UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2020
or
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number: 001-36741
FIRST NORTHWEST BANCORP
(Exact name of registrant as specified in its charter)
Washington
46-1259100
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer I.D. Number)
105 West 8th Street, Port Angeles, Washington
98362
(Address of principal executive offices)
(Zip Code)
Registrant's telephone number, including area code:
(360) 457-0461
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Trading Symbol(s):
Name of each exchange on which registered:
Common Stock, par value $0.01 per share
FNWB
The Nasdaq Stock Market LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: As of August 4, 2020, there were 10,302,737 shares of common stock, $0.01 par value per share, outstanding.
TABLE OF CONTENTS
PART 1 - FINANCIAL INFORMATION
Page
Item 1 - Financial Statements (Unaudited)
3
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations
33
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
49
Item 4 - Controls and Procedures
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
50
Item 1A - Risk Factors
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
Item 3 - Defaults Upon Senior Securities
51
Item 4 - Mine Safety Disclosures
Item 5 - Other Information
Item 6 - Exhibits
52
SIGNATURES
53
As used in this report, the terms, “we,” “our,” and “us,” and “Company” refer to First Northwest Bancorp ("First Northwest") and its consolidated subsidiary, unless the context indicates otherwise. When we refer to “First Federal” or the “Bank” in this report, we are referring to First Federal Savings and Loan Association of Port Angeles, the wholly owned subsidiary of First Northwest Bancorp.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
FIRST NORTHWEST BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share information) (Unaudited)
June 30, 2020
December 31, 2019
ASSETS
Cash and due from banks
Interest-bearing deposits in banks
Investment securities available for sale, at fair value
Loans held for sale
Loans receivable (net of allowance for loan losses of $12,109 and $9,628)
Federal Home Loan Bank (FHLB) stock, at cost
Accrued interest receivable
Premises and equipment, net
Mortgage servicing rights, net
Bank-owned life insurance, net
Prepaid expenses and other assets
Total assets
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Borrowings
Accrued interest payable
Accrued expenses and other liabilities
Advances from borrowers for taxes and insurance
Total liabilities
Shareholders' Equity
Preferred stock, $0.01 par value, authorized 5,000,000 shares, no shares issued or outstanding
Common stock, $0.01 par value, authorized 75,000,000 shares; issued and outstanding 10,432,963 shares at June 30, 2020, and 10,731,639 shares at December 31, 2019
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss), net of tax
Unearned employee stock ownership plan (ESOP) shares
Total shareholders' equity
Total liabilities and shareholders' equity
See selected notes to the consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data) (Unaudited)
Three Months Ended
Six Months Ended
June 30,
2020
2019
INTEREST INCOME
Interest and fees on loans receivable
Interest on mortgage-backed securities
Interest on investment securities
Interest on deposits and other
FHLB dividends
Total interest income
INTEREST EXPENSE
Total interest expense
Net interest income
PROVISION FOR LOAN LOSSES
Net interest income after provision for loan losses
NONINTEREST INCOME
Loan and deposit service fees
Mortgage servicing fees, net of amortization
Net gain on sale of loans
Net gain on sale of investment securities
Increase in cash surrender value of bank-owned life insurance
Other income
Total noninterest income
NONINTEREST EXPENSE
Compensation and benefits
Data processing
Occupancy and equipment
Supplies, postage, and telephone
Regulatory assessments and state taxes
Advertising
Professional fees
FDIC insurance premium
FHLB prepayment penalty
Other expense
Total noninterest expense
INCOME BEFORE PROVISION FOR INCOME TAXES
PROVISION FOR INCOME TAXES
NET INCOME
Basic and diluted earnings per common share
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(In thousands) (Unaudited)
Other comprehensive income:
Income tax provision related to unrealized holding gains
Reclassification adjustment for gains on sales of securities realized in income
Other comprehensive income, net of tax
COMPREHENSIVE INCOME
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Three Months Ended June 30, 2020 and 2019
Common Stock
Additional Paid-in
Retained
Unearned ESOP
Total Shareholders'
Shares
Amount
Capital
Earnings
Income, Net of Tax
Equity
BALANCE, March 31, 2019
Net income
Common stock repurchased
Share-based compensation
ESOP shares committed to be released
Cash dividends declared and paid ($0.03 per share)
BALANCE, June 30, 2019
BALANCE, March 31, 2020
Restricted stock award forfeitures net of grants
Cash dividends declared and paid ($0.05 per share)
BALANCE, June 30, 2020
BALANCE, December 31, 2018
Cash dividends declared and paid ($0.06 per share)
BALANCE, December 31, 2019
Restricted stock award grants net of forfeitures
Cash dividends declared and paid ($0.10 per share)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30,
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization
Amortization and accretion of premiums and discounts on investments, net
(Accretion) amortization of deferred loan fees, net
Amortization of mortgage servicing rights, net
Additions to mortgage servicing rights, net
Net increase (decrease) on the valuation allowance on mortgage servicing rights
Provision for loan losses
Allocation of ESOP shares
Gain on sale of loans, net
Gain on sale of securities available for sale, net
Increase in cash surrender value of life insurance, net
Origination of loans held for sale
Proceeds from loans held for sale
Change in assets and liabilities:
Increase in accrued interest receivable
Increase in prepaid expenses and other assets
Decrease in accrued interest payable
Increase in accrued expenses and other liabilities
Net cash from operating activities
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of securities available for sale
Proceeds from maturities, calls, and principal repayments of securities available for sale
Proceeds from sales of securities available for sale
Proceeds from maturities, calls, and principal repayments of securities held to maturity
(Purchase) redemption of FHLB stock
Net increase in loans receivable
Purchase of premises and equipment, net
Net cash from investing activities
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits
Proceeds from long-term FHLB advances
Repayment of long-term FHLB advances
Net decrease in short-term FHLB advances
Net increase in advances from borrowers for taxes and insurance
Dividends paid
Repurchase of common stock
Net cash from financing activities
NET INCREASE IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS, beginning of period
CASH AND CASH EQUIVALENTS, end of period
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest on deposits and borrowings
Income taxes
NONCASH INVESTING ACTIVITIES
Unrealized gain on securities available for sale
Loans transferred to real estate owned and repossessed assets, net of deferred loan fees and allowance for loan losses
Lease liabilities arising from obtaining right-of-use assets
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Basis of Presentation and Critical Accounting Policies
Organization and Nature of business - First Northwest Bancorp, a Washington corporation, became the holding company of First Federal Savings and Loan Association of Port Angeles on January 29, 2015, upon completion of the Bank's conversion from a mutual to stock form of organization (the "Conversion"). In connection with the Conversion, the Company issued an aggregate of 12,167,000 shares of common stock at an offering price of $10.00 per share for gross proceeds of $121.7 million. An additional 933,360 shares of Company common stock and $400,000 in cash were contributed to the First Federal Community Foundation ("Foundation"), a charitable foundation that was established in connection with the Conversion, resulting in the issuance of a total of 13,100,360 shares. The Company received $117.6 million in net proceeds from the stock offering of which $58.4 million were contributed to the Bank upon Conversion.
Pursuant to the Bank's Plan of Conversion (the "Plan") adopted by its Board of Directors, and as approved by its members, the Company established an employee stock ownership plan ("ESOP"). On December 18, 2015, the ESOP completed its open market purchases, with funds borrowed from the Company, of 8% of the common stock issued in the Conversion for a total of 1,048,029 shares.
First Northwest's business activities generally are limited to passive investment activities and oversight of its investment in First Federal. Accordingly, the information set forth in this report, including the consolidated unaudited financial statements and related data, relates primarily to the Bank.
The Bank is a community-oriented financial institution providing commercial and consumer banking services to individuals and businesses in Western Washington State with offices in Clallam, Jefferson, Kitsap, King, and Whatcom counties. These services include deposit and lending transactions that are supplemented with borrowing and investing activities.
Basis of presentation - The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by U.S. Generally Accepted Accounting Principles ("GAAP") for complete financial statements. These unaudited interim consolidated financial statements should be read in conjunction with our audited consolidated financial statements and accompanying notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2019. In our opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the consolidated financial statements in accordance with GAAP have been included. Operating results for the three and six months ended June 30, 2020, are not necessarily indicative of the results that may be expected for future periods.
In preparing the unaudited interim consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to a determination of the allowance for loan losses ("ALLL"), fair value of financial instruments, and deferred tax assets and liabilities.
Principles of consolidation - The accompanying consolidated financial statements include the accounts of First Northwest Bancorp and its wholly owned subsidiary, First Federal. All material intercompany accounts and transactions have been eliminated in consolidation.
Subsequent Events - The Company has evaluated subsequent events for potential recognition and disclosure and has included additional information where appropriate.
Recently adopted accounting pronouncements
In August 2018, FASB issued ASU No. 2018-13, Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement, which removes, modifies, and adds certain disclosure requirements related to fair value measurements in ASC 820. This guidance eliminates certain disclosure requirements for fair value measurements: the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, an entity’s policy for the timing of transfers between levels of the fair value hierarchy and an entity’s valuation processes for Level 3 fair value measurements. This guidance also adds new disclosure requirements for public entities: changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements of instruments held at the end of the reporting period, and the range and weighted average of significant unobservable inputs used to develop recurring and nonrecurring Level 3 fair value measurements, including how the weighted average is calculated. Furthermore, this guidance modifies certain requirements which will involve disclosing: transfers into and out of Level 3 of the fair value hierarchy, purchases and issuances of Level 3 assets and liabilities, and information about the measurement uncertainty of Level 3 fair value measurements as of the reporting date. This guidance is effective for public companies in fiscal years beginning after December 15, 2019, with early adoption permitted. This ASU did not have a material impact on the Company's consolidated financial statements.
In August 2018, FASB issued ASU No. 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, to provide guidance on implementation costs incurred in a cloud computing arrangement that is a service contract. The ASU aligns the accounting for such costs with the guidance on capitalizing costs associated with developing or obtaining internal-use software. Specifically, the ASU amends ASC 350 to include in its scope implementation costs of such arrangements that are service contracts and clarifies that a customer should apply ASC 350-40 to determine which implementation costs should be capitalized. This ASU, which is effective for fiscal years beginning after December 15, 2019, did not have a material impact on the Company’s financial statements.
In March 2020, the FASB issued ASU No. 2020-03, Codification Improvements to Financial Instruments. The amendments represent clarification and improvements to the codification and correct unintended application. This standard was effective immediately upon issuance and its adoption did not have a material effect on the Company’s financial statements.
Recently issued accounting pronouncements not yet adopted
Credit Losses
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Loss, which updates the guidance on recognition and measurement of credit losses for financial assets. The new requirements, known as the current expected credit loss model (CECL) will require entities to adopt an impairment model based on expected losses rather than incurred losses. ASU No. 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Upon adoption, the Company will change processes and procedures to calculate the allowance for loan losses, including changes in assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. In addition, the current accounting policy and procedures for other-than-temporary impairment on investment securities available for sale will be replaced with an allowance approach.
Additional updates were issued in ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging (Topic 825), Financial Instruments. This ASU clarifies and improves guidance related to the previously issued standards on credit losses, hedging and recognition and measurement of financial instruments. The amendments provide entities with various measurement alternatives and policy elections related to accounting for credit losses and accrued interest receivable balances. Entities are also able to elect a practical expedient to separately disclose the total amount of accrued interest included in the amortized cost basis as a single balance to meet certain disclosure requirements. The amendments clarify that the estimated allowance for credit losses should include all expected recoveries of financial assets and trade receivables that were previously written off and expected to be written off. The amendments also allow entities to use projections of future interest rate environments when using a discounted cash flow method to measure expected credit losses on variable-rate financial instruments.
In addition, new updates were issued through ASU No. 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief. This amendment allows entities to elect the fair value option on certain financial instruments. On adoption, an entity is allowed to irrevocably elect the fair value option on an instrument-by-instrument basis. This alternative is available for all instruments in the scope of Subtopic 326-20 except for existing held-to-maturity debt securities. If an entity elects the fair value option, the difference between the instrument’s fair value and carrying amount is recognized as a cumulative-effect adjustment.
In November 2019, the FASB issued ASU 2019-10 which defers the effective date for this guidance for smaller reporting companies from the interim and annual periods beginning after December 15, 2020 to the interim and annual periods beginning after December 15, 2022. Early adoption is permitted for interim and annual periods beginning after December 15, 2018. The Company plans to defer adoption of CECL until January 1, 2023.
The Company is evaluating the provisions of ASU No. 2016-13, ASU No. 2019-04 and ASU No. 2019-05, and will closely monitor developments and additional guidance to determine the potential impact on the Company’s consolidated financial statements. At this time, we cannot reasonably estimate the impact the implementation of these ASUs will have on the Company's consolidated financial statements. The Company's internal project management team continues to review models, work with our third-party vendor, and discuss changes to processes and procedures to ensure the Company is fully compliant with the amendments at the adoption date.
Other Pronouncements
In December 2019, FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. ASU 2019-12 simplifies various aspects related to accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The standard also clarifies and amends existing guidance to improve consistent application. This ASU, which is effective for fiscal years beginning after December 15, 2020, is not expected to have a material impact on the Company's financial statements. Early adoption is permitted.
In January 2020, the FASB issued ASU No. 2020-01, Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)-Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. ASU 2020-01 clarifies the interaction between accounting standards related to equity securities, equity method investments, and certain derivatives including accounting for the transition into and out of the equity method and measuring certain purchased options and forward contracts to acquire investments. The ASU, which is effective for fiscal years beginning after December 15, 2020, is not expected to have a material effect on the Company's financial statements.
In March 2020, the FASB issued ASU No. 2020-04 Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. ASU 2020-04 provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. The amendments are effective for the Company as of March 12, 2020 through December 31, 2022. The Company does not believe this standard will have a material impact on its financial statements.
Reclassifications - Certain amounts in the unaudited interim consolidated financial statements for prior periods have been reclassified to conform to the current unaudited financial statement presentation with no effect on net income or shareholders' equity.
Note 2 - Securities
The amortized cost, gross unrealized gains and losses, and estimated fair value of securities classified as available-for-sale at June 30, 2020 are summarized as follows:
Gross
Estimated
Amortized Cost
Unrealized Gains
Unrealized Losses
(In thousands)
Available for Sale
Municipal bonds
U.S. government agency issued asset-backed securities (ABS agency)
Corporate issued asset-backed securities (ABS corporate)
Corporate issued debt securities (Corporate debt)
U.S. Small Business Administration securities (SBA)
Mortgage-backed securities:
U.S. government agency issued mortgage-backed securities (MBS agency)
Corporate issued mortgage-backed securities (MBS corporate)
Total securities available for sale
The amortized cost, gross unrealized gains and losses, and estimated fair value of securities classified as available-for-sale at December 31, 2019, are summarized as follows:
ABS agency
ABS corporate
Corporate debt
SBA
MBS agency
MBS corporate
There were no securities classified as held-to-maturity at June 30, 2020 and December 31, 2019.
The following shows the unrealized gross losses and fair value of the investment portfolio by length of time that individual securities in each category have been in a continuous loss position as of June 30, 2020:
Less Than Twelve Months
Twelve Months or Longer
Total
Gross Unrealized Losses
Fair Value
Total available for sale
The following shows the unrealized gross losses and fair value of the investment portfolio by length of time that individual securities in each category have been in a continuous loss position as of December 31, 2019:
The Company may hold certain investment securities in an unrealized loss position that are not considered other than temporarily impaired ("OTTI"). At June 30, 2020 and December 31, 2019, there were 33 and 62 investment securities in an unrealized loss position, respectively.
We believe that the unrealized losses on our investment securities relate principally to the general change in interest rates, market demand, and related volatility, rather than credit quality, that has occurred since the initial purchase, and such unrecognized losses or gains will continue to vary with general interest rate level and market fluctuations in the future. Certain investments in a loss position are guaranteed by government entities or government sponsored entities. The Company does not intend to sell the securities in an unrealized loss position and believes it is not likely it will be required to sell these investments prior to a market price recovery or maturity.
There were no OTTI losses during the three and six months ended June 30, 2020 and 2019.
The amortized cost and estimated fair value of investment securities by contractual maturity are shown in the following tables at the dates indicated. Expected maturities of mortgage-backed securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties; therefore, these securities are shown separately.
Available-for-Sale
Estimated Fair Value
Due within one year
Due after one through five years
Due after five through ten years
Due after ten years
Total mortgage-backed securities
All other investment securities:
Total all other investment securities
Total investment securities
Sales of securities available-for-sale for the periods shown are summarized as follows:
Three Months Ended June 30,
Proceeds from sales
Gross realized gains
Gross realized losses
Note 3 - Loans Receivable
Loans receivable consisted of the following at the dates indicated:
Real Estate:
One-to-four family
Multi-family
Commercial real estate
Construction and land
Total real estate loans
Consumer:
Home equity
Auto and other consumer
Total consumer loans
Commercial business loans
Total loans
Less:
Net deferred loan fees
Premium on purchased loans, net
Allowance for loan losses
Total loans receivable, net
Allowance for Loan Losses. The Company maintains a general allowance for loan losses based on evaluating known and inherent risks in the loan portfolio, including management’s continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, and current and anticipated economic conditions. The reserve is an estimate based upon factors and trends identified by management at the time the financial statements are prepared.
The following tables summarize changes in the ALLL and loan portfolio by segment and impairment method for the periods shown:
At or For the Three Months Ended June 30, 2020
One-to-
Commercial
Construction
Home
Auto and other
four family
real estate
and land
equity
consumer
business
Unallocated
ALLL:
Beginning balance
Provision for (recapture of) loan losses
Charge-offs
Recoveries
Ending balance
At or For the Six Months Ended June 30, 2020
At June 30, 2020
Total ALLL
General reserve
Specific reserve
Loans collectively evaluated (1)
Loans individually evaluated (2)
(1) Loans collectively evaluated for general reserves.
(2) Loans individually evaluated for specific reserves.
At or For the Three Months Ended June 30, 2019
(Recapture of) provision for loan losses
At or For the Six Months Ended June 30, 2019
At December 31, 2019
Impaired loans. A loan is considered impaired when First Federal has determined that it may be unable to collect payments of principal or interest when due under the contractual terms of the loan. Impairment is measured on a loan-by-loan basis for all loans in the portfolio except smaller balance homogeneous loans and certain qualifying troubled debt restructuring ("TDR") loans.
The following table presents a summary of loans individually evaluated for impairment by portfolio segment at the dates indicated:
Recorded Investment
Unpaid Principal Balance
Related Allowance
With no allowance recorded:
Commercial business
With an allowance recorded:
Total impaired loans:
Average Recorded Investment
Interest Income Recognized
Interest income recognized on a cash basis on impaired loans for the three and six months ended June 30, 2020, was $56,000 and $126,000, respectively.
The following table presents the average recorded investment in loans individually evaluated for impairment and the related interest income recognized for the periods shown:
June 30, 2019
Interest income recognized on a cash basis on impaired loans for the three and six months ended June 30, 2019, was $94,000 and $183,000, respectively.
The following table presents the recorded investment in nonaccrual loans by class of loan at the dates indicated:
Total nonaccrual loans
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. There were no loans past due 90 days or more and still accruing interest at June 30, 2020 and December 31, 2019.
The following table presents past due loans, net of partial loan charge-offs, by class, as of June 30, 2020:
30-59 Days
60-89 Days
90 Days or More
Past Due
Current
Total Loans
The following table presents past due loans, net of partial loan charge-offs, by class, as of December 31, 2019:
Credit quality indicator. Federal regulations provide for the classification of lower quality loans and other assets, such as debt and equity securities, as substandard, doubtful, or loss; risk ratings 6, 7, and 8 in our 8-point risk rating system, respectively. An asset is considered substandard if it is inadequately protected by the current net worth and pay capacity of the borrower or of any collateral pledged. Substandard assets include those characterized by the distinct possibility that First Federal will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all the weaknesses inherent in those classified 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 those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
When First Federal classifies problem assets as either substandard or doubtful, it may establish a specific allowance to address the risk specifically or allow the loss to be addressed in the general allowance. General allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities but that, unlike specific allowances, have not been specifically allocated to certain problem assets. When an insured institution classifies problem assets as a loss, it is required to charge off such assets in the period in which they are deemed uncollectible. Assets that do not currently expose First Federal to enough risk to warrant classification as substandard or doubtful but do possess identified weaknesses are designated as either watch or special mention assets; risk ratings 4 and 5 in our risk rating system, respectively. Loans not otherwise classified are considered pass graded loans and are rated 1-3 in our risk rating system.
Additionally, First Federal categorizes loans as performing or nonperforming based on payment activity. Loans that are more than 90 days past due and nonaccrual loans are considered nonperforming.
The following table represents the internally assigned grade as of June 30, 2020, by class of loans:
Pass
Watch
Special Mention
Substandard
The following table represents the internally assigned grade as of December 31, 2019, by class of loans:
The following table represents the credit risk profile based on payment activity as of June 30, 2020, by class of loans:
Nonperforming
Performing
The following table represents the credit risk profile based on payment activity as of December 31, 2019, by class of loans:
Troubled debt restructuring. A TDR is a loan to a borrower who is experiencing financial difficulty that has been modified from its original terms and conditions in such a way that First Federal is granting the borrower a concession of some kind. First Federal has granted a variety of concessions to borrowers in the form of loan modifications. The modifications are generally related to the loan's interest rate, term and payment amount or a combination thereof.
The Coronavirus Aid, Relief, and Economic Security Act of 2020 signed into law on March 27, 2020, ("CARES Act") provided guidance around the modification of loans as a result of the COVID-19 pandemic, which outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term (i.e., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act and related regulatory guidance if they are less than 30 days past due on their contractual payments at the time a modification program is implemented. As of June 30, 2020, the Company had approved COVID-19 pandemic related loan modifications for 297 loans aggregating to $128.4 million, or 12.9% of loans receivable. Loan modifications in accordance with the CARES Act and related regulatory guidance are still subject to an evaluation in regard to determining whether or not a loan is deemed to be impaired.
The following table is a summary of information with respect to total COVID-19 loan modifications as of June 30, 2020 (dollars in thousands):
Count
Balance
Percent
The following table is a summary of information pertaining to TDR loans included in impaired loans at the dates indicated:
Total TDR loans
Allowance for loan losses related to TDR loans
Total nonaccrual TDR loans
There were no newly restructured and renewals or modifications of existing TDR loans that occurred during the three and six months ended June 30, 2020 or June 30, 2019.
There were no TDR loans which incurred a payment default within 12 months of the restructure date during three and six months ended June 30, 2020.
The following table presents newly restructured and renewals or modifications of existing TDR loans by class that occurred during the three and six months ended June 30, 2019, by type of concession granted.
Number
Rate
Term
Combination
of Contracts
Modification
Modifications
(Dollars in thousands)
Pre-modification outstanding recorded investment
One- to four-family
Post-modification outstanding recorded investment
The following is a summary of TDR loans which incurred a payment default within 12 months of the restructure date during the three and six months ended June 30, 2019.
TDR loans that subsequently defaulted
No additional funds were committed to be advanced in connection with impaired loans at June 30, 2020.
The following table presents TDR loans by class at the dates indicated by accrual and nonaccrual status.
Accrual
Nonaccrual
Note 4 - Deposits
The aggregate amount of time deposits in excess of the Federal Deposit Insurance Corporation ("FDIC") insured limit, currently $250,000, at June 30, 2020 and December 31, 2019, were $94.0 million and $93.5 million, respectively. Deposits and weighted-average interest rates at the dates indicated are as follows:
Weighted-Average Interest Rate
Savings
Transaction accounts
Money market accounts
Certificates of deposit
Maturities of certificates at the dates indicated are as follows:
Within one year or less
After one year through two years
After two years through three years
After three years through four years
After four years through five years
After five years
Brokered certificates of deposits of $86.3 million and $51.6 million are included in the June 30, 2020 and December 31, 2019 certificate of deposits totals above, respectively.
Deposits at June 30, 2020 and December 31, 2019, included $76.9 million and $57.4 million, respectively, in public fund deposits. Investment securities with a carrying value of $43.2 million and $35.5 million were pledged as collateral for these deposits at June 30, 2020 and December 31, 2019, respectively. This exceeds the minimum collateral requirements established by the Washington Public Deposit Protection Commission.
Interest on deposits by type for the periods shown was as follows:
Note 5 - Federal Taxes on Income
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.
The effective tax rates were 18.9% and 18.9% for the six months ended June 30, 2020 and 2019, respectively. The effective tax rates differ from the statutory maximum federal tax rate for 2020 and 2019 of 21%, largely due to the nontaxable earnings on bank owned life insurance and tax-exempt interest income earned on certain investment securities and loans.
Note 6 - Earnings per Share
Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. In addition, nonvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are considered participating securities and are included in the computation of earnings per share.
The following table presents a reconciliation of the components used to compute basic and diluted earnings per share for the three and six months ended June 30, 2020 and 2019.
(In thousands, except share data)
Numerator:
Denominator:
Basic weighted average common shares outstanding
Dilutive restricted stock grants
Diluted weighted average common shares outstanding
Basic earnings per share
Diluted earnings per share
Unallocated ESOP shares are not included as outstanding for either basic or diluted earnings per share calculations. As of June 30, 2020 and 2019, there were 767,522 and 820,556 shares in the ESOP that remain unallocated, respectively.
Potential dilutive shares are excluded from the computation of EPS if their effect is anti-dilutive. There were 35,508 and zero restricted stock award anti-dilutive weighted-average shares for the three months ended June 30, 2020 and 2019 respectively. There were 28,111 and zero restricted stock award anti-dilutive weighted-average shares for the six months ended June 30, 2020 and 2019 respectively.
Note 7 - Employee Benefits
Employee Stock Ownership Plan
In connection with the Conversion, the Company established an ESOP for eligible employees of the Company and the Bank. Employees of the Company and the Bank who have been credited with at least 1,000 hours of service during a 12-month period are eligible to participate in the ESOP.
Pursuant to the Plan, the ESOP purchased shares in the open market with funds borrowed from First Northwest. The Bank will make contributions to the ESOP in amounts necessary to amortize the ESOP loan payable to First Northwest over a period of 20 years, bearing estimated interest at 2.46%. The loan is secured by shares purchased with the loan proceeds and will be repaid by the ESOP with funds from the Bank's discretionary contributions to the ESOP and earnings on the ESOP assets. An annual principal and interest payment of $835,000 was made by the ESOP during the six months ended June 30, 2020.
As shares are committed to be released from collateral, the Company reports compensation expense equal to the average daily market prices of the shares and the shares become outstanding for EPS computations. The compensation expense is accrued monthly throughout the year. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are recorded as a reduction of debt and accrued interest.
Compensation expense related to the ESOP for the three months ended June 30, 2020 and 2019, was $109,000 and $120,000, respectively. Compensation expense related to the ESOP for the six months ended June 30, 2020 and 2019, was $260,000 and $327,000, respectively.
Shares issued to the ESOP as of the dates indicated are as follows:
Allocated shares
Committed to be released shares
Unallocated shares
Total ESOP shares issued
Fair value of unallocated shares
Note 8 - Stock-based Compensation
In May 2020, the Company's shareholders approved the First Northwest Bancorp 2020 Equity Incentive Plan ("2020 EIP"), which provides for the grant of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock shares or restricted stock units, and performance share awards to eligible participants through May 2030. The cost of awards under the 2020 EIP generally is based on the fair value of the awards on their grant date. The maximum number of shares that may be utilized for awards under the 2020 EIP is 520,000. At June 30, 2020, there were 520,000 total shares available for grant under the 2020 EIP, all of which are available to be granted as restricted shares.
As a result of the approval of the 2020 EIP, the First Northwest Bancorp 2015 Equity Incentive Plan (the "2015 EIP") was frozen and no additional awards will be made. At June 30, 2020, there were no shares available for grant under the 2015 EIP. At this date, there were 277,400 shares granted under the 2015 EIP that are expected to vest subject to the 2015 EIP plan provisions.
During the three and six months ended June 30, 2020, 27,500 and 62,600 shares of restricted stock were awarded, respectively, and no stock options were granted. There were no shares of restricted stock awarded during the three and six months ended June 30, 2019. Awarded shares of restricted stock vest ratably over five years from the date of grant provided the eligible participant remains in service to the Company. The Company recognizes compensation expense for the restricted stock awards based on the fair value of the shares at the grant date amortized over five years.
For the three months ended June 30, 2020 and 2019, total compensation expense for the 2015 EIP was $250,000 and $270,000, respectively. For the six months ended June 30, 2020 and 2019, total compensation expense for the 2015 EIP was $555,000 and $553,000, respectively.
Included in the above compensation expense for the three months ended June 30, 2020 and 2019, directors' compensation was $86,000 and $85,000, respectively. For the six months ended June 30, 2020 and 2019, directors' compensation was $171,000 and $170,000, respectively.
The following table provide a summary of changes in non-vested restricted stock awards for the period shown:
For the Three Months Ended
Weighted-Average Grant Date Fair Value
Non-vested at April 1, 2020
Granted
Forfeited
Non-vested at June 30, 2020
For the Six Months Ended
Non-vested at January 1, 2020
As of June 30, 2020, there was $3.1 million of total unrecognized compensation cost related to non-vested shares granted as restricted stock awards. The cost is expected to be recognized over the remaining weighted-average vesting period of approximately 3.42 years.
Note 9 - Fair Value Accounting and Measurement
Fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants in the Company’s principal market. The Company has established and documented its process for determining the fair values of its assets and liabilities, where applicable. Fair value is based on quoted market prices, when available, for identical or similar assets or liabilities. In the absence of quoted market prices, management determines the fair value of the Company’s assets and liabilities using valuation models or third-party pricing services, both of which rely on market-based parameters when available, such as interest rate yield curves, option volatilities and credit spreads, or unobservable inputs. Unobservable inputs may be based on management’s judgment, assumptions, and estimates related to credit quality, liquidity, interest rates, and other relevant inputs.
Any changes to valuation methodologies are reviewed by management to ensure they are relevant and justified. Valuation methodologies are refined as more market-based data becomes available.
A three-level valuation hierarchy is used in determining fair value that is based on the transparency of the inputs used in the valuation process. The inputs used in determining fair value in each of the three levels of the hierarchy are as follows:
Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 - Either: (i) quoted prices for similar assets or liabilities; (ii) observable inputs, such as interest rates or yield curves; or (iii) inputs derived principally from or corroborated by observable market data.
Level 3 - Unobservable inputs.
The hierarchy gives the highest ranking to Level 1 inputs and the lowest ranking to Level 3 inputs. The level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the overall fair value measurement.
Qualitative disclosures of valuation techniques - Securities available for sale: where quoted prices are available in an active market, securities are classified as Level 1. Level 1 instruments include highly liquid government bonds, securities issued by the U.S. Treasury, and exchange-traded equity securities.
If quoted prices are not available, management determines fair value using pricing models, quoted prices of similar securities, which are considered Level 2, or discounted cash flows. In certain cases, where there is limited activity in the market for an instrument, assumptions must be made to determine their fair value. Such instruments are classified as Level 3.
Assets and liabilities measured at fair value on a recurring basis - Assets and liabilities are considered to be valued on a recurring basis if fair value is measured regularly (i.e., daily, weekly, monthly, or quarterly). The following tables show the Company’s assets measured at fair value on a recurring basis at the dates indicated:
Significant Other Observable Inputs
(Level 1)
(Level 2)
(Level 3)
Securities available-for-sale
Quoted Prices in Active
Markets for Identical Assets or Liabilities
Significant Unobservable
Inputs
Assets and liabilities measured at fair value on a nonrecurring basis - Assets are considered to be valued on a nonrecurring basis if the fair value measurement of the instrument does not necessarily result in a change in the amount recorded on the consolidated balance sheets. Generally, nonrecurring valuation is the result of the application of other accounting pronouncements that require assets or liabilities to be assessed for impairment or recorded at the lower of cost or fair value.
The following tables present the Company’s assets measured at fair value on a nonrecurring basis at the dates indicated:
Level 1
Level 2
Level 3
Impaired loans
At June 30, 2020 and December 31, 2019, there were no impaired loans with discounts to appraisal disposition value or other unobservable inputs.
The following tables present the carrying value and estimated fair value of financial instruments at the dates indicated:
Fair Value Measurements Using:
Carrying Amount
Financial assets
Cash and cash equivalents
Investment securities available for sale
FHLB stock
Financial liabilities
Demand deposits
Loans receivable, net
Time deposits
Financial assets and liabilities other than investment securities are not traded in active markets. Estimated fair values require subjective judgments and are approximate. The estimates of fair value in the previous table are not necessarily representative of amounts that could be realized in actual market transactions, or of the underlying value of the Company. The methods and assumptions used by the Company in estimating fair values of financial instruments as set forth below in accordance with ASC Topic 825, Financial Instruments, as amended by ASU 2016-01 requiring public entities to use the exit price notion effective January 1, 2018, are as follows:
Securities - Fair values for investment securities are primarily measured using information from a third-party pricing service. The pricing service uses pricing models based on market data. In the event that limited or less transparent information is provided by the third-party pricing service, fair value is estimated using secondary pricing services or non-binding third-party broker quotes.
Loans receivable, net - At June 30, 2020, the fair value of loans is estimated by discounting the future cash flows using the current rate at which similar loans and leases would be made to borrowers with similar credit and for the same remaining maturities. Additionally, to be consistent with the requirements under FASB ASC Topic 820 for Fair Value Measurements and Disclosures, the loans were valued at a price that represents the Company’s exit price or the price at which these instruments would be sold or transferred.
Mortgage servicing rights, net - The estimated fair value of mortgage servicing rights is based on market prices for comparable mortgage servicing contracts when available. If no comparable contract is available, the estimated fair value is based on a valuation model that calculates the present value of estimated future net servicing income.
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. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by the use of words such as “believes,” “expects,” “anticipates,” “estimates” or similar expressions. Forward-looking statements include, but are not limited to:
•
statements of our goals, intentions and expectations;
statements regarding our business plans, prospects, growth and operating strategies;
statements regarding the quality of our loan and investment portfolios;
estimates of our risks and future costs and benefits; and
statements concerning the potential effects of the COVID-19 pandemic on the Bank's business and financial results and conditions.
These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:
developments and changes in Federal and state laws and regulations, such as the recently enacted Coronavirus Aid Relief and Economic Security Act (“CARES Act”) addressing the economic effects of the COVID-19 pandemic and increased regulation of the banking industry through legislative action and revised rules and standards applied by the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Washington Department of Financial Institutions;
changes in general economic conditions, either nationally or in our market area, that are worse than expected;
changes in policy and regulation as it pertains to the Small Business Administration’s Paycheck Protection Program (“PPP”) and the bank’s participation as a lender in the PPP and similar program and its effect on the Bank’s liquidity, financial results, business and customers, including the availability of program funds and the ability of customers to comply with the requirements and otherwise perform with respect to loans obtained under such programs.
the credit risks of our lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;
fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market area;
a decrease in the secondary market demand for loans that we originate for sale;
management’s assumptions in determining the adequacy of the allowance for loan losses;
our ability to control operating costs and expenses;
whether our management team can implement our operational strategy, including but not limited to our loan growth;
our ability to successfully execute on merger and/or acquisition strategies and integrate any newly acquired assets, liabilities, customers, systems, and management personnel into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;
staffing needs and associated expenses in response to product demand or the implementation of corporate strategies, including our growth strategies related to the home lending center and new branches;
the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;
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;
increased competitive pressures among financial services companies;
our ability to attract and retain deposits;
our ability to retain key members of our senior management team;
changes in consumer spending, borrowing and savings habits;
our ability to successfully manage our growth in compliance with regulatory requirements;
results of examinations of us by the Washington State Department of Financial Institutions, Department of Banks, the Federal Deposit Insurance Corporation, the Federal Reserve Bank of San Francisco, or other regulatory authorities, which could result in restrictions that may adversely affect our liquidity and earnings;
changes in accounting policies and practices, as may be adopted by the financial institutions regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board;
disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions;
inability of key third-party vendors to perform their obligations to us; and
other economic, competitive, governmental, regulatory and technical factors affecting our operations, pricing, products and services and other risks described elsewhere in our filings with the Securities and Exchange Commission, including this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2019.
Further, statements about the potential effects of the COVID-19 pandemic on the Bank’s businesses and financial results and condition may constitute forward-looking statements and are subject to the risk that the actual effects may differ, possibly materially, from what is reflected in those forward-looking statements due to factors and future developments that are uncertain, unpredictable and in many cases beyond the Bank’s control, including the scope and duration of the pandemic, actions taken by governmental authorities in response to the pandemic, and the direct and indirect impact of the pandemic on the Bank, its customers and third parties. These developments could have an adverse impact on our financial position and our results of operations.
Any of the forward-looking statements that we make in this report and in other statements we make may turn out to be wrong because of inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot anticipate or predict. Any forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. Due to these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur, and you should not put undue reliance on any forward-looking statements.
General
First Northwest is a bank holding company which primarily engages in the business activity of its subsidiary, First Federal. First Federal is a community-oriented financial institution serving Clallam, Jefferson, Kitsap, Whatcom, and King counties in Washington, through its Seattle lending center and ten full-service branches. Our business and operating strategy is focused on building sustainable earnings through hiring experienced bankers, geographic expansion, and diversifying our loan product mix, expanding our deposit product offerings that deliver value-added solutions, enhancing existing services and digital service delivery channels, and enhancing our infrastructure to support the changing needs and expectations of our customers.
We offer a wide range of products and services focused on the lending and depository needs of Western Washington. While we have a concentration of first lien one- to four-family mortgage loans, we continue to increase our origination and portfolio balances of commercial real estate and multi-family real estate. We have also increased our auto and consumer loans, through indirect and purchased auto loan programs, in order to diversify our asset portfolio and increase interest income. We continue to originate one- to four-family residential mortgage loans and regularly sell conforming loans into the secondary market to increase noninterest income and manage interest rate risk. We also retain one- to four-family first and second lien loans in our portfolio to generate interest income. We offer consumer and business deposit products, including transaction accounts, savings and money market accounts, and certificates of deposit for individuals, businesses, and nonprofit organizations. Deposits are our primary source of funds for lending and investing activities. We also borrow funds, typically from the Federal Home Loan Bank of Des Moines, to provide additional funding and interest rate risk management tools.
First Northwest is affected by prevailing economic conditions as well as government policies and regulations concerning, among other things, monetary and fiscal affairs, housing and financial institutions. Deposit flows are influenced by several factors, including interest rates paid on competing time deposits, alternative investment options available to our customers, account maturities, the number and quality of our deposit originators, digital delivery systems, marketing and promotion, and the overall level of personal income and savings. Lending activities are influenced by the demand for funds, our credit policies, the number and quality of our lenders and credit underwriters, digital delivery systems, and regional economic cycles.
Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income earned on our loans and investments and interest expense paid on our deposits and borrowings. Changes in levels of interest rates and cash flows from existing assets and liabilities affect our net interest income. A secondary source of income is noninterest income, which includes revenue we receive from providing products and services, including service charges on deposit accounts, mortgage banking income, earnings from bank-owned life insurance, investment services income, and gains and losses from sales of securities.
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 losses inherent in our loan portfolio through our allowance for loan losses. As credit metrics improve, such as a loan's risk rating, property values increase, or recoveries of amounts previously charged off are received, a recapture of previously recognized provision for loan losses may be added to net income.
Noninterest expenses we incur in operating our business consist of salaries and employee benefit costs, occupancy and equipment expenses, federal deposit insurance premiums and regulatory assessments, data processing expenses, advertising and promotion expenses, marketing and promotion expenses, expenses related to real estate and personal property owned and other miscellaneous expenses.
COVID-19 Pandemic. In late 2019 and early 2020, the COVID-19 pandemic manifested its impact on individuals, companies, and governmental entities around the world. It significantly impacted the global economy and created a challenging operating environment. As economic conditions deteriorated in mid-March 2020 as a result of the COVID-19 pandemic, we responded in several ways. Some of the key adjustments and developments include the following:
For our employees:
◦
Enhanced the ability of our employees to work remotely, adjusting branch operating hours and restricting lobby access in most cases.
Provided significant support to employees by granting an increase in flexibility with paid leave, temporarily adjusting vacation policies, and increasing the cleaning of facilities to enable a safer environment for those employees that are not able to work from home.
Increased compensation for hourly employees and providing additional compensation for exempt employees below the level of Senior Vice President.
For our customers and communities:
Offering short-term loan payment and fee forbearance programs. Many borrowers requested and received temporary forbearance from obligations to assist them with the expected shortage in their near-term cash flow.
Facilitating government programs like the Small Business Administration's Paycheck Protection Program ("SBA PPP") and Main Street Lending Program ("MSLP") established by the Federal Reserve.
Investing in our communities. We plan to use a portion of the proceeds received from the SBA PPP loans and invest in the communities we serve.
For our shareholders and regulators:
Maintained our capital ratios at strong levels and materially increased our provision for loan losses to $2.8 million for the first half of 2020, compared to $669,000 for all of 2019.
On March 23, 2020, the State of Washington announced the Stay Home, Stay Healthy order for all residents, resulting in the closing of businesses or a substantial reduction in business activity. Conditions have since improved in most of the counties within our footprint allowing many businesses to expand services or reopen under current guidelines. The sectors that continue to be most heavily impacted include hospitality; restaurant and food services; and lessors of commercial real estate to hospitality, restaurant, and retail establishments. At June 30, 2020, the Company’s exposure as a percent of the total loan portfolio to these industries was 5.1%, 0.2%, and 4.9%, respectively.
The Company has worked with loan customers on loan deferral and forbearance plans. As of June 30, 2020, the Company had granted payment deferral plans on 297 loans totaling $128.4 million compared to 23 loans totaling $1.4 million as of March 31, 2020. These modifications were not classified as TDRs at June 30, 2020, in accordance with the guidance of the CARES Act and related regulatory guidance. The Company is continuing to work on forbearance plans with customers impacted by the COVID-19 pandemic. For additional information on COVID-19 deferrals, see Note 3 of the Notes to Consolidated Financial Statements contained in "Item 1, Financial Statements."
During the quarter ended June 30, 2020, we provided assistance to many small businesses through the SBA's Paycheck Protection Program. This program provides small businesses with funds to pay up to eight weeks of payroll costs including benefits. A portion of the funds can also be used to pay interest on mortgages, rent, and utilities. On June 5, 2020, the Paycheck Protection Program Flexibility Act ("PPPFA") was enacted. Main provisions of the PPPFA extended the repayment period from two to five years, extended the covered expense period from eight to 24 weeks, and lowered the percent of forgiveness amount required to be used for eligible payroll costs to 60%. The PPPFA also extends the repayment start date until after the SBA makes a decision on the application for loan forgiveness.
We processed approximately $30.6 million of loans for 440 customers through the SBA PPP program as of June 30, 2020. The average loan amount approved was approximately $69,000. Payments by borrowers on these loans begin six months after the note date, and interest, at 1%, will continue to accrue during the six-month deferment. Loans can be forgiven in whole or part (up to full principal and any accrued interest). We partnered with StreetShares to assist our borrowers with the loan forgiveness application process.
Loan processing fees paid to the Bank from the SBA of 5% on loans of $350,000 or less, 3% on loans of more than $350,000 but less than $2.0 million, and 1% for loans of $2.0 million or more are accounted for as loan origination fees. Net deferred fees are recognized over the life of the loan, or two years, as a yield adjustment on the loans. As of June 30, 2020, the Company had received $1.3 million in processing fees. If a loan is paid off or forgiven by the SBA prior to its maturity date, the remaining unamortized deferred fees will be recognized in interest income at that time. At such time that any of these loans are forgiven or repaid before the scheduled maturity, we expect an increase in interest income and the net interest margin during that period.
Critical Accounting Policies
There are no material changes to the critical accounting policies as disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2019.
Comparison of Financial Condition at June 30, 2020 and December 31, 2019
Assets. Total assets increased to $1.48 billion at June 30, 2020 from $1.31 billion at December 31, 2019.
Total loans, excluding loans held for sale, increased $112.6 million to $996.4 million at June 30, 2020, from $883.8 million at December 31, 2019. During the six months ended June 30, 2020, one- to four-family residential loans increased $19.3 million, as we purchased a $28.0 million mortgage loan pool. Multi-family loans increased $7.2 million, as we continued to build this part of the loan portfolio. Commercial real estate loans increased by $11.5 million as we continue to build our lending presence in King and Whatcom Counties as well as in our legacy markets. Commercial business loans increased $57.9 million as we funded PPP loans and increased balances generated through the Northpointe Bank Mortgage Participation Program which provides interim financing to mortgage originators based on the contractual sale agreement of a mortgage loan during the first half of 2020. Auto and other consumer loans decreased $2.9 million as we scaled back funding in our specialty auto loan portfolio. Competition for quality commercial credits remains; however, impacts of the COVID-19 pandemic effect both the supply and demand for credit. An increase in refinance activity of one- to-four family residential loans also occurred during the period.
Construction and land loans increased $21.0, or 56.4%, to $58.2 million at June 30, 2020, from $37.2 million at December 31, 2019. The majority of our construction loans are geographically dispersed throughout the Puget Sound region and, as a result, these loans are susceptible to risks that may vary depending on the nature and location of the project. We manage our construction lending by utilizing a licensed third-party vendor to assist us in monitoring our construction projects and intend to begin utilizing internal staffing to monitor certain projects, which we expect will enhance fee income related to these loans. In March 2020, the vast majority of construction projects in Washington State were put on hold as a result of Governor Jay Inslee’s “Stay Home, Stay Safe” order. By June 30, 2020, most projects were able to restart under specific criteria. We continue to monitor the projects currently in our portfolio to determine the impact of COVID-19 on completion. As of this point in time, we have no reason to believe that any of the projects in process will not be completed.
We monitor real estate values and general economic conditions in our market areas, in addition to assessing the strength of our borrowers, in order to prudently underwrite construction loans. For the majority of 2019, we decreased our construction lending, which resulted in a decline in construction balances at the end of the year compared to 2018. In the fourth quarter of 2019 and the first quarter of 2020, we increased production in construction lending and our commitments increased accordingly. We continually assess our lending strategies across all product lines and markets within which we do business in order to improve earnings while also prudently managing credit risk.
The following tables show our construction commitments by type and geographic concentrations at the dates indicated:
North Olympic Peninsula (1)
Puget Sound Region (2)
Other Washington
Construction Commitment
One- to four-family residential
Multi-family residential
Total commitment
Construction Funds Disbursed
Total disbursed
Undisbursed Commitment
Total undisbursed
Land Funds Disbursed
Total disbursed for land
(1) Includes Clallam and Jefferson counties.
(2) Includes Kitsap, Mason, Thurston, Pierce, King, Snohomish, Skagit, Whatcom, and Island counties.
North Olympic Peninsula
Puget Sound Region
Total Commitment
During the six months ended June 30, 2020, the Company originated $276.3 million of loans, of which $145.1 million, or 52.5%, were originated in the Puget Sound region, $115.7 million, or 41.9%, in the North Olympic Peninsula, $11.9 million, or 4.3%, in other areas throughout Washington State, and $3.7 million, or 1.3%, in Oregon. The Company purchased an additional $28.0 million in one- to four-family loans and $15.9 million in specialty auto loans, during the six months ended June 30, 2020. We will continue to evaluate opportunities to grow loans through wholesale channels in order to supplement our organic originations and increase net interest income.
Our allowance for loan losses increased $2.5 million, or 25.8%, to $12.1 million at June 30, 2020, from $9.6 million at December 31, 2019. The increase was due to a $2.8 million loan loss provision, offset by net charge-offs of $285,000 for the six- month period. The provision is largely attributed to qualitative factor adjustments made in response to the economic impact of the COVID-19 pandemic, as well as to account for growth in the loan portfolio. The allowance for loan losses as a percentage of total loans at June 30, 2020 and December 31, 2019 was 1.2% and 1.1%, respectively.
Nonperforming loans increased $1.6 million, or 86.9%, to $3.4 million at June 30, 2020, from $1.8 million at December 31, 2019, mainly attributable to an increase in nonperforming one- to four-family loans of $845,000, multi-family loans of $297,000, construction and land loans of $108,000, and commercial business loans of $308,000, partially offset by a decrease in commercial real estate loans of $74,000. Nonperforming loans to total loans increased to 0.3% at June 30, 2020, from 0.2% at December 31, 2019. The allowance for loan losses as a percentage of nonperforming loans decreased to 360.8% at June 30, 2020, from 536.1% at December 31, 2019.
At June 30, 2020, there were $2.5 million in restructured loans, of which $2.4 million were performing in accordance with their modified payment terms and returned to accrual status. Classified loans increased $154,000 to $5.1 million at June 30, 2020, from $5.0 million at December 31, 2019
Asset quality remains consistent with December 31, 2019. Net loan charge-offs are concentrated mainly in our auto loan portfolio. We recently adjusted our indirect auto loan product offerings and underwriting criteria to improve credit quality and reduce future charge-off activity. We continue to monitor the indirect auto loan program in order to prudently balance risk and return within the portfolio. We believe our allowance for loan losses is adequate to absorb the known and inherent risks of loss in the loan portfolio as of June 30, 2020. While the ultimate impact of the COVID-19 pandemic and response from Federal and State government remains to be seen, we increased the qualitative factor related to the economy this quarter.
Loans receivable, excluding loans held for sale, consisted of the following at the dates indicated:
The following table represents nonperforming assets at the dates indicated.
Nonperforming loans:
Real estate loans:
Consumer loans:
Total nonperforming loans
Real estate owned:
Land
Total real estate owned
Repossessed assets
Total nonperforming assets
Nonaccrual and 90 days or more past due loans as a percentage of total loans
Investment securities increased $48.7 million, or 15.4%, to $364.3 million at June 30, 2020, from $315.6 million at December 31, 2019, due to the purchase and sale of securities, normal payments and prepayment activity, and an increase in the market value of the portfolio. Mortgage-backed securities represent the largest portion of our investment securities portfolio and totaled $110.1 million at June 30, 2020, or 30.2% of the investment securities portfolio, a decrease during the year of $58.4 million, or 34.7%, from $168.5 million at December 31, 2019. Other investment securities, including municipal bonds and other asset-backed securities, were $254.2 million at June 30, 2020, or 69.8% of the investment securities portfolio, an increase of $107.1 million from $147.1 million at December 31, 2019. The investment portfolio, including mortgage-backed securities, had an estimated projected average life of 6.7 years as of June 30, 2020, and 5.0 years as of December 31, 2019, and had an estimated average repricing term of 4.8 years as of June 30, 2020, and 3.7 years as of December 31, 2019, based on the interest rate environment at those times.
The investment portfolio was comprised of 58.9% in amortizing securities at June 30, 2020 and 81.8% at December 31, 2019. The projected average life of our securities may vary due to prepayment activity, which, particularly in the mortgage-backed securities portfolio, is impacted by prevailing mortgage interest rates. Management maintains a focus on enhancing the mix of earning assets by originating loans as a percentage of earning assets; however, we continue to purchase investment securities as a source of additional interest income. For additional information, see Note 2 of the Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q.
Liabilities. Total liabilities increased $172.1 million to $1.30 billion at June 30, 2020, from $1.13 billion at December 31, 2019, primarily due to an increase in deposits of $168.7 million.
Deposit balances increased 16.8%, to $1.17 billion at June 30, 2020, from $1.00 billion at December 31, 2019. There was an $82.2 million increase in money market accounts, a $62.7 million increase in transaction accounts, and a $6.8 million increase in savings accounts during the year. The increase in deposits is in large part due to the Federal government's response to the pandemic including stimulus payments, additional unemployment benefits, and deferrals of Federal tax payment due dates. These actions, coupled with decreased spending by consumers and business, resulted in higher deposit balances. In addition to collecting customer deposits, we utilize brokered certificates of deposit ("brokered CDs") as an additional funding source in order to manage our cost of funds, reduce our reliance on public funds deposits, and allow flexibility when competing on retail rates. At June 30, 2020, we had $86.3 million in brokered CDs included in the $325.2 million balance of certificates of deposit.
Equity. Total shareholders' equity decreased $536,000 to $176.3 million for the six months ended June 30, 2020. The decrease was due to $5.5 million the in repurchases of shares of common stock, largely offset by an after-tax increase in other comprehensive income of $2.3 million due to the increased value of our available-for-sale securities portfolio, as well as year-to-date net income of $2.9 million.
Comparison of Results of Operations for the Three Months Ended June 30, 2020 and 2019
General. Net income decreased $103,000, or 4.9%, to $2.0 million for the three months ended June 30, 2020, compared to net income of $2.1 million for the three months ended June 30, 2019. The decrease is mainly due to a larger loan loss provision in the current period compared to the same period one year ago, which was partially offset by a decrease in net noninterest expense. An increase in noninterest income driven by mortgage revenue offset an increase in noninterest expense due primarily to higher compensation expenses.
Net Interest Income. Net interest income increased $437,000 to $10.1 million for the three months ended June 30, 2020., compared to $9.7 million for the three months ended June 30, 2019 The yield on average interest-earning assets decreased 47 basis points to 3.79% for the three months ended June 30, 2020, compared to 4.26% for the same period in the prior year. This was due to a decrease in market interest rates and a decrease in the ratio of total loans to assets in the current period compared to one year ago from 67.4% to 69.9%.
The average cost of interest-bearing liabilities decreased 44 basis points to 0.89% for the three months ended June 30, 2020, compared to 1.33% for the same period last year. The decrease was due in part to a reduction in the level and cost of borrowings given the prepayment of higher costing FHLB borrowings in the first quarter of 2020. As a result, our average cost of FHLB borrowings decreased to 1.13% in the first quarter of 2020 compared to 2.99% for the same period one year prior. The cost of interest-bearing deposits decreased by 17 basis points to 0.87% compared to 1.04% for the three months ended June 30, 2019, given decreasing market rates.
Due to the average yield on interest-earning assets decreasing at a faster pace than our interest-bearing liabilities, the net interest margin decreased 13 basis points to 3.10% for the three months ended June 30, 2020, from 3.23% for the same period in 2019. For additional information, see Rate/Volume Analysis contained in Item 2 of this Form 10-Q.
Interest Income. Total interest income decreased $425,000, or 3.3%, to $12.4 million for the three months ended June 30, 2020, from $12.8 million for the comparable period in 2019. Interest and fees on loans receivable decreased $237,000, to $10.2 million for the three months ended June 30, 2020, from $10.5 million for the three months ended June 30, 2019, due primarily to a decrease in the yield on loans and securities. Average loan yields decreased 34 basis points to 4.40% for the three months ended June 30, 2020 compared to the three months ended June 30, 2019 due to a decrease in market rates and an increase in the amount of lower yielding loans as a percentage of loans, including Northpointe and PPP loans.
Interest income on investment securities increased $347,000 to $1.3 million for the three months ended June 30, 2020, compared to $1.0 million for the three months ended June 30, 2019, due to a $96.6 million increase in average balances partially offset by an 86 basis point decrease in average yield related to a decrease in the yield on variable rate securities. The change in average yield on investment securities does not include the benefit of nontaxable income from municipal bonds. Interest income on mortgage-backed and related securities for the three months ended June 30, 2020 decreased $452,000, or 37.9%, compared to the three months ended June 30, 2019, the result of a decrease of $43.3 million in the average balance and a 49 basis point decrease in the average yield in the 2020 period.
The following table compares average earning asset balances, associated yields, and resulting changes in interest income for the periods shown:
Average Balance Outstanding
Yield
Increase (Decrease) in Interest Income
Investment securities
Mortgage-backed securities
Total interest-earning assets
Interest Expense. Total interest expense decreased $862,000, or 27.8%, to $2.2 million for the three months ended June 30, 2020, compared to $3.1 million for the three months ended June 30, 2019, mainly due to an 80.6% decrease in interest paid on borrowings. Interest expense on deposits decreased slightly for the three months ended June 30, 2020, due to lower rates offsetting the impact of increased balances. The average balance of interest-bearing deposits increased $141.2 million, or 17.7%, to $937.0 million for the three months ended June 30, 2020, from $795.8 million for the three months ended June 30, 2019, as we continued to target deposit growth in new and existing market areas as well as the industry-wide impact of surge deposits during the pandemic. During the three months ended June 30, 2020, the average balance of savings accounts increased $9.7 million and the related weighted-average cost decreased 29 basis points compared to the same period in 2019. The average balance of certificates of deposit balances grew $90.5 million and the weighed-average cost decreased by 51 basis points, mainly as a result of the utilization of brokered CDs. During the three months ended June 30, 2020, the average balance of money market accounts increased $34.0 million compared to the same period in the prior year. The average cost of deposits decreased by 17 basis points to 0.87% for the three months ended June 30, 2020, from 1.04% for the three months ended June 30, 2019. Borrowing costs decreased due to a decrease in balances and the average rate paid during the most recent quarter compared to the same period in 2019.
The following table details average balances, cost of funds and the change in interest expense for the periods shown:
Increase (Decrease) in Interest Expense
Savings accounts
Total interest-bearing liabilities
Provision for Loan Losses. The provision for loan losses was $1.5 million during the three months ended June 30, 2020, compared to a $255,000 provision for loan losses for the three months ended June 30, 2019. This was mainly due to an increase to the economic qualitative factor resulting from the uncertainty surrounding COVID-19 and its potential impact on the loans in our portfolio.
The following table details activity and information related to the allowance for loan losses for the periods shown:
Net charge-offs
Allowance for losses as a percentage of total gross loans receivable at the end of this period
Allowance for loan losses as a percentage of nonaccrual loans at end of period
Noninterest Income. Noninterest income increased $2.7 million, or 188.8%, to $4.1 million for the three months ended June 30, 2020, from $1.4 million for the three months ended June 30, 2019, primarily due to the gain on sales of mortgage loans of $1.9 million, the gain on sale of investment securities of $604,000, and an increase in the cash surrender value of bank owned life insurance of $482,000. Loan and deposit fees decreased by $230,000 due to fewer non-sufficient funds fees as transaction volume reduced during the quarter as well as customers generally carrying higher balances in their deposit accounts.
The following table provides a detailed analysis of the changes in the components of noninterest income for the periods shown:
Increase (Decrease)
Noninterest Expense. Noninterest expense increased $2.0 million or 24.3% during the three months ended June 30, 2020, compared to the three months ended June 30, 2019, mainly due to a 25.5% increase in compensation and benefits driven by additional staffing and higher commissions paid on loan production, which increased 656.4%. Occupancy and equipment increased 18.0% and advertising increased 64.6%.
The following table provides an analysis of the changes in the components of noninterest expense for the periods shown:
Other
Provision for Income Tax. Income tax expense of $464,000 was recorded for the three months ended June 30, 2020, compared to $493,000 for the three months ended June 30, 2019, generally due to a decrease in income before taxes of $132,000. For additional information, see Note 5 of the Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q.
Comparison of Results of Operations for the Six Months Ended June 30, 2020 and 2019
General. Net income decreased $1.4 million, or 33.5%, to $2.9 million for the six months ended June 30, 2020, compared to net income of $4.3 million for the six months ended June 30, 2019, due to an increase in provision for loan losses and noninterest expense partially offset by an increase in noninterest income.
Net Interest Income. Net interest income increased $244,000 to $19.5 million for the six months ended June 30, 2020, from $19.3 million for the six months ended June 30, 2019. This increase was mainly the result of an increase in average earning assets of $60.7 million. The yield on average interest-earning assets decreased 36 basis points to 3.87% for the six months ended June 30, 2020, compared to 4.23% for the same period in the prior year.
The net interest margin decreased 11 basis points to 3.11% for the six months ended June 30, 2020, from 3.22% for the same period in 2019. A 36 basis point decrease in asset yields was offset by a 30 basis point decrease in our cost of interest-bearing liabilities, reducing our net interest rate spread and net interest margin.
The $244,000 increase in net interest income during the six months ended June 30, 2020, compared to the six months ended June 30, 2019, was the result of a $1.1 million decrease in interest expense driven by an improvement in the cost of interest-bearing liabilities which was partially offset by a decrease in interest income. The decrease in interest expense of borrowings of $1.4 million was the main contributor to the increase in net interest income.
The average cost of interest-bearing liabilities decreased to 0.99% for the six months ended June 30, 2020, compared to 1.29% for the same period last year, due primarily to decreases in borrowing volume of $905,000 and decreases attributable to rates of $486,000.
Interest Income. Total interest income decreased $960,000, or 3.8%, to $24.3 million for the six months ended June 30, 2020, from $25.3 million for the comparable period in 2019, primarily due to a decrease in the average yields on interest-earning assets. Interest and fees on loans receivable decreased $493,000, to $20.1 million for the six months ended June 30, 2020, from $20.6 million for the six months ended June 30, 2019, in spite of an increase in the average balance of net loans receivable of $24.0 million compared to the prior year. Average loan yields decreased 24 basis points to 4.45% for the six months ended June 30, 2020 compared to the six months ended June 30, 2019.
Total interest income from securities decreased $344,000 to $4.1 million for the six months ended June 30, 2020 from $4.4 million for the same period in 2019. While the average balance of total securities increased $30.5 million, the average yield decreased 48 basis points. Interest income on investment securities increased $406,000, or 20.5% to $2.4 million for the six months ended June 30, 2020, compared to $2.0 million for the six months ended June 30, 2019, due to an increase in the average balance of $63.2 million partially offset by a decrease in average yield of 71 basis points compared to the same period in 2019. The change in average yields on investment securities does not include the benefit of nontaxable income from municipal bonds. Interest income on mortgage-backed and related securities for the six months ended June 30, 2020 decreased $750,000, or 30.6%, compared to the six months ended June 30, 2019, reflecting a $32.7 million decrease in the average balance and a decrease in yield of 41 basis points.
Interest Expense. Total interest expense decreased $1.2 million, or 20.0%, to $4.8 million for the six months ended June 30, 2020, compared to $6.0 million for the six months ended June 30, 2019, due to a decrease in borrowing costs of $1.4 million, or 68.7%. Interest expense on deposit costs increased for the six months ended June 30, 2020, by $187,000 due to an increase in average interest-bearing balances. The average balance of interest-bearing deposits increased $97.8 million, or 12.3%, to $893.0 million for the six months ended June 30, 2020, from $795.2 million for the six months ended June 30, 2019, as we continued to target growth in deposits in new and existing market areas and surge deposits related to the pandemic.
During the six months ended June 30, 2020, interest expense on cost of certificates of deposit increased due to an increase in average balance of $73.9 million partially offset by a decrease in the average rate paid of 33 basis points, compared to the six months ended June 30, 2019. During the same period, the average balances of savings, transaction, and money market accounts increased $11.0 million, $3.6 million and $9.3 million, respectively. The average cost of all deposit products decreased to 0.94% for the six months ended June 30, 2020, from 1.00% for the six months ended June 30, 2019. Borrowing costs decreased as higher rate long term advances were prepaid during the six months.
Provision for Loan Losses. The provision for loan losses was $2.8 million during the six months ended June 30, 2020, primarily due to the uncertainty in economic conditions created by the ongoing COVID-19 pandemic and growth in the loan portfolio, and was $590,000 for the six months ended June 30, 2019, primarily due to charge-off activity in our indirect auto loan portfolio.
Noninterest Income. Noninterest income increased $3.7 million, or 140.4%, to $6.4 million for the six months ended June 30, 2020, from $2.7 million for the six months ended June 30, 2019, mainly due to an increase in gain on sale of mortgage loans of $2.2 million. Gain on sale of investments for the six months ended June 30, 2020, totaled $1.2 million compared to $57,000 recognized in the first six months of 2019. The cash surrender value of bank-owned life insurance increased $667,000 in the first six months of 2020 due to a BOLI restructure that resulted in recognition of market gains as well as additional investment in BOLI.
Noninterest Expense. Noninterest expense increased $3.6 million, or 22.3%, to $19.7 million for the six months ended June 30, 2020, compared to $16.1 million for the six months ended June 30, 2019, primarily as a result of an increase in compensation and benefits as well as occupancy and equipment as we added staff to generate revenue. Compensation and benefits also increased due to an $829,000 increase in commissions paid on increased mortgage production as well as one-time pandemic related payments made to staff. We also incurred a one-time FHLB prepayment penalty of $210,000 as we retired long term debt to reduced interest expense.
Provision for Income Tax. An income tax expense of $668,000 was recorded for the six months ended June 30, 2020, compared to $1.0 million for the six months ended June 30, 2019, due to a decrease in income before taxes of $1.7 million. For additional information, see Note 5 of the Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q.
Average Balances, Interest and Average Yields/Cost
The following table set forth, for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin (otherwise known as net yield on interest-earning assets), and the ratio of average interest-earning assets to average interest-bearing liabilities. Also presented is the weighted average yield on interest-earning assets, rates paid on interest-bearing liabilities and the resultant spread at June 30, 2020 and 2019. Income and all average balances are monthly average balances, which management deems to be not materially different than daily averages. Nonaccrual loans have been included in the table as loans carrying a zero yield.
Average
Interest
Yield/
Earned/
Outstanding
Paid
Loans receivable, net (1)
Total interest-earning assets (2)
Interest-bearing liabilities:
Total deposits
Net interest rate spread
Net earning assets
Net interest margin (3)
Average interest-earning assets to average interest-bearing liabilities
(1) The average loans receivable, net balances include nonaccrual loans.
(2) Includes interest-bearing deposits (cash) at other financial institutions.
(3) Net interest income divided by average interest-earning assets.
Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to outstanding balances and changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
June 30, 2020 vs. 2019
Increase (Decrease) Due to
Volume
Total Increase (Decrease)
Interest earning assets:
Investments
Other(1)
Interest-bearing transaction accounts
Net change in interest income
(1) Includes interest-bearing deposits (cash) at other financial institutions.
Off-Balance Sheet Activities
In the normal course of operations, First Federal engages in a variety of financial transactions that are not recorded in the financial statements. These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks. These transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. For the six months ended June 30, 2020 and the year ended December 31, 2019, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows.
Contractual Obligations
At June 30, 2020, our scheduled maturities of contractual obligations were as follows:
Within
After 1 Year Through
After 3 Years Through
Beyond
1 Year
3 Years
5 Years
Borrower taxes and insurance
Commitments and Off-Balance Sheet Arrangements
The following table summarizes our commitments and contingent liabilities with off-balance sheet risks as of June 30, 2020:
Amount of Commitment Expiration
Committed
Commitments to originate loans:
Fixed-rate
Unfunded commitments under lines of credit or existing loans
Standby letters of credit
Total commitments
Liquidity Management
Liquidity is the ability to meet current and future financial obligations of a short-term and long-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of securities, and borrowings from the FHLB. While maturities and scheduled amortization of loans and securities are usually predictable sources of funds, deposit flows, calls of investment securities and borrowed funds, and prepayments on loans and investment securities are greatly influenced by general interest rates, economic conditions and competition, which can cause those sources of funds to fluctuate.
Management regularly adjusts our investments in liquid assets based upon an assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our interest-rate risk and investment policies.
Our most liquid assets are cash and cash equivalents followed by available for sale securities. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At June 30, 2020, cash and cash equivalents totaled $49.6 million, and unpledged securities classified as available-for-sale with a market value of $250.7 million provided additional sources of liquidity. We pledged collateral to support borrowings from the FHLB of $112.4 million and have an established borrowing arrangement with the Federal Reserve Bank of San Francisco, for which available-for-sale securities with a market value of $46.2 million were pledged as of June 30, 2020.
At June 30, 2020, we had $1.7 million in loan commitments outstanding, $120.5 million in undisbursed loans and standby letters of credit, including $68.4 million in undisbursed construction loan commitments.
Certificates of deposit due within one year as of June 30, 2020 totaled $240.1 million, or 73.8% of certificates of deposit with a weighted-average rate of 1.20%. We believe the large percentage of certificates of deposit that mature within one year reflects customers' hesitancy to invest their funds for longer periods as market interest rates have recently declined. If these maturing deposits are not renewed, however, we will be required to seek other sources of funds, including other certificates of deposit, non-maturity deposits, and borrowings. We have the ability to attract and retain deposits by adjusting the interest rates offered as well as through sales and marketing efforts in the markets we serve. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on certificates of deposit. In addition, we believe that our branch network, and the general cash flows from our existing lending and investment activities, will provide us more than adequate long-term liquidity. For additional information, see the Consolidated Statements of Cash Flows in Item 1 of this Form 10-Q.
The Company is a separate legal entity from the Bank and provides for its own liquidity to pay its operating expenses and other financial obligations. At June 30, 2020, the Company (on an unconsolidated basis) had liquid assets of $12.4 million.
Capital Resources
At June 30, 2020, shareholders' equity totaled $176.3 million, or 11.9% of total assets. Our book value per share of common stock was $17.07 at June 30, 2020, compared to $16.48 at December 31, 2019.
At June 30, 2020, the Bank exceeded all regulatory capital requirements and was considered "well capitalized" under FDIC regulatory capital guidelines.
The following table provides the capital requirements and actual results for First Federal at June 30, 2020.
Actual
Minimum Capital Requirements
Minimum Required to be Well-Capitalized
Ratio
Tier I leverage capital (to average assets)
Common equity tier I (to risk-weighted assets)
Tier I risk-based capital (to risk-weighted assets)
Total risk-based capital (to risk-weighted assets)
In order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses, the Bank must maintain common equity tier 1 capital ("CET1") at an amount greater than the required minimum levels plus a capital conservation buffer of 2.5%.
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data presented in this report have been prepared according to generally accepted accounting principles in the United States, which require the measurement of financial and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs and the effect that general inflation may have on both short-term and long-term interest rates. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than do general levels of inflation. Although inflation expectations do affect interest rates, interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
There has not been any material change in the market risk disclosures contained in First Northwest Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2019.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
An evaluation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) was carried out under the supervision and with the participation of the Company's Chief Executive Officer (Principal Executive Officer), Chief Financial Officer (Principal Financial and Accounting Officer), and other members of the Company's management team as of the end of the period covered by this quarterly report. The Company's Chief Executive Officer and Chief Financial Officer concluded that as of June 30, 2020, the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.
(b) Changes in Internal Controls.
There have been no changes in the Company's internal control over financial reporting (as defined in 13a-15(f) of the Exchange Act) that occurred during the quarter ended June 30, 2020, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
The Company intends to continually review and evaluate the design and effectiveness of its disclosure controls and procedures and to improve its controls and procedures over time and to correct any deficiencies that it may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Company's business. While the Company believes the present design of its disclosure controls and procedures is effective to achieve its goal, future events affecting its business may cause the Company to modify its disclosure controls and procedures. The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent every error or instance of fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
Item 1. Legal Proceedings
From time to time, the Company is engaged in legal proceedings in the ordinary course of business, none of which are currently considered to have a material impact on the Company’s financial position or results of operations.
Item 1A. Risk Factors
The disclosures below supplement the risk factors previously disclosed under Part I. Item 1A of the Company's Form 10-K for the year ended December 31, 2019.
The effects of the COVID-19 pandemic could adversely affect our customers future results of operations and/or the market price of our stock.
The COVID-19 pandemic continues to rapidly evolve, as do federal, state and local efforts to address it. Both the direct effects of the pandemic and the resulting United States governmental responses are of an unprecedented scope as it impacts both the health and the economy of our country and the world at large. No one can predict the extent or duration of the pandemic, or its effect on the markets that we serve. Further, the ongoing efforts and impact of the government in mitigating the health and the economic effects of the pandemic cannot currently be predicted, whether on our business or as to the economy as a whole. The pandemic has thus far resulted in significant volatility in international and United States markets, which could adversely affect the market price of our stock. To date, the pandemic has resulted in significant business disruption and volatility in the international and domestic markets, which has adversely affected the market price of our stock and stocks in general
The Company continues to manage through uncertainties and complexities created by the pandemic. As an essential business, our employees have been able to work safely in our branch locations and over 70% of our workforce has the ability to work from home. However, the economic downturn in local markets we serve could result in increased credit risk associated with the loan portfolio as customers are unable to repay loans and meet their obligations, as well as adversely impact our earnings. We believe our strong capital position will be important in managing through the unknown impact of the pandemic.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a)
Not applicable.
(b)
(c)
The following table summarizes common stock repurchases during the three months ended June 30, 2020:
Period
Total Number of Shares Purchased
Average Price Paid per Share
April 1, 2020 - April 30, 2020
May 1, 2020 - May 31, 2020
June 1, 2020 - June 30, 2020
(1) On December 5, 2019, the Company announced that its Board of Directors had authorized the repurchase of up to an additional 535,097 shares of its common stock, or approximately 5% of its shares of common stock issued and outstanding as of December 2, 2019. As of June 30, 2020, a total of 393,304 shares, or 73.5% percent of the shares authorized in the December 2019 stock repurchase plan, have been purchased at an average cost of $12.88 per share, leaving 141,793 shares available for future purchases.
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
COVID-19 Legislation and Regulation.
General. Governments at the federal, state, and local levels continue to take steps to address the impact of the COVID-19 emergency. On March 27, 2020 the President signed into law the historic $2 trillion federal stimulus package known as the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which included $350 billion in stimulus for small businesses under the so-called “Paycheck Protection Program,” along with direct stimulus payments (i.e., “economic impact payments” or “stimulus checks”) for many eligible Americans. The initial amounts available under the Paycheck Protection Program were quickly exhausted in less than two weeks, which prompted Congress to negotiate additional funding. On April 24, 2020, the Paycheck Protection Program and Health Care Enforcement Act was signed into law to replenish funding to the Paycheck Protection Program and to provide other spending for hospitals and virus testing. Further, on July 3, 2020 the President extended the deadline for potential borrowers to apply for Paycheck Protection Program funds until August 8, 2020. The legislative and regulatory landscape surrounding COVID-19 is rapidly changing, and neither the Company nor the Bank can predict with certainty the impact it will have on our operations or business.
Item 6. Exhibits
Exhibit
No.
Exhibit Description
Filed
Herewith
Form
Original Exhibit No.
Filing Date
SEC File No.
10.1*
X
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
Certification pursuant to Section 906 of the Sarbanes-Oxley Act
101
The following materials from the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, formatted in Inline Extensible Business Reporting Language (iXBRL): (1) Consolidated Balance Sheets; (2) Consolidated Statements of Income; (3) Consolidated Statements of Comprehensive Income; (4) Consolidated Statements of Cash Flows; and (5) Selected Notes to Consolidated Financial Statements
Pursuant to the requirements 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.
Date: August 10, 2020
/s/ Matthew P. Deines
Matthew P. Deines
President, Chief Executive Officer and Director
(Principal Executive Officer)
/s/ Geraldine L. Bullard
Geraldine L. Bullard
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)