Item 1. Business
General
First Financial Northwest, Inc. (“First Financial Northwest” or “the Company”), a Washington corporation, was formed on June 1, 2007 for the purpose of becoming the holding company for First Savings Bank Northwest (“First Savings Bank” or “the Bank”) in connection with the conversion from a mutual holding company structure to a stock holding company structure completed on October 9, 2007. At December 31, 2011, we had total assets of $1.1 billion, net loans of $703.3 million, deposits of $788.7 million and stockholders’ equity of $181.3 million. First Financial Northwest’s business activities generally are limited to passive investment activities and oversight of its investment in First Savings Bank. Accordingly, the information set forth in this report, including consolidated financial statements and related data, relates primarily to First Savings Bank.
First Savings Bank was organized in 1923 as a Washington state chartered savings and loan association, converted to a federal mutual savings and loan association in 1935 and converted to a Washington state chartered mutual savings bank in 1992. In 2002, First Savings Bank reorganized into a two-tier mutual holding company structure, became a stock savings bank and became the wholly-owned subsidiary of First Financial of Renton. In connection with the conversion, First Savings Bank changed its name to “First Savings Bank Northwest.”
First Financial Northwest, Inc. is a savings and loan holding company and is subject to regulation by the Board of Governors of the Federal Reserve System (“Federal Reserve”) as the successor to the Office of Thrift Supervision (“OTS”) in the oversight and regulation of savings and loan holding companies. First Savings Bank is examined and regulated by the Washington State Department of Financial Institutions (“DFI”) and by the Federal Deposit Insurance Corporation (“FDIC”). First Savings Bank is required to have certain reserves set by the Board of Governors of the Federal Reserve System and is a member of the Federal Home Loan Bank of Seattle (“FHLB”), which is one of the 12 regional banks in the Federal Home Loan Bank System (“FHLB System”).
First Savings Bank is a community-based savings bank primarily serving the Puget Sound Region, which consists primarily of King and, to a lesser extent, Pierce, Snohomish and Kitsap counties, Washington through our full-service banking office located in Renton, Washington. First Savings Bank’s business consists of attracting deposits from the public and utilizing these funds to originate one-to-four family, multifamily, commercial real estate, business, consumer and to a lesser extent construction/land development loans. Our current business strategy includes an emphasis on one-to-four family residential, multifamily and commercial real estate lending.
At December 31, 2011, $335.5 million or 46.4% of our total loan portfolio was comprised of one-to-four family loans; commercial real estate loans were $232.3 million or 32.1%; multifamily loans were $113.7 million or 15.7%; construction/land development loans were $25.1 million or 3.5%; and consumer and business loans were $12.5 million and $3.9 million, or 1.7% and 0.6%, respectively. Included in our one-to-four family residential, commercial real estate, multifamily and construction/land development portfolios at December 31, 2011, were $58.9 million, $20.3 million, $12.7 million and $5.0 million of total loans, respectively, to our five largest borrowing relationships.
The principal executive office of First Savings Bank is located at 201 Wells Avenue South, Renton, Washington, 98057, our telephone number is (425) 255-4400.
Regulatory Actions
On April 14, 2010, the OTS and members of the Board of Directors of First Financial Northwest entered into an informal supervisory agreement or Memorandum of Understanding (“MOU”) which is now enforced by the Federal Reserve as the successor to the OTS. Under the terms of the MOU, the Company agreed, among other things, to provide notice to and obtain a written non-objection from the Federal Reserve prior to the Company (a) declaring a dividend or redeeming any capital stock and (b) incurring, issuing, renewing or repurchasing any new debt. Further, in connection with a prior examination of the Bank by the FDIC and DFI, we must obtain a written non-objection from the FDIC before engaging in any transaction that would materially change the balance sheet
composition (including growth in total assets of five percent or more), significantly change funding sources (including brokered deposits) or declare or pay cash dividends. In addition, both First Financial Northwest and the Bank must obtain prior regulatory approval before adding any new director or senior executive officer or changing the responsibilities of any current senior executive officer or pay pursuant to or by entering into certain severance and other forms of compensation agreements.
The Bank entered into a Stipulation to the Issuance of a Consent Order (“Order”) with the FDIC and the DFI which became effective on September 24, 2010. Under the terms of the Order, the Bank cannot declare dividends or repurchase stock without the prior written approval of the FDIC. Other material provisions of the Order require the Bank to:
•
Maintain and preserve qualified management;
•
Increase the Board of Directors’ participation in the Bank’s affairs;
•
Obtain an independent study of management and the personnel structure of the Bank;
•
Maintain specified capital levels;
•
Eliminate loans classified as “Loss” at its regulatory examination, and reduce the loans classified as “Doubtful” and “Substandard” as a percent of capital;
•
Revise its policy with respect to the allowance for loan losses;
•
Not extend additional credit to borrowers whose loan had been classified as “Loss” and is uncollected;
•
Revise its lending and collection policies and practices;
•
Develop a plan to reduce the amount of commercial real estate loans;
•
Enhance its written funds management and liquidity policy;
•
Develop a three-year strategic plan;
•
Not solicit brokered deposits and comply with certain deposit rate restrictions;
•
Eliminate and correct all violations of laws; and
•
Prepare and submit progress reports to the FDIC and DFI.
The Bank has implemented a comprehensive plan to achieve full compliance with the Order. The Order contains target dates to achieve the items listed above, including that the Bank’s Tier 1 capital ratio and total risk-based capital ratio be at least 10% and 12%, respectively. At December 31, 2011, the Bank’s Tier 1 capital ratio was 13.54% and its total risk-based capital ratio was 24.76%, both of which exceeded the requirements of the Order.
Adversely classified assets as a percent of Tier 1 capital plus the allowance for loan and lease losses (“ALLL”) was 128% at the beginning of 2010. The Order required this ratio to be below 65% by March 2011 for the adversely classified assets identified at the time of that examination. We achieved this target as of September 30, 2010 and remained in compliance with this requirement at December 31, 2011.
The Order also required that the Bank develop a written plan to systematically reduce the amount of loans to borrowers in the commercial real estate loan category, including its construction/land development loans which are considered commercial real estate for purposes of this calculation. At September 30, 2010, the Bank’s commercial real estate loans, excluding owner-occupied properties, represented 314% of its total risk-based capital including construction/land development loans which equaled 84% of its total risk-based capital. At December 31, 2011, the Bank’s concentration in commercial real estate loans was reduced to 229% of its risk-based capital including the construction/land development loan portfolio which equaled 30% of total risk-based capital.
The Order also required the Bank to obtain an independent management study and adopt a plan to implement the recommendations from the study, that was satisfactory to its regulators. The Bank has obtained the independent management study and continues to work on implementing the study’s recommendations, including the addition of new Board members and the evaluation of senior management. We have added two new Board members to the Board of Directors of the Bank and First Financial Northwest who we believe will further enhance the knowledge and expertise of each of these Boards of Directors. Effective December 31, 2011 two of our Board members retired and changed their status to directors emeriti. Senior management has also been evaluated in connection with the independent management study and efforts are being made to identify outside individuals who
would augment the leadership of our organization and who possess the experience and qualifications to strengthen and establish the foundation for our future growth.
A copy of the Order is attached to the Form 8-K that was filed with the SEC on September 27, 2010. The Order will remain in effect until modified or terminated by the FDIC and the DFI. For more information about the Order and its impact on First Financial Northwest and the Bank see “Item 1A.
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. 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 and results of operations. The value or market price of our common stock could decline due to any of these identified or other risks and you could lose all or part of your investment.
Certain regulatory restrictions imposed on us; lack of compliance could result in monetary penalties and/or additional regulatory actions.
The Bank entered into an Order with the Federal Deposit Insurance Corporation and the Washington State Department of Financial Institutions, which became effective on September 24, 2010. Under the terms of the Order, the Bank is required, among other things, to take certain measures in the areas of management, capital, classified assets, loan loss allowance determination, lending, liquidity management, and board oversight. Specifically, the Order requires that the Bank maintain a Tier 1 capital ratio and a total risk-based capital ratio of at least 10% and 12%, respectively, and reduce assets classified as substandard to below 65% by March 2011. The Bank must also revise its lending and collection and written funds management and liquidity policies, including a plan to reduce its reliance on non-core funding sources, revise its policy for determining the allowance for loan losses, develop a plan to reduce its commercial real estate concentrations and submit to regulators a strategic business plan and independent management study. The Order specifies certain timeframes for meeting these requirements and the Bank must furnish periodic progress reports to the Federal Deposit Insurance Corporation and Washington State Department of Financial Institutions regarding its compliance with the Order. In addition, the Bank will not be able to pay cash dividends to First Financial Northwest without prior approval from the Federal Deposit Insurance Corporation and Washington State Department of Financial Institutions.
On April 14, 2010, the members of the Board of Directors of First Financial Northwest entered into an memorandum of understanding with the Office of Thrift Supervision which is now enforced by the Federal Reserve as the successor to the Office of Thrift Supervision. Under the terms of the memorandum of understanding, the Company agreed, among other things, to provide notice to and obtain written non-objection from the Federal Reserve (as successor to the Office of Thrift Supervision) prior to the Company (a) declaring a dividend or redeeming any capital stock; and (b) incurring, issuing, renewing or repurchasing any new debt. In addition, both the Company and the Bank must obtain prior regulatory approval before adding any new director or senior executive officer or changing the responsibilities of any current senior executive officer or pay pursuant to or by entering into certain severance and other forms of compensation agreements.
At December 31, 2011, First Savings Bank exceeded all current regulatory capital requirements, including the requirements in the Order and the Bank has implemented a comprehensive plan in an attempt to achieve full compliance with the Order. The Order also requires assets classified as substandard as a percentage of Tier 1 capital plus allowance for loan losses be below 65% by March 2011. The Bank met and has exceeded this requirement since December 31, 2010 and has continued to reduce these adversely classified assets during the year ended December 31, 2011. (See Item 1, “Business - How We Are Regulated - Regulation and Supervision of First Savings Bank - Capital Requirements,” and Note 13 of the Notes to the Consolidated Financial Statements included in Item 8 for additional information regarding regulatory capital requirements for First Savings Bank for the year ended December 31, 2011).
The Order and memorandum of understanding will remain in effect until stayed, modified, terminated or suspended by the Federal Deposit Insurance Corporation and the Washington State Department of Financial Institutions and the Federal Reserve Bank as successor to the Office of Thrift Supervision, as the case may be. If either the Company or the Bank fail to comply with the Order or the memorandum of understanding, they could be subject to various remedies, including among others, the regulator’s exercise of powers to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to
direct an increase in capital, to restrict growth, to remove officers and/or directors and to assess civil monetary penalties. Management of the Bank has been taking action and implementing programs to comply with the requirements of the Order. Although compliance will be determined by the Federal Deposit Insurance Corporation and the Washington State Department of Financial Institutions, management believes that the Bank will comply in all material respects with the Order. Any of these regulators may determine at their sole discretion that the matters covered in the Order have not been addressed satisfactorily, or that any current or past actions, violations, or deficiencies could be the subject of further regulatory enforcement actions. Such enforcement actions could involve penalties or limitations on our business and negatively affect our ability to implement our business plan, pay dividends on our common stock or the value of our common stock as well as our financial condition and results of operations.
Our business may continue to be adversely affected by downturns.
Substantially all of our loans are to businesses and individuals in the state of Washington. A continuing decline in the economies of the four counties in which we operate, 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. In particular, Washington has experienced substantial home price declines and increased foreclosures and has experienced above average unemployment rates.
A further deterioration in economic conditions, or a prolonged delay in the economic recovery in the market area we serve 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;
•
demand for our products and services may decline;
•
collateral for loans, especially real estate, may decline further in value, in turn reducing customers’ borrowing power, reducing the value of assets and collateral associated with existing loans; and
•
the amount of our low-cost or noninterest-bearing deposits may decrease.
Our construction/land development loans are based upon estimates of costs and the value of the completed project.
We make construction/land development loans to contractors and builders primarily to finance the construction of single-family homes and subdivisions. We originate these loans whether or not the collateral property underlying the loan is under contract for sale. At December 31, 2011, construction/land development loans totaled $25.1 million, or 3.5% of our total loan portfolio. Land loans, which are loans made with land as security, totaled $17.0 million, or 2.3% of our total loan portfolio at December 31, 2011. Land loans include raw land and land acquisition and development loans. In addition, at December 31, 2011, we had $1.9 million of commercial and multifamily construction loans and $6.2 million, of one-to-four family loans.
Construction/land development lending generally involves additional risks because funds are advanced upon the security of the project, which is of uncertain value prior to its completion. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation of real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. In addition, because of current uncertainties in the residential real estate market, property values have become more difficult to determine than they have historically been. This type of lending also typically involves higher loan principal amounts and is often concentrated with a small number of builders. A further 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. Many 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.
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. These loans are also generally more difficult to monitor. In addition, speculative construction loans to a builder are often associated with homes that are not pre-sold and thus pose a greater potential risk than construction loans to individuals on their personal residences. At December 31, 2011, $8.2 million of our construction/land development loans were for speculative construction loans and $9.2 million, or 36.7%, of our construction/land development loans were classified as nonperforming.
Our level of commercial real estate loans may expose us to increased lending risks.
While commercial 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. In our primary market areas of King, Pierce, Snohomish and Kitsap counties, Washington, the housing market has slowed, with weaker demand for housing, higher inventory levels and longer marketing times. A further downturn in housing, or in 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. Many 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.
At December 31, 2011, we had $232.3 million of commercial real estate loans, representing 32.1% of our total loan portfolio. These loans typically involve higher principal amounts than other types of loans and repayment 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, which 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 loans also expose a lender to greater credit risk than loans secured by 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 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, which may increase the risk of default or non-payment.
A secondary market for most types of commercial 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 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.
Our concentration in non-owner occupied real estate loans may expose us to increased credit risk.
At December 31, 2011, $147.4 million, or 43.9% of our one-to-four family residential mortgage loan portfolio and 20.4% of our total loan portfolio, consisted of loans secured by non-owner occupied residential properties. At December 31, 2011, nonperforming, non-owner occupied one-to-four family residential loans amounted to $4.8 million. Prior to foreclosure, loans that were classified as non-owner occupied residential properties and are now classified as other real estate owned, amounted to $7.0 million at December 31, 2011. 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 lax property maintenance standards, which has a negative impact on 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, 2011, we had 50 non-owner occupied residential loan relationships, each having an outstanding balance over $500,000, with aggregate outstanding balances of $115.7 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, 2011, $335.4 million, or 46.4% of our total loan portfolio, was secured by first liens on one-to-four family residential loans. In addition, at December 31, 2011, our home equity lines of credit totaled $10.0 million. These types of 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. The decline in residential real estate values as a result of the downturn in the Washington housing market has reduced the value of the real estate collateral securing these types of loans and increased the risk that we would incur losses if borrowers default on their loans. Continued declines in both the volume of real estate sales and the sales prices coupled with the current recession and the associated 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.
Many of our residential mortgage loans are secured by liens on mortgage properties in which the borrowers have little or no equity because of the decline in home values in our market area. 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.
If our allowance for loan losses is not adequate, we may be required to make further increases in our provision for loan losses and to charge-off additional loans in the future, which could adversely affect our results of operations.
For the years ended December 31, 2011 and 2010, we recorded a provision for loan losses of $4.7 million and $53.1 million, respectively. We also recorded net loan charge-offs of $10.7 million and $63.6 million for the years ended December 31, 2011 and 2010. We continue to experience loan delinquencies and credit losses. Slower sales and excess inventory in the housing market has been the primary cause of foreclosures for residential construction/land development loans, which represent 34.6% of our nonperforming assets at December 31, 2011 compared with 48.7% at December 31, 2010. At December 31, 2011 our total nonperforming assets had decreased to $49.7 million compared to $93.0 million at December 31, 2010. Further, construction/land development and commercial real estate loans have a higher risk of loss than residential loans.
If current trends in the housing and real estate markets continue, 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, which could have a material adverse effect on our financial condition and results of operations.
We may experience fluctuations in our operating results.
We reported net income of $4.2 million for the fiscal year ended December 31, 2011; however, we recorded a net loss of $54.1 million and $40.7 million for the years ended December 31, 2010 and 2009, respectively. The losses in 2010 and 2009 primarily resulted from our high level of nonperforming assets and the resultant increased provision for loan losses. Although, our nonperforming assets have declined, we continue to monitor the
performance and strength of our loan portfolio, as increases in our nonperforming assets and provision for loan losses could cause us to incur losses in future quarterly or annual periods. In addition, several factors affecting our business can cause significant fluctuations in our quarterly and annual results of operations. In particular, fluctuations in the volume of our loan originations, the differences between our cost of funds and yield on assets and problems generally affecting the mortgage loan industry can result in increases or decreases in our revenues from quarter to quarter.
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
Lending is a primary part of our business and each loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
•
the cash flow of the borrower and/or the project being financed;
•
in the case of a collateralized loan, changes and uncertainties as to the future value of the collateral;
•
the duration of the loan;
•
the credit history of a particular borrower; and
•
changes in economic and industry conditions.
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by our management through periodic reviews and consideration of several factors, including, but not limited to:
•
our general reserve, based on our historical default and loss experience and certain macroeconomic factors based on management’s expectations of future events;
•
and our specific reserve, based on our evaluation of nonperforming loans and their underlying collateral.
The determination of the appropriate level of the allowance for loan losses 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 allowance for loan losses, 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 allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in the need for increases in our provision for loan losses. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses.
Our allowance for loan losses was 2.3% of loans net of undisbursed funds and 69.9% of nonperforming loans net of undisbursed funds at December 31, 2011. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. 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.
If our investments in other real estate owned are not properly valued our earnings could be reduced.
We use current property valuations in the form of appraisals when a loan has been foreclosed and the property taken in as other real estate owned. Subsequently, an evaluation is performed by our experienced lending staff during the assets’ holding period. Our net book value in the loan at the time of foreclosure and thereafter is compared to the updated market 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, the fair value of our investments in other real estate owned may not be sufficient to recover our net book value in such assets, resulting in the need for additional charge-offs. Additional material charge-offs to other real estate owned could have a material adverse effect on our financial condition and results of operations.
In addition, bank regulators periodically review our other real estate owned and may require us to recognize additional charge-offs. Any increase in our charge-offs, as required by such regulators, may have a material adverse effect on our financial condition, results of operations and capital.
We are subject to interest rate risk.
Our earnings and cash flows are largely dependent upon 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. 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 assets and liabilities and (iii) the average duration of our mortgage-backed securities portfolio and other interest-earning assets. 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. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
Further, a portion of our adjustable-rate loans have interest rate floors below which the loan's contractual interest rate may not adjust. Approximately 15% of our loan portfolio was comprised of adjustable-rate loans at December 31, 2011. At that date, $28.4 million, or 26.1%, of these loans 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 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 which could have a material adverse effect on our results of operations.
Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition 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.
Further deterioration in the financial position of the Federal Home Loan Bank of Seattle may result in future impairment losses on our investment in Federal Home Loan Bank of Seattle stock.
At December 31, 2011, we owned $7.4 million of stock of the Federal Home Loan Bank of Seattle. As a condition of membership at the Federal Home Loan Bank of Seattle, we are required to purchase and hold a certain amount of Federal Home Loan Bank of Seattle stock. This requirement is based, in part, upon the outstanding principal balance of advances from the Federal Home Loan Bank of Seattle and is calculated in accordance with the Capital Plan of the Federal Home Loan Bank of Seattle. Our Federal Home Loan Bank of Seattle stock has a par value of $100, is carried at cost, and is subject to recoverability testing. The Federal Home Loan Bank of Seattle announced that it had a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency, its primary regulator as of December 31, 2008, and that it would suspend future dividends and the repurchase and redemption of outstanding common stock. As a result, the Federal Home Loan Bank of Seattle has not paid a dividend since the fourth quarter of 2008. In August 2009, under the Federal Housing Finance Agency's prompt corrective action regulations, the Federal Home Loan Bank of Seattle received a capital classification of "undercapitalized" and has subsequently remained so classified, due to, among other things, risk-based capital deficiencies as of March 31, 2009 and June 30, 2009, the deterioration in the value of its private-label mortgage-backed securities and the amount of accumulated unrealized losses stemming from that deterioration, and the amount of its retained earnings. On October 25, 2010, the Federal Home Loan Bank of Seattle entered into a
consent order with the Federal Housing Finance Agency. The consent order required, among other matters, the Federal Home Loan Bank of Seattle meet and maintain certain minimum financial requirements. The Federal Home Loan Bank of Seattle has communicated that, with the exception of a retained earnings requirement, it is in compliance with the minimum financial requirements and has continued taking the specified actions and is working toward meeting the agreed-upon milestones and timelines for completing capital management, asset composition, and other operational and risk management improvements as indicated in the consent order. As a result, we have not recorded an impairment on our investment in Federal Home Loan Bank of Seattle stock. We will continue, however, to monitor the financial condition of the Federal Home Loan Bank of Seattle and its compliance with the consent order as it relates to, among other things, the recoverability of our investment.
Increases in deposit insurance premiums and special Federal Deposit Insurance Corporation assessments will hurt our earnings.
The Dodd-Frank Act established 1.35% of total insured deposits as the minimum reserve ratio. The Federal Deposit Insurance Corporation has adopted a plan under which it will meet this ratio by the statutory deadline of September 30, 2020. For institutions with assets less than $10 billion, the Dodd-Frank Act requires the Federal Deposit Insurance Corporation to offset the effect of the increase in the minimum reserve ratio to 1.35% from the former minimum of 1.15%. The Federal Deposit Insurance Corporation has not announced how it will implement this offset. In addition to the statutory minimum ratio, the Federal Deposit Insurance Corporation must set a designated reserve ratio, which may exceed the statutory minimum. The Federal Deposit Insurance Corporation has set 2.0% as the designated reserve ratio.
As required by the Dodd-Frank Act, the Federal Deposit Insurance Corporation has adopted final regulations under which insurance premiums are based on an institution’s total assets minus its tangible equity instead of its deposits. While our Federal Deposit Insurance Corporation premiums initially will be reduced, it is possible that our insurance premiums will increase under these final regulations in future periods.
Continued weak or worsening credit availability could limit our ability to replace deposits and fund loan demand, which could adversely affect our earnings and capital levels.
Continued weak or worsening credit availability and the inability to obtain adequate funding to replace deposits and fund continued loan growth may negatively affect asset growth and, consequently, our earnings capability and capital levels. In addition to any deposit growth, maturity of investment securities and loan payments, we rely from time to time on advances from the Federal Home Loan Bank of Seattle and other funding sources to fund loans. Negative operating results or economic conditions could adversely affect these additional funding sources, which could limit the funds available to us. Our liquidity position could be significantly constrained if we are unable to access funds from the Federal Home Loan Bank of Seattle, 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. In this case, our results of operations and financial condition would be negatively affected.
Our access to funding sources in amounts adequate to finance our activities or the terms of which 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 markets in which our loans are concentrated 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 in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets. In addition, recent changes in the collateralization requirements and other provisions of the Washington public funds deposit programs have changed the economic benefit associated with accepting public funds deposits, which may affect our need to utilize alternative sources of liquidity. At December 31, 2011 we had $22.0 million in public funds.
Our single branch location limits our ability to attract retail deposits and as a result a large portion of our deposits are certificates of deposit, including “Jumbo” certificates which may not be as stable as other types of deposits.
Our single branch location limits our ability to compete with larger institutions for noninterest bearing deposits 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, 2011, $570.0 million, or 72.3%, of our total deposits were certificates of deposit and, of that amount, $416.5 million, or 73.1%, were “jumbo” certificates of $100,000 or more ($22.0 million or 2.8% of our total deposits were public funds). 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 which could increase our cost of funds and negatively impact our interest rate spread and financial condition.
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.
Financial reform legislation enacted by Congress will, among other things, tighten capital standards, create a new Consumer Financial Protection Bureau and result in new laws and regulations that are expected to increase our costs of operations.
On July 21, 2010, President Obama signed the Dodd-Frank Act. This new law has significantly changed the bank regulatory structure and affected the lending, deposit, investment 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 are given 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 eliminated the Office of Thrift Supervision, First Financial Northwest’s former primary federal regulator on July 21, 2011 and authorized the Board of Governors of the Federal Reserve System to supervise and regulate all savings and loan holding companies, including First Financial Northwest, in addition to bank holding companies, which it also regulates. The regulations of the Office of Thrift Supervision will remain in effect after July 21, 2011, until modified by the Board of Governors. Under the Dodd-Frank Act, savings and loan holding companies will become subject to capital requirements established by the Board of Governors in 2015.
Certain provisions of the Dodd-Frank Act are expected to have a near term impact on the Company. Among the many requirements in the Dodd-Frank Act for new banking regulations is a requirement for new capital regulations to be adopted within 18 months after the date of enactment. These regulations must be at least as stringent as, and may call for higher levels of capital than, current regulations. In addition, effective one year after the date of enactment, the Dodd-Frank Act eliminated the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest-bearing checking accounts. Depending on competitive responses,
this significant change to existing law could have an adverse impact on the Company’s interest expense and deposit balances.
The Dodd-Frank Act also broadens the base for Federal Deposit Insurance Corporation insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor and non-interest-bearing transaction accounts and interest on lawyers trust accounts have unlimited deposit insurance through December 31, 2012.
The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments and authorizes the SEC to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. The legislation also directs the federal banking regulators to issue rules prohibiting incentive compensation that encourages inappropriate risks. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether or not the company is publicly traded.
The Dodd-Frank Act created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad 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 Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Financial institutions with $10 billion or less in assets, such as First Savings Bank, will continue to be examined for compliance with the consumer laws by their primary bank regulators.
Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Bank. However, it is expected that at a minimum, compliance with this law and implementing its regulations will increase our operating and compliance costs and could increase our interest expense. Any additional changes in our regulation and oversight, whether in the form of new laws, rules or regulations could make compliance more difficult or expensive or otherwise materially adversely affect our business, financial condition or prospects. For additional information, see Item 1, “Business - How We Are Regulated - Recently Enacted Regulatory Reform.”
New or changing tax, accounting, and regulatory rules and interpretations could significantly impact strategic initiatives, results of operations, cash flows, and financial condition.
The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit a company’s stockholders. These regulations may sometimes impose significant limitations on operations. The significant federal and state banking regulations that affect us are described in this report under the heading “Item 1. Business-Regulation.” These regulations, along with the currently existing tax, accounting, securities, insurance, 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.
Such changes could subject us to additional costs, limit the types of financial services and products we may offer, restrict mergers and acquisitions, investments, access to capital, the location of banking offices and/or increase the ability of non-banks to offer competing financial services and products, among other things. Further, recent regulatory changes to the rules for overdraft fees for debit transactions and interchange fees could reduce our fee income which would result in a reduction of our noninterest income. Our failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputational damage and could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.
Our litigation related costs might increase.
The Bank, from time to time, becomes subject to legal proceedings that arise in the ordinary course of the Bank’s business. In the current economic environment litigation may increase significantly as a result of defaulted borrowers asserting claims to defeat or delay foreclosure proceedings. Expenses of legal proceedings could adversely affect the Bank’s results of operations until they are resolved. There can be no assurance that the Bank’s loan workout and other activities will not expose the Bank to legal actions, including lender liability or environmental claims.
State taxes may increase.
Washington State currently has a deficit for the ensuing biennium of approximately $1.5 billion and as a result, state taxes may increase. The State Legislature is considering a variety of tax measures to balance the State budget which, if passed into law, may increase our State tax expense.
We will incur additional expenses managing real estate acquired through foreclosure.
We have foreclosed and continue to foreclose on loans in our portfolio. These foreclosures may result in charge-offs and other expenses for items such as: property management and legal which will have a negative affect on future earnings.
Our real estate lending also exposes us to the risk of environmental liabilities.
In the course of our business, we may foreclose and take title to real estate and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition and results of operations could be materially and adversely affected.
We rely heavily on the proper functioning of our technology.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
We rely on third-party service providers for much of our communications, information, operating and financial control systems technology. 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 locate alternative sources of such services, and we cannot assure 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. Any of these circumstances could have an adverse effect on our business.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable. 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.
Item 2.
Item 2. Properties
At December 31, 2011, we had one full service office, which we own in Renton, Washington. This site is the corporate office for First Financial Northwest and First Savings Bank and is located at 201 Wells Avenue South, Renton, Washington. This location is also the site for the operations of First Financial Northwest’s subsidiary, First Financial Diversified Corporation, at 208 Williams Avenue South. The lending division operations of First Savings Bank are located at 207 Wells Avenue South.
Item 3.
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, 2011, 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.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
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, under the symbol “FFNW.” As of December 31, 2011, there were 18.8 million shares of common stock issued and outstanding and we had 893 shareholders of record, excluding persons or entities who hold stock in nominee or “street name” accounts with brokers.
Dividends
Under federal regulations, the dollar amount of dividends First Savings Bank may pay to First Financial Northwest, Inc. depends upon its capital position and recent net income. Generally, if First Savings Bank satisfies its regulatory capital requirements, it may make dividend payments up to the limits prescribed in the state law and FDIC regulations. However, under the Order, the Bank is not able to pay dividends to First Financial Northwest without the prior approval of the DFI and the FDIC. Further, First Savings Bank may not declare or pay a dividend on or repurchase any of its common stock if it would cause the regulatory capital of the Bank to be reduced below the amount required for the liquidation account which was established in connection with the conversion. First Savings Bank is 100% owned by First Financial Northwest, Inc. Under Washington law, First Financial Northwest is prohibited from paying a dividend if, as a result of its payment, it would be unable to pay its debts as they become due in the normal course of business, or if First Financial Northwest’s total liabilities would exceed its total assets. Under the terms of the MOU, First Financial Northwest must provide notice to and obtain written non-objection from the Federal Reserve prior to declaring a dividend. See “Item 1. Business - How We Are Regulated - Regulation and Supervision of First Financial Northwest - Dividends” and Note 13 of Notes to the Consolidated Financial Statements contained in Item 8.
The following table sets forth the high and low of and dividends declared on, First Financial Northwest’s common stock during each of the quarters in the years ended December 31, 2011 and 2010. The following information was provided by The Nasdaq Stock Market LLC.
Stock Repurchases
First Financial Northwest has implemented various stock buy-back programs since June 2008. On November 5, 2008, First Financial Northwest announced a plan to repurchase and retire 2,285,280 shares, or approximately 10% of its outstanding common stock which was completed on February 9, 2009. The plan was amended on February 18, 2009 to authorize the repurchase of an additional 2,056,752 shares or approximately 10% of our outstanding common stock. At December 31, 2011, 294,400 shares remain outstanding to be repurchased under the plan. No shares were repurchased during the year ended December 31, 2011.
Under the MOU First Financial Northwest must provide notice to and obtain written non-objection from the Federal Reserve prior to First Financial Northwest repurchasing any capital stock.
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 Nasdaq Bank Index, and the SNL Thrift Index, a peer group index. 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 October 10, 2007, (the first trading day following the completion of First Financial Northwest’s public offering), and is the base amount used in the graph. The closing price of First Financial Northwest’s common stock on December 31, 2011 was $5.90.
Item 6.
Item 6. Selected Financial Data
The following table sets forth certain information concerning our consolidated financial position and results of operations at and for the dates indicated and have 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.
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 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, which appear in Item 8 of this Form 10-K. You should read the information in this section in conjunction with the business and financial information regarding First Savings Bank as 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.
Overview
First Savings Bank is a community-based savings bank primarily serving King and to a lesser extent, Pierce, Snohomish and Kitsap counties, Washington through our full-service banking office located in Renton, Washington. First Savings Bank’s business consists of attracting deposits from the public and utilizing these funds to originate one-to-four family residential, multifamily, commercial real estate, construction/land development, business and consumer loans. Our current business strategy emphasizes one-to-four family residential, multifamily and commercial real estate lending.
Continuing adverse conditions in the national and local economies have resulted in a challenging operating environment for financial institutions, particularly in the Pacific Northwest. Over the last three years, the national residential lending market has experienced severe conditions as loan delinquencies and foreclosure rates rose to unprecedented volumes. During 2011, the residential lending market improved somewhat especially late in the year, but remained at depressed levels. Nationally at December 31, 2011, the delinquency rate for one-to-four family residential loans 30 days or more delinquent was 7.6% and the percentage of loans in foreclosure was 4.4% according to the National Delinquency Survey published by the Mortgage Bankers Association.
Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Changes in levels of interest rates affect our net interest income. Since First Savings Bank is liability-sensitive, meaning its liabilities reprice at a faster rate than its interest-earning assets, the lower interest rate environment that we are currently experiencing has contributed to an improvement in our net interest rate spread.
During 2011, our provision for loan losses totaled $4.7 million, a decrease of $48.4 million from $53.1 million for the year ended December 31, 2010. The decrease in the provision during 2011 was attributable to the decline in the level of nonperforming loans, improved delinquency rates, the decline in the level of charge-offs and the decrease in the loan portfolio. We will continue to monitor our loan portfolio and make adjustments to our ALLL as we deem necessary.
Our noninterest expenses consist primarily of compensation and benefits, occupancy and equipment, data processing, OREO related expenses, professional services, deposit insurance premiums and other general and administrative expenses. Compensation and benefits consist primarily of the salaries and wages paid to our employees, payroll taxes and expenses for retirement and other employee benefits. Occupancy and equipment expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of real estate taxes, depreciation charges, maintenance and costs of utilities. OREO related expenses consist primarily of maintenance and costs of utilities for the OREO inventory, market valuation adjustments, build-out expenses, gains and losses from OREO sales, legal fees, real estate taxes and insurance.
Our noninterest expenses decreased $4.9 million during the year ended December 31, 2011 as compared to 2010. The decrease was primarily attributable to a $5.5 million decrease in net OREO expenses, including gains on the sale of OREO, during the year ended December 31, 2011.
Business Strategy
Our long-term business strategy is to operate and grow First Savings Bank as a well-capitalized and profitable community bank, offering one-to-four family residential, commercial and multifamily real estate, consumer, business and to a lesser extent construction/land development loans along with a diversified array of deposits 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 mortgage production capability by:
•
Capitalizing on our intimate knowledge of our local communities to serve the convenience and needs of customers, delivering a consistent and high-quality level of professional service;
•
Offering competitive deposit rates and developing customer relationships to expand our core deposits, diversifying the deposit mix by growing lower cost deposits, attracting new customers and expanding our footprint in the geographical area we serve;
•
Managing our loan portfolio to minimize concentrations 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 our overall efficiency and profitability.
Critical Accounting Policies
Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. The following are our critical accounting policies.
Allowance for Loan Losses. Management recognizes that loan losses may occur over the life of a loan and that the ALLL must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Our methodology for analyzing the ALLL consists of two components: general and specific allowances. The general allowance is determined by applying factors to our various groups of loans. Management considers factors such as charge-off history, the prevailing economy, borrower’s ability to repay, the regulatory environment, competition, geographic and loan type concentrations, policy and underwriting standards, nature and volume of the loan portfolio, management’s experience level, our loan review and grading systems, the value of underlying collateral and the level of problem loans in assessing the ALLL. The specific allowance component is created when management believes that the collectibility of a specific loan has been impaired and a loss is probable. The specific reserves are computed using current appraisals, listed sales prices and other available information less costs to complete, if any, and costs to sell the property. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events differ from predictions.
Our Board of Directors approves the provision for loan losses on a quarterly basis. The allowance is increased by the provision for loan losses, which is charged against current period earnings and decreased by the amount of actual loan charge-offs, net of recoveries.
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, which would negatively affect earnings. For additional information see the section titled “We may be required to make further increases in our provision for loan losses and to charge-off additional loans in the future, which could adversely affect our results of operations,” within the section titled “Item 1A. Risk Factors” in this Form 10-K.
Valuation of OREO and Foreclosed Assets. 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 Statements of Income. Expenses 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: a) expenses, such as our charitable contribution to the First Financial Northwest Foundation, that can be carried forward to be utilized against profits in future years; b) expenses recognized in our financial statements but disallowed in the tax return until the associated cash flow occurs; and c) writedowns in the value of assets for financial statement purposes that are not deductible for tax purposes until the asset is sold or deemed worthless.
We record a valuation allowance to reduce our deferred tax assets to the amount which 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. See “Item 8. Financial Statements and Supplementary Data, Notes to Consolidated Financial Statements, Note 12 Federal Income Taxes.”
Other-Than-Temporary Impairments On the Market Value of Investments. Declines in the fair value of any available for sale or held to maturity investment below their cost that is deemed to be other-than-temporary results in a reduction in the carrying amount of the investment to that of 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. An unrealized loss in the value of an equity security is generally considered temporary when the fair value of the security is below the carrying value primarily due to current market conditions and not deterioration in the financial condition of the issuer. Other factors that may be considered in determining whether a decline in the value of either a debt or an equity 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 advisors or market analysts. Therefore, continued deterioration of market conditions could result in additional impairment losses recognized within the investment portfolio.
Comparison of Financial Condition at December 31, 2011 and December 31, 2010
General. At December 31, 2011, total assets decreased $134.3 million to $1.1 billion from $1.2 billion at December 31, 2010. This decrease in total assets was primarily the result of reductions in net loans receivable of $153.2 million and investments available for sale of $35.6 million partially offset by an increase of $69.2 million in interest-bearing deposits. Total liabilities decreased $141.1 million to $878.1 million at December 31, 2011 from $1.0 billion at December 31, 2010 primarily due to a decrease of $131.6 million in deposits and a decrease of $10.0 million in advances from the FHLB. Stockholders’ equity increased $6.8 million to $181.3 million at December 31, 2011 from $174.5 million at December 31, 2010 primarily due to net income of $4.2 million for the year.
Assets. The following table details the changes in the composition of our assets from December 31, 2010 to December 31, 2011.
Interest-bearing deposits increased $69.2 million from December 31, 2010 primarily as a result of funds received from decreases in net loans receivable of $153.2 million and in investments available for sale of $35.6 million. We utilized the liquidity generated to reduce our FHLB advances by $10.0 million and fund the decrease in customer deposits of $131.6 million.
Net loans receivable decreased $153.2 million to $703.3 million at December 31, 2011 compared to $856.5 million at December 31, 2010. Loan originations for the year ended December 31, 2011 totaled $31.6 million, a decrease of $27.8 million from the year ended December 31, 2010. The decline in our loan portfolio was the result of weak loan demand, paydowns due to normal borrower activity, short-sales, charge-offs and transfers of nonperforming loans to OREO. Loan originations declined primarily as a result of our focus on improving the performance of our loan portfolio and reducing our nonperforming assets. Loan originations included $11.2 million in one-to-four family residential; $4.1 million in commercial real estate, $6.8 million in multifamily and $5.8 million in consumer loans. We also originated $1.4 million in construction/land development and $2.3 million in business loans. Loan repayments during 2011 were $165.5 million and loans transferred to OREO totalled $26.2 million.
Our investments available for sale decreased $35.6 million, or 21.6%, to $129.0 million at December 31, 2011 from $164.6 million at December 31, 2010. During the year ended December 31, 2011, we sold $76.9 million of investments. Gross proceeds from the sales were $79.1 million with net gains of $2.2 million. During the year ended December 31, 2011, we purchased $74.7 million of investments which included $40.0 million of U.S. government agency securities with the remaining purchases primarily consisting of Fannie Mae and Freddie Mac fixed-rate, mortgage-backed securities. The purchases and sales of investments throughout 2011 were executed to improve our interest rate risk position, deploy excess liquidity into investments as there was weak demand for loans to creditworthy borrowers in our market area and to take advantage of gains in our securities portfolio.
Our nonperforming loans decreased to $23.7 million at December 31, 2011 from $62.9 million at December 31, 2010. Nonperforming loans as a percent of our total loan portfolio, net of undisbursed funds, was 3.28% and 7.14% at December 31, 2011 and 2010, respectively. The following table presents a breakdown of our nonperforming assets:
There were no undisbursed funds related to our nonperforming loans at December 31, 2011. Foregone interest during the year ended December 31, 2011 relating to all nonperforming loans totaled $2.2 million. We continued to execute our strategy implemented in 2009, when we hired experienced professionals to form a special assets department whose primary focus was on the prompt and effective management of our troubled and nonperforming assets to expedite their disposition and minimize any losses. This strategy changed our long-standing practice of promoting builder-partnering solutions as opposed to that of Bank-directed solutions such as foreclosures, short-sales and accepting deeds in lieu of foreclosure. This approach has resulted in First Savings Bank foreclosing or accepting deeds in lieu of foreclosure on $26.2 million of real estate during 2011 and $50.2 million during 2010. We anticipate continued foreclosure activity in 2012 but at lower levels than in 2011 and 2010.
Management performs an impairment analysis on a loan when it determines it is probable that all contractual amounts of principal and interest will not be paid as scheduled. The analysis usually occurs when a loan has been classified as substandard or placed on nonaccrual status. If the market value 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 in the ALLL for the loan or by adjusting an existing reserve amount.
Deposits. During the year ended December 31, 2011, deposits decreased $131.6 million to $788.7 million as compared to $920.2 million at December 31, 2010. The decrease in deposits was primarily the result of our strategy to reduce our total assets, mainly cash, as a result of low loan demand. In addition, we did not renew certificates of deposit from municipalities and other government related entities due to the higher cost of maintaining these accounts. Public funds declined to $22.0 million at December 31, 2011 from $58.7 million at December 31, 2010. We experienced decreases in our noninterest bearing accounts of $2.7 million, money market accounts of $13.4 million and certificates of deposit of $118.7 million, which were offset by increases in NOW accounts of $735,000 and savings accounts of $2.4 million. These decreases also reflect our strategy to compete less aggressively on deposit interest rates to reduce our cost of funds. We did not have any brokered deposits at December 31, 2011 and 2010.
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 advances at December 31, 2011 were $83.1 million, a decrease of $10.0 million, or 10.7%, from $93.1 million at December 31, 2010. We utilized our excess liquidity to repay some of our advances to manage our funding costs.
Stockholders’ Equity. Total stockholders’ equity increased $6.8 million, or 3.9%, to $181.3 million at December 31, 2011 from $174.5 million at December 31, 2010. The increase was primarily the result of net income of $4.2 million, generated during the year ended December 31, 2011.
Comparison of Operating Results for the Years Ended December 31, 2011 and December 31, 2010
General. Net income for the year ended December 31, 2011 was $4.2 million, compared to a net loss of $54.1 million for the prior year. The $58.3 million increase in net income was primarily the result of a $48.4 million decrease in the provision for loan losses, a $1.5 million increase in noninterest income, a $4.9 million decrease in noninterest expense and a $4.0 million decrease in the provision for federal income taxes.
Net Interest Income. Net interest income in 2011 was $32.6 million, a $418,000 or 1.3% decrease from $33.0 million in 2010, as a result of the changes in interest income and interest expense as detailed below.
Interest Income. Total interest income decreased $9.5 million to $51.0 million for the year ended December 31, 2011 from $60.5 million for the year ended December 31, 2010. The following table compares detailed average interest-earning asset balances, associated yields and resulting changes in interest and dividend income for the years ended December 31, 2011 and 2010:
The $9.5 million decline in interest income for 2011 as compared to 2010 was primarily a result of the $204.2 million, or 21.0% decline in the average balance of our loan portfolio. The yield on average interest-earning assets declined 24 basis points to 4.72% for the year ended December 31, 2011 from 4.96% for 2010 reflecting both the general decline in interest rates and foregone interest as a result of nonperforming assets during 2011. Interest income from net loans receivable decreased $9.2 million to $46.6 million for the year ended December 31, 2011 from $55.8 million for the year ended December 31, 2010. The yield on net loans receivable increased to 6.07% for the year ended December 31, 2011 from 5.74% in 2010, an increase of 33 basis points, or $2.5 million net of $2.2 million of foregone interest. The yield on the loan portfolio increased during 2011 as compared to 2010 as we were able to reduce the level of nonperforming loans which were not earning any income but which were included in the yield calculation. The increase in loan interest income related to yield was offset by an $11.7 million decrease in interest income from the reduction in the average loan portfolio during 2011 as compared to 2010.
The yield on investments available for sale decreased 67 basis points to 2.76%, or $981,000, during 2011 as compared to 2010. Interest income from investments available for sale was positively impacted by $536,000 due to the increase in the average investment balance of $15.6 million to $146.2 million for the year ended December 31, 2011 from $130.6 million for the year ended December 31, 2010.
Interest Expense. Total interest expense for the year ended December 31, 2011 was $18.5 million, a decrease of $9.1 million from the prior year. The following table details average balances, cost of funds and the resulting decrease in interest expense for the years ended December 31, 2011 and 2010:
Total interest expense for the year ended December 31, 2011 decreased $9.1 million or 32.9% to $18.5 million from $27.6 million in 2010. The decline in interest expense for the year ended December 31, 2011 as compared to 2010 was primarily a result of the general decrease in interest rates which equated to a decrease in interest expense of $5.7 million. Our overall cost of funds decreased to 1.94% for 2011 from 2.56% in 2010. The decline in the cost of our certificates of deposit, which accounted for $5.6 million of the $9.1 million decline in total interest expense was primarily due to a decrease in the average rate paid on the certificates of deposit from 2.88% in 2010 to 2.33% in 2011 due to new and renewing certificates of deposits priced at lower interest rates. The average balance of certificates of deposit decreased by $66.8 million to $653.1 million at December 31, 2011 from $719.9 million at December 31, 2010 accounting for $1.9 million of the decrease in interest expense on certificates of deposit. Total average interest-bearing liabilities decreased $121.1 million to $955.1 million in 2011 as compared to $1.1 billion in 2010. The average balance of deposits decreased $81.4 million and the average balance of advances from the FHLB decreased $39.8 million during 2011 as compared to 2010. Our interest rate spread for 2011 was 2.78% for the twelve months ended December 31, 2011 as compared to 2.40% in 2010. Our net interest margin increased to 3.01% in 2011 as compared to 2.70% in 2010.
Provision for Loan Losses. Management recognizes that loan losses may occur over the life of a loan and that the ALLL must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Our methodology for analyzing the ALLL consists of two components: general and specific allowances. The general allowance is determined by applying factors to our various groups of loans. Management considers factors such as charge-off history, the prevailing economy, borrower’s ability to repay, the regulatory environment, competition, geographic and loan type concentrations, policy and underwriting standards, nature and volume of the loan portfolio, managements’ experience level, our loan review and grading systems, the value of underlying collateral and the level of problem loans in assessing the ALLL. The specific allowance component is created when management believes that the collectibility of a specific loan, has been impaired and a loss is probable. The specific reserves are computed using current appraisals, listed sales prices and other available information less costs to complete, if any, and costs to sell the property. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events differ from predictions.
The ALLL was $16.6 million or 2.29% of total loans outstanding, net of undisbursed funds at December 31, 2011 as compared to $22.5 million or 2.56% of total loans outstanding, net of undisbursed funds at December 31, 2010.
A provision for loan losses of $4.7 million was recorded for the year ended December 31, 2011. The comparable provision for loan losses for the year ended December 31, 2010 totaled $53.1 million. As of December 31, 2011 nonperforming loans, net of undisbursed funds, totaled $23.7 million as compared to $62.9 million at December 31, 2010. Of our nonperforming loans, $9.2 million related to the construction/land development loan
portfolio, primarily located in Kitsap and Whatcom counties, $9.8 million related to the one-to-four family residential loan portfolio, $3.7 million related to the commercial real estate loan portfolio and $949,000 related to the multifamily loan portfolio. The construction/land development loans are to homebuilders whose sales have been affected by the challenging economic conditions. The decrease in the provision during 2011 was attributable to the decrease in the level of nonperforming loans, the reductions of loan charge-offs and the decrease in our total loan portfolio, in particular our construction/land development loans.
Although we believe that we used the best information available to establish the ALLL, future additions to the allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. In addition, unforeseen market conditions could result in adjustments to the ALLL and net income could be significantly affected, if circumstances differ substantially from the assumptions used in determining the allowance.
We believe that the ALLL as of December 31, 2011 was adequate to absorb the probable and inherent risks of loss in the loan portfolio at that date. While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will 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, 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 following table details activity and information related to the ALLL for the years ended December 31, 2011 and 2010. All loan balances and ratios are calculated using loan balances that are net of undisbursed funds.
Noninterest Income. Noninterest income increased $1.5 million to $2.5 million for the year ended December 31, 2011 from the year ended December 31, 2010. The following table provides a detailed analysis of the changes in the components of noninterest income:
The increase in noninterest income for the year ended December 31, 2011 was primarily related to the increase in gains on sales of investments of $1.4 million as we improved our interest rate risk position and capitalized on favorable market conditions related to our investment portfolio. To improve our interest rate risk position, we sold longer-term, fixed-rate, mortgage-backed securities and replaced them with shorter-term, adjustable-rate U.S. agency securities.
Noninterest Expense. Noninterest expense decreased $4.9 million during the year ended December 31, 2011 to $26.2 million, from $31.1 million for the year ended December 31, 2010. The following table provides a detailed analysis of the changes in the components of noninterest expense:
The decrease in noninterest expense was primarily attributable to a decrease in OREO related expenses during 2011 of $5.5 million to $3.3 million at December 31, 2011 from $8.8 million at December 31, 2010. OREO decreased $4.1 million to $26.0 million at December 31, 2011 from $30.1 million at December 31, 2010 which contributed to the decrease in net expenses. The increase in compensation and benefits expense was primarily related to our pension expense as a result of a lower than expected yield earned on the underlying investments in the plan and the vesting of new employees into the plan.
Federal Income Tax Expense. There was no provision for federal income taxes for the year ended December 31, 2011, a decrease of $4.0 million from the year ended December 31, 2010. The Company’s tax
benefits from net operating loss carryforwards offset the tax provision that would have been required. At December 31, 2011, the remaining net operating loss carryforward totaled $11.1 million.
Comparison of Financial Condition at December 31, 2010 and December 31, 2009
General. At December 31, 2010, total assets decreased $121.7 million to $1.2 billion from $1.3 billion at December 31, 2009. This decrease in total assets was primarily the result of a decrease in loans receivable, net of $182.8 million offset by an increase of $67.2 million in investments available for sale. Total liabilities decreased $67.6 million to $1.0 billion at December 31, 2010 from $1.1 billion at December 31, 2009 primarily as a result of a decrease of $19.2 million in deposits and a decrease of $46.8 million in advances from the FHLB. Stockholders’ equity decreased $54.0 million to $174.5 million at December 31, 2010 from $228.5 million at December 31, 2009. The decrease was primarily the result of a net loss for the year.
Assets. The following table details the changes in the composition of our assets from December 31, 2009 to December 31, 2010.
Cash on hand and in banks and interest-bearing deposits decreased $6.5 million from December 31, 2009 as a result of the Bank managing its liquidity position to improve its interest rate risk and net interest margin by using excess funds to reduce its advances from the FHLB.
Loans receivable, net decreased $182.8 million to $856.5 million at December 31, 2010 compared to $1.0 billion at December 31, 2009. Loan originations for the year ended December 31, 2010 totaled $59.4 million and included: $14.6 million in one-to-four family residential; $12.6 million for commercial real estate, $16.1 million for multifamily loans and $6.8 million in consumer loans. Included in the one-to-four family residential loan originations were $772,000 of permanent loans where the builders have financed homes that are or will be rented by third parties. We also originated $9.0 million in construction related loans to our merchant builders so they could continue to complete their projects and utilize their existing land inventory and $293,000 in business loans.
Our investments available for sale increased $67.2 million or 69.0% to $164.6 million at December 31, 2010 from $97.4 million at December 31, 2009 as we deployed excess liquidity into investments as there was weak demand for loans to creditworthy borrowers in our market area. During the year ended December 31, 2010, we sold $24.2 million of investments. Gross proceeds from the sales were $25.1 million with net gains of $843,000. For the year ended December 31, 2010, we purchased $130.6 million of principally Fannie Mae and Freddie Mac fixed-rate, mortgage-backed securities to utilize our excess liquidity.
Our nonperforming loans decreased to $62.9 million at December 31, 2010 from $120.7 million at December 31, 2009. As a percentage of our total loan portfolio, net of undisbursed funds, the amount of nonperforming loans was 7.14% and 11.23% at December 31, 2010 and 2009, respectively. The following table presents a breakdown of our nonperforming assets:
___________
(1) The majority of these loans are related to our merchant builders-rental properties.
The undisbursed funds related to our nonperforming loans totaled $1.1 million. The foregone interest during the year ended December 31, 2010 relating to all nonperforming loans, totaled $6.1 million. We continued to implement our strategy implemented during the latter part of 2009, when we hired experienced professionals to form a special assets team whose primary focus was on the prompt and effective management of our troubled, nonperforming assets and to expedite their disposition and minimize any losses. This strategy changed our long-standing practice of promoting builder-partnering solutions as opposed to that of Bank-directed solutions which included foreclosures, short-sales and accepting deeds in lieu of foreclosure. This approach has resulted in First Savings Bank foreclosing or accepting deeds in lieu of foreclosure on $50.2 million of real estate during 2010 compared to $11.8 million during 2009.
Deposits. During the year ended December 31, 2010, deposits decreased $19.2 million to $920.2 million at December 31, 2010. The decrease in deposits was primarily the result of our strategy to reduce the level of deposits we accept from municipalities and other government related entities due to the higher cost of maintaining these accounts. We experienced increases in our noninterest bearing accounts of $5.4 million and NOW accounts of $718,000, which were offset by decreases in certificates of deposit accounts of $25.0 million; savings accounts of $36,000 and money market accounts of $333,000. We did not have any brokered deposits at December 31, 2010 and 2009.
Advances. We use advances from the FHLB as an alternative funding source to deposits to manage funding costs, reduce interest rate risk and to leverage our balance sheet. Total advances at December 31, 2010 were $93.1 million, a decrease of $46.8 million, or 33.5% from $139.9 million at December 31, 2009. The decrease in advances was related to the excess liquidity generated from a decrease in loans receivable, net being utilized to repay some of our advances to manage our funding costs.
Stockholders’ Equity. Total stockholders’ equity decreased $54.0 million or 23.6%, to $174.5 million at December 31, 2010 from $228.5 million at December 31, 2009. The decrease was primarily a result of the net loss of $54.1 million, during the year ended December 31, 2010.
Comparison of Operating Results for the Years Ended December 31, 2010 and December 31, 2009
General. Our net loss for the year ended December 31, 2010 was $54.1 million, compared to a net loss of $40.7 million for the prior year. The $13.4 million increase in our net loss was primarily the result of a $1.8 million increase in the provision for loan losses, a $16.5 million increase in our provision for federal income taxes and a $991,000 decrease in noninterest income offset by an increase of $1.9 million in net interest income and a $4.0 million decrease in noninterest expense.
Net Interest Income. Net interest income in 2010 was $33.0 million, a 6.0% increase from $31.1 million in 2009, as a result of the changes in interest income and interest expense as detailed below.
Interest Income. Total interest income decreased $4.5 million to $60.5 million for the year ended December 31, 2010 from $65.0 million for the year ended December 31, 2009. The following table compares detailed average interest-earning asset balances, associated yields and resulting changes in interest income for the years ended December 31, 2010 and 2009:
The decline in interest income for 2010 as compared to 2009 was a result of the decrease in yield on interest-earning assets of 25 basis points or a $276,000 decline in interest income. The yield on average interest-earning assets declined to 4.96% for the year ended December 31, 2010 from 5.21% for 2009 reflecting both the general decline in interest rates and foregone interest as a result of nonperforming assets during 2010. The yield on net loans receivable increased to 5.74% for the year ended December 31, 2010 from 5.60% in 2009, an increase of 14 basis points, or $1.3 million net of $6.1 million of foregone interest. The yield on investments available for sale decreased 84 basis points to 3.43%, or $1.1 million from the same time period in 2009. The decline in interest income for the year was also the result of an additional $3.9 million decrease in interest income due to the reduction in the average net loan portfolio balance of $70.3 million for the year ended December 31, 2010 as compared to 2009. The average net loan portfolio balance for the year ended December 31, 2010 was $971.8 million as compared to $1.0 billion for 2009. Interest income was negatively impacted by $1.0 million due to the decrease in the average investments balance of $24.1 million to $130.6 million for the year ended December 31, 2010 from $154.7 million for the year ended December 31, 2009.
Interest Expense. Total interest expense for the year ended December 31, 2010 was $27.6 million, a decrease of $6.4 million from the prior year. The following table details average balances, cost of funds and the resulting decrease in interest expense for the years ended December 31, 2010 and 2009:
Total interest expense for the year ended December 31, 2010 decreased $6.4 million or 18.7% to $27.6 million from $33.9 million in 2009. The decline in interest expense for the year ended December 31, 2010 as compared to 2009 was primarily a result of the general decrease in interest rates which equated to a decrease in interest expense of $8.1 million. Our overall cost of funds decreased to 2.56% for 2010 from 3.35% in 2009. The cost of our certificates of deposit, which accounted for the majority of the decline in interest expense, decreased from 3.79% in 2009 to 2.88% in 2010, resulting in a $6.5 million savings. The costs associated with the increase in the average balance of our interest-bearing liabilities of $1.8 million partially offset the $8.1 million decline in interest expense due to the decrease in interest rates. Total average interest-bearing liabilities increased $64.2 million to $1.1 billion in 2010 as compared to $1.0 billion in 2009. The balance of average deposits increased $81.1 million and the average balance of advances from the FHLB decreased $16.9 million during 2010 as compared to 2009. Our interest rate spread for 2010 was 2.40% for the twelve months ended December 31, 2010 as compared to 1.86% in 2009. Our net interest margin increased to 2.70% in 2010 as compared to 2.49% in 2009. Both our interest rate spread and our net interest margin were reduced during 2010 by foregone interest and $105.7 million of average nonperforming loans which are included in interest-earning assets.
Provision for Loan Losses. A provision for loan losses of $53.1 million was recorded for the year ended December 31, 2010. The comparable provision for loan losses for the year ended December 31, 2009 totaled $51.3 million. As of December 31, 2010 nonperforming loans, net of undisbursed funds, totaled $62.9 million as compared to $120.7 million at December 31, 2009. Of our nonperforming loans, $32.9 million related to the construction/land development loan portfolio, primarily located in King and Pierce counties, $22.7 million related to the one-to-four family loan portfolio and $7.3 million relate to the commercial real estate loan portfolio. The construction/land development loans are to homebuilders whose sales have been affected by the challenging economic conditions. The majority of the one-to-four family residential loans are related to our merchant builder rental properties. The increase in the provision was attributable to the level of nonperforming loans, the continued depressed real estate values, the uncertain economic environment in our market area, the FDIC liquidations of financial institutions in the Pacific Northwest and the effect it has had on our market area, the level of charge-offs during 2010 and the increase in the number of requests for loan modifications.
The allowance for loan losses was $22.5 million or 2.56% of total loans outstanding, net of undisbursed funds at December 31, 2010 as compared to $33.0 million or 3.07% of total loans outstanding, net of undisbursed funds at December 31, 2009. The following table details activity and information related to the allowance for loan losses for the years ended December 31, 2010 and 2009. All loan balances and ratios are calculated using loan balances that are net of undisbursed funds.
Noninterest Income. Noninterest income decreased $991,000 to $1.0 million for the year ended December 31, 2010 from the year ended December 31, 2009. The following table provides a detailed analysis of the changes in the components of noninterest income:
The decrease in noninterest income for the year ended December 31, 2010 was primarily related to the decrease in gains on sales of investments of $1.1 million as a result of fewer sales during 2010.
Noninterest Expense. Noninterest expense decreased $4.0 million during the year ended December 31, 2010 to $31.1 million, from $35.1 million for the year ended December 31, 2009. The following table provides a detailed analysis of the changes in the components of noninterest expense:
The decrease in noninterest expense was primarily attributable to a $14.2 million decrease in goodwill impairment as a result of a one-time charge taken in 2009 with no comparable charge in 2010, offset by an increase of $8.6 million in OREO related expenses during 2010. OREO related expenses increased as a result of the increase in OREO property inventory from $11.8 million at December 31, 2009 to $30.1 million at December 31, 2010.
Federal Income Tax Expense. Federal income tax expense increased $16.5 million resulting from a federal income tax expense of $4.0 million incurred during the year ended December 31, 2010 as compared to an income tax benefit of $12.5 million for the comparable period in 2009. The increase was due to having a full valuation allowance on the deferred tax assets.
Average Balances, Interest and Average Yields/Cost
The following table sets forth information, for the periods indicated, regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate 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.
___________________
(1) The average loans receivable, net balances inlcude nonaccruing loans.
Yields Earned and Rates Paid
The following table sets forth for the periods and at the dates indicated, the weighted-average yields earned on our assets, the weighted-average interest rates paid on our liabilities, together with the net yield on interest-earning assets.
Rate/Volume Analysis
The following table sets forth 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.
Asset and Liability Management and Market Risk
General. Our Board of Directors has established an asset/liability management policy to guide management in maximizing net interest rate spread by managing the differences in terms between interest-earning assets and interest-bearing liabilities while maintaining acceptable levels of liquidity, capital adequacy, interest rate sensitivity, credit risk and profitability. The policy includes the use of an Asset/Liability Management Committee comprised of certain members of senior management. The Committee’s purpose is to communicate, coordinate and manage our asset/liability position consistent with our business plan and Board-approved policies. The Asset/Liability Management Committee meets quarterly to review various areas including:
•
economic conditions;
•
interest rate outlook;
•
asset/liability mix;
•
interest rate risk sensitivity;
•
current market opportunities to promote specific products;
•
historical financial results;
•
projected financial results; and
•
capital position.
The Committee also reviews current and projected liquidity needs. As part of its procedures, the Asset/Liability Management 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.
Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time. Our loans generally have longer maturities than our deposits. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
We have utilized the following strategies in our efforts to manage interest rate risk:
•
we have attempted, where possible, to extend the maturities of our deposits which typically fund our long-term assets;
•
we have invested in securities with relatively short average lives, generally less than eight years; and
•
we have added adjustable-rate securities to our investment portfolio.
How We Measure the Risk of Interest Rate Changes. We monitor First Savings Bank’s interest rate sensitivity on a quarterly basis to measure the change in net interest income as a percentage of net income in varying rate environments. Management uses various assumptions to evaluate the sensitivity of our operations to changes in interest rates. Although management believes these assumptions are reasonable, the interest rate sensitivity of our assets and liabilities on net interest income and the market value of portfolio equity could vary substantially if different assumptions were used or actual experience differs from these assumptions. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react differently to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities lag behind changes in market interest rates. Non-uniform changes and fluctuations in market interest rates across various maturities will also affect the results presented. In addition, certain assets, such as adjustable-rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. 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 demonstrated in the past that the tiering structure of our deposit accounts during changing rate environments results in relatively lower volatility and less than market rate changes in our interest expense for deposits. We tier our deposit accounts by balance and rate, whereby higher balances within an account earn higher rates of interest. Therefore, deposits that are not very rate sensitive (generally, lower balance tiers) are separated from deposits that are rate sensitive (generally, higher balance tiers). When interest rates rise, we do not have to raise interest rates proportionately on less rate sensitive accounts to retain these deposits. These assumptions are based upon our analysis of our customer base, competitive factors and historical experience.
Our income simulation model examines changes in net interest income in which interest rates were assumed to remain at their base level, gradually increase by 100, 200 and 300 basis points over a 12 month period, or decline assuming a gradual 100 basis point reduction in rates. Reductions of rates by 200 and 300 basis points were not reported due to the very low rate environment. The current federal funds rate is 0.25% making a 200 and 300 basis point decrease impossible.
The following table illustrates the change in our net interest income at December 31, 2011 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.
The following table illustrates the change in our net portfolio value (“NPV”) at December 31, 2011 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.
__________
(1)
The current federal funds rate is 0.25%, making a 200 and 300 basis point decline in rates impossible.
(2)
The net portfolio value is the difference between the present value of the discounted cash flows of assets and liabilities and represents the market value of the Company’s equity for any given interest rate scenario. Net portfolio value is useful for determining, on a market basis, how equity changes in response to various interest rate scenarios. Large changes in net portfolio value reflect increased interest rate sensitivity and generally more volatile earnings streams.
(3)
The increase or decrease (change) in the estimated net portfolio value at the indicated change in interest rates compared to the net portfolio value assuming no change in interest rates.
(4)
Net portfolio value divided by the market value of assets.
(5)
The increase or decrease (change) in the net portfolio value divided by the market value of assets (base case).
(6)
The market value of assets under the various interest rate scenarios. This value is derived from the simulation model and reflects the sensitivity of those assets to interest rate changes.
When interest rates rise by 100, 200 or 300 basis points, our net interest income initially increases because a significant portion (about 29%) of our interest-earning assets are based on indices that adjust frequently to changes in market interest rates. Our interest-earning assets are primarily fixed-rate, intermediate-term and long-term loans, and to a less extent cash, investment securities and loans with yields based on market indexes. An increasing percentage of our interest-bearing liabilities are relatively short-term deposits or FHLB borrowings. Deposits comprise the majority and their repricing is dependent upon management’s response to increasing interest rates or, in the case of certificates of deposit, the contractual maturity of the deposit instrument.
When interest rates rise by 100, 200 or 300 basis points, our net portfolio value of equity declines. The decrease is primarily due to the impact of increasing interest rates on our loan portfolio which loses value in rising rate environments because of its predominately long-term, fixed-rate nature. Typically during a rising interest rate environment, interest-bearing deposits reprice more rapidly than our interest-earning assets. During 2011, we increased our holdings of cash and remixed our investment security portfolio by selling fixed-rate investments and purchasing adjustable-rate investments, both of which had the benefit of increasing our interest-earning assets sensitivity to changes in market interest rates.
When interest rates decline by 100 basis points, our net interest income increases slightly because our loan portfolio is primarily fixed-rate and does not reprice lower. Both cash and nonmaturity deposits reprice immediately but offset each other. A significant portion of our interest-bearing liabilities are certificates of deposit, which will reprice over the next twelve months.
When interest rates decline by 100 basis points, our net portfolio value of equity would increase modestly. The increase is primarily due to the fixed-rate nature of our loan portfolio whose value appreciates in declining rate environments because the discounted present value increases as market rates decline.
The net interest income and net portfolio value tables presented above are predicated upon a stable balance sheet with no growth or change in asset or liability mix. In addition, the net portfolio value is based upon the present value of discounted cash flows using our estimates of current replacement rates to discount the cash flows. The effects of changes in interest rates in the net interest income table are based upon a cash flow simulation of our existing assets and liabilities and, for purposes of simplifying the analysis, assumes that delinquency rates would not change as a result of changes in interest rates, although there can be no assurance that this will be the case. Delinquency rates may change when interest rates change; as a result of changes in the loan portfolio mix, underwriting conditions, loan terms or changes in economic conditions that have a delayed effect on the portfolio. The model we use does not change the delinquency rate for the various interest rate scenarios. Even if interest rates change in the designated amounts, there can be no assurance that our assets and liabilities would perform as set forth above. Also, a change in U.S. Treasury rates in the designated amounts accompanied by a change in the shape of the Treasury yield curve would cause changes to the net portfolio value and net interest income other than those indicated above.
Liquidity
We are required to have enough cash flow in order to maintain sufficient liquidity to ensure a safe and sound operation. We maintain cash flows above the minimum level believed to be adequate to meet the requirements of normal operations, including potential deposit outflows. On a daily basis, we review and update cash flow projections to ensure that adequate liquidity is maintained.
Our primary sources of funds are customer deposits, loan and investment repayments, maturing investment securities and advances from the FHLB. These funds, together with equity, are used to make loans, acquire investment securities and other assets, and fund continuing operations. While maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by the level of interest rates, economic conditions and competition. We believe that our current liquidity position, and our forecasted operating results are sufficient to fund all of our existing commitments.
Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in short-term investments such as overnight deposits or agency or mortgage-backed securities. On a longer term basis, we maintain a strategy of investing in various lending products as described in greater detail under “Item 1. Business - Lending Activities.” At December 31, 2011, the total approved loan origination commitments outstanding amounted to $1.9 million. At the same date, the undisbursed portion of construction loans in process totaled $1.4 million and unused lines of credit were $8.7 million. We use our sources of funds primarily to meet ongoing commitments, to pay maturing certificates of deposit and savings withdrawals, to fund loan commitments and to maintain our portfolio of investment securities. Certificates of deposit scheduled to mature in one year or less at December 31, 2011 totaled $296.3 million. Management’s policy is to maintain deposit rates at levels that are competitive with other local financial institutions, although recently we have been less aggressive in competing for certificates of deposit and public funds in order to reduce our cost of funds and as a result of a lack of loan demand from creditworthy borrowers. Based on historical experience, we believe that a significant portion of maturing deposits will remain with First Savings Bank. In addition, we had the ability at December 31, 2011 to borrow an additional $30.0 million from the FHLB and $10.0 million from an unused line of credit with another financial institution as funding sources to meet commitments and for liquidity purposes. Effective February 27, 2012, the FHLB increased our line of credit to 25% of assets from 10% at December 31, 2011. See the Consolidated Statements of Cash Flows in Item 8 of this report for further details on our cash flow activities.
We measure our liquidity based on our ability to fund our assets and to meet liability obligations when they come due. Liquidity (and funding) risk occurs when funds cannot be raised at reasonable prices, or in a reasonable time frame, to meet our normal or unanticipated obligations. We regularly monitor the mix between our assets and our liabilities to manage effectively our liquidity and funding requirements.
Our primary source of funds is our deposits. When deposits are not available to provide the funds for our assets, we use alternative funding sources. These sources include, but are not limited to: advances from the FHLB, wholesale funding, brokered deposits, federal funds purchased and dealer repurchase agreements, as well as other short-term alternatives. We may also liquidate assets to meet our funding needs.
On a monthly basis, we estimate our liquidity sources and needs for the next twelve months. Also, we determine funding concentrations and our need for sources of funds other than deposits. This information is used by our Asset/Liability Management Committee in forecasting funding needs and investing opportunities.
Capital
Our total stockholders’ equity was $181.3 million at December 31, 2011. Consistent with our goal to operate a sound and profitable financial organization we will actively seek to maintain a “well capitalized” institution in accordance with regulatory standards. As of December 31, 2011, First Savings Bank exceeded all regulatory capital requirements. Regulatory capital ratios for First Savings Bank were as follows as of December 31, 2011: Total capital to risk-weighted assets was 24.76% (as compared to the 12% required under the Order); Tier I capital to risk-weighted assets was 23.49%; and Tier I capital to average assets was 13.54% (as compared to the 10% required under the Order). The regulatory capital requirements to be considered well capitalized are 10%, 6% and 5%, respectively. First Savings Bank met the financial ratios for “well-capitalized” status at December 31, 2011, based on the general percentages in the regulatory guidelines, however, First Savings Bank is no longer regarded as well-capitalized for federal regulatory purposes as a result of the deficiencies cited in the Order. See “Item 1, Business - How We Are Regulated - Regulation and Supervision of First Savings Bank - Capital Requirements.”
Commitments and Off-Balance Sheet Arrangements
We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and the unused portions of lines of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. Commitments to extend credit and lines of credit are not recorded as an asset or liability by us until the instrument is exercised. At December 31, 2011 and 2010, we had no commitments to originate loans for sale.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the loan agreement. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the customer. The amount and type of collateral required varies, but may include real estate and income-producing commercial properties.
The following table summarizes our outstanding commitments to originate loans, to advance additional amounts pursuant to outstanding lines of credit and to disburse funds related to our construction loans at December 31, 2011.
First Financial Northwest and its subsidiaries from time to time are involved in various claims and legal actions arising in the ordinary course of business. There are currently no matters that in the opinion of management, would have a material adverse effect on First Financial Northwest’s consolidated financial position, results of operation or liquidity.
Among our contingent liabilities are exposures to limited recourse arrangements with respect to sales of whole loans and participation interests.
We anticipate that we will continue to have sufficient funds and alternative funding sources to meet our current commitments.
The following table presents a summary of significant contractual obligations as of December 31, 2011, maturing as indicated:
___________
(1)
Deposit accounts with indeterminate maturities, such as noninterest bearing, NOW, savings and money market accounts are reflected as obligations due in less than one year.
(footnotes continue on following page)
(2)
Includes maximum payments related to employee benefit plans, assuming all future vesting conditions are met. Additional information about employee benefit plans is provided in “Item 8. Financial Statements and Supplementary Data, Notes to Consolidated Financial Statements, Note 11 Benefit Plans.”
Impact of Inflation
The Consolidated Financial Statements and related financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles generally require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.
Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. The primary impact of inflation is reflected in the increased cost of our operations. As a result, interest rates generally have a more significant impact on a financial institution’s performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. In a period of rapidly rising interest rates, the liquidity and maturity structures of our assets and liabilities are critical to the maintenance of acceptable performance levels.
The principal effect of inflation on earnings, as distinct from levels of interest rates, is in the area of noninterest expense. Expense items such as employee compensation, employee benefits and occupancy and equipment costs may be subject to increases as a result of inflation. An additional effect of inflation is the possible increase in dollar value of the collateral securing loans that we have made. Our management is unable to determine the extent, if any, to which properties securing loans have appreciated in dollar value due to inflation.
Recent Accounting Pronouncements
See “Item 8. Financial Statements and Supplementary Data, Notes to Consolidated Financial Statements, Note 1 Recently Issued Accounting Pronouncements.”
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information contained under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management and Market Risk” of this Form 10-K is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
First Financial Northwest, Inc.
We have audited the accompanying consolidated balance sheets of First Financial Northwest, Inc. and subsidiaries (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of income, stockholders' equity and comprehensive income (loss), and cash flows for each of the years for the three year period ended December 31, 2011. We also have audited the Company’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits.
We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risks. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Financial Northwest, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, First Financial Northwest, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
/s/ Moss Adams LLP
Everett, Washington
March 9, 2012
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Dollars in thousands, except share data)
(Continued)
(Continued)
(Continued)
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies
Description of Business
First Financial Northwest, Inc. (“First Financial Northwest” or “the Company”), a Washington corporation, was formed on June 1, 2007 for the purpose of becoming the holding company for First Savings Bank Northwest (“First Savings Bank” or “the Bank”) in connection with the conversion from a mutual holding company structure to a stock holding company structure. The mutual to stock conversion was completed on October 9, 2007. First Financial Northwest’s business activities generally are limited to passive investment activities and oversight of its investment in First Savings Bank. Accordingly, the information presented in the consolidated financial statements and related data, relates primarily to First Savings Bank. First Financial Northwest, Inc. is a savings and loan holding company and is subject to regulation by the Board of Governors of the Federal Reserve System (“Federal Reserve”) as the successor to the Office of Thrift Supervision (“OTS”). First Savings Bank is regulated by the Federal Deposit Insurance Corporation (“FDIC”) and the Washington State Department of Financial Institutions (“DFI”).
First Savings Bank was organized in 1923 as a Washington state-chartered savings and loan association, converted to a federal mutual savings and loan association in 1935, and converted to a Washington state-chartered mutual savings bank in 1992. In 2002, First Savings Bank reorganized into a two-tier mutual holding company structure, became a stock savings bank and became the wholly-owned subsidiary of First Financial of Renton, Inc. In connection with the mutual to stock conversion in 2007, First Savings Bank changed its name to First Savings Bank Northwest.
First Savings Bank is a community-based savings bank primarily serving King and, to a lesser extent, Pierce, Snohomish and Kitsap counties, Washington through our full-service banking office located in Renton, Washington. First Savings Bank’s business consists of attracting deposits from the public and utilizing these deposits to originate one-to-four family residential, multifamily, commercial real estate, construction/land development, business and consumer loans. Our current business strategy includes an emphasis on one-to-four family residential, multifamily and commercial real estate lending.
Basis of Presentation and Use of Estimates
The accounting and reporting policies of the Company conform to U.S. generally accepted accounting principles (“GAAP”). In preparing the consolidated financial statements, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided. Actual results could differ from these estimates. Material estimates particularly subject to change include the allowance for loan and lease losses (“ALLL”), other real estate owned (“OREO”), deferred tax assets and the fair values of financial instruments.
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries First Savings Bank Northwest and First Financial Diversified Corporation. All significant intercompany balances and transactions between the Company and its subsidiaries have been eliminated in consolidation.
Certain amounts in the consolidated financial statements for prior years have been reclassified to conform to the current consolidated financial statement presentation.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand and in banks, interest-bearing deposits and federal funds sold all with maturities of three months or less.
The Bank is required to maintain an average reserve balance with the Federal Reserve Bank or maintain such reserve balance in the form of cash. There was no specified reserve balance required at December 31, 2011 and 2010, since the Bank held its excess cash and maintained higher average balances at the Federal Reserve Bank.
Investments
Investments are classified into one of three categories: (1) held-to-maturity, (2) available-for-sale, or (3) trading. We had no held-to-maturity or trading securities at December 31, 2011 or 2010. Investments are categorized as held-to-maturity when we have the positive intent and ability to hold them to maturity.
Investments available-for-sale are recorded at fair value. Unrealized gains and losses on investments available-for-sale are excluded from earnings and are reported in other comprehensive income (loss), net of applicable taxes within the consolidated statement of stockholders’ equity. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
The estimated fair value of investments is based on quoted market value prices for investments traded in the public marketplace or dealer quotes. Mortgage-backed investments represent participation interest in pools of first mortgage loans originated and serviced by the issuers of the investments.
Amortization of purchase premiums and discounts are included in investment income using the level-yield method over the remaining period to contractual maturity.
Management makes an assessment to determine whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other-than-temporary basis. We consider many factors including the severity and duration of the impairment, recent events specific to the issuer or industry, and for debt securities, external credit ratings and recent downgrades. Securities on which there is an unrealized loss that is deemed to be an other-than-temporary impairment (“OTTI”) are written down to fair value. For equity securities, the write-down is recorded as a realized loss in noninterest income on our Consolidated Statements of Income. For debt securities, if we intend to sell the security or it is likely that we will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If we do not intend to sell the security and it is not likely that we will be required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are presented as separate categories within OCI.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loans Receivable
Loans are recorded at their outstanding principal balance adjusted for charge-offs, the ALLL and net deferred fees or costs. Interest on loans is calculated using the simple interest method based on the month end balance of the principal amount outstanding and is credited to income as earned.
The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the loan is well secured and in the process of collection. Consumer and other loans are typically managed in the same manner. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is doubtful.
All interest accrued but not collected on loans that are placed on nonaccrual is reversed against interest income. The interest on these loans is accounted for on the cash-basis until qualifying for return to accrual status. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for Loan Losses
The ALLL is a valuation allowance for probable incurred credit losses. Losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Any subsequent recoveries are credited to the allowance.
The ALLL is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans and factors such as the nature and volume of the loan portfolio, historical loss considerations, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. The evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.
While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions or changes to the credit quality of the loan portfolio. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s ALLL. Such agencies may require management to make adjustments to the allowance based on their judgments about information available to them at the time of their examination.
Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, market conditions, rent rolls and the financial strength of the borrower(s) and guarantor(s), if any. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrowers, including the length of the delay, the reasons for the delay, the borrower’s prior payment history and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured by the fair value method on a loan-by-loan basis.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
When a loan is identified as impaired, its impairment is measured using the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases, we use an observable market price or current fair value of the collateral, less selling costs when foreclosure is probable, instead of discounted cash flows. If we determine that the value of the impaired loan is less than the recorded investment in the loan, an impairment is recognized through an allowance estimate or a charge-off to the ALLL.
Loan Fees
Loan origination fees and certain direct origination costs are deferred and amortized as an adjustment to the yield of the loans over their contractual lives, using the effective interest method. In the event loans are sold, the remaining deferred loan origination fees and/or costs are recognized as a component of the gains or losses on the sales of loans.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. The estimated useful lives used to compute depreciation and amortization for buildings and building improvements is 15 to 40 years and for furniture, fixtures and equipment is three to seven years. We review buildings, improvements and equipment for impairment on an annual basis or whenever events or changes in the circumstances indicate that the undiscounted cash flows for the property are less than its carrying value. If identified, an impairment loss is recognized through a charge to earnings based on the fair value of the property.
Federal Home Loan Bank Stock
As a member of the Federal Home Loan Bank System, we are required to maintain a minimum level of investment in Federal Home Loan Bank of Seattle (“FHLB”) stock, based on specified percentages of our outstanding FHLB advances. Ownership of FHLB stock is restricted to the FHLB and member institutions. Our investment in FHLB stock is carried at par value ($100 per share), which reasonably approximates its fair value. At December 31, 2011 and 2010, the Bank’s minimum required investment in FHLB stock was $3.7 million and $4.2 million, respectively. We may request redemption, at par value, of any stock in excess of the amount we are required to hold. Stock redemptions are at the discretion of the FHLB. At December 31, 2011, the Bank had $7.4 million of FHLB stock.
As a result of the ongoing turmoil in the capital and mortgage markets, the FHLB of Seattle has a risk-based capital deficiency largely as a result of write-downs on its private label mortgage-backed securities portfolios. Management evaluates FHLB stock for impairment. The determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as: (1) the significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB and (4) the liquidity position of the FHLB.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On October 25, 2010, the FHLB agreed to the stipulation and issuance of a Consent Order by its primary regulator, the Federal Housing Finance Agency (“FHFA”). The Consent Order sets forth requirements for capital management, asset composition, and other operational and risk management improvements. The FHLB may not repurchase member stock or pay dividends, until they achieve and maintain financial thresholds established by the FHFA as part of the agency’s supervisory process, subject to FHFA’s approval. We have determined there is not an other-than-temporary impairment on the FHLB stock investment as of December 31, 2011.
Other Real Estate Owned
OREO consists principally of properties acquired through foreclosure and is stated at the lower of cost or estimated market value less selling costs. Losses arising from the acquisition of property, in full or partial satisfaction of loans, are charged to the ALLL.
Subsequent to the transfer to foreclosed assets held for sale, these assets continue to be recorded at the lower of cost or fair value (less estimated costs to sell), based on periodic evaluations. Subsequent write-downs in value are charged to noninterest expense. Generally, legal and professional fees associated with foreclosures are expensed as incurred. Costs incurred to improve property prior to sale are capitalized; however, in no event are recorded costs allowed to exceed estimated fair value. Subsequent gains, losses, or expenses recognized on the sale of these properties are included in noninterest expense. The amounts that will ultimately be recovered from foreclosed assets may differ substantially from the carrying value of the assets because of future market factors beyond management’s control.
Loan Commitments and Related Financial Instruments
Financial instruments include off-balance sheet credit instruments, such as commitments to make loans, unused lines of credit and commercial letters of credit issued to meet customer financing needs. The face amount of these items represents the exposure to loss before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Stock-Based Compensation
Compensation cost is recognized for stock options and restricted stock awards, based on the fair value of these awards at the grant date. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the grant date is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
Federal Income Taxes
The Company files a consolidated Federal income tax return. Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to be applied to taxable income in the periods in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not. A tax position that meets the “more likely than not” recognition threshold is measured to determine the amount of benefit to recognize. The tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement.
At December 31, 2011 and 2010, we had no unrecognized tax benefits. Our policy is to recognize interest and penalties on unrecognized tax benefits in federal income tax expense in the Consolidated Statements of Income. There were no interest and penalties for the years ended December 31, 2011 and 2010. The tax years subject to examination by the Internal Revenue Service (“IRS”) are the years ended December 31, 2011 and 2010. The IRS is currently conducting a limited scope audit of our federal tax return for the year ended December 31, 2010 due to our loss carryback for that year.
Employee Stock Ownership Plan
The cost of shares issued to the ESOP, but not yet allocated to participants, is shown as a reduction of stockholders’ equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Dividends on allocated ESOP shares reduce retained earnings; dividends on unearned ESOP shares reduce debt and accrued interest.
Earnings (Loss) Per Share (“EPS”)
Basic EPS is computed by dividing net income or (loss) by the weighted-average number of common shares outstanding during the period. As ESOP shares are committed to be released they become outstanding for EPS calculation purposes. ESOP shares not committed to be released are not considered outstanding. The basic EPS calculation excludes the dilutive effect of all common stock equivalents. Diluted earnings (loss) per share reflects the weighted-average potential dilution that could occur if all potentially dilutive securities or other commitments to issue common stock were exercised or converted into common stock using the treasury stock method.
Comprehensive Income (Loss)
Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on investments available-for-sale which are also recognized as separate components of equity, net of tax.
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Segment Information
The Company’s activities are considered to be a single industry segment for financial reporting purposes. The Company is engaged in the business of attracting deposits from the general public and providing lending services. Substantially all income is derived from a diverse base of commercial, mortgage and consumer lending activities and investments.
Recently Issued Accounting Pronouncements
In January 2011, The Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20 (“ASU 2011-01”). This ASU temporarily delays the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. The delay is intended to allow the FASB time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about restructuring will then be coordinated. The guidance is effective for interim and annual periods ending after September 15, 2011. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
In April 2011, the FASB issued ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring (“ASU 2011-02”). The update provides additional guidance relating to when creditors should classify loan modifications as troubled debt restructurings. The ASU also ends the deferral issued in January 2011 of the disclosures about troubled debt restructurings required by ASU No. 2010-20. The provisions of ASU No. 2011-02 and the disclosure requirements of ASU No. 2010-20 are effective for the Company’s interim reporting period ending September 30, 2011. The guidance applies retrospectively to restructurings occurring on or after January 1, 2011. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
In April 2011, the FASB issued ASU No. 2011-03, Reconsideration of Effective Control for Repurchase Agreements (“ASU 2011-03”). The update amends existing guidance to remove from the assessment of effective control, the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and, as well, the collateral maintenance implementation guidance related to that criterion. ASU No. 2011-03 is effective for the Company’s reporting period beginning on or after December 15, 2011. The guidance applies prospectively to transactions or modification of existing transactions that occur on or after the effective date and early adoption is not permitted. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.
In April 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). The update amends existing guidance regarding the highest and best use and valuation premise by clarifying these concepts are only applicable to measuring the fair value of nonfinancial assets. The Update also clarifies that the fair value measurements of financial assets and financial liabilities which have offsetting market risks or counterparty credit risks that are managed on a portfolio basis, when several criteria are met, can be measured at the net risk position. Additional disclosures about Level 3 fair value measurements are required including a quantitative disclosure of the unobservable inputs and assumptions used in the measurement, a description of the valuation process in place, and discussion of the sensitivity of fair value changes in unobservable inputs and interrelationships about those inputs as well as disclosure of the level of the fair value of items that are not
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
measured at fair value in the financial statements but disclosure of fair value is required. The provisions of ASU No. 2011-04 are effective for the Company’s reporting period beginning after December 15, 2011 and should be applied prospectively. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.
In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”). The update amends current guidance to allow a company the option of presenting the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The provisions do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments do not change the option for a company to present components of other comprehensive income either net of related tax effects or before related tax effects, with one amount shown for the aggregate income tax expense (benefit) related to the total of other comprehensive income items. The amendments do not affect how earnings per share is calculated or presented. The provisions of ASU No. 2011-05 are effective for the Company’s reporting periods beginning after December 15, 2011 and should be applied retrospectively. Early adoption is permitted and there are no required transition disclosures. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.
In December 2011, the FASB issued ASU No. 2011-10, Derecognition of in Substance Real Estate - a Scope Clarification (“ASU 2011-10”), which amends Topic 360, “Property, Plant and Equipment.” The objective of this ASU is to resolve diversity in practice about whether the guidance in Topic 360 applies to a parent that ceases to have a controlling financial interest (as described in Topic 810, Consolidations) in a subsidiary that is in substance real estate as a result of default on the subsidiary's nonrecourse debt. Under ASU 2011-10, when a parent ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary's nonrecourse debt, the reporting entity should apply the guidance in Subtopic 360-20 to determine whether it should derecognize the in substance real estate. Generally, a reporting entity would not satisfy the requirements to derecognize the in substance real estate before the legal transfer of the real estate to the lender and the extinguishment of the related nonrecourse indebtedness. That is, even if the reporting entity ceases to have a controlling financial interest under Subtopic 810-10, the reporting entity would continue to include the real estate, debt, and the results of the subsidiary's operations in its consolidated financial statements until legal title to the real estate is transferred to legally satisfy the debt. This ASU is effective for the Company’s financial statements for annual and interim periods beginning on or after June 15, 2012, and must be applied prospectively. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.
In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”), which amends Topic 210, “Balance Sheet.” This ASU requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. Offsetting (netting) assets and liabilities is an important aspect of presentation in financial statements, and differences in the offsetting requirements in GAAP and International Financial Reporting Standards (“IFRS”) account for a significant difference in the amounts presented in statements of financial position prepared in accordance with GAAP and in the amounts presented in those statements prepared in accordance with IFRS for certain institutions. This difference reduces the comparability of statements of financial position. As a result, users of financial statements requested that the differences should be addressed expeditiously. In response to those requests, the FASB and the International Accounting Standards Board (“IASB”) are issuing joint requirements that will enhance current disclosures.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of GAAP and those entities that prepare their financial statements on the basis of IFRS. This ASU is effective for the Company’s financial statements for annual periods beginning on or after January 1, 2013, and must be applied retrospectively. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.
In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update 2011-05 (“ASU 2011-12”). This ASU defers only those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments. ASU 2011-12 was issued in order to allow the FASB time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the FASB is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, the Company will continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before the issuance of ASU 2011-05. ASU 2011-12 is effective for the Company’s financial statements for annual and interim periods beginning after December 31, 2011, and must be applied prospectively. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.
Note 2 - Regulatory Items
On April 14, 2010, the OTS and members of the Board of Directors of First Financial Northwest entered into an informal supervisory agreement or Memorandum of Understanding (“MOU”) which is now enforced by the Federal Reserve as the successor to the OTS. Under the terms of the MOU, the Company agreed, among other things, to provide notice to and obtain a written non-objection from the Federal Reserve prior to the Company (a) declaring a dividend or redeeming any capital stock and (b) incurring, issuing, renewing or repurchasing any new debt. Further, in connection with a prior examination of the Bank by the FDIC and DFI, we must obtain a written non-objection from the FDIC before engaging in any transaction that would materially change the balance sheet composition (including growth in total assets of five percent or more), significantly change funding sources (including brokered deposits) or declare or pay cash dividends. In addition, both the Company and the Bank must obtain prior regulatory approval before adding any new director or senior executive officer or changing the responsibilities of any current senior executive officer or pay pursuant to or by entering into certain severance and other forms of compensation agreements.
The Bank entered into a Stipulation to the Issuance of a Consent Order (“Order”) with the FDIC and the DFI which became effective on September 24, 2010. Under the terms of the Order, the Bank cannot declare dividends or repurchase stock without the prior written approval of the FDIC. Other material provisions of the Order require the Bank to:
·
Maintain and preserve qualified management;
·
Increase the Board of Directors’ participation in the Bank’s affairs;
·
Obtain an independent study of management and the personnel structure of the Bank;
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
·
Maintain specified Capital levels;
·
Eliminate loans classified as “Loss” at its regulatory examination, and reduce the loans classified as “Doubtful” and “Substandard” as a percent of capital;
·
Revise its policy with respect to the allowance for loan losses;
·
Not extend additional credit to borrowers whose loan had been classified as “Loss” and is uncollected;
·
Revise its lending and collection policies and practices;
·
Develop a plan to reduce the amount of commercial real estate loans;
·
Enhance its written funds management and liquidity policy;
·
Develop a three-year strategic plan;
·
Not solicit brokered deposits and comply with certain deposit rate restrictions;
·
Eliminate and correct all violations of laws; and
·
Prepare and submit progress reports to the FDIC and DFI.
The Bank has implemented a comprehensive plan to achieve full compliance with the Order. The Order contains target dates to achieve the items listed above, including that the Bank’s Tier 1 capital ratio and total risk-based capital ratio be at least 10% and 12%, respectively. At December 31, 2011, the Bank’s Tier 1 capital ratio was 13.54% and its total risk-based capital ratio was 24.76%, which exceeded the requirements of the Order.
Adversely classified assets as a percent of Tier 1 capital plus the ALLL was 128% at the beginning of 2010. The Order required this ratio to be below 65% by March 2011 for the adversely classified assets identified at that examination. We achieved this target as of September 30, 2010 and remained in compliance with this requirement at December 31, 2011.
The Order also required that the Bank develop a written plan to systematically reduce the amount of loans to borrowers in the commercial real estate loan category, including its construction/land development loans which are considered commercial real estate for purposes of this calculation. At September 30, 2010, the Bank’s commercial real estate loans, excluding owner-occupied properties, represented 314% of its total risk-based capital including construction/land development loans which equaled 84% of its total risk-based capital. At December 31, 2011, the Bank’s concentration in commercial real estate loans was reduced to 229% of its risk-based capital including the construction/land development loan portfolio which equaled 30% of total risk-based capital.
The Order also required the Bank to obtain an independent management study and adopt a plan to implement the recommendations from the study, satisfactory to its regulators. The Bank has obtained the independent management study and continues to work on implementing the study’s recommendations, including the addition of new Board members and the evaluation of senior management. We have added two new Board members to the Boards of Directors of the Bank and the Company who we believe will further enhance the knowledge and expertise of each of these Boards of Directors. Effective December 31, 2011, two of our Board members have retired and changed their status to director emeriti. Senior management has also been evaluated in connection with the independent management study and efforts are being made to identify outside individuals who would augment the leadership of our organization and who possess the experience and qualifications to strengthen and establish the foundation for our future growth.
A copy of the Order is attached to the Form 8-K that we filed with the Securities and Exchange Commission (“SEC”) on September 27, 2010. The Order will remain in effect until modified or terminated by the FDIC and the DFI.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Investments
The following tables summarize the amortized cost and fair value of investments available-for-sale at December 31, 2011 and 2010 and the corresponding amounts of gross unrealized gains and losses.
There were no investments classified as held to maturity at December 31, 2011 or 2010.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The amortized cost and estimated fair value of investments available-for-sale at December 31, 2011, by expected maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Investments not due at a single maturity date, primarily mortgage-backed investments are shown separately.
Under Washington State law, in order to participate in the public funds program we are required to pledge 100% of the public deposits we hold in the form of eligible securities. Investments with a market value of $31.8 million and $68.7 million were pledged as collateral for public deposits at December 31, 2011 and 2010, respectively, both of which exceeded the minimum collateral requirements established by the Washington Public Deposit Protection Commission. In addition, $5.7 million of investments were pledged as collateral for FHLB advances at December 31, 2011. At December 31, 2010, there were no investments pledged for FHLB advances.
Sales of available-for-sale investments were as follows:
The tax expense related to these net realized gains and losses was $779,000, $295,000 and $683,000 for the years ended December 31, 2011, 2010 and 2009, respectively.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables summarize the aggregate fair value and gross unrealized loss by length of time those investments have been continuously in an unrealized loss position.
At December 31, 2011, we had one security with a gross unrealized loss totaling $270,000 with a fair value totaling $1.1 million that had an unrealized loss for greater than one year. At December 31, 2010, we had four securities with gross unrealized losses totaling $473,000 and fair values totaling $1.9 million that had an unrealized loss for more than one year.
There were no losses related to OTTI for the years ended December 31, 2011 or 2010 and $152,000 for the year ended December 31, 2009. These OTTI losses were a result of the severity and duration of the decline in the market value of our investment in the AMF Ultra Short Mortgage Fund. We do not consider any other securities to be other-than-temporarily impaired.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4 - Loans Receivable
Loans receivable are summarized as follows:
___________
(1)
Includes $147.4 million and $173.4 million of non-owner occupied loans at December 31, 2011 and 2010, respectively.
(2)
We do not include construction loans that will convert to permanent loans in the construction/land development category. We consider these loans to be "rollovers" in that one loan is originated for both the construction loan and permanent financing. These loans are classified according to the underlying collateral. As a result, at December 31, 2011, we had $12.5 million, or 5.4%, of our total commercial real estate portfolio and $3.5 million, or 3.1%, of our total multifamily loan portfolio in these "rollover" type of loans. At December 31, 2010, we had $5.4 million, or 1.3%, of our total one-to-four family residential loan portfolio, $28.4 million, or 10.4%, of our total commercial real estate portfolio and $4.1 million, or 2.8%, of our total multifamily loan portfolio in these "rollover" type of loans. The $1.8 million and $6.6 million of commercial real estate land loans at December 31, 2011 and 2010, respectively, were not included in the construction/land development category because we classify raw land or buildable lots where we do not intend to finance the construction as commercial real estate land loans.
At December 31, 2011 and 2010 there were no loans classified as held for sale.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loan Origination/Risk Management
One-to-four family residential loans are originated generally using secondary market underwriting guidelines. We originate both fixed-rate and adjustable-rate loans in our residential lending program. We are a portfolio lender which means we originate loans for our portfolio and do not generally sell loans into the secondary market. This loan portfolio comprised 46.4% and 44.7% of total loans at December 31, 2011 and 2010, respectively.
Multifamily loans have higher loan balances, are more difficult to evaluate and monitor and involve a greater degree of risk than one-to-four family residential loans. Often payments on loans secured by multifamily properties are dependent on the successful operation and management of the property; therefore, repayment of these loans may be affected by adverse conditions in the real estate market or the economy. We generally require and obtain loan guarantees from financially capable parties based upon the review of personal financial statements. If the borrower is a corporation, we generally require and obtain personal guarantees from the corporate principals based upon a review of their personal financial statements and individual credit reports. This loan portfolio comprised 15.7% and 16.2% of total loans at December 31, 2011 and 2010, respectively.
Commercial real estate loans are subject to underwriting standards and processes similar to those of multifamily loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or the general economy. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At December 31, 2011, approximately 6.6% of the outstanding principal balances of the Bank’s commercial real estate loans were secured by owner-occupied properties. This loan portfolio comprised 32.1% and 30.6% of total loans at December 31, 2011 and 2010, respectively.
Construction/land development loans that are secured by non-owner occupied properties generally require the borrower to have had an existing relationship with the Bank and have a proven record of success. Construction/land development loans are underwritten utilizing feasibility studies, independent appraisal reviews, lease rates and financial analysis of the developers and property owners. Construction/land development loans are generally based upon estimates of costs and value associated with the completed project. These estimates may be inaccurate. These loans often involve the disbursement of funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be sales of developed property or an interim loan commitment from the Bank until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing. This loan portfolio comprised 3.5% and 6.3% of total loans at December 31, 2011 and 2010, respectively.
Historically we have generally not made business loans, however, we have recently begun to offer this type of lending. Business loans are generally secured by business equipment, accounts receivable, inventory or other property. Loan terms vary from typically one to five years. The interest rates on such loans are either fixed-rate or adjustable-rate indexed to The Wall Street Journal prime rate plus a margin. Our business lending policy includes credit file documentation and analysis of the borrower’s background, capacity to repay the loan, the
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
adequacy of the borrower’s capital and collateral, as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower’s past, present and future cash flows is also an important aspect of our credit analysis. We generally obtain personal guarantees on our business loans. This loan portfolio comprised 0.6% and 0.1% of total loans at December 31, 2011 and 2010, respectively.
The Bank originates consumer loans which consist of home equity loans, personal lines of credit and savings account loans. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. This activity, coupled with the relatively small loan amounts that are spread over many individual borrowers, minimizes risk. This loan portfolio comprised 1.7% and 2.1% of total loans at December 31, 2011 and 2010, respectively.
Concentrations of Credit
Most of the Bank’s lending activity occurs within the state of Washington. The primary market areas include King and to a lesser extent Pierce, Snohomish and Kitsap counties. The Bank’s loan portfolio consists of one-to-four family residential loans which comprised 46.4% of the total loan portfolio at December 31, 2011. Commercial real estate and multifamily loans were 32.1% and 15.7%, respectively, of the total loan portfolio at December 31, 2011, with construction/land development loans, consumer and business loans accounting for the remaining 5.8% of the loan portfolio.
The Bank originates both adjustable and fixed interest rate loans. The composition of loans receivable was as follows:
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The majority of the adjustable-rate loans are tied to the prime rate as published in The Wall Street Journal. The remaining adjustable-rate loans have interest rate adjustment limitations and are generally indexed to the FHLB Long-Term Bullet advance rates published by the FHLB of Seattle. Future market factors may affect the correlation of the interest rate adjustment with the rates we pay on short-term deposits that have been primarily utilized to fund these loans.
When we classify problem assets as either substandard or doubtful, pursuant to Federal regulations, we may establish a specific reserve in an amount we deem prudent to address the risk specifically or we may allow the loss to be addressed in the general allowance. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to the particular problem assets. When an insured institution classifies problem assets as a loss, pursuant to Federal regulations, it is required to charge-off such assets in the period in which they are deemed uncollectible. Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by our regulators, who can require the establishment of additional loss allowances.
Loan grades are used by the Bank to identify and track potential problem loans which do not rise to the levels described for substandard, doubtful or loss. The grades for watch and special mention are assigned to loans which have been criticized based upon known characteristics such as periodic payment delinquency or stale financial information from the borrower and/or guarantors. Loans identified as criticized (watch and special mention) or classified (substandard, doubtful or loss) are subject to problem loan reporting every three months.
An analysis of the changes in the ALLL is summarized as follows:
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table is a summary of our ALLL and loan portfolio by type of loan and reserve method for the periods indicated.
Nonperforming loans, net of undisbursed funds, were $23.7 million, $62.9 million and $120.7 million at December 31, 2011, 2010 and 2009, respectively. Foregone interest on nonaccrual loans for the years ended December 31, 2011, 2010 and 2009 was $2.2 million, $6.1 million and $7.3 million, respectively.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loans committed to be advanced in connection with impaired loans at December 31, 2011 and 2010 were $36,000 and $1.1 million, respectively.
The following tables represent a summary of loans individually evaluated for impairment by the type of loan for the periods indicated.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of information pertaining to impaired loans, nonperforming assets and troubled debt restructured loans (“TDRs”).
_____________
(1) There were no loans 90 days or more past due and still accruing interest at December 31, 2011 and 2010.
(2) TDRs are also considered impaired loans and are included in "Total impaired loans."
Nonaccrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual when they are 90 days delinquent, or when, in management’s opinion, the borrower is unable to meet scheduled payment obligations.
A loan is considered impaired when we have determined that we may be unable to collect payments of principal or interest when due under the terms of the loan. In the process of identifying loans as impaired, management takes into consideration factors which include payment history and status, collateral value and financial condition of the borrower. Minor payment delays and insignificant payment shortfalls typically do not result in a loan being classified as impaired. The significance of payment delays and shortfalls is considered by management on a case by case basis, after taking into consideration the circumstances surrounding the loans and the borrowers, including payment history and amounts of any payment shortfall, length and reason for delay and the likelihood of return to stable performance. Impairment is measured on a loan by loan basis for all loans in the portfolio.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table is a summary of loan balances of nonaccrual loans by type of loan.
The following tables represent a summary of the aging of loans by type.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Credit Quality Indicators. We utilize a nine-point risk rating system and assign a risk rating for all credit exposures. The risk rating system is designed to define the basic characteristics and identify risk elements of each credit extension. Credits risk rated 1 through 5 are considered to be “pass” credits. Pass credits can be assets where there is virtually no credit risk, such as cash secured loans with funds on deposit with the Bank. Pass credits also include credits that are on our watch list, where the borrower exhibits potential weaknesses, which may, if not checked or corrected, negatively affect the borrower’s financial capacity and threaten their ability to fulfill debt obligations in the future. Credits classified as special mention are risk rated 6 and possess weaknesses that deserve management’s close attention. Special mention assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Substandard credits are risk rated 7. An asset is considered substandard if it is inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged. Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful are risk rated 8 and have all the weaknesses inherent in those credits classified as substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions and values. Assets classified as loss are risk rated 9 and are considered uncollectible and cannot be justified as a viable asset for the Bank.
The following tables represent a summary of loans by type and risk category.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables represent a summary of the loan portfolio by type and payment activity.
(1)
There were $183.0 million of owner-occupied one-to-four family residential loans and $142.6 million of non-owner occupied one-to-four family residential loans classified as performing.
(2)
There were $5.0 million of owner-occupied one-to-four family residential loans and $4.8 million of non-owner occupied one-to-four family residential loans classified as nonperforming.
(3)
Net of undisbursed funds.
(1) There were $217.3 million of owner-occupied one-to-four family residential loans and $158.6 million of non-owner occupied one-to-four family residential loans classified as performing.
(2)
There were $8.0 million of owner-occupied one-to-four family residential loans and $14.7 million of non-owner occupied one-to-four family residential loans classified as nonperforming.
(3)
Net of undisbursed funds.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents our TDRs recorded investment before and after the modification.
____________
(1) An A/B Note restructure strategy occurs infrequently and involves charging-down the "A" note portion of the relationship to an acceptable loan to value ratio and positive debt service coverage at the time of the restructure while the "B" note represents the charged-off portion of the relationship at the time of the restructure.
At December 31, 2011, we had $36,000 in commitments to extend additional credit to borrowers whose loan terms have been modified in TDRs. All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation of the ALLL.
The TDR loans that occurred during the twelve months ended December 31, 2011 were primarily a result of granting the borrower interest only payment for a period of time ranging from one to three years. These modifications resulted in a charge to the ALLL of $351,000 for the twelve months ended December 31, 2011. The impaired portion of the loan that has been reduced to interest only payments for a specific period of time is calculated based on the present value of expected future cash flows discounted at the loan’s effective interest rate. The effective interest rate is the rate of return implicit on the original loan. The original contractual interest rate is adjusted for any deferred loan fees or costs, premiums or discounts existing at the origination or acquisition of the loan. This impaired amount reduces the ALLL and a valuation allowance is established to reduce the loan balance. As loan payments are received in future months, the ALLL entry is reversed and the valuation allowance is reduced on a straight-line basis over the modification period.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of loans that were modified as TDRs within the previous 12 months and for which there was a payment default during that period.
TDRs that default after they have been modified are typically evaluated individually on a collateral basis. Any additional impairment further reduces the ALLL.
Certain of the Bank’s executive officers and directors have loans with the Bank. The aggregate dollar amount of these loans outstanding to related parties is summarized as follows:
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 5 - Other Real Estate Owned
The following table represents a summary of OREO.
OREO includes properties acquired by the Bank through foreclosure and deed in lieu of foreclosure. OREO at December 31, 2011 consisted of $8.2 million in one-to-four family residential homes and $8.0 million in construction/land development projects and $9.8 million in commercial real estate buildings.
Note 6 - Premises and Equipment
Premises and equipment consisted of the following:
Depreciation expense was $1.1 million, $1.1 million and $802,000 for the years ended December 31, 2011, 2010 and 2009, respectively.
Note 7 - Fair Value
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
We determined the fair values of our financial instruments based on the fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
measuring fair values. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our estimates for market assumptions.
Valuation inputs refer to the assumptions market participants would use in pricing a given asset or liability using one of the three valuation techniques. Inputs can be observable or unobservable. Observable inputs are those assumptions that market participants would use in pricing the particular asset or liability. These inputs are based on market data and are obtained from an independent source. Unobservable inputs are assumptions based on the Bank’s own information or estimate of assumptions used by market participants in pricing the asset or liability. Unobservable inputs are based on the best and most current information available on the measurement date.
All inputs, whether observable or unobservable, are ranked in accordance with a prescribed fair value hierarchy:
·
Level 1 - Quoted prices for identical instruments in active markets.
·
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable.
·
Level 3 - Instruments whose significant value drivers are unobservable.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables present the balances of assets and liabilities measured at fair value on a recurring basis (there were no transfers between Level 1 and Level 2 recurring measurements).
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The tables below present the balances of assets and liabilities measured at fair value on a nonrecurring basis.
Investments available-for-sale at December 31, 2011 consisted primarily of mortgage-backed securities, bank qualified municipal bonds and agency securities. The estimated fair value of Level 1 investments is based on quoted market prices. The estimated fair value of Level 2 investments is based on quoted prices for similar investments in active markets, identical or similar investments in markets that are not active and model-derived valuations whose inputs are observable.
The fair value of impaired loans is calculated using the collateral value method or on a discounted cash flow basis. Inputs used in the collateral value method include appraised values, estimates of certain completion costs and closing and selling costs. Some of these inputs may not be observable in the marketplace.
OREO is measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The carrying amounts and estimated fair values of financial instruments at December 31, 2011 and 2010 were as follows:
Fair value estimates, methods, and assumptions are set forth below for our financial instruments:
·
Financial instruments with book value equal to fair value: The fair value of financial instruments that are short-term or reprice frequently and that have little or no risk are considered to have a fair value equal to book value. These instruments include cash on hand and in banks, interest-bearing deposits, FHLB stock, accrued interest receivable and accrued interest payable. FHLB stock is not publicly-traded, however it may be redeemed on a dollar-for-dollar basis, for any amount the Bank is not required to hold, subject to the FHLB’s discretion. The fair value is therefore equal to the book value.
·
Investments available-for-sale: The fair value of all investments excluding FHLB stock was based upon quoted market prices for similar investments in active markets, identical or similar investments in markets that are not active and model-derived valuations whose inputs are observable.
·
Loans receivable: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value of fixed-rate loans is estimated using discounted cash flow analysis, utilizing interest rates that would be offered for loans with similar terms to borrowers of similar credit quality. As a result of current market conditions, cash flow estimates have been further discounted to include a credit factor. The fair value of nonperforming loans is estimated using the fair value of the underlying collateral.
·
Liabilities: The fair value of deposits with no stated maturity, such as statement savings, NOW and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows using current interest rates for certificates of deposit with similar remaining maturities. The fair value of FHLB advances is estimated based on discounting the future cash flows using current interest rates for debt with similar remaining maturities.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
·
Off balance sheet commitments: No fair value adjustment is necessary for commitments made to extend credit, which represents commitments for loan originations or for outstanding commitments to purchase loans. These commitments are at variable rates, are for loans with terms of less than one year and have interest rates which approximate prevailing market rates, or are set at the time of loan closing.
Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business. The fair value has not been estimated for assets and liabilities that are not considered financial instruments.
Note 8 - Accrued Interest Receivable
Accrued interest receivable consisted of the following:
Note 9 - Deposits
Deposit accounts consisted of the following:
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2011, scheduled maturities of certificates of deposit were as follows:
Deposits included public funds of $22.0 million and $58.7 million at December 31, 2011 and 2010, respectively.
Certificates of deposit of $100,000 or more included in deposits at December 31, 2011 and 2010, were $416.5 million and $510.9 million, respectively. Interest expense on these certificates totaled $11.6 million, $15.5 million, and $17.8 million for the years ended December 31, 2011, 2010 and 2009, respectively.
Included in deposits are accounts of $3.5 million and $3.1 million at December 31, 2011 and 2010, respectively which are controlled by management, members of the Board of Directors and related entities.
Interest expense on deposits was as follows:
Note 10 - Other Borrowings
The FHLB functions as a central reserve bank providing credit for member financial institutions. At December 31, 2011 and 2010, the Bank maintained credit facilities with the FHLB totaling $113.0 million and $317.4 million with outstanding balances of $83.1 million and $93.1 million, respectively. The credit facility was collateralized by $205.0 million of single-family residential mortgages and $64.1 million of multifamily loans under a blanket lien arrangement at December 31, 2011. At December 31, 2010, a collateral in possession arrangement was in force. Effective February 27, 2012, the FHLB increased our line of credit to 25% of assets from 10% at December 31, 2011. We also had a $10.0 million unused line of credit facility with another financial institution at December 31, 2011.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Outstanding advances consisted of the following:
Note 11 - Benefit Plans
Multiemployer Pension Plans
We participate in the Pentegra Defined Benefit Plan for Financial Institutions (“The Pentegra DB Plan”), a tax-qualified defined-benefit pension plan that covers substantially all employees after one year of continuous employment. Pension benefits vest over a period of five years of credited service. T he Pentegra DB Plan’s Employer Identification Number is 13-5645888 and the Plan Number is 333. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes and as a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra DB Plan.
The Pentegra DB Plan is a single plan under Internal Revenue Code Section 413(c) and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra DB Plan, contributions made by a participating employer may be used to provide benefits to participants of other participating employers.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The table below presents the funded status (market value of plan assets divided by funding target) of our plan as of July 1,:
Total contributions made to the Pentegra DB Plan, as reported on Form 5500, equal $203.6 million and $133.9 million for the plan years ending June 30, 2010 and June 30, 2009, respectively. Our contributions to the Pentegra DB Plan are not more than 5% of the total contributions to the Pentegra DB Plan. Our policy is to fund pension costs as accrued.
Total contributions during the years ended December 31, were:
We also have post employment agreements with certain key officers to provide supplemental retirement benefits. For each of the years ended December 31, 2011, 2010 and 2009, the annual plan premium cost was $49,000. Additionally, we recorded $289,000, $81,000 and $108,000 of deferred compensation expense for the years ended December 31, 2011, 2010 and 2009, respectively.
401(k) Plan
We have a savings plan under Section 401(k) of the Internal Revenue Code, covering substantially all employees after 90 days of continuous employment. Under the plan, employee contributions up to 6% will be matched 50% by the Company. Such matching becomes vested over a period of five years of credited service. Employees may make investments in various stock, money market or fixed income plans. We contributed $150,000, $138,000 and $274,000 to the plan for the years ended December 31, 2011, 2010 and 2009, respectively.
Employee Stock Ownership Plan
We provide an ESOP for the benefit of substantially all employees. The ESOP borrowed $16.9 million from the Company and used those funds to acquire 1,692,800 shares of the Company’s stock at the time of the initial public offering at a price of $10.00 per share.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Shares purchased by the ESOP with the loan proceeds are held in a suspense account and are allocated to ESOP participants on a pro rata basis as principal and interest payments are made by the ESOP to the Company. The loan is secured by shares purchased with the loan proceeds and will be repaid by the ESOP with funds from the Company’s discretionary contributions to the ESOP and earnings on the ESOP assets. Annual principal and interest payments of $1.6 million were made by the ESOP during 2011, 2010 and 2009.
As shares are committed to be released from collateral, we report compensation expense equal to the daily average market prices of the shares and the shares become outstanding for EPS computations. The compensation expense is accrued throughout the year.
A summary of key transactions for the ESOP follows:
Shares held by the ESOP are as follows:
Stock-Based Compensation
In June 2008, our shareholders approved the First Financial Northwest, Inc. 2008 Equity Incentive Plan (“Plan”). The Plan provides for the grant of stock options, restricted stock and stock appreciation rights.
Total compensation expense for the Plan was $2.0 million, $1.9 million and $2.0 million for the years ended December 31, 2011, 2010 and 2009, respectively, and the related income tax benefit was $690,000, $681,000 and $713,000 for the years ended December 31, 2011, 2010 and 2009, respectively.
Stock Options
The Plan authorized the grant of stock options amounting to 2,285,280 shares to its directors, advisory directors, officers and employees. Option awards are granted with an exercise price equal to the market price of our common stock at the grant date. These option awards have a vesting period of five years, with 20% vesting on the anniversary date of each grant date, and a contractual life of ten years. Any unexercised stock options will expire ten years after the grant date or sooner in the event of the award recipient’s death, disability or termination of service with the Company or the Bank. We have a policy of issuing new shares from authorized but unissued
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
common stock upon the exercise of stock options. At December 31, 2011, remaining options for 911,756 shares of common stock were available for grant under the Plan.
The fair value of each option award is estimated on the grant date using a Black-Scholes model that uses the assumptions noted in the table below. The dividend yield is based on the current quarterly dividend in effect at the time of the grant. Historical employment data is used to estimate the forfeiture rate. In previous years, we elected to use a weighted-average of our peers’ historical stock price information in conjunction with our own stock price history due to the limited amount of history available regarding our stock price. Now that sufficient stock price information is available regarding our stock, we will utilize historical volatility of our stock price over a specified period of time for the expected volatility assumption. We base the risk-free interest rate on the U.S. Treasury Constant Maturity Indices in effect on the date of the grant. We elected to use the “Share-Based Payments” method permitted by the Securities and Exchange Commission to calculate the expected term. This method uses the vesting term of an option along with the contractual term, setting the expected life at a midpoint. There were no options granted during the year ended December 31, 2011.
The fair value of options granted was determined using the following weighted-average assumptions as of the grant date.
A summary of the Company’s stock option plan awards for the year ended December 31, 2011, follows:
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2011, there was $801,000 of total unrecognized compensation cost related to nonvested stock options granted under the Plan. The cost is expected to be recognized over the remaining weighted-average vesting period of 1.7 years.
Restricted Stock Awards
The Plan authorized the grant of restricted stock awards amounting to 914,112 shares to directors, advisory directors, officers and employees. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at the grant date. The restricted stock awards’ fair value is equal to the value on the grant date. Shares awarded as restricted stock vest ratably over a five-year period beginning at the grant date with 20% vesting on the anniversary date of each grant date. At December 31, 2011, remaining restricted awards for 167,078 shares were available to be issued. Shares that have been repurchased totaled 310,494 and are held in trust until they are issued in connection with the agreement.
A summary of changes in nonvested restricted stock awards for the period ended December 31, 2011, follows:
As of December 31, 2011 there was $2.4 million of total unrecognized compensation costs related to nonvested shares granted as restricted stock awards. The cost is expected to be recognized over the remaining weighted-average vesting period of 1.8 years. The total fair value of shares vested during the years ended December 31, 2011 and 2010 was $1.4 million for each year.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 - Federal Income Taxes
The components of income tax expense (benefit) are as follows:
A reconciliation of the tax provision based on the statutory corporate rate of 35% during the years ended December 31, 2011, 2010 and 2009 on pretax income is as follows:
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The net deferred tax asset, included in the accompanying consolidated balance sheets, consisted of the following:
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. These calculations are based on many complex factors including estimates of the timing of reversals of temporary differences, the interpretation of federal income tax laws, and a determination of the differences between the tax and the financial reporting basis of assets and liabilities. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax assets and liabilities.
Under GAAP, a valuation allowance is required to be recognized if it is “more likely than not” that a portion of the deferred tax asset will not be realized.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Our policy is to evaluate our deferred tax assets on a quarterly basis and record a valuation allowance for our deferred tax assets if we do not have sufficient positive evidence indicating that we will have carryback potential or future taxable income available to utilize our deferred tax assets. Our federal net operating loss carryforward was $31.6 million at December 31, 2011 and will expire in 2030. The Bank has an AMT credit carryforward totaling $1.5 million, with no expiration date.
Our deferred tax asset valuation account consisted of the following specific valuation allowances.
The Company has qualified under provisions of the Internal Revenue Code to compute federal income taxes after deductions of additions to the bad debt reserves. At December 31, 2011 and 2010, the Company had a taxable temporary difference of approximately $4.5 million that arose before 1988 (base year amount). A deferred tax liability has not been recognized for the temporary difference. Management does not expect this temporary difference to reverse in the foreseeable future.
Note 13 - Regulatory Capital Requirements
Under Federal regulations, pre-conversion retained earnings are restricted for the protection of pre-conversion depositors.
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and, possibly, additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.
The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table that follows) of total and Tier 1 capital to risk-weighted assets (as defined in the regulations) and of Tier 1 capital to average assets.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Although the Bank is well-capitalized at December 31, 2011, based on the general percentages in the regulatory guidelines, the Bank is no longer regarded as well-capitalized for federal regulatory purposes, as a result of the deficiencies cited in the Order (see Note 2 - Regulatory Items). As a result of this reclassification, the Bank’s borrowing costs and terms from the FHLB, as well as the Bank’s premiums to the Deposit Insurance Fund administered by the FDIC, are expected to be higher than they would were the Bank not operating under the Order.
As of December 31, 2011, according to the most recent notification from the FDIC, the Bank was categorized as adequately capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since the notification that management believes have changed the Bank’s category.
The Bank’s actual capital amounts and ratios are presented in the following table.
The Orders restrict the Bank and the Company from making any capital distributions including the payment of a dividend.
Note 14 - Commitments and Guarantees
Commitments to extend credit are agreements to lend to customers in accordance with predetermined contractual provisions. These commitments are for specific periods or, may contain termination clauses and may require the payment of a fee. The total amounts of unused commitments do not necessarily represent future credit exposure or cash requirements, in that commitments can expire without being drawn upon. Unfunded commitments to extend credit totaled $11.9 million and $22.3 million at December 31, 2011 and 2010, respectively. Fixed-rate commitments totaled $895,000 (interest rates ranged from 3.63% to 4.38%) and $963,000 (interest rates ranged from 5.13% to 7.00%) at December 31, 2011 and 2010, respectively.
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 15 - Parent Company Only Financial Statements
Presented below are the condensed balance sheets, income statements and statements of cash flows for First Financial Northwest, Inc.
FIRST FINANCIAL NORTHWEST, INC.
Condensed Balance Sheets
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FIRST FINANCIAL NORTHWEST, INC.
Condensed Income Statements
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FIRST FINANCIAL NORTHWEST, INC.
Condensed Statements of Cash Flows
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 - Earnings (Loss) Per Share
The following table presents a reconciliation of the components used to compute basic and diluted earnings (loss) per share.
Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. There were 1,323,524, 1,333,524 and 1,433,524 anti-dilutive shares outstanding related to options to acquire the Company’s common stock at December 31, 2011, 2010 and 2009, respectively.
Note 17 - Other Comprehensive Income (Loss)
The components of other comprehensive income (loss) and related tax effects are as follows:
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of accumulated other comprehensive income included in stockholders’ equity, are as follows:
(Continued)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 18 - Summarized Consolidated Quarterly Financial Data (Unaudited)
The following table presents summarized consolidated quarterly data for each of the last three years.
(Continued)
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
(i) Disclosure Controls and Procedures.
An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) was carried out as of December 31, 2011 under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management. Our Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial and Accounting Officer) concluded that, as of December 31, 2011, our disclosure controls and procedures were effective in ensuring that information we are required to disclose in the reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure, specified in the SEC’s rules and forms.
(ii) Internal Control Over Financial Reporting.
(a) Management’s report on internal control over financial reporting.
First Financial Northwest’s management is responsible for establishing and maintaining adequate internal control over financial reporting. First Financial Northwest’s internal control system is designed to provide reasonable assurance to our management and the Board of Directors regarding the preparation and fair presentation of published financial statements. Nonetheless, all internal control systems, no matter how well designed, have inherent limitations. Even systems determined to be effective as of a particular date can provide only reasonable assurance with respect to financial statement preparation and presentation and may not eliminate the need for restatements.
First Financial Northwest’s management assessed the effectiveness of First Financial Northwest’s internal control over financial reporting as of December 31, 2011. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on our assessment, we believe that, as of December 31, 2011, First Financial Northwest’s internal control over financial reporting is effective based on those criteria.
Moss Adams LLP, an independent registered public accounting firm, has audited the Company’s consolidated financial statements and the effectiveness of our internal control over financial reporting as of December 31, 2011, which is included in Item 8. Financial Statements and Supplementary Data.
(b) Attestation report of the registered public accounting firm.
See Item 8. Financial Statements and Supplementary Data.
(c) Changes in internal control over financial reporting.
There were no significant changes in First Financial Northwest’s internal control over financial reporting during First Financial Northwest’s most recent fiscal quarter that have materially affected or are reasonably likely to materially affect, First Financial Northwest’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
There was no information to be disclosed by us in a report on Form 8-K during the fourth quarter of fiscal 2011 that was not so disclosed.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information required under the section captioned “Proposal 1 -- Election of Directors” in First Financial Northwest’s Definitive Proxy Statement for the 2012 Annual Meeting of Stockholders (“Proxy Statement”) is incorporated herein by reference.
For information regarding the executive officers of First Financial Northwest and the Bank, see the information contained herein under the section captioned “Item 1. Business - Personnel - Executive Officers of the Registrant.”
Audit Committee Financial Expert
Our Audit Committee is composed of Directors Dr. Gary F. Kohlwes (Chairman), Gary F. Faull and Joann E. Lee. Each member of the Audit Committee is “independent” as defined in listing standards of The Nasdaq Stock Market LLC. Our Board of Directors has designated Director Joann E. Lee as the Audit Committee financial expert, as defined in the SEC’s Regulation S-K. Director Joann E. Lee is independent as that term is used in Item 407(d)(5)(i)(B) of SEC’s regulation S-K.
Code of Business Conduct and Ethics
A copy of the Code of Business Conduct and Ethics is available on our website at www.fsbnw.com under Investor Relations - Corporate Overview - Governance Documents. Additionally, any material amendments to, or waiver from a provision of the Code of Business Conduct and Ethics will be posted to the same website.
Compliance with Section 16(a) of the Exchange Act
The information required by this item under the section captioned “Section 16 (a) Beneficial Ownership Reporting Compliance” in the Proxy Statement is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information required by this item under the sections captioned “Executive Compensation” and “Directors’ Compensation” in the Proxy Statement are incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a)
Security Ownership of Certain Beneficial Owners.
The information required by this item under the section captioned “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement is incorporated herein by reference.
(b)
Security Ownership of Management.
The information required by this item under the sections captioned “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement is incorporated herein by reference.
(c) Changes In Control
First Financial Northwest is not aware of any arrangements, including any pledge by any person of securities of First Financial Northwest, the operation of which may at a subsequent date result in a change in control of First Financial Northwest.
(d) Equity Compensation Plan Information
The following table summarizes share and exercise price information about First Financial Northwest’s equity compensation plans as of December 31, 2011.
____________
(1)
The restricted shares granted under the 2008 Equity Incentive Plan were purchased by First Financial Northwest in open market transactions and subsequently issued to First Financial Northwest’s directors and certain employees. As of December 31, 2011, there were 747,034 restricted shares granted pursuant to the 2008 Equity Incentive Plan and 167,078 shares were available for future grants of restricted stock.
Item 13.
Item 13. Certain Relationships and Related Transactions and Director Independence
The information required by this item under the sections captioned “Meetings and Committees of the Board of Directors and Corporate Governance -- Corporate Governance -- Related Party Transactions” and “Meetings and Committees of the Board of Directors and Corporate Governance Matters -- Corporate Governance -- Director Independence” in the Proxy Statement are incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this item under the section captioned “Independent Auditors and Related Fees” in the Proxy Statement is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) Exhibits
3.1
Articles of Incorporation of First Financial Northwest (1)
3.2
Bylaws of First Financial Northwest (1)
Form of stock certificate of First Financial Northwest(1)
10.1
Form of Employment Agreement for President and Chief Executive Officer (1)
10.2
Form of Change in Control Severance Agreement for Executive Officers (1)
10.3
Form of First Savings Bank Employee Severance Compensation Plan (1)
10.4
Form of Supplemental Executive Retirement Agreement entered into by First Savings Bank with Victor Karpiak, Harry A. Blencoe and Robert H. Gagnier (1)
10.5 Form of Financial Institutions Retirement Fund (1)
10.6 Form of 401(k) Retirement Plan (2)
10.7 2008 Equity Incentive Plan (3)
10.8 Forms of incentive and non-qualified stock option award agreements (4)
10.9 Form of restricted stock award agreement (4)
Code of Business Conduct and Ethics (5)
Subsidiaries of the Registrant
Consent of Independent Registered Public Accounting Firm- Moss Adams LLP
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
32.2
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
The following materials from First Financial Northwest’s Annual Report on Form 10-K for the year ended December 31, 2011, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Statements of Income; (3) Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income; (4) Consolidated Statements of Cash Flows; and (5) Selected Notes to Consolidated Financial Statements.*
*Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
_____________
(1)
Filed as an exhibit to First Financial Northwest’s Registration Statement on Form S-1 (333-143539).
(2)
Filed as an exhibit to First Financial Northwest’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 and incorporated herein by reference.
(3)
Filed as Appendix A to First Financial Northwest’s definitive proxy statement dated April 15, 2008.
(4)
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated July 1, 2008.
(5)
Registrant elects to satisfy Regulation S-K §229.406(c) by posting its Code of Ethics on its website at www.fsbnw.com.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/Victor Karpiak
Chairman of the Board, President and Chief
March 9, 2012
Victor Karpiak
Executive Officer
(Principal Executive Officer)
/s/Kari A. Stenslie
Chief Financial Officer
March 9, 2012
Kari A. Stenslie
(Principal Financial and Accounting Officer)
/s/Joann E. Lee
Director
March 9, 2012
Joann E. Lee
/s/Gary F. Kohlwes
Director
March 9, 2012
Gary F. Kohlwes
/s/Robert L. Anderson
Director
March 9, 2012
Robert L. Anderson
/s/Gerald Edlund
Gerald Edlund
Director
March 9, 2012
/s/Gary F. Faull
Director
March 9, 2012
Gary F. Faull
/s/M. Scott Gaspard
Director
March 9, 2012
M. Scott Gaspard
/s/Daniel L. Stevens
Director
March 9, 2012
Daniel L. Stevens
Exhibit Index
Exhibit No. Description
Subsidiaries of the Registrant
Consent of Independent Registered Public Accounting Firm- Moss Adams LLP
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32.1
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
32.2
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
The following materials from First Financial Northwest’s Annual Report on Form 10-K for the year ended December 31, 2011, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Statements of Income; (3) Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income; (4) Consolidated Statements of Cash Flows; and (5) Selected Notes to Consolidated Financial Statements
*Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.