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FFNW > SEC Filings for FFNW > Form 10-Q on 9-May-2013All Recent SEC Filings

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Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements
Certain matters discussed in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to: the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs, that may be affected by deterioration in the housing and commercial real estate markets, and may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our reserves; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; results of examinations of us by the Federal Reserve Bank of San Francisco ("Federal Reserve") and our bank subsidiary by the

Federal Deposit Insurance Corporation ("FDIC"), the Washington State Department of Financial Institutions, Division of Banks ("DFI") or other regulatory authorities, including the possibility that any such regulatory authority may initiate enforcement actions against the Company or the Bank to take corrective action and refrain from unsafe and unsound practices which also may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; our ability to pay dividends on our common stock; our ability to attract and retain deposits; increases in premiums for deposit insurance; our ability to control operating costs and expenses; the use of estimates in determining the fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; computer systems on which we depend could fail or experience a security breach; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our branch expansion strategy; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired or may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; costs and effects of litigation, including settlements and judgments; increased competitive pressures among financial services companies; our ability to reduce our noninterest expenses; changes in consumer spending, borrowing and savings habits; legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, including the interpretation of regulatory capital or other rules, including as a result of Basel III; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd Frank Act") and the implementing regulations; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; the economic impact of war or any terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting our operations; pricing, products and services; and other risks detailed from time to time in our filings with the U.S. Securities and Exchange Commission ("SEC"), including our Annual Report on Form 10-K for the year ended December 31, 2012 ("2012 Form 10-K"). Any of the forward-looking statements that we make in this Form 10-Q and in the other public reports and statements we make may turn out to be wrong because of the inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Because of these and other uncertainties, our actual future results may be materially different from those expressed in any forward-looking statements made by or on our behalf. Therefore, these factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. We undertake no responsibility to update or revise any forward-looking statements.

Regulatory Items

During April 2013, the Memorandum of Understanding ("MOU") by and between the Bank and the FDIC and the DFI (originally effective March 27, 2012) was terminated. Also in April 2013, the MOU by and between First Financial Northwest and the FRB (originally effective April 14, 2010) was terminated. As a result, the Company is no longer required to obtain the approval of the FRB prior to the repurchase of its common stock and for the payment of any cash dividends. The FDIC, DFI and FRB have also terminated the Bank's and First Financial Northwest's "troubled condition" status.


First Savings Bank is a wholly-owned subsidiary of First Financial Northwest and, as such, comprises substantially all of the activity for First Financial 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 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.

Our primary source of revenue 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.

An offset to net interest income is the provision for loan losses, which represents the periodic charge to operations which is required to adequately provide for probable losses inherent in our loan portfolio.

Our noninterest expenses consist primarily of salaries and employee benefits, occupancy and equipment, data processing, OREO-related expenses, professional fees, regulatory assessments and other general and administrative expenses. Salaries and employee 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 expenses, 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 related to the properties included in the OREO inventory.

Net income for the three months ended March 31, 2013 was $1.6 million, or $0.09 per diluted share, as compared to net income of $622,000, or $0.04 per diluted share for the three months ended March 31, 2012. The change in operating results in the first quarter of 2013, as compared to the first quarter of 2012, was primarily the result of a $321,000 decrease in net interest income, a $1.7 million decrease in the provision for loan losses, a $177,000 decrease in noninterest income, an increase of $257,000 in noninterest expense and an $11,000 increase in the provision for federal income taxes.

During the three months ended March 31, 2013, our total loan portfolio decreased $1.1 million, or 0.2% from December 31, 2012, primarily due to a $6.1 million, or 2.0% decrease in one-to-four family residential loans and a $1.3 million, or 1.1% decrease in the multifamily loan portfolio. Our construction/land development loans increased $2.5 million, or 13.0% and commercial real estate loans increased $4.7 million, or 2.1% during the same period.

The following table details our five largest lending relationships at March 31, 2013:

                            Residential                         Commercial Real
                              (Rental                           Estate (Rental         Construction/Land      Aggregate Balance
     Borrower (1)           Properties)       Multifamily         Properties)             Development           of Loans (2)
                                                                     (In thousands)
Real estate builder       $      19,852     $           -     $              96     $               4,436     $        24,384
Real estate investor                  -                 -                18,046                         -              18,046
Real estate builder (3)          14,472                 -                   222                         -              14,694
Real estate investor              8,879             4,021                   926                         -              13,826
Real estate builder (4)          12,795                 -                   806                         -              13,601
Total                     $      55,998     $       4,021     $          20,096     $               4,436     $        84,551


(1) The composition of borrowers represented in the table may change between periods.

(2) Net of LIP.

(3) Of this amount, $13.1 million were considered impaired loans, all of which were performing one-to-four family residential loans.

(4) Of this amount, $12.8 million were considered impaired loans, of which $12.0 million were performing one-to-four family residential loans and $806,000 is a restructured performing commercial real estate loan.

These relationships, which represent 12.7% of our loans, net of undisbursed funds, decreased $1.1 million from December 31, 2012. Of the three builders listed above, two are operating under restructured loan plans established by the Bank. As of March 31, 2013, both continue to perform in accordance with the terms of their respective plans. None of the restructured loans to these two borrowers have ever been delinquent, except for one commercial real estate loan which was restructured and brought current at the end of 2010. The remaining three borrowers were current on their loan payments at March 31, 2013. We monitor the performance of these borrowing relationships very closely due to the concentration risk they possess in relation to the entire loan portfolio.

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 and Lease Losses. Management recognizes that loan losses may occur over the life of a loan and that the ALLL must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Our methodology for analyzing the ALLL consists of two components: general and specific allowances. The

general allowance is determined by applying factors to our various groups of loans. Management considers factors such as charge-off history, 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 collectability 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. 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 ALLL based on their judgments about information available to them at the time of their examination.

Our Audit Committee approves the provision for loan losses on a quarterly basis and the Board of Directors ratifies the Audit Committees' actions. 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 "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," within the section titled "Item 1A. Risk Factors" in our 2012 Form 10-K.

Valuation of OREO and Foreclosed Assets. Real estate properties acquired through foreclosure or by deed-in-lieu of foreclosure are initially recorded at fair value less estimated costs to sell. Fair value is generally determined by management based on a number of factors, including third-party appraisals of fair value in an orderly sale. Accordingly, the valuation of OREO is subject to significant external and internal judgment. If the carrying value of the loan at the date a property is transferred into OREO exceeds the fair value less estimated costs to sell, the excess is charged to the ALLL. Management periodically reviews OREO values to determine whether the property continues to be carried at the lower of its recorded book value or fair value, net of estimated costs to sell. Any further decreases in the value of OREO are considered valuation adjustments and are charged to noninterest expense in the Consolidated Income Statements. Expenses 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 are related to: a) net operating loss carryforwards; b) the ALLL; c) employee benefit plans; d) expenses recognized in our financial statements but disallowed in the tax return until the associated cash flow occurs; and e) write-downs in the value of assets for financial statement purposes that are not deductible for tax purposes until the asset is sold or deemed worthless.

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.

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 advisers or market analysts. Therefore, continued deterioration of market conditions could result in additional impairment losses recognized within the investment portfolio.

Fair Value. FASB ASC 820, Fair Value Measurements and Disclosures, establishes a hierarchical disclosure framework associated with the level of pricing observability utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no pricing observability and a higher degree of judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction.
Comparison of Financial Condition at March 31, 2013 and December 31, 2012

General. At March 31, 2013, total assets decreased $56.0 million to $886.7 million from $942.7 million at December 31, 2012. This decrease in total assets was primarily the result of reductions in interest-bearing deposits of $62.1 million, net loans receivable of $1.1 million and OREO of $1.0 million, partially offset by an increase of $8.5 million in investments available-for-sale. Total liabilities decreased $57.5 million to $698.0 million at March 31, 2013 from $755.5 million at December 31, 2012, primarily due to a decrease of $15.7 million in deposits and $49.1 million in advances from the FHLB, partially offset by a $6.3 million increase in investment transactions payable. Investment transactions payable represents investment securities that have been purchased where the settlement date is in the future. Stockholders' equity increased $1.6 million to $188.7 million at March 31, 2013 from $187.1 million at December 31, 2012, primarily due to net income of $1.6 million for the first quarter of 2013.

Assets. Total assets were $886.7 million at March 31, 2013, a decrease of $56.0 million, or 5.9% from $942.7 million at December 31, 2012. The following table details the changes in the composition of our assets at March 31, 2013 from December 31, 2012.

                                          Balance at        Increase/(Decrease) from            Percent
                                        March 31, 2013          December 31, 2012         Increase/(Decrease)
                                                               (Dollars in thousands)
Cash on hand and in
banks                                 $          4,388     $                  99                      2.3 %
deposits                                        21,303                   (62,149 )                  (74.5 )
Investments available-for-sale, at
fair value                                     160,770                     8,508                      5.6
Loans receivable,
net                                            649,369                    (1,099 )                   (0.2 )
Premises and equipment, net                     17,867                      (206 )                   (1.1 )
FHLB stock, at cost                              7,215                       (66 )                   (0.9 )
Accrued interest receivable                      3,523                        39                      1.1
Deferred tax assets, net                         1,000                         -                        -
OREO                                            16,310                    (1,037 )                   (6.0 )
Prepaid expenses and other assets                4,975                       (24 )                    0.5
Total assets                          $        886,720     $             (55,935 )                   (5.9 )

Interest-bearing deposits decreased $62.1 million to $21.3 million at March 31, 2013, from $83.5 million at December 31, 2012. During the quarter, excess liquidity was used primarily to restructure our FHLB advances, including the repayment of a $50.0 million maturing FHLB advance, as discussed below. We subsequently borrowed a $34.0 million fixed-rate FHLB advance at a rate of 0.81%. Investments available-for-sale increased $8.5 million, or 5.6% to $160.8 million at March 31, 2013, from $152.3 million at December 31, 2012. Net loans receivable decreased $1.1 million to $649.4 million at March 31, 2013 from December 31, 2012. Loan originations for the quarter were $28.6 million, of which $10.9 million and $11.3 million were in one-to-four family residential and commercial real estate loans, respectively. Principal repayments for the loan portfolio during the quarter were $26.0 million and loans transferred to OREO were $3.4 million. OREO decreased $1.0 million, or 6.0% to $16.3 million at March 31, 2013, from $17.3 million at December 31, 2012 as we continue to sell our inventory of foreclosed real estate.

As of March 31, 2013, the consolidated balance sheet included gross deferred tax assets of $20.4 million and a deferred tax asset valuation allowance of $16.5 million. The remaining $19.8 million of tax benefits may be recognized in the future if the Company remains profitable. Deferred tax liabilities totaled $2.9 million, resulting in a net deferred tax asset of $1.0 million at March 31, 2013.

Deposits. During the first three months of 2013, deposits decreased $15.7 million to $650.1 million at March 31, 2013, compared to $665.8 million at December 31, 2012. Deposit accounts consisted of the following:

                                     Balance at March       Increase/ (Decrease)             Percent
                                         31, 2013          from December 31, 2012      Increase/(Decrease)
                                                             (Dollars in thousands)
Noninterest-bearing                 $           6,201     $               47                      0.8 %
NOW                                            17,386                  1,442                      9.0
Statement savings                              18,319                     46                      0.3
Money market                                  154,858                 (6,861 )                   (4.2 )
Certificates of deposit                       453,370                (10,337 )                   (2.2 )
                                    $         650,134     $          (15,663 )                   (2.4 )

NOW accounts increased $1.4 million during the first quarter of 2013, offset by decreases of $6.9 million and $10.3 million in money market accounts and certificates of deposit, respectively. The decrease in certificates of deposit was primarily the result of our strategy to utilize our excess liquidity, mainly cash, to reduce higher-cost deposits by competing less aggressively on deposit interest rates. We believe customers who were more interest rate sensitive elected to withdraw their funds to invest in higher yielding investment products, which contributed to the decline in our deposit balances. Included in the certificates of deposit balance at March 31, 2013 was $11.9 million in public funds. We did not have any brokered deposits at March 31, 2013 or December 31, 2012.

Advances. We use advances from the FHLB as an alternative funding source to manage funding costs, reduce interest rate risk and to leverage our balance sheet. Total FHLB advances at March 31, 2013 were $34.0 million, a decrease of $49.1 million from December 31, 2012. During the quarter, we repaid a $50.0 million maturing FHLB advance with an interest rate of 2.17% and prepaid $33.0 . . .

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