Stock-Based Compensation

In June 2016, First Financial Northwest’s shareholders approved the First Financial Northwest, Inc. 2016 Equity Incentive Plan (“2016 Plan”). This plan provides for the granting of incentive stock options (“ISO”), non-qualified stock options (“NQSO”), restricted stock and restricted stock units until June 2026. The 2016 Plan established 1,400,000 shares available to grant with a maximum of 400,000 of these shares available to grant as restricted stock awards. Each share issued as a restricted stock award counts as two shares towards the total shares available to award.

Under the 2016 Plan, the vesting date for each option award or restricted stock award is determined by an award committee and specified in the award agreement. In the case of restricted stock awards granted in lieu of cash payments of directors’ fees, the grant date is used as the vesting date unless the award agreement provides otherwise.

As a result of the approval of the 2016 Plan, the First Financial Northwest, Inc. 2008 Equity Incentive Plan (“2008 Plan”) was frozen and no additional awards will be made. At June 30, 2018, the remaining 5,000 shares of unvested restricted stock awards under the 2008 Plan are expected to vest in 2018. In addition, 84,000 stock options granted under the 2008 Plan are expected to vest and be available for exercise, and an additional 231,000 stock options from the 2008 Plan were available for exercise at June 30, 2018, subject to the 2008 Plan provisions. At June 30, 2018, there were 1,290,670 total shares available for grant under the 2016 Plan, including 345,335 shares available to be granted as restricted stock.

For the three months ended June 30, 2018 and 2017, total compensation expense for the 2008 and 2016 Plans was $326,000 and $291,000, respectively, and the related income tax benefit was $68,000 and $102,000, respectively.

For the six months ended June 30, 2018 and 2017, total compensation expense for the 2008 and 2016 Plans was $409,000 and $401,000, respectively, and the related income tax benefit was $86,000 and $141,000, respectively.

Stock Options

Under the 2008 Plan, stock option awards were granted with an exercise price equal to the market price of First Financial Northwest’s common stock at the grant date. These option awards have a vesting period of five years, with 20% vesting on the anniversary date of each grant date, and a contractual life of 10 years. Any unexercised stock options expires ten years after the grant date, or sooner in the event of the award recipient’s death, disability or termination of service with the Company and the Bank.

Under the 2016 Plan, the exercise price and vesting period for stock options are determined by the award committee and specified in the award agreement, however, the exercise price shall not be less than the fair market value of a share as of the grant date. Any unexercised stock option will expire 10 years after the award date or sooner in the event of the award recipient’s death, disability, retirement, or termination of service.

The fair value of each option award is estimated on the grant date using a Black-Scholes model that uses the following assumptions. The dividend yield is based on the current quarterly dividend in effect at the time of the grant. Historical employment data is used to estimate the forfeiture rate. The historical volatility of the Company’s stock price over a specified period of time is used for the expected volatility assumption. First Financial Northwest bases the risk-free interest rate on the U.S. Treasury Constant Maturity Indices in effect on the date of the grant. First Financial Northwest elected to use the “Share-Based Payments” method permitted by the SEC to calculate the expected term. This method uses the vesting term of an option along with the contractual term, setting the expected life at the midpoint.

Under certain conditions, a cashless exercise of vested stock options may occur by the option holder surrendering the number of options valued at the current stock price at the time of exercise to cover the total cost to exercise. The surrendered options are canceled and are unavailable for reissue.

A summary of the Company’s stock option plan awards and activity for the three and six months ended June 30, 2018, follows:



	For the Three Months Ended June 30, 2018
	Shares		Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term in Years	Aggregate Intrinsic Value
Outstanding at April 1, 2018	442,940		$	10.22		$	2,894,042
Exercised	(127,940	)	9.91			1,044,826
Outstanding at June 30, 2018	315,000		10.34		5.49	2,891,350
Vested and expected to vest assuming a 3% forfeiture rate over the vesting term	312,480		10.33		5.48	2,870,965
Exercisable at June 30, 2018	231,000		9.94		5.22	2,211,850


	For the Six Months Ended June 30, 2018
	Shares		Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term in Years	Aggregate Intrinsic Value
Outstanding at January 1, 2018	452,940		$	10.21		$	2,402,096
Exercised	(137,940	)	9.90			1,112,026
Outstanding at June 30, 2018	315,000		10.34		5.49	2,891,350
Vested and expected to vest assuming a 3% forfeiture rate over the vesting term	312,480		10.33		5.48	2,870,965
Exercisable at June 30, 2018	231,000		9.94		5.22	2,211,850

As of June 30, 2018, there was $184,000 of total unrecognized compensation cost related to nonvested stock options granted under the 2008 Plan. The cost is expected to be recognized over the remaining weighted-average vesting period of 1.66 years. There were no stock options granted during the six months ended June 30, 2018.

Restricted Stock Awards

The 2008 Plan authorized the grant of restricted stock awards to directors, advisory directors, officers and employees. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at the grant date. The restricted stock awards’ fair value is equal to the stock price on the grant date. Shares awarded under this plan as restricted stock vest ratably over a five-year period beginning at the grant date with 20% vesting on the anniversary date of each grant date.

The 2016 Plan authorizes the grant of restricted stock awards subject to vesting periods or terms as defined by the award committee and specified in the award agreement. Restricted stock awards granted in lieu of cash payments for directors’ fees are subject to immediate vesting on the grant date unless the award agreement provides otherwise.

A summary of changes in nonvested restricted stock awards for the three and six months ended June 30, 2018, follows:



	For the Three Months Ended June 30, 2018
	Shares		Weighted-Average Grant Date Fair Value
Nonvested at April 1, 2018	25,987		$	14.93
Granted	9,192		19.98
Vested	(9,192	)	19.98
Nonvested at June 30, 2018	25,987		14.93
Expected to vest assuming a 3% forfeiture rate over the vesting term	25,207		14.93


	For the Six Months Ended June 30, 2018
	Shares		Weighted-Average Grant Date Fair Value
Nonvested at January 1, 2018	5,000		$	10.88
Granted	30,179		17.14
Vested	(9,192	)	19.98
Nonvested at June 30, 2018	25,987		14.93
Expected to vest assuming a 3% forfeiture rate over the vesting term	25,207		14.93

As of June 30, 2018, there was $222,000 of total unrecognized compensation costs related to nonvested shares granted as restricted stock awards. The cost is expected to be recognized over the remaining weighted-average vesting period of eight months.