expense increased $574,000 to the purchase and call activity, we received principal repayments of $15.9 million on our investments available-for-sale during the 2016.
The effective duration of our portfolio increased to 4.00% at December 31, 2016 as compared to 3.20% at December 31, 2015. Effective duration is a measure that attempts to quantify the anticipated percentage change in the value of an investment (or portfolio) in the event of a 100 basis point change in market yields. Since the Bank’s portfolio includes securities with embedded options (including call options on bonds and prepayment options on mortgage-backed securities), management believes that effective duration is an appropriate metric to use as a tool when analyzing the Bank’s investment securities portfolio, as effective duration incorporates assumptions relating to such embedded options, including changes in cash flow assumptions as interest rates change.
Loans receivable. Net loans receivable increased by $129.9$3.5 million during 2016 to $815.0 million2022, primarily due to increases of $74.8 million, or 120.5% in our net construction/land loans and $59.5 million or 24.4% in our commercial real estate loans. These increases were partially offset by a decrease of $4.3 million in our one-to-four family residential loans. Commercial real estate and one-to-four family residential loans continue to be the largest concentrations in our loan portfolio at 33.7% and 27.7%, respectively, of total loans. Our construction/land loans increased to 23.2% of our total loan portfolio in 2016 from 15.5% in 2015 as we continued to originate more of these shorter term, higher yielding loans. During 2016, we supplemented our loan originations by purchasing $61.1 million in performing residential and non-residential commercial real estate and multifamily loans from other financial institutions. The loans were purchased at a 1.8% - 3.0% premium and are intended to be held to maturity. Included in these real estate loan purchases were $20.9 million of real estate loans secured by properties located in Washington. The remaining balance of $40.2 million of loan purchases were multifamily and commercial real estate loans secured by properties located in Arizona, California, Colorado, Oregon, and Utah, reflecting our efforts to geographically diversify our loan portfolio with loans meeting our investment and credit quality objectives.
The quality of our loan portfolio continued to improve during 2016 as our nonperforming loans decreased to $858,000 at December 31, 2016 from $1.1 million at December 31, 2015. Nonperforming loans as a percent of our total loans remained low at 0.10% and 0.16% at December 31, 2016 and 2015, respectively. Adversely classified loans, defined as substandard or below, decreased to $1.9 million at December 31, 2016, from $3.3 million at December 31, 2015. The following table presents a breakdown of our nonperforming assets:
|
| | | | | | | | | | | | | | | |
| | December 31, | | Amount of Change | | Percent of Change |
| | 2016 | | 2015 |
| | (Dollars in thousands) |
Nonperforming loans: | | | | | | | | |
One-to-four family residential | | $ | 798 |
| | $ | 996 |
| | $ | (198 | ) | | (19.9 | )% |
Consumer | | 60 |
| | 89 |
| | (29 | ) | | (32.6 | ) |
Total nonperforming loans | | 858 |
| | 1,085 |
| | (227 | ) | | (20.9 | ) |
OREO | | 2,331 |
| | 3,663 |
| | (1,332 | ) | | (36.4 | ) |
Total nonperforming assets | | $ | 3,189 |
| | $ | 4,748 |
| | $ | (1,559 | ) | | (32.8 | )% |
We continued to focus on reducing our nonperforming assets through loan work outs or pursuing foreclosure. Foregone interest during the year ended December 31, 2016travel expenses, subscription, postage relating to nonperforming loans totaled $51,000. There was no LIPthe aforementioned marketing expenses, miscellaneous loan expense and business entertainment related to nonperforming loans at December 31, 2016 or 2015. OREO decreased to $2.3expenses as business generating opportunities increased this year.
Federal Income Tax Expense. We recorded a $3.2 million at December 31, 2016 as we continued to sell our inventory of foreclosed real estate. During 2016, we sold two propertiesfederal income tax provision for $988,000 and had no additional foreclosures. During 2015, we sold nine properties for $6.2 million and foreclosed on one property for $141,000. The decline in both the transfer of properties into OREO and the sale of OREO properties reflects our continuing efforts to identify the problem loans within our portfolio and to take prompt appropriate actions to turn nonperforming assets into performing assets.
Allowance for loan and lease losses. The ALLL was $11.0 million or 1.32% of total loans outstanding at December 31, 2016 as2022, compared to $9.5 million or 1.36% of total loans outstanding at December 31, 2015. The ALLL represented 1,276.3% of nonperforming loans at December 31, 2016 compared to 872.2% at December 31, 2015. The following table details activity and information related to the ALLL for the years ended December 31, 2016 and 2015. All loan balances and ratios are calculated using loan balances that are net of LIP.
|
| | | | | | | |
| At or For the Years Ended December 31, |
| 2016 | | 2015 |
| (Dollars in thousands) |
ALLL balance at beginning of year | $ | 9,463 |
| | $ | 10,491 |
|
Recapture of provision for loan losses | 1,300 |
| | (2,200 | ) |
Charge-offs | (83 | ) | | (362 | ) |
Recoveries | 271 |
| | 1,534 |
|
ALLL balance at end of year | $ | 10,951 |
| | $ | 9,463 |
|
ALLL as a percent of total loans, net of LIP | 1.32 | % | | 1.36 | % |
ALLL as a percent of nonperforming loans | 1,276.34 |
| | 872.17 |
|
Total nonperforming loans | $ | 858 |
| | $ | 1,085 |
|
Nonperforming loans as a percent of total loans | 0.10 | % | | 0.16 | % |
Total loans receivable, net LIP | $ | 828,161 |
| | $ | 697,416 |
|
Total loans originated | 359,019 |
| | 229,780 |
|
Deposits. During the year ended December 31, 2016, deposits increased $42.1 million to $717.5 million as compared to $675.4 million at December 31, 2015. Our retail certificates of deposit increased by $32.8 million primarily as a result of the increased customer base with our new branch locations. Retail deposits in our three new branch locations increased by $30.6 million during 2016 as a direct result of our added market presence and focus on relationship development. These efforts also resulted in a $4.0 million increase in noninterest-bearing deposits and a $2.3 million increase in interest-bearing demand deposits.
Partially offsetting these increases, our money market accounts decreased by $6.4 million during the year ended December 31, 2016. Money market accounts related to short term deposits from large construction developers that are part of the EB-5 Immigrant Investor Program to fund development projects decreased to $8.5 million at December 31, 2016 from $62.8 million at December 31, 2015 as these funds were withdrawn in support of the construction projects. We do not anticipate new short term accounts of this nature to be a significant part of our retail deposits.
Brokered certificates of deposit increased by $9.3 million during the year to $75.5 million at December 31, 2016. While brokered certificates of deposit may carry a higher cost than our retail certificates, their remaining maturity periods of 18 to 48 months, along with the enhanced call features of the majority of these deposits, assist us in our interest rate risk management efforts.
At December 31, 2016 and December 31, 2015, we held $23.7 million and $16.0 million in public funds, respectively, nearly all of which were retail certificates of deposit.
Advances. We use advances from the FHLB as an alternative funding source to manage funding costs, reduce interest rate risk and to leverage our balance sheet. Total FHLB advances at December 31, 2016 were $171.5 million as compared to $125.5 million at December 31, 2015. During 2016, we restructured our borrowings by paying off $84.0 million of maturing advances, and adding an $80.0 million FHLB member option variable rate advance which reprices monthly and allows prepayment without penalties on the repricing dates and a $50.0 million three-month fixed rate advance entered into simultaneously with an interest rate swap for the same amount. Our average borrowings during 2016 were $163.9 million. At December 31, 2016, $70.0 million of our FHLB advances were due to mature in 2017, $21.5 million were due in one to three years and the remaining $80.0 million is due to mature in seven years.
Cash Flow Hedge. As part of its interest rate risk management efforts, the Bank entered into a five-year, $50 million notional, pay fixed, receive floating cash flow hedge or interest rate swap with a qualified institution on October 25, 2016. Under the terms of the agreement, the Bank will pay a fixed interest rate of 1.34% for five years and will in return receive an interest payment based on the three-month LIBOR index, which resets quarterly. Concurrently, the Bank borrowed a $50 million fixed rate three-month FHLB advance that will be renewed quarterly at the fixed interest rate at that time. Effectiveness of the swap is evaluated quarterly with any ineffectiveness recognized as a gain or a loss on the income statement in noninterest income. A change in the fair value of the cash flow hedge is recognized as an other asset or other liability on the balance sheet with the tax-effected portion of the change included in other comprehensive income. At December 31, 2016, we recognized a $1.3 million fair value asset as a result of the increase in market value of the hedge agreement.
Stockholders’ Equity. Total stockholders’ equity decreased $32.5 million, or 19.1% to $138.1 million at December 31, 2016 from $170.7 million at December 31, 2015, primarily due to common stock repurchases totaling $40.8 million. Partially offsetting the repurchase activity, retained earnings increased $6.1 million due to net income of $8.9$2.9 million for 2016, reduced by $2.8 million of dividends paid to shareholders. Additional paid-in-capital decreased $39.5 million due to the repurchase and retirement of 2,864,389 shares of common stock at an average price of $14.07 per share, partially offset by $621,000 of stock‑based compensation expense, $297,000 from the exercise of stock options and $476,000 from the annual allocation of ESOP shares.
Comparison of Operating Results for the Years Ended December 31, 2016 and December 31, 2015
Net Interest Income. Net interest income in 2016 was $34.2 million, a $3.8 million or 12.3% increase from $30.4 million in 2015 due to a $4.5 million increase in interest income partially offset by a $756,000 increase in interest expense.2021. The increase in interestfederal income was primarily a result of a $50.5 million increase during the year ended December 31, 2016 in the average balance of our interest-earning assets, primarily due to our loan growth. In addition, as we moved funds from lower yielding interest-earning deposits to higher yielding loans receivable, we improved the total average yield on interest-earning assets by 26 basis points to 4.39%tax provision for the year ended December 31, 2016 as compared 4.13% for the prior year. These changes resulted in an increase to our interest rate spread of 24 basis points to 3.47% for the year ended December 31, 2016 from 3.23%. In addition, for the year ended December 31, 2016 our net interest margin increased 22 basis points to 3.60% from 3.38% for the year ended December 31, 2015. The following table compares average interest-earning asset balances, associated yields, and resulting changes in interest and dividend income for the years ended December 31, 2016 and 2015:
|
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2016 | | 2015 | | Change in Interest and Dividend Income |
| Average Balance | | Yield | | Average Balance | | Yield | |
| (Dollars in thousands) |
Loans receivable, net | $ | 765,948 |
| | 4.99 | % | | $ | 667,739 |
| | 5.18 | % | | $ | 3,606 |
|
Investments available-for-sale | 132,372 |
| | 2.31 |
| | 121,893 |
| | 1.84 |
| | 812 |
|
Interest-earning deposits | 45,125 |
| | 0.52 |
| | 104,476 |
| | 0.26 |
| | (39 | ) |
FHLB stock | 7,714 |
| | 2.62 |
| | 6,527 |
| | 1.06 |
| | 133 |
|
Total interest-earning assets | $ | 951,159 |
| | 4.39 | % | | $ | 900,635 |
| | 4.13 | % | | $ | 4,512 |
|
During the year ended December 31, 2016, the $3.6 million increase in loan interest income2022 was primarily the result of a $98.2$1.2 million increase in the average balance ofpretax net loans receivable. The increase to interest generated from this loan growth was partially offset by a decrease in the average loan yield to 4.99% from 5.18% for the year ended December 31, 2016 and 2015, respectively.
Interest income from investments available-for-sale increased $812,000 during 2016 as a combined result of a $10.5 million increase in the average balance of our investments and a 47 basis point increase in the average yield to 2.31% from 1.84% a year ago. The increase in the average yield was a result of the restructuring of our investments portfolio by purchasing longer term higher-yielding investment securities to increase earnings on our investment portfolio.
Interest income on interest-earning deposits decreased $39,000 during the year ended December 31, 2016 as a result of the $59.4 million decrease in the average balance of these deposits and despite the Federal Reserve’s federal funds rate increases in December 2016 and 2015 which positively impacted the rate we receive on our interest-earning deposits. The average rate earned on interest-earning deposits increased 26 basis points for the year ended December 31, 2016, as compared to the prior year.
Interest expense increased $756,000 to $7.5 million for the year ended December 31, 2016 from $6.8 million for the year ended December 31, 2015. The increase in interest expense during 2016 was primarily a result of the increase in the average balance of interest-bearing liabilities as we acquired funds to be used for loan growth and stock repurchases. The following table details average balances, cost of funds and the resulting increase in interest expense for the years ended December 31, 2016 and 2015:
income.
|
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2016 | | 2015 | | Change in Interest Expense |
| Average Balance | | Cost | | Average Balance | | Cost | |
| (Dollars in thousands) |
Interest-bearing demand accounts | $ | 17,545 |
| | 0.17 | % | | $ | 17,866 |
| | 0.10 | % | | $ | 12 |
|
Statement savings accounts | 29,221 |
| | 0.16 |
| | 26,083 |
| | 0.15 |
| | 7 |
|
Money market accounts | 196,670 |
| | 0.44 |
| | 167,139 |
| | 0.36 |
| | 267 |
|
Certificates of deposit, retail | 335,496 |
| | 1.17 |
| | 338,180 |
| | 1.06 |
| | 360 |
|
Certificates of deposit, brokered | 69,392 |
| | 1.76 |
| | 64,917 |
| | 1.91 |
| | (23 | ) |
Advances from the FHLB | 163,893 |
| | 0.86 |
| | 133,527 |
| | 0.95 |
| | 133 |
|
Total interest-bearing liabilities | $ | 812,217 |
| | 0.92 | % | | $ | 747,712 |
| | 0.90 | % | | $ | 756 |
|
The average cost of our deposits increased by five basis points during 2016 primarily as a result of the increase in market interest rates that occurred late in 2015. As a result of the early redemption of several brokered certificates of deposit and obtaining new brokered certificates at lower rates, we were able to reduce our cost of these funds by 15 basis points.
Reductions in the average cost of FHLB advances were a further benefit to our net interest margin. Although the average balance of our FHLB advances increased by $30.4 million year over year, we were able to replace maturing longer-term fixed rate advances and obtain additional advances by utilizing short-term, variable rate advances, thereby reducing the overall average cost of these funds by nine basis points. In addition, low-rate fed funds borrowing was utilized during 2016 as needed to provide the necessary funds for loan growth, then were paid off as core deposits increased.
Provision for Loan Losses. Our provision for loan losses was $1.3 million for the year ended December 31, 2016 as compared to a recapture of the provision for loan losses of $2.2 million for the year ended December 31, 2015. The additional provision in 2016 was primarily the result of a $130.0 million increase in net loans receivable. The quality of our loan portfolio continued to improve as indicated by our credit metrics and that the loans evaluated individually for specific reserves decreased by $12.4 million. The related specific reserves declined to $309,000 at December 31, 2016 from $732,000 at December 31, 2015. In comparison, the recapture recognized in 2015 was primarily the result of recoveries of previously charged-off loans and declines in classified and special mention loans.
Noninterest Income. Noninterest income increased $1.4 million to $2.7 million for the year ended December 31, 2016 from $1.3 million for the year ended December 31, 2015. The following table provides a detailed analysis of the changes in the components of noninterest income:
|
| | | | | | | | | | |
| Year Ended December 31, 2016 | | Change from December 31, 2015 | | Percentage Change |
| (Dollars in thousands) |
Service fees on deposit accounts | $ | 83 |
| | $ | 14 |
| | 20.3 | % |
Loan service fees | 445 |
| | 294 |
| | 194.7 |
|
Gain on sale of investments, net | 50 |
| | (42 | ) | | (45.7 | ) |
BOLI change in cash surrender value | 844 |
| | 311 |
| | 58.3 |
|
Wealth management revenue | 813 |
| | 630 |
| | 344.3 |
|
Other | 416 |
| | 165 |
| | 65.7 |
|
Total noninterest income | $ | 2,651 |
| | $ | 1,372 |
| | 107.3 | % |
The largest change to our noninterest income was the $630,000 increase in wealth management revenue to $813,000 for the year ended December 31, 2016 as compared to $183,000 for the year ended December 31, 2015. The increase in 2016 is a reflection of the full year of operations and increased investment sales commissions. The Bank began offering wealth management services during the second quarter of 2015.
Our BOLI policies generated $844,000 of income for the year ended December 31, 2016 as a result of the increase in cash surrender values of these policies. The $311,000 increase from the year ended December 31, 2015 was primarily the result of holding throughout the year ended December 31, 2016, $20.0 million in additional BOLI policies purchased in April 2015. In
addition, we replaced a $10.2 million BOLI policy with a higher yielding policy in the second quarter of 2016. We recognize the increase in cash surrender value of these policies as noninterest income, which assists in offsetting expenses for employee benefits.
Loan service fees increased by $294,000 for the year ended December 31, 2016 primarily as a result of the growth and related activity in our loan portfolio. In addition, other noninterest income increased by $165,000 during 2016 primarily as a result of $226,000 of fees received on loans where certain commercial loan customers participate in an interest rate swap. As a result of the interest rate swap, these commercial loan customers pay a fixed interest rate to us, which we forward to a third party broker institution and receive variable interest payments based on one month LIBOR in return. On most of these loans, in addition to the interest payment, the Bank receives a fee from the counterparty that is recognized as noninterest income at the time the loan is originated. In comparison, for the year ended December 31, 2015, other noninterest income solely included a $95,000 gain on the sale of investment property.
Noninterest Expense. Noninterest expense increased $3.0 million to $22.9 million for the year ended December 31, 2016 from $19.9 million for the year ended December 31, 2015. The following table provides a detailed analysis of the changes in the components of noninterest expense:
|
| | | | | | | | | | |
| Year Ended December 31, 2016 | | Change from December 31, 2015 | | Percentage Change |
| (Dollars in thousands) |
Salaries and employee benefits | $ | 15,377 |
| | $ | 1,437 |
| | 10.3 | % |
Occupancy and equipment | 1,984 |
| | 544 |
| | 37.8 |
|
Professional fees | 1,979 |
| | 348 |
| | 21.3 |
|
Data processing | 911 |
| | 152 |
| | 20.0 |
|
OREO-related expenses, net | 294 |
| | 778 |
| | (160.7 | ) |
Regulatory assessments | 420 |
| | (50 | ) | | (10.6 | ) |
Insurance and bond premiums | 349 |
| | (10 | ) | | (2.8 | ) |
Marketing | 194 |
| | (17 | ) | | (8.1 | ) |
Other general and administrative | 1,441 |
| | (111 | ) | | (7.2 | ) |
Total noninterest expense | $ | 22,949 |
| | $ | 3,071 |
| | 15.4 | % |
For the year ended December 31, 2016, salaries and employee benefits increased by $1.4 million as compared to the previous year to $15.4 million as a result of normal wage increases and the hiring of 14 new full time positions in support of our growth, new branches and new product lines. Occupancy and equipment expense increased $544,000 to $2.0 million during 2016 as a result of the locations of new branches.
OREO-related expenses were $294,000, a $778,000 decline from a $484,000 reimbursement the previous year. Valuation expense to adjust our carrying value to market value increased by $216,000 for the year ended December 31, 2016 as compared to the year ended December 31, 2015. In addition, sales of OREO properties resulted in a net loss of $613,000 in 2016 as compared to a net gain of $526,000 in 2015.
Other general and administrative expenses decreased by $111,000 during the year ended December 31, 2016. The primary contributor to this decline was a recapture of $160,000 in the reserve for unfunded commitments. This reserve is funded to absorb estimated probable losses related to unfunded credit facilities. The strong credit quality metrics of the Company’s loan portfolio resulted in corresponding modifications in the unfunded commitment reserve calculation methodology, resulting in the recapture during the year. In comparison, for the year ended December 31, 2015, we recognized $148,000 in additional expense representing an increase in the reserve for unfunded commitments.
Federal Income Tax Expense. We recorded a $3.7 million federal income tax provision for 2016, compared to $4.9 million for 2015, primarily as a result of the decrease in pre-tax net income. In addition, a $213,000 tax benefit was incurred for the year ended December 31, 2016 as a partial result of utilization of the capital loss carryforward on our 2015 federal tax return. The provision was based on a 35% tax rate, adjusted for permanent and temporary differences.
Average Balances, Interest and Average Yields/Cost
The following table presents information regarding average balances of assets and liabilities as well as interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spreads, net interest margins and the ratio of average interest-earning assets to average interest-bearing liabilities. Average balances have been calculated using the average daily balances during the period. Interest and dividends are not reported on a tax equivalent basis.
| | | Year Ended December 31, | | Year Ended December 31, |
| 2017 | | 2016 | | 2015 | | 2022 | | 2021 | | 2020 |
| Average Balance (1) | | Interest and Dividends | | Yield/Cost | | Average Balance (1) | | Interest and Dividends | | Yield/Cost | | Average Balance (1) | | Interest and Dividends | | Yield/Cost | | Average Balance (1) | | Interest and Dividends | | Yield/Cost | | Average Balance (1) | | Interest and Dividends | | Yield/Cost | | Average Balance (1) | | Interest and Dividends | | Yield/Cost |
| (Dollars in thousands) | | (Dollars in thousands) |
Interest-earnings assets: | | | | | | | | | | | | | | | | | | Interest-earnings assets: | | | | | | | | | |
Loans receivable, net | $ | 878,449 |
| | $ | 43,607 |
| | 4.96 | % | | $ | 765,948 |
| | $ | 38,218 |
| | 4.99 | % | | $ | 667,739 |
| | $ | 34,612 |
| | 5.18 | % | Loans receivable, net | $ | 1,128,835 | | | $ | 52,935 | | | 4.69 | % | | $ | 1,098,772 | | | $ | 50,170 | | | 4.57 | % | | $ | 1,120,889 | | | $ | 52,546 | | | 4.69 | % |
Investments available-for-sale | 134,105 |
| | 3,504 |
| | 2.61 |
| | 132,372 |
| | 3,054 |
| | 2.31 |
| | 121,893 |
| | 2,242 |
| | 1.84 |
| |
Investments, taxable | | Investments, taxable | 180,085 | | | 5,105 | | | 2.83 | | | 151,768 | | | 2,765 | | | 1.82 | | | 124,162 | | | 2,960 | | | 2.38 | |
Investments, non-taxable | | Investments, non-taxable | 23,063 | | | 498 | | | 2.16 | | | 24,342 | | | 459 | | | 1.89 | | | 9,422 | | | 236 | | | 2.50 | |
Interest-earning deposits | 22,194 |
| | 237 |
| | 1.07 |
| | 45,125 |
| | 235 |
| | 0.52 |
| | 104,476 |
| | 274 |
| | 0.26 |
| Interest-earning deposits | 30,176 | | | 386 | | | 1.28 | | | 60,482 | | | 72 | | | 0.12 | | | 25,108 | | | 52 | | | 0.21 | |
FHLB stock | 8,914 |
| | 296 |
| | 3.32 |
| | 7,714 |
| | 202 |
| | 2.62 |
| | 6,527 |
| | 69 |
| | 1.06 |
| FHLB stock | 6,256 | | | 318 | | | 5.08 | | | 6,271 | | | 332 | | | 5.29 | | | 6,600 | | | 320 | | | 4.85 | |
Total interest-earning assets | 1,043,662 |
| | 47,644 |
| | 4.57 |
| | 951,159 |
| | 41,709 |
| | 4.39 |
| | 900,635 |
| | 37,197 |
| | 4.13 |
| Total interest-earning assets | 1,368,415 | | | 59,242 | | | 4.33 | | | 1,341,635 | | | 53,798 | | | 4.01 | | | 1,286,181 | | | 56,114 | | | 4.36 | |
Noninterest earning assets | 64,994 |
| | | | | | 59,084 |
| | | | | | 57,519 |
| | | | | Noninterest earning assets | 87,324 | | | 79,841 | | | 75,423 | | |
Total average assets | $ | 1,108,656 |
| | | | | | $ | 1,010,243 |
| | | | | | $ | 958,154 |
| | | | | Total average assets | $ | 1,455,739 | | | $ | 1,421,476 | | | $ | 1,361,604 | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | Interest-bearing liabilities: | | | | | | |
Interest-bearing demand accounts | $ | 25,267 |
| | $ | 73 |
| | 0.29 | % | | $ | 17,545 |
| | $ | 30 |
| | 0.17 | % | | $ | 17,866 |
| | $ | 18 |
| | 0.10 | % | Interest-bearing demand accounts | $ | 101,744 | | | $ | 478 | | | 0.47 | % | | $ | 106,684 | | | $ | 90 | | | 0.08 | % | | $ | 92,839 | | | $ | 292 | | | 0.31 | % |
Statement savings accounts | 28,160 |
| | 42 |
| | 0.15 |
| | 29,221 |
| | 47 |
| | 0.16 |
| | 26,083 |
| | 40 |
| | 0.15 |
| |
Savings accounts | | Savings accounts | 23,823 | | | 7 | | | 0.03 | | | 21,715 | | | 6 | | | 0.03 | | | 18,369 | | | 15 | | | 0.08 | |
Money market accounts | 247,770 |
| | 1,779 |
| | 0.72 |
| | 196,670 |
| | 870 |
| | 0.44 |
| | 167,139 |
| | 603 |
| | 0.36 |
| Money market accounts | 593,984 | | | 3,744 | | | 0.63 | | | 545,306 | | | 1,601 | | | 0.29 | | | 415,190 | | | 3,497 | | | 0.84 | |
Certificates of deposit, retail | 345,981 |
| | 4,362 |
| | 1.26 |
| | 335,496 |
| | 3,934 |
| | 1.17 |
| | 338,180 |
| | 3,574 |
| | 1.06 |
| Certificates of deposit, retail | 273,197 | | | 3,635 | | | 1.33 | | | 342,147 | | | 5,519 | | | 1.61 | | | 430,179 | | | 9,474 | | | 2.20 | |
Certificates of deposit, brokered | 75,488 |
| | 1,261 |
| | 1.67 |
| | 69,392 |
| | 1,220 |
| | 1.76 |
| | 64,917 |
| | 1,243 |
| | 1.91 |
| |
Brokered deposits | | Brokered deposits | 41,603 | | | 1,091 | | | 2.62 | | | — | | | — | | | — | | | 30,492 | | | 727 | | | 2.38 | |
Total deposits | 722,666 |
| | 7,517 |
| | 1.04 |
| | 648,324 |
| | 6,101 |
| | 0.94 |
| | 614,185 |
| | 5,478 |
| | 0.89 |
| Total deposits | 1,034,351 | | | 8,955 | | | 0.87 | | | 1,015,852 | | | 7,216 | | | 0.71 | | | 987,069 | | | 14,005 | | | 1.42 | |
Advances from the FHLB and other borrowings | 192,227 |
| | 2,505 |
| | 1.30 |
| | 163,893 |
| | 1,406 |
| | 0.86 |
| | 133,527 |
| | 1,273 |
| | 0.95 |
| Advances from the FHLB and other borrowings | 113,890 | | | 1,934 | | | 1.70 | | | 115,466 | | | 1,603 | | | 1.39 | | | 125,392 | | | 1,640 | | | 1.31 | |
Total interest-bearing liabilities | 914,893 |
| | 10,022 |
| | 1.10 |
| | 812,217 |
| | 7,507 |
| | 0.92 |
| | 747,712 |
| | 6,751 |
| | 0.90 |
| Total interest-bearing liabilities | 1,148,241 | | | 10,889 | | | 0.95 | | | 1,131,318 | | | 8,819 | | | 0.78 | | | 1,112,461 | | | 15,645 | | | 1.41 | |
Noninterest bearing liabilities | 51,116 |
| | | | | | 37,834 |
| | | | | | 32,538 |
| | | | | Noninterest bearing liabilities | 148,813 | | | 130,117 | | | 93,556 | | |
Average equity | 142,647 |
| | | | | | 160,192 |
| | | | | | 177,904 |
| | | | | Average equity | 158,685 | | | 160,041 | | | 155,587 | | |
Total average liabilities and equity | $ | 1,108,656 |
| | | | | | $ | 1,010,243 |
| | | | | | $ | 958,154 |
| | | | | Total average liabilities and equity | $ | 1,455,739 | | | $ | 1,421,476 | | | $ | 1,361,604 | | |
Net interest income | | | $ | 37,622 |
| | | | | | $ | 34,202 |
| | | | | | $ | 30,446 |
| | | Net interest income | | | $ | 48,353 | | | | | $ | 44,979 | | | | | $ | 40,469 | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Interest rate spread | | | | | 3.47 | % | | | | | | 3.47 | % | | | | | | 3.23 | % | |
| Net interest margin | | | | | 3.60 | % | | | | | | 3.60 | % | | | | | | 3.38 | % | Net interest margin | | 3.53 | % | | 3.35 | % | | 3.15 | % |
Ratio of average interest- | | | | | | | | | | | | | | | | | | Ratio of average interest- | |
earning assets to average | | | | | | | | | | | | | | | | | | earning assets to average | |
interest-bearing liabilities | 114.07 | % | | | | | | 117.11 | % | | | | | | 120.45 | % | | | | | interest-bearing liabilities | | 119.17 | % | | 118.59 | % | | 115.62 | % | |
The following table presents the weighted-average yields earned on our assets and the weighted-average interest rates paid on our liabilities, together with theas well as our interest rate spread and net yield on interest-earning assetsinterest margin, at and liabilities, for the datesperiods indicated.
The following table presents the effects of changing rates and volumes on our net interest income. Information is provided with respect to: (1) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); and (2) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Changes in rate/volume are allocated proportionately to the changes in rate and volume.
The Committee also reviews current and projected liquidity needs. As part of its procedures, the Committee regularly reviews interest rate risk by forecasting the impact that changes in interest rates may have on net interest income and the market value of portfolio equity, which is defined as the net present value of an institution’s existing assets, liabilities and off-balance sheet instruments and evaluating such impacts against the maximum potential change in the market value of portfolio equity that is authorized by the Board of Directors.
interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
We have utilized the following strategies in our efforts to manage interest rate risk:
The inability of our loans to adjust downward can contribute to increased income in periods of declining interest rates. However, when loans are at their floors, there is a further risk that our interest income may not increase as rapidly as our cost of funds during periods of increasing interest rates. Further, in the event of a significant change in interest rates, prepayment and early withdrawal levels would likely deviate from those assumed. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. We consider all these factors in monitoring our interest rate exposure.
The assumptions we use are based upon a combination of proprietary and market data that reflect historical results and current market conditions. These assumptions relate to interest rates, prepayments, deposit decay rates and the market value of certain assets under the various interest rate scenarios. We use market data to determine prepayments and maturities of loans, investments and borrowings and use our own assumptions on deposit decay rates except for time deposits. Time deposits are modeled to reprice to market rates upon their stated maturities. We also assume that non-maturity deposits can be maintained with rate adjustments not directly proportionate to the change in market interest rates, based upon our historical deposit decay rates, which are substantially lower than market decay rates. We have demonstratedobserved in the past that the tiering structure of our deposit accounts during changing rate environments results inhave relatively lower volatility and less than market rate changes in our interest expense for deposits. We tier our deposit accounts by balance and rate, whereby higher balances within an account earn higher rates of interest. Therefore, deposits that are not very rate sensitive (generally, lower balance tiers) are separated from deposits that are rate sensitive (generally, higher balance tiers).changes. When interest rates rise, we do
not have to raise interest rates proportionately on less rate sensitive accounts to retain these deposits. These assumptions are based upon our analysis of our customer base, competitive factors, and historical experience.
The following table illustrates the estimated change in our net interest income over the next 12 months from December 31, 2017,2022, that would occur in the event of an immediate change in interest rates equally across all maturities, with no effect given to any steps that we might take to counter the effect of that interest rate movement.