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FFNW > SEC Filings for FFNW > Form 10-Q on 7-Aug-2013All Recent SEC Filings

Show all filings for FIRST FINANCIAL NORTHWEST, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for FIRST FINANCIAL NORTHWEST, INC.


7-Aug-2013

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.

Overview

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 June 30, 2013 was $16.4 million or $0.95 per diluted share, as compared to net income of $1.4 million or $0.08 per diluted share for the three months ended June 30, 2012. The improvement in operating results in the second quarter of 2013, as compared to the second quarter of 2012 was the result of a partial reversal of the deferred tax asset valuation allowance of $13.8 million, a $1.3 million decrease in total noninterest expense, a $544,000 increase in net interest income and a $550,000 reduction in the provision for loan losses partially offset by a $175,000 decrease in noninterest income. The decrease in total noninterest expense includes reductions of $709,000 in net OREO-related expenses, $588,000 in proxy contest and related litigation expense and $220,000 in FDIC deposit insurance premiums, partially offset by an increase of $304,000 in salaries and employee benefits

For the six months ended June 30, 2013, the Company had net income of $17.9 million, or $1.03 per diluted share, as compared to net income of $2.0 million, or $0.11 per diluted share for the comparable period in 2012. The improvement in operating results for the six months ended June 30, 2013, as compared to the same period last year was the result of a partial reversal of the deferred tax asset valuation allowance of $13.8 million, a $223,000 increase in net interest income, a $2.3 million decrease in the provision for loan losses and a $1.0 million decrease in noninterest expense, partially offset by a $352,000 decrease in noninterest income. The $1.0 million decrease in noninterest expense was comprised of reductions of $1.4 million in net OREO-related expenses, $499,000 in proxy contest and related litigation expenses, $198,000 in professional fees and $101,000 in occupancy and equipment partially offset by a $679,000 increase in prepayment penalties on FHLB advances and a $491,000 increase in salaries and employee benefits.

During the six months ended June 30, 2013, our total loan portfolio increased $10.4 million, or 1.6% from December 31, 2012, primarily due to a $15.2 million, or 6.9% increase in commercial real estate loans and a $10.0 million, or 51.4% increase in construction/land development loans partially offset by a $12.1 million, or 4.0% decrease in one-to-four family residential loans. Our multifamily loan portfolio balance was basically unchanged since December 31, 2012.

The following table details our five largest lending relationships at June 30, 2013:


                            One-to-Four
                              Family
                            Residential                         Commercial Real
                              (Rental                           Estate (Rental         Construction/Land      Aggregate Balance
     Borrower (1)           Properties)       Multifamily         Properties)             Development           of Loans (2)
                                                                     (In thousands)
Real estate builder       $      18,484     $           -     $              95     $               3,875     $        22,454
Real estate investor                  -                 -                18,020                         -              18,020
Real estate builder (3)          14,418                 -                   220                         -              14,638
Real estate investor              8,845             4,004                 1,714                         -              14,563
Real estate builder (4)          12,747                 -                   803                         -              13,550
Total                     $      54,494     $       4,004     $          20,852     $               3,875     $        83,225


________


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

(2) Net of LIP.

(3) Of this amount, $13.3 million were considered impaired loans, all of which were performing one-to-four family residential loans.

(4) Of this amount, $12.7 million were considered impaired loans, of which $11.9 million were performing one-to-four family residential loans and $803,000 is a restructured performing commercial real estate loan.

These relationships, which represent 12.4% of our loans, net of undisbursed funds, decreased $2.4 million from December 31, 2012. Of the three builders listed above, two are operating under restructured loan plans established by the Bank. As of June 30, 2013, the loans to both builders 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 June 30, 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

Our significant accounting policies are fundamental to understanding our results of operations and financial condition because they require that we use estimates and assumptions that may affect the value of our assets or liabilities and our financial results. These policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. These policies govern the allowance for loan and lease losses ("ALLL"), the valuation of OREO and foreclosed assets, and the calculation of deferred taxes, fair values and other-than-temporary impairments on the market value of investments. These policies and estimates are described in further detail in

Part II, Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations and Note 1, Summary of Significant Accounting Policies within the 2012 Form 10-K. There have not been any material changes in the Company's critical accounting policies and estimates as compared to the disclosure contained in the Company's 2012 Form 10-K.

Comparison of Financial Condition at June 30, 2013 and December 31, 2012

General. At June 30, 2013, total assets decreased $40.4 million to $902.2 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 $55.6 million and OREO of $3.1 million, partially offset by increases of $13.9 million in net deferred tax assets, $3.3 million in net loans receivable and $1.4 million in cash on hand. Total liabilities decreased $40.4 million to $715.1 million at June 30, 2013 from $755.5 million at December 31, 2012, primarily due to decreases of $35.0 million in deposits and $9.1 million in advances from the FHLB, partially offset by a $2.7 million increase in investment transactions payable. Stockholders' equity decreased $42,000 to $187.1 million from December 31, 2012, primarily the result of net income of $17.9 million generated during the six months ended June 30, 2013 and share-based compensation of $1.5 million offset by $16.5 million related to the repurchase and retirement of common stock, a $2.6 million decline in accumulated other comprehensive income and the payment of $658,000 in dividends to shareholders.

Assets. Total assets were $902.2 million at June 30, 2013, a decrease of $40.4 million, or 4.3% from $942.7 million at December 31, 2012. The following table details the changes in the composition of our assets at June 30, 2013 from December 31, 2012.


                                         Balance at        Increase/(Decrease) from            Percent
                                        June 30, 2013          December 31, 2012         Increase/(Decrease)
                                                               (Dollars in thousands)
Cash on hand and in
banks                                 $         5,682     $               1,393                    32.5  %
Interest-bearing
deposits                                       27,837                   (55,615 )                 (66.6 )
Investments available-for-sale, at
fair value                                    152,664                       402                     0.3
Loans receivable,
net                                           653,757                     3,289                     0.5
Premises and equipment, net                    17,679                      (394 )                  (2.2 )
FHLB stock, at cost                             7,149                      (132 )                  (1.8 )
Accrued interest receivable                     3,633                       149                     4.3
Deferred tax assets, net                       14,870                    13,870                 1,387.0
OREO                                           14,226                    (3,121 )                 (18.0 )
Prepaid expenses and other assets               4,718                      (281 )                  (5.6 )
Total assets                          $       902,215     $             (40,440 )                  (4.3 )%

Interest-bearing deposits decreased $55.6 million to $27.8 million at June 30, 2013, from $83.5 million at December 31, 2012. During the six months ended June 30, 2013, excess liquidity was used primarily to fund maturing certificates of deposit and restructure our FHLB advances by prepaying $33.1 million with a weighted-average interest rate of 2.93% and contemporaneously borrowing a three year $34.0 million fixed-rate FHLB advance at a rate of 0.81%. In addition, during the six months ended June 30, 2013, we repaid a $50.0 million maturing FHLB advance with an interest rate of 2.17% and borrowed $40.0 million in FHLB fixed-rate advances at an average rate of 79 basis points to fund our loan growth. Investments available-for-sale increased $402,000, or 0.3% to $152.7 million at June 30, 2013, from $152.3 million at December 31, 2012. Net loans receivable increased $3.3 million to $653.8 million at June 30, 2013 from December 31, 2012. Loan originations for the six months ended June 30, 2013 were $82.8 million, of which $26.3 million and $30.8 million were in one-to-four family residential and commercial real estate loans, respectively. Principal repayments for the loan portfolio during the six months ended June 30, 2013 were $62.8 million and loans transferred to OREO were $5.4 million. OREO decreased $3.1 million, or 18.0% to $14.2 million at June 30, 2013, from $17.3 million at December 31, 2012 as we continue to sell our inventory of foreclosed real estate.

During the second quarter of 2013, we sold $30.0 million of low yielding, adjustable-rate, agency securities and purchased $23.9 million of fixed-rate investments and $7.1 million of adjustable-rate investments. These purchases included mortgage-backed securities, collateralized mortgage obligations ("CMOs") securities and investment grade corporate bonds offering significantly higher yields than the securities sold during the quarter. The yields on the securities purchased during the quarter range from 0.98% to 2.36% as compared to the yields on the securities sold which ranged from 0.24% to 0.45%.

As of June 30, 2013, the consolidated balance sheet included gross deferred tax assets of $20.0 million and a deferred tax asset valuation allowance of $2.6 million. Management anticipates utilizing $2.1 million of the remaining valuation allowance to offset our projected tax expense in the third and fourth quarters of 2013. The remaining $545,000 deferred tax asset valuation allowance which related to a capital loss carryforward will most likely not be recognized. The ultimate utilization of the remaining valuation allowance and realization of deferred tax assets is dependent upon the Company remaining profitable. Deferred tax liabilities totaled $2.5 million, resulting in a net deferred tax asset of $14.9 million at June 30, 2013.

Deposits. During the first six months of 2013, deposits decreased $35.0 million to $630.8 million at June 30, 2013, compared to $665.8 million at December 31, 2012. Deposit accounts consisted of the following:


                                     Balance at June       Increase/ (Decrease)
                                         30, 2013         from December 31, 2012    Percent Increase/(Decrease)
                                                               (Dollars in thousands)
Noninterest-bearing                 $          7,948     $            1,794                       29.2  %
NOW                                           17,432                  1,488                        9.3
Statement savings                             18,526                    253                        1.4
Money market                                 147,217                (14,502 )                     (9.0 )
Certificates of deposit                      439,714                (23,993 )                     (5.2 )
                                    $        630,837     $          (34,960 )                     (5.3 )%

Money market and certificates of deposit accounts decreased $14.5 million and $24.0 million, respectively, during the first six months of 2013 partially offset by increases of $1.8 million and $1.5 million in noninterest-bearing and NOW accounts for the same period. 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 June 30, 2013 was $10.7 million in public funds compared to $1.8 million in public funds at December 31, 2012. We did not have any brokered deposits at June 30, 2013 or December 31, 2012.

FHLB 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 June 30, 2013 were $74.0 million, a decrease of $9.1 million from December 31, 2012. During the six months ended June 30, 2013, we restructured our balance sheet by prepaying $33.1 million in FHLB advances with a weighted-average interest rate of 2.93% incurring a prepayment penalty of $679,000 which were replaced with a $34.0 million three year advance from the FHLB at 0.81%. In January 2013, a $50.0 million advance from the FHLB, with an interest rate of 2.17%, matured and was not renewed. In addition, during the second quarter of 2013, we borrowed $40.0 million in FHLB fixed-rate advances at an average interest rate of 0.79%, of which $20.0 million will mature in May 2016 and the remaining $20.0 million will mature in April 2017. These funds were borrowed to fund our loan growth.

Stockholders' Equity. Total stockholders' equity decreased $42,000 to $187.1 million at June 30, 2013 from approximately the same amount at December 31, 2012. The decrease was primarily the result of net income of $17.9 million generated during the six months ended June 30, 2013 and share-based compensation of $1.5 million offset by $16.5 million related to the repurchase and retirement of common stock and a $2.6 million decline in accumulated other comprehensive income which includes the unrealized loss, net of taxes, on investments available-for-sale. During the period, we also paid $658,000 in dividends to shareholders. The decline in accumulated other comprehensive income reflects the recent rise in long-term market interest rates that reduced the fair value of our investment portfolio.

Comparison of Operating Results for the Three and Six Months Ended June 30, 2013 and 2012

General. Net income for the quarter ending June 30, 2013 was $16.4 million, an increase of $15.0 million from $1.4 million for the comparable quarter in the prior year. The increase in net income was due to a $13.8 million federal income tax benefit related to the partial reversal of the valuation allowance on deferred tax assets, a $544,000 increase in net interest income, a $550,000 reduction in the provision for loan losses and a $1.3 million decrease in noninterest expense, partially offset by a $175,000 decrease in noninterest income.

Net Interest Income. Net interest income for the quarter ended June 30, 2013 increased $544,000 to $7.8 million, as compared to $7.3 million for the same quarter in 2012. The increase was attributable to a $1.3 million decrease in interest expense partially offset by a $715,000 decrease in interest income. Average interest-earning assets decreased $117.7 million to $841.6 million for the three months ended June 30, 2013, from the same quarter in 2012 primarily due to a decrease in the average balance of our interest-bearing deposits of $127.4 million partially offset by an increase of $12.4 million in the average balance of investments available-for-sale. Average interest-bearing liabilities decreased $128.5 million to $686.9 million for the second quarter of 2013 compared to the second quarter of 2012, primarily due to declines in the average balance of our money market accounts, certificates of deposit and FHLB advances of $17.2 million, $90.3 million and $24.5 million, respectively. During the same period, our yield on interest-earning assets increased 26 basis points while our cost of funds decreased 45 basis points. Our interest rate spread for the quarter ended June 30, 2013 increased 71 basis points to 3.51% compared to 2.80% for the second quarter of 2012. Our net interest margin for the second quarter of 2013 increased 68 basis points to 3.71% from 3.03% for the same quarter last year. The


ratio of average interest-earning assets to average interest-bearing liabilities increased to 122.52% at June 30, 2013, from 117.64% at June 30, 2012, reflecting our efforts to convert nonearning assets to earning assets, resulting in a more efficient balance sheet.

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