10-Q 1 fnwb-12312014x10q.htm 10-Q FNWB-12.31.2014-10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the quarterly period ended December 31, 2014
 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
(I.R.S. Employer
or organization)
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

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 ý No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).
Yes ý No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
Accelerated filer
¨
Non-accelerated filer
x
Smaller reporting company
¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No ý

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: As of February 11, 2015, there were 13,100,360 shares of common stock, $.01 par value per share, outstanding.





FIRST NORTHWEST BANCORP
FORM 10-Q
TABLE OF CONTENTS


PART 1 - FINANCIAL INFORMATION
 
 
Page
Item 1 - Financial Statements (Unaudited)
4
 
 
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations
47
 
 
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
64
 
 
Item 4 - Controls and Procedures
64
 
 
PART II - OTHER INFORMATION
 
 
 
Item 1 - Legal Proceedings
65
 
 
Item 1A - Risk Factors
65
 
 
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
65
 
 
Item 3 - Defaults Upon Senior Securities
65
 
 
Item 4 - Mine Safety Disclosures
65
 
 
Item 5 - Other Information
65
 
 
Item 6 - Exhibits
65
 
 
SIGNATURES
66


As used in this report, the terms, “we,” “our,” and “us,” and “Company” refer to First Northwest Bancorp 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.




EXPLANATORY NOTE

First Northwest Bancorp, a Washington corporation (the "Registrant" or the "Company"), was formed in connection with the conversion of First Federal Savings and Loan Association of Port Angeles (“First Federal” or “the Bank”) from the mutual to the stock form of organization. The conversion and the Company's initial stock offering were completed on January 29, 2015. In the conversion the Company sold an aggregate of 12,167,000 shares of common stock at a price of $10.00 per share in a subscription offering. As of the reporting date of December 31, 2014, the conversion had not been completed. The Company had not issued any shares of its common stock, had no assets or liabilities, and had not conducted any business other than that of an organizational nature. Consequently, since the closing of the conversion occurred following the December 31, 2014 quarter end, the information presented in this Form 10-Q is for First Federal, the subsidiary of First Northwest Bancorp. For further information see Note 11 of the Notes to Consolidated Financial Statements.





PART I - FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands) (Unaudited)

ASSETS
 
December 31,
 
June 30,
 
2014
 
2014
 
 
 
 
Cash and due from banks
$
11,867

 
$
14,228

Interest-bearing deposits in banks
127,416

 
4,732

 
 
 
 
Total cash and cash equivalents
139,283

 
18,960

 
 
 
 
Investment securities available for sale, at fair value
192,303

 
178,972

Investment securities held to maturity, at amortized cost
49,854

 
53,244

Loans held for sale

 
613

Loans receivable (net of allowance for loan losses
 
 
 
of $7,666 and $8,072)
493,536

 
496,184

Federal Home Loan Bank (FHLB) stock, at cost
9,843

 
10,047

Accrued interest receivable
2,218

 
2,272

Premises and equipment, net
12,073

 
12,287

Mortgage servicing rights, net
1,139

 
1,266

Bank-owned life insurance, net
18,089

 
18,066

Real estate owned and repossessed assets
2,026

 
810

Prepaid expenses and other assets
3,787

 
2,571

 
 
 
 
Total assets
$
924,151

 
$
795,292

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
LIABILITIES
 
 
 
Deposits
$
740,824

 
$
600,399

Borrowings
90,033

 
105,133

Deferred tax liability, net
1,256

 
1,110

Accrued interest payable
264

 
262

Accrued expenses and other liabilities
7,955

 
6,355

Advances from borrowers for taxes and insurance
810

 
1,038

 
 
 
 
Total liabilities
841,142

 
714,297

 
 
 
 
COMMITMENTS AND CONTINGENCIES (NOTE 9)

 

 
 
 
 
EQUITY
 
 
 
Retained earnings
81,394

 
79,663

Accumulated other comprehensive income, net of tax
1,615

 
1,332

 
 
 
 
Total equity
83,009

 
80,995

 
 
 
 
Total liabilities and equity
$
924,151

 
$
795,292


See selected notes to the consolidated financial statements.

4


FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands) (Unaudited)

 
Three Months Ended
 
Six Months Ended
 
December 31,
 
December 31,
 
2014
 
2013
 
2014
 
2013
INTEREST INCOME
 
 
 
 
 
 
 
Interest and fees on loans receivable
$
5,606

 
$
5,620

 
$
11,135

 
$
11,018

Interest on mortgage-backed and related securities
757

 
684

 
1,533

 
1,344

Interest on investment securities
330

 
269

 
647

 
555

Interest-bearing deposits and other
22

 
15

 
27

 
29

FHLB dividends
2

 
2

 
5

 
5

Total interest income
6,717

 
6,590

 
13,347

 
12,951

INTEREST EXPENSE
 
 
 
 
 
 
 
Deposits
382

 
385

 
753

 
789

Borrowings
734

 
827

 
1,470

 
1,654

Total interest expense
1,116

 
1,212

 
2,223

 
2,443

Net interest income
5,601

 
5,378

 
11,124

 
10,508

PROVISION FOR (RECAPTURE OF) LOAN LOSSES

 
(1
)
 

 
432

Net interest income after provision for (recapture of) loan losses
5,601

 
5,379

 
11,124

 
10,076

NONINTEREST INCOME
 
 
 
 
 
 
 
Loan and deposit service fees
824

 
912

 
1,659

 
1,773

Mortgage servicing fees, net of amortization
60

 
42

 
133

 
75

Net gain on sale of loans
41

 
151

 
138

 
354

Net (loss) on sale of investment securities

 

 

 
(68
)
(Decrease) increase in cash surrender value of bank-owned life insurance
(16
)
 
(25
)
 
23

 
15

Other income
70

 
79

 
168

 
152

Total noninterest income
979

 
1,159

 
2,121

 
2,301

NONINTEREST EXPENSE
 
 
 
 
 
 
 
Compensation and benefits
3,049

 
2,719

 
6,089

 
5,354

Real estate owned and repossessed assets (income) expense, net
(146
)
 
148

 
(62
)
 
162

Data processing
622

 
538

 
1,232

 
1,032

Occupancy and equipment
768

 
738

 
1,562

 
1,447

Supplies, postage, and telephone
171

 
181

 
331

 
368

Regulatory assessments and state taxes
78

 
102

 
163

 
209

Advertising
144

 
147

 
272

 
276

Professional fees
128

 
194

 
297

 
380

FDIC insurance premium
131

 
130

 
267

 
281

Other
497

 
449

 
808

 
803

Total noninterest expense
5,442

 
5,346

 
10,959

 
10,312

INCOME BEFORE PROVISION FOR
 
 
 
 
 
 
 
INCOME TAXES
1,138

 
1,192

 
2,286

 
2,065

PROVISION FOR INCOME TAXES
256

 
335

 
555

 
528

NET INCOME
$
882

 
$
857

 
$
1,731

 
$
1,537



See selected notes to the consolidated financial statements.

5


FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands) (Unaudited)

 
Three Months Ended
 
Six Months Ended
 
December 31,
 
December 31,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
NET INCOME
$
882

 
$
857

 
$
1,731

 
$
1,537

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
Unrealized gain (loss) on securities
 
 
 
 
 
 
 
Unrealized holding gain (loss), net of taxes of
 
 
 
 
 
 
 
$122, $(3), $149, and $(470), respectively
232

 
(6
)
 
283

 
(913
)
Reclassification adjustments for losses on sale
 
 
 
 
 
 
 
of securities, net of taxes of $0, $0, $0,
 
 
 
 
 
 
 
and $23, respectively

 

 

 
45

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net
232

 
(6
)
 
283

 
(868
)
 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME
$
1,114

 
$
851

 
$
2,014

 
$
669



See selected notes to the consolidated financial statements.

6


FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
For the Six Months Ended December 31, 2014 and 2013
(In thousands) (Unaudited)

 
Retained
Earnings
 
Accumulated Other Comprehensive Income, Net of Tax
 
Total
Equity
 
 
 
 
 
 
BALANCE, June 30, 2013
$
76,995

 
$
1,628

 
$
78,623

 
 
 
 
 
 
Net income
1,537

 
 
 
1,537

Other comprehensive loss, net of tax
 
 
(868
)
 
(868
)
 
 
 
 
 
 
Comprehensive income
 
 
 
 
$
669

 
 
 
 
 
 
BALANCE, December 31, 2013
$
78,532

 
$
760

 
$
79,292

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, June 30, 2014
$
79,663

 
$
1,332

 
$
80,995

 
 
 
 
 
 
Net income
1,731

 
 
 
1,731

Other comprehensive income, net of tax
 
 
283

 
283

 
 
 
 
 
 
Comprehensive income
 
 
 
 
$
2,014

 
 
 
 
 
 
BALANCE, December 31, 2014
$
81,394

 
$
1,615

 
$
83,009



See selected notes to the consolidated financial statements.

7


FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)

 
Six Months Ended
 
December 31,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net income
$
1,731

 
$
1,537

Adjustments to reconcile net income to net cash
 
 
 
from operating activities
 
 
 
Depreciation and amortization
492

 
555

Amortization and accretion of premiums and discounts
 
 
 
on investments, net
638

 
1,089

Amortization of deferred loan fees, net
(84
)
 
(101
)
Amortization of mortgage servicing rights
167

 
235

Additions to mortgage servicing rights
(40
)
 
(63
)
(Recoveries) on the valuation allowance
 
 
 
on mortgage servicing rights, net

 
(1
)
Provision for loan losses

 
432

(Gain) loss on sale of real estate owned and repossessed assets, net
(215
)
 
21

Gain on sale of loans
(138
)
 
(354
)
Loss on sale of securities available for sale

 
68

Write-down on real estate owned and repossessed assets
84

 
82

Increase in cash surrender value of life insurance
(23
)
 
(15
)
Origination of loans held for sale
(6,095
)
 
(11,924
)
Proceeds from loans held for sale
6,846

 
12,151

Change in assets and liabilities:
 
 
 
Decrease in accrued interest receivable
54

 
141

Increase in prepaid expenses and other assets
(1,216
)
 
(334
)
Increase in accrued interest payable
2

 
2

Increase (decrease) in accrued expenses and other liabilities
1,600

 
(4,104
)
 
 
 
 
Net cash from operating activities
3,803

 
(583
)
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Purchase of securities available for sale
(25,943
)
 
(1,967
)
Proceeds from maturities, calls, and principal repayments
 
 
 
of securities available for sale
12,595

 
22,267

Proceeds from sales of securities available for sale

 
10,556

Purchase of securities held to maturity

 
(5,961
)
Proceeds from maturities, calls, and principal repayments
 
 
 
of securities held to maturity
3,199

 
4,486

Proceeds from FHLB stock redemption
204

 
192

Proceeds from sale of real estate owned and repossessed assets
795

 
1,213

Loan originations, net of repayments, write-offs, and recoveries
852

 
(20,276
)
Purchase of premises and equipment, net
(279
)
 
(383
)
 
 
 
 
Net cash from investing activities
(8,577
)
 
10,127


See selected notes to the consolidated financial statements.

8


FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(In thousands) (Unaudited)

 
Six Months Ended
 
December 31,
 
2014
 
2013
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Net increase in deposits
140,425

 
5,336

Proceeds from FHLB advances
17,100

 

Repayment of FHLB advances
(32,200
)
 

Net (decrease) increase in advances from borrowers
 
 
 
for taxes and insurance
(228
)
 
60

 
 
 
 
Net cash from financing activities
125,097

 
5,396

 
 
 
 
NET INCREASE IN CASH AND CASH EQUIVALENTS
120,323

 
14,940

 
 
 
 
CASH AND CASH EQUIVALENTS, beginning of period
18,960

 
22,948

 
 
 
 
CASH AND CASH EQUIVALENTS, end of period
$
139,283

 
$
37,888

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
 
 
 
Cash paid during the year for
 
 
 
Interest on deposits and other borrowings
$
2,221

 
$
2,441

 
 
 
 
Income taxes
$
250

 
$
740

 
 
 
 
NONCASH INVESTING ACTIVITIES
 
 
 
Unrealized gain (loss) on securities available for sale
$
432

 
$
(1,383
)
 
 
 
 
Loans foreclosed upon with repossession transferred to
 
 
 
real estate owned and repossessed assets
$
1,880

 
$
539



See selected notes to the consolidated financial statements.

9

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 1 - Basis of Presentation and Critical Accounting Policies

Nature of business - First Federal Savings and Loan Association of Port Angeles provides commercial and consumer banking services to individuals and businesses located primarily on the Olympic Peninsula in the state of Washington. These services include deposit and lending transactions that are supplemented with other 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 June 30, 2014 audited consolidated financial statements and accompanying notes included in our Registration Statement on Form S-1, as filed with the SEC. 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 six months ended December 31, 2014, are not necessarily indicative of the results that may be expected for the year ended June 30, 2015. 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), mortgage servicing rights, fair value of financial instruments, deferred tax assets and liabilities, and the valuation of impaired loans and real estate owned and repossessed assets.

Plan of conversion and change in corporate form - On January 29, 2015, in accordance with a Plan of Conversion (Plan) adopted by its Board of Directors and as approved by its members, the Bank converted from a mutual savings bank to a stock savings bank, and became the wholly-owned subsidiary of the Company, a bank holding company registered with the Board of Governors of the Federal Reserve System (Federal Reserve). 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 net proceeds of approximately $117.8 million. An additional 933,360 shares of Company common stock were contributed to the First Federal Community Foundation, a charitable foundation established in connection with the conversion, resulting in the issuance of a total of 13,100,360 shares. From the proceeds, the Company made a capital contribution of approximately $58.5 million to the Bank. The Bank intends to use this additional capital for future lending and investment activities and for general and other corporate purposes subject to regulatory limitations.

Pursuant to the Plan, the Bank’s Board of Directors adopted an employee stock ownership plan (“ESOP”) which intends to purchase in the open market 8% of the common stock or 1,048,029 shares.

Conversion costs were deferred and deducted from the proceeds of the shares sold in the offering during the third quarter of fiscal year 2015. As of December 31, 2014, there were conversion costs totaling $2.2 million which had been deferred, and were included in other assets. Total conversion costs were netted against capital raised in the mutual-to-stock conversion transaction on January 29, 2015.

At the time of conversion, the Bank established a liquidation account in an amount equal to its total net worth, approximately $79.7 million, as of June 30, 2014, the latest statement of financial condition appearing in the Company's prospectus. The liquidation account will be maintained for the benefit of eligible depositors who continue to maintain their accounts at the Bank after the conversion. The liquidation account will be reduced annually to the extent that eligible depositors have reduced their qualifying deposits. Subsequent increases will not restore an eligible holder’s interest in the liquidation account. In the event of a complete liquidation, each eligible depositor will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held. The liquidation account balance is not available for payment of dividends, and the Bank may not pay dividends if those dividends would reduce equity capital below the required liquidation account amount. The conversion has been accounted for as a change in corporate form with the historic basis of the Bank's assets, liabilities, and equity unchanged as a result.


10

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 1 - Basis of Presentation and Critical Accounting Policies (continued)

Principles of consolidation - The accompanying consolidated financial statements include the accounts of First Federal Savings and Loan Association of Port Angeles, its wholly owned subsidiary, North Olympic Peninsula Services, Inc., and majority-owned Craft3 Development IV, LLC. North Olympic Peninsula Services, Inc. owns a building currently rented in whole to First Federal and receives an immaterial amount of income from insurance contracts. Craft3 is a partnership investment which offers loans qualifying under the New Markets Tax Credit rules. All material intercompany accounts and transactions have been eliminated in consolidation.

Recently issued accounting pronouncements - In January 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects. The objective of this ASU is to provide guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. The amendments in this ASU modify the conditions that a reporting entity must meet to be eligible to use a method other than the equity or cost methods to account for qualified affordable housing project investments. If the modified conditions are met, the amendments permit an entity to amortize the initial cost of the investment in proportion to the amount of tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense (benefit). Additionally, the amendments introduce new recurring disclosures about all investments in qualified affordable housing projects irrespective of the method used to account for the investments. The amendments in this ASU should be applied retrospectively to all periods presented. The amendments in this ASU are effective for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. The adoption of ASU No. 2014-11 is not expected to have a material impact on First Federal's consolidated financial statements.

In January 2014, the FASB issued ASU No. 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. This ASU includes amendments that clarify a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan causing an in substance repossession or foreclosure to occur upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The adoption of ASU No. 2014-11 is not expected to have a material impact on First Federal's consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which creates Topic 606 and supersedes Topic 605, Revenue Recognition. The core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In general, the new guidance requires companies to use more judgment and make more estimates than under current guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The standard is effective for public entities for interim and annual periods beginning after December 15, 2016; early adoption is not permitted. For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied to all of the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. First Federal is currently evaluating the impact of this ASU.


11

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 1 - Basis of Presentation and Critical Accounting Policies (continued)

In June 2014, the FASB issued ASU No. 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures, which changes the accounting for repurchase-to-maturity transactions and repurchase financing arrangements. It also requires additional disclosures about repurchase agreements and other similar transactions. The ASU aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. Going forward, these transactions would all be accounted for as secured borrowings. The ASU also requires new and expanded disclosures. This ASU is effective for the first interim or annual period beginning after December 15, 2014. The adoption of ASU No. 2014-11 is not expected to have a material impact on First Federal's consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Topic 718, Compensation – Stock Compensation, as it relates to awards with performance conditions that affect vesting to account for such awards. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this ASU can be applied prospectively or retrospectively and are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, with early adoption permitted. First Federal is currently evaluating the impact of this ASU.

In August 2014, the FASB issued ASU No. 2014-14, Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40: Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure). The amendments in this ASU require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met: (1) the loan has a government guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The adoption of ASU No. 2015-1 is not expected to have a material impact on First Federal's consolidated financial statements.

In January 2015, the FASB issued ASU No. 2015-01, Income Statement--Extraordinary and Unusual Items (Subtopic 225-20). The ASU eliminates the need to separately classify, present, and disclose extraordinary events. The disclosure of events or transactions that are unusual or infrequent in nature will be included in other guidance. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. The adoption of ASU No. 2015-1 is not expected to have a material impact on First Federal's consolidated financial statements.

Reclassifications - Certain reclassifications have been made to the 2014 and 2013 unaudited interim consolidated financial statements to conform to the 2014 presentation with no effect on net income or equity.


12

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 2 - Securities

The amortized cost, gross unrealized gains and losses, and estimated fair value of securities classified as available-for-sale and held-to-maturity at December 31, 2014, are summarized as follows:

 
December 31, 2014
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
(In thousands)
Available for Sale
 
 
 
 
 
 
 
Investment Securities
 
 
 
 
 
 
 
Municipal bonds
$
9,808

 
$
235

 
$
(6
)
 
$
10,037

U.S. government agency issued bonds (Agency bonds)
8,788

 

 
(22
)
 
8,766

U.S. government agency issued asset-backed securities (ABS agency)
10,134

 

 
(318
)
 
9,816

Corporate issued asset-backed securities (ABS corporate)
14,751

 

 

 
14,751

U.S. Small Business Administration securities (SBA)
26,578

 
524

 
(21
)
 
27,081

 
 
 
 
 
 
 
 
Total
$
70,059

 
$
759

 
$
(367
)
 
$
70,451

 
 
 
 
 
 
 
 
Mortgage-Backed Securities
 
 
 
 
 
 
 
U.S. government agency issued mortgage-backed securities
    (MBS agency)
$
119,852

 
$
2,229

 
$
(229
)
 
$
121,852

 
 
 
 
 
 
 
 
Total securities available for sale
$
189,911

 
$
2,988

 
$
(596
)
 
$
192,303

 
 
 
 
 
 
 
 
Held to Maturity
 
 
 
 
 
 
 
Investment Securities
 
 
 
 
 
 
 
Municipal bonds
$
15,430

 
$
445

 
$
(10
)
 
$
15,865

SBA
991

 
3

 
(1
)
 
993

 
 
 
 
 
 
 
 
Total
$
16,421

 
$
448

 
$
(11
)
 
$
16,858

 
 
 
 
 
 
 
 
Mortgage-Backed Securities
 
 
 
 
 
 
 
MBS agency
$
33,433

 
$
985

 
$
(59
)
 
$
34,359

 
 
 
 
 
 
 
 
Total securities held to maturity
$
49,854

 
$
1,433

 
$
(70
)
 
$
51,217



13

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 2 - Securities (continued)

The amortized cost, gross unrealized gains and losses, and estimated fair value of securities classified as available-for-sale and held-to-maturity at June 30, 2014, are summarized as follows:
 
June 30, 2014
 
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
(In thousands)
Available for Sale
 
 
 
 
 
 
 
Investment Securities
 
 
 
 
 
 
 
Municipal bonds
$
7,418

 
$
139

 
$
(32
)
 
$
7,525

ABS agency
10,585

 

 
(445
)
 
10,140

SBA
28,355

 
600

 
(11
)
 
28,944

 
 
 
 
 
 
 
 
Total
$
46,358

 
$
739

 
$
(488
)
 
$
46,609

 
 
 
 
 
 
 
 
Mortgage-Backed Securities
 
 
 
 
 
 
 
MBS agency
$
130,654

 
$
2,078

 
$
(369
)
 
$
132,363

 
 
 
 
 
 
 
 
Total securities available for sale
$
177,012

 
$
2,817

 
$
(857
)
 
$
178,972

 
 
 
 
 
 
 
 
Held to Maturity
 
 
 
 
 
 
 
Investment Securities
 
 
 
 
 
 
 
Municipal bonds
$
15,826

 
$
199

 
$
(18
)
 
$
16,007

SBA
1,080

 
4

 
(1
)
 
1,083

 
 
 
 
 
 
 
 
Total
$
16,906

 
$
203

 
$
(19
)
 
$
17,090

 
 
 
 
 
 
 
 
Mortgage-Backed Securities
 
 
 
 
 
 
 
MBS agency
$
36,338

 
$
692

 
$
(138
)
 
$
36,892

 
 
 
 
 
 
 
 
Total securities held to maturity
$
53,244

 
$
895

 
$
(157
)
 
$
53,982



14

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 2 - Securities (continued)

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, 2014:

 
Less Than Twelve Months
 
Twelve Months or Longer
 
Total
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In thousands)
Available for Sale
 
 
 
 
 
 
 
 
 
 
 
Investment Securities
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
$
(6
)
 
$
2,406

 
$

 
$

 
$
(6
)
 
$
2,406

Agency bonds
(22
)
 
8,766

 

 

 
(22
)
 
8,766

ABS agency
(207
)
 
5,954

 
(111
)
 
3,862

 
(318
)
 
9,816

SBA
(7
)
 
2,244

 
(14
)
 
4,810

 
(21
)
 
7,054

Total
$
(242
)
 
$
19,370

 
$
(125
)
 
$
8,672

 
$
(367
)
 
$
28,042

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-Backed Securities
 
 
 
 
 
 
 
 
 
 
 
MBS agency
$
(1
)
 
$
2,751

 
$
(228
)
 
$
17,210

 
$
(229
)
 
$
19,961

 
 
 
 
 
 
 
 
 
 
 
 
Held to Maturity
 
 
 
 
 
 
 
 
 
 
 
Investment Securities
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
$

 
$

 
$
(10
)
 
$
1,314

 
$
(10
)
 
$
1,314

SBA

 

 
(1
)
 
252

 
(1
)
 
252

Total
$

 
$

 
$
(11
)
 
$
1,566

 
$
(11
)
 
$
1,566

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-Backed Securities
 
 
 
 
 
 
 
 
 
 
 
MBS agency
$
(5
)
 
$
2,714

 
$
(54
)
 
$
7,033

 
$
(59
)
 
$
9,747


15

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 2 - Securities (continued)

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, 2014:

 
Less Than Twelve Months
 
Twelve Months or Longer
 
Total
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In thousands)
Available for Sale
 
 
 
 
 
 
 
 
 
 
 
Investment Securities
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
$

 
$

 
$
(32
)
 
$
3,827

 
$
(32
)
 
$
3,827

ABS agency
(288
)
 
6,088

 
(157
)
 
4,053

 
(445
)
 
10,141

SBA

 

 
(11
)
 
5,068

 
(11
)
 
5,068

Total
$
(288
)
 
$
6,088

 
$
(200
)
 
$
12,948

 
$
(488
)
 
$
19,036

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-Backed Securities
 
 
 
 
 
 
 
 
 
 
 
MBS agency
$
(24
)
 
$
14,233

 
$
(345
)
 
$
24,379

 
$
(369
)
 
$
38,612

 
 
 
 
 
 
 
 
 
 
 
 
Held to Maturity
 
 
 
 
 
 
 
 
 
 
 
Investment Securities
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
$

 
$

 
$
(18
)
 
$
1,311

 
$
(18
)
 
$
1,311

SBA

 

 
(1
)
 
260

 
(1
)
 
260

Total
$

 
$

 
$
(19
)
 
$
1,571

 
$
(19
)
 
$
1,571

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-Backed Securities
 
 
 
 
 
 
 
 
 
 
 
MBS agency
$
(13
)
 
$
5,728

 
$
(125
)
 
$
7,921

 
$
(138
)
 
$
13,649



First Federal may hold certain investment securities in an unrealized loss position that are not considered other than temporarily impaired (OTTI). At December 31, 2014, there were 20 investment securities with $666,000 of unrealized losses and a fair value of approximately $59.3 million. At June 30, 2014, there were 23 investment securities with $1.0 million of unrealized losses and a fair value of approximately $72.9 million.

The unrealized losses on investments in debt securities relate principally to the general change in interest rates and illiquidity, and not credit quality, that has occurred since the securities’ purchase dates, and such unrecognized losses or gains will continue to vary with general interest rate level fluctuations in the future. As management does not intend to sell the securities, and it is not likely they will be required to sell the securities before their anticipated recovery, no declines are deemed to be other than temporary.

The unrealized losses on investment and mortgage-backed securities were caused by interest rate changes. Certain investments in a loss position are guaranteed by government entities or government sponsored entities. It is expected that securities in a loss position would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and First Federal does not intend to sell the securities and believes it is not likely it will be required to sell these investments until a market price recovery or maturity, these investments are not considered other than temporarily impaired.

There were no OTTI losses during the three and six months ended December 31, 2014 or 2013.

16

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 2 - Securities (continued)

The amortized cost and estimated fair value of investment and mortgage-backed securities by contractual maturity are shown in the following tables at the dates indicated. Actual maturities may differ from contractual maturities for investments where borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
December 31, 2014
 
Available-for-Sale
 
Held-to-Maturity
 
Amortized
Cost
 
Estimated
Fair Value
 
Amortized
Cost
 
Estimated
Fair Value
 
(In thousands)
Investment Securities
 
 
 
 
 
 
 
Due within one year
$
6,927

 
$
6,927

 
$
395

 
$
401

Due after one through five years

 

 
166

 
168

Due after five through ten years
13,960

 
14,177

 
4,364

 
4,416

Due after ten years
49,172

 
49,347

 
11,496

 
11,873

 
 
 
 
 
 
 
 
 
$
70,059

 
$
70,451

 
$
16,421

 
$
16,858

 
 
 
 
 
 
Mortgage-Backed Securities
 
 
 
 
 
 
 
Due within one year
$

 
$

 
$

 
$

Due after one through five years

 

 
88

 
93

Due after five through ten years
5,027

 
5,076

 
7,390

 
7,513

Due after ten years
114,825

 
116,776

 
25,955

 
26,753

 
 
 
 
 
 
 
 
 
$
119,852

 
$
121,852

 
$
33,433

 
$
34,359


 
June 30, 2014
 
Available-for-Sale
 
Held-to-Maturity
 
Amortized
Cost
 
Estimated
Fair Value
 
Amortized
Cost
 
Estimated
Fair Value
 
(In thousands)
Investment Securities
 
 
 
 
 
 
 
Due within one year
$

 
$

 
$
250

 
$
251

Due after one through five years

 

 
562

 
577

Due after five through ten years
2,048

 
2,119

 
3,084

 
3,138

Due after ten years
44,310

 
44,490

 
13,010

 
13,124

 
 
 
 
 
 
 
 
 
$
46,358

 
$
46,609

 
$
16,906

 
$
17,090

 
 
 
 
 
 
Mortgage-Backed Securities
 
 
 
 
 
 
 
Due within one year
$

 
$

 
$

 
$

Due after one through five years

 

 
161

 
171

Due after five through ten years
5,030

 
5,048

 
8,667

 
8,816

Due after ten years
125,624

 
127,315

 
27,510

 
27,905

 
 
 
 
 
 
 
 
 
$
130,654

 
$
132,363

 
$
36,338

 
$
36,892



17

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 2 - Securities (continued)

During the three and six months ended December 31, 2014 and the three months ended December 31, 2013, First Federal did not sell any investment securities. During the six months ended December 31, 2013, First Federal sold available-for-sale securities with gross proceeds of $10.6 million with no gross realized gains and gross realized losses of $68,000.


Note 3 - Loans Receivable

Loans receivable consist of the following at the dates indicated:
 
December 31, 2014
 
June 30, 2014
 
(In thousands)
One to four family
$
247,695

 
$
241,910

Commercial
185,391

 
190,660

Consumer
47,652

 
50,761

Construction and land
19,588

 
20,497

 
500,326

 
503,828

Less:
 
 
 
Net deferred loan fees
900

 
862

(Premium) on purchased loans, net
(1,776
)
 
(1,290
)
Allowance for loan losses
7,666

 
8,072

 
6,790

 
7,644

Total loans receivable, net
$
493,536

 
$
496,184


Loans, by the earlier of next repricing date or maturity, at the dates indicated:
 
December 31, 2014
 
June 30, 2014
 
(In thousands)
Adjustable-rate loans
 
 
 
Due within one year
$
72,967

 
$
84,008

After one but within five years
131,078

 
124,065

After five but within ten years
41,566

 
34,020

After ten years

 

 
245,611

 
242,093

Fixed-rate loans
 
 
 
Due within one year
8,669

 
11,298

After one but within five years
17,665

 
19,619

After five but within ten years
45,635

 
47,709

After ten years
182,746

 
183,109

 
254,715

 
261,735

 
$
500,326

 
$
503,828


The adjustable-rate loans have interest rate adjustment limitations and are generally indexed to multiple indices. Future market factors may affect the correlation of adjustable loan interest rates with the rates First Federal pays on the short-term deposits that have been primarily used to fund such loans.

18

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

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 December 31, 2014
 
One to Four
Family
 
Commercial
 
Consumer
 
Construction
and Land
 
Unallocated
 
Total
ALLL:
(In thousands)
Beginning balance
$
3,746

 
$
1,893

 
$
1,489

 
$
431

 
$
424

 
$
7,983

Provision for loan losses
(348
)
 
58

 
(68
)
 
(23
)
 
381

 

Charge-offs
(103
)
 

 
(234
)
 
(4
)
 

 
(341
)
Recoveries
5

 
3

 
15

 
1

 

 
24

Ending balance
$
3,300

 
$
1,954

 
$
1,202

 
$
405

 
$
805

 
$
7,666


 
At or For the Six Months Ended December 31, 2014
 
One to Four
Family
 
Commercial
 
Consumer
 
Construction
and Land
 
Unallocated
 
Total
ALLL:
(In thousands)
Beginning balance
$
3,408

 
$
2,354

 
$
1,678

 
$
397

 
$
235

 
$
8,072

Provision for loan losses
3

 
(403
)
 
(226
)
 
56

 
570

 

Charge-offs
(122
)
 

 
(290
)
 
(49
)
 

 
(461
)
Recoveries
11

 
3

 
40

 
1

 

 
55

Ending balance
$
3,300

 
$
1,954

 
$
1,202

 
$
405

 
$
805

 
$
7,666

 
 
 
 
 
 
 
 
 
 
 
 
Allowance by portfolio segment:
 
 
 
 
 
 
 
 
 
 
 
Total ALLL
$
3,300

 
$
1,954

 
$
1,202

 
$
405

 
$
805

 
$
7,666

General reserve
3,105

 
1,812

 
1,103

 
371

 
805

 
7,196

Specific reserve
195

 
142

 
99

 
34

 

 
470

 
 
 
 
 
 
 
 
 
 
 
 
Loan balance:
 
 
 
 
 
 
 
 
 
 
 
Total loans
$
247,695

 
$
185,391

 
$
47,652

 
$
19,588

 
$

 
$
500,326

General reserves (1)
240,549

 
181,659

 
46,876

 
19,039

 

 
488,123

Specific reserves (2)
7,146

 
3,732

 
776

 
549

 

 
12,203

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) Loans collectively evaluated for general reserves.
 
 
 
 
 
 
 
 
 
 
(2) Loans individually evaluated for specific reserves.
 
 
 
 
 
 
 
 
 
 


19

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

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 December 31, 2013
 
One to Four
Family
 
Commercial
 
Consumer
 
Construction
and Land
 
Unallocated
 
Total
 
(In thousands)
Beginning balance
$
3,758

 
$
1,919

 
$
1,950

 
$
324

 
$
231

 
$
8,182

Provision for loan losses
(389
)
 
(108
)
 
(130
)
 
(1
)
 
627

 
(1
)
Charge-offs
(436
)
 

 
(31
)
 
(14
)
 

 
(481
)
Recoveries
83

 
5

 
14

 

 

 
102

Ending balance
$
3,016

 
$
1,816

 
$
1,803

 
$
309

 
$
858

 
$
7,802


 
At or For the Six Months Ended December 31, 2013
 
One to Four
Family
 
Commercial
 
Consumer
 
Construction
and Land
 
Unallocated
 
Total
 
(In thousands)
Beginning balance
$
3,667

 
$
1,774

 
$
2,015

 
$
297

 
$
221

 
$
7,974

Provision for loan losses
(298
)
 
34

 
33

 
26

 
637

 
432

Charge-offs
(439
)
 

 
(307
)
 
(15
)
 

 
(761
)
Recoveries
86

 
8

 
62

 
1

 

 
157

Ending balance
$
3,016

 
$
1,816

 
$
1,803

 
$
309

 
$
858

 
$
7,802




 
At the Year Ended June 30, 2014
 
One to Four
Family
 
Commercial
 
Consumer
 
Construction
and Land
 
Unallocated
 
Total
 
(In thousands)
Allowance by portfolio segment:
 
 
 
 
 
 
 
 
 
 
 
Total ALLL
$
3,408

 
$
2,354

 
$
1,678

 
$
397

 
$
235

 
$
8,072

General reserve
3,238

 
2,077

 
1,558

 
381

 
235

 
7,489

Specific reserve
170

 
277

 
120

 
16

 

 
583

 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
Total loans
$
241,910

 
$
190,660

 
$
50,761

 
$
20,497

 
$

 
$
503,828

General reserves (1)
234,300

 
184,895

 
49,843

 
20,057

 

 
489,095

Specific reserves (2)
7,610

 
5,765

 
918

 
440

 

 
14,733

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) Loans collectively evaluated for general reserves.
 
 
 
 
 
 
 
 
 
 
(2) Loans individually evaluated for specific reserves.
 
 
 
 
 
 
 
 
 
 


20

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

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. In the process of identifying loans as impaired, management takes into consideration factors that include payment history and status, collateral value, financial condition of the borrower, and the probability of collecting scheduled payments in the future. Minor payment delays and insignificant payment shortfalls typically do not result in a loan being classified as impaired. The significance of payment delays and shortfalls is considered by management on a case-by-case basis after taking into consideration the totality of circumstances surrounding the loans and the borrowers, including payment history and amounts of any payment shortfall, length and reason for delay, and likelihood of return to stable performance. Impairment is measured on a loan-by-loan basis for all loans in the portfolio except smaller balance homogeneous loans and certain qualifying TDR loans.


The following table presents a summary of loans individually evaluated for impairment by portfolio segment at the dates indicated:

 
December 31, 2014
 
June 30, 2014
 
Recorded
Investments
(Loan Balance
Less Charge-off)
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Recorded
Investments
(Loan Balance
Less Charge-off)
 
Unpaid
Principal
Balance
 
Related
Allowance
 
(In thousands)
With no allowance recorded
 
 
 
 
 
 
 
 
 
 
 
One to four family
$
3,849

 
$
4,508

 
$

 
$
4,103

 
$
4,720

 
$

Commercial
2,090

 
2,148

 

 
977

 
1,032

 

Consumer
170

 
265

 

 
383

 
579

 

Construction and land
311

 
356

 

 
313

 
358

 

Loans with no allowance recorded
6,420

 
7,277

 

 
5,776

 
6,689

 

With an allowance recorded
 
 
 
 
 
 
 
 
 
 
 
One to four family
3,297

 
3,463

 
195

 
3,507

 
4,113

 
170

Commercial
1,642

 
1,642

 
142

 
4,788

 
4,883

 
277

Consumer
606

 
667

 
99

 
535

 
557

 
120

Construction and land
238

 
262

 
34

 
127

 
151

 
16

Loans with an allowance recorded
5,783

 
6,034

 
470

 
8,957

 
9,704

 
583

Total
 
 
 
 
 
 
 
 
 
 
 
One to four family
7,146

 
7,971

 
195

 
7,610

 
8,833

 
170

Commercial
3,732

 
3,790

 
142

 
5,765

 
5,915

 
277

Consumer
776

 
932

 
99

 
918

 
1,136

 
120

Construction and land
549

 
618

 
34

 
440

 
509

 
16

 
$
12,203

 
$
13,311

 
$
470

 
$
14,733

 
$
16,393

 
$
583



21

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

The following tables present the average recorded investment in loans individually evaluated for impairment and the related interest income recognized for the periods shown:

 
Three Months Ended
December 31, 2014
 
Six Months Ended
December 31, 2014
 
Average
Investment in
Impaired Loans
 
Interest
Income Recognized
 
Average
Investment in
Impaired Loans
 
Interest
Income Recognized
 
 (In thousands)
With no allowance recorded
 
 
 
 
 
 
 
One to four family
$
3,893

 
$
83

 
$
3,959

 
$
109

Commercial
2,662

 
18

 
2,584

 
47

Consumer
196

 
3

 
258

 
6

Construction and land
310

 
15

 
311

 
16

Loans with no allowance recorded
7,061

 
119

 
7,112

 
178

With an allowance recorded
 
 
 
 
 
 
 
One to four family
3,304

 
70

 
3,321

 
105

Commercial
1,802

 
20

 
2,496

 
40

Consumer
722

 
14

 
717

 
21

Construction and land
162

 
10

 
160

 
11

Loans with an allowance recorded
5,990

 
114

 
6,694

 
177

Total
 
 
 
 
 
 
 
One to four family
7,197

 
153

 
7,280

 
214

Commercial
4,464

 
38

 
5,080

 
87

Consumer
918

 
17

 
975

 
27

Construction and land
472

 
25

 
471

 
27

 
$
13,051

 
$
233

 
$
13,806

 
$
355



22

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

The following tables present the average recorded investment in loans individually evaluated for impairment and the related interest income recognized for the periods shown:

 
Three Months Ended
December 31, 2013
 
Six Months Ended
December 31, 2013
 
Average
Investment in
Impaired Loans
 
Interest
Income Recognized
 
Average
Investment in
Impaired Loans
 
Interest
Income Recognized
 
(In thousands)
With no allowance recorded
 
 
 
 
 
 
 
One to four family
$
5,202

 
$
138

 
$
4,637

 
$
156

Commercial
3,235

 
40

 
2,546

 
95

Consumer
629

 
38

 
2,097

 
38

Construction and land
7

 
6

 
3

 
7

Loans with no allowance recorded
9,073

 
222

 
9,283

 
296

With an allowance recorded
 
 
 
 
 
 
 
One to four family
4,186

 
61

 
3,699

 
86

Commercial
3,257

 
26

 
2,314

 
69

Consumer
900

 
14

 
1,931

 
24

Construction and land
198

 
8

 
173

 
12

Loans with an allowance recorded
8,541

 
109

 
8,117

 
191

Total
 
 
 
 
 
 
 
One to four family
9,388

 
199

 
8,336

 
242

Commercial
6,492

 
66

 
4,860

 
164

Consumer
1,529

 
52

 
4,028

 
62

Construction and land
205

 
14

 
176

 
19

 
$
17,614

 
$
331

 
$
17,400

 
$
487


Interest income recognized on a cash basis on impaired loans was$112,000, $140,000, $235,000, and $296,000 for the three and six months ended December 31, 2014 and 2013, respectively.


23

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

The following table presents the recorded investment in nonaccrual loans by class of loan at the dates indicated:
 
December 31,
 
June 30,
 
2014
 
2014
 
(In thousands)
One to four family
 
 
 
One to four family Olympic Peninsula1
$
3,096

 
$
3,223

One to four family other
307

 
320

Commercial
 
 
 
Commercial real estate
223

 
1,913

Consumer
 
 
 
Home equity
196

 
340

Consumer other
71

 
41

Construction and land
 
 
 
Land and development
238

 
127

 
$
4,131

 
$
5,964


1 Olympic Peninsula is limited to properties located in the Washington State counties of Clallam and Jefferson in these tables.


24

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

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 December 31, 2014 and June 30, 2014.

The following table presents past due loans, net of partial loan charge-offs, by class, as of December 31, 2014:

 
30-59
Days
Past Due
 
60-89
Days
Past Due
 
90 Days
or More
Past Due
 
Total
Past Due
 
Current
 
Total
Loans
 
(In thousands)
One to four family
 
 
 
 
 
 
 
 
 
 
 
One to four family Olympic Peninsula
$
1,243

 
$
831

 
$
1,376

 
$
3,450

 
$
165,498

 
$
168,948

One to four family other
768

 
178

 

 
946

 
77,801

 
78,747

Commercial
 
 
 
 
 
 
 
 
 
 
 
Multi-family

 

 

 

 
37,253

 
37,253

Commercial real estate

 
16

 
53

 
69

 
131,770

 
131,839

Commercial business

 
 
 

 

 
16,299

 
16,299

Consumer
 
 
 
 
 
 
 
 
 
 
 
Home equity
183

 
164

 
5

 
352

 
38,088

 
38,440

Auto
39

 
14

 

 
53

 
4,656

 
4,709

Consumer other
9

 
126

 
10

 
145

 
4,358

 
4,503

Construction and land
 
 
 
 
 
 
 
 
 
 
 
Construction

 

 

 

 
8,308

 
8,308

Land and development
114

 
109

 
197

 
420

 
10,860

 
11,280

 
$
2,356

 
$
1,438

 
$
1,641

 
$
5,435

 
$
494,891

 
$
500,326




25

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

The following table presents past due loans, net of partial loan charge-offs, by class, as of June 30, 2014:
 
30-59
Days
Past Due
 
60-89
Days
Past Due
 
90 Days
or More
Past Due
 
Total
Past Due
 
Current
 
Total
Loans
 
(In thousands)
One to four family
 
 
 
 
 
 
 
 
 
 
 
One to four family Olympic Peninsula
$

 
$
650

 
$
1,181

 
$
1,831

 
$
166,079

 
$
167,910

One to four family other

 
319

 

 
319

 
73,681

 
74,000

Commercial
 
 
 
 
 
 
 
 
 
 
 
Multi-family

 

 

 

 
45,100

 
45,100

Commercial real estate

 

 
98

 
98

 
127,930

 
128,028

Commercial business

 

 

 

 
17,532

 
17,532

Consumer
 
 
 
 
 
 
 
 
 
 
 
Home equity
34

 
111

 
114

 
259

 
39,805

 
40,064

Auto
86

 

 

 
86

 
5,532

 
5,618

Consumer other
42

 
60

 

 
102

 
4,977

 
5,079

Construction and land
 
 
 
 
 
 
 
 
 
 
 
Construction

 

 

 

 
8,222

 
8,222

Land and development

 
45

 
53

 
98

 
12,177

 
12,275

 
$
162

 
$
1,185

 
$
1,446

 
$
2,793

 
$
501,035

 
$
503,828






26

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

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. 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 First Federal may 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 particular 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 sufficient risk to warrant classification as substandard or doubtful but possess identified weaknesses are designated as either watch or special mention assets. At December 31, 2014 and June 30, 2014, First Federal had loans classified as substandard and no loans classified as doubtful or loss. Loans not otherwise classified are considered pass graded loans.

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 December 31, 2014, by class of loans:
 
Pass
 
Watch
 
Special
Mention
 
Sub-
Standard
 
Total
 
(In thousands)
One to four family
 
 
 
 
 
 
 
 
 
One to four family Olympic Peninsula
$
159,795

 
$
3,142

 
$
1,530

 
$
4,481

 
$
168,948

One to four family other
76,029

 
1,472

 
175

 
1,071

 
78,747

Commercial
 
 
 
 
 
 
 
 
 
Multi-family
32,320

 
4,295

 

 
638

 
37,253

Commercial real estate
118,893

 
8,691

 
1,346

 
2,909

 
131,839

Commercial business
9,736

 
5,904

 

 
659

 
16,299

Consumer
 
 
 
 
 
 
 
 
 
Home equity
37,153

 
481

 
262

 
544

 
38,440

Auto
4,481

 
156

 
34

 
38

 
4,709

Consumer other
4,101

 
167

 
39

 
196

 
4,503

Construction and land
 
 
 
 
 
 
 
 
 
Construction
8,308

 

 

 

 
8,308

Land and development
10,437

 
453

 
49

 
341

 
11,280

 
$
461,253

 
$
24,761

 
$
3,435

 
$
10,877

 
$
500,326



27

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

The following table represents the internally assigned grade as of June 30, 2014, by class of loans:
 
Pass
 
Watch
 
Special
Mention
 
Sub-
Standard
 
Total
 
(In thousands)
One to four family
 
 
 
 
 
 
 
 
 
One to four family Olympic Peninsula
$
156,484

 
$
4,154

 
$
2,114

 
$
5,158

 
$
167,910

One to four family other
72,809

 
203

 
605

 
383

 
74,000

Commercial
 
 
 
 
 
 
 
 
 
Multi-family
39,879

 
4,337

 

 
884

 
45,100

Commercial real estate
111,319

 
9,471

 
1,570

 
5,668

 
128,028

Commercial business
10,369

 
6,514

 

 
649

 
17,532

Consumer
 
 
 
 
 
 
 
 
 
Home equity
38,224

 
367

 
778

 
695

 
40,064

Auto
5,442

 
135

 
26

 
15

 
5,618

Consumer other
4,732

 
125

 
94

 
128

 
5,079

Construction and land
 
 
 
 
 
 
 
 
 
Construction
8,025

 
197

 

 

 
8,222

Land and development
11,341

 
524

 
47

 
363

 
12,275

 
$
458,624

 
$
26,027

 
$
5,234

 
$
13,943

 
$
503,828





28

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

The following table represents the credit risk profile based on payment activity as of December 31, 2014, by class of loans:
 
Nonperforming
 
Performing
 
Total
 
(In thousands)
One to four family
 
 
 
 
 
One to four family Olympic Peninsula
$
3,096

 
$
165,852

 
$
168,948

One to four family other
307

 
78,440

 
78,747

Commercial
 
 
 
 
 
Multi-family

 
37,253

 
37,253

Commercial real estate
223

 
131,616

 
131,839

Commercial business

 
16,299

 
16,299

Consumer
 
 
 
 
 
Home equity
196

 
38,244

 
38,440

Auto

 
4,709

 
4,709

Consumer other
71

 
4,432

 
4,503

Construction and land
 
 
 
 
 
Construction

 
8,308

 
8,308

Land and development
238

 
11,042

 
11,280

 
$
4,131

 
$
496,195

 
$
500,326


The following table represents the credit risk profile based on payment activity as of June 30, 2014, by class of loans:
 
Nonperforming
 
Performing
 
Total
 
(In thousands)
One to four family
 
 
 
 
 
One to four family Olympic Peninsula
$
3,223

 
$
164,687

 
$
167,910

One to four family other
320

 
73,680

 
74,000

Commercial
 
 
 
 
 
Multi-family

 
45,100

 
45,100

Commercial real estate
1,913

 
126,115

 
128,028

Commercial business

 
17,532

 
17,532

Consumer
 
 
 
 
 
Home equity
340

 
39,724

 
40,064

Auto

 
5,618

 
5,618

Consumer other
41

 
5,038

 
5,079

Construction and land
 
 
 
 
 
Construction

 
8,222

 
8,222

Land and development
127

 
12,148

 
12,275

 
$
5,964

 
$
497,864

 
$
503,828




29

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

Troubled debt restructuring (TDR) - 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 granted can generally be described in the following categories:

Rate modification - A modification in which the interest rate is changed.

Term modification - A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Payment modification - A modification in which the dollar amount of the payment is changed. Interest-only modifications in which a loan is converted to interest-only payments for a period of time are included in this category.

Combination modification - Any other type of modification, including the use of multiple categories above.

Upon identifying a receivable as a troubled debt restructuring, First Federal classifies the loan as impaired for purposes of determining the allowance for loan losses. This requires the loan to be evaluated individually for impairment, generally based on the expected cash flows under the new terms discounted at the loan’s original effective interest rates. For TDR loans that subsequently default, the method of determining impairment is generally the fair value of the collateral less estimated selling costs.

The following is a summary of information pertaining to TDR loans included in impaired loans at the dates indicated:
 
December 31,
 
June 30,
 
2014
 
2014
 
(In thousands)
Total TDR loans
$
9,798

 
$
12,164

Allowance for loan losses related to TDR loans
$
312

 
$
363

Total nonaccrual TDR loans
$
1,907

 
$
3,536




30

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

There were no new TDR loans, or renewals or modifications of existing TDR loans during the three and six months ended December 31, 2014.

There were no TDR loans that were modified within the 12 months prior to December 31, 2014, and for which there was a payment default during the three and six months ended December 31, 2014.


The following table presents newly restructured and renewals or modifications of existing TDR loans by class that occurred during the three months ended December 31, 2013, by type of concession granted:
 
Number
of Contracts
 
Rate
Modification
 
Term
Modification
 
Combination
Modification
 
Total
Modifications
 
 
 
(Dollars in thousands)
Pre-modification outstanding recorded investment
 
 
 
 
 
 
 
 
 
One to four family
 
 
 
 
 
 
 
 
 
One to four family Olympic Peninsula
6

 
$
319

 
$

 
$
533

 
$
852

Consumer
 
 
 
 
 
 
 
 
 
Consumer other
1

 

 

 
1

 
1

 
7

 
$
319

 
$

 
$
534

 
$
853

Post-modification outstanding recorded investment
 
 
 
 
 
 
 
 
 
One to four family
 
 
 
 
 
 
 
 
 
One to four family Olympic Peninsula
6

 
$
317

 
$

 
$
542

 
$
859

Consumer
 
 
 
 
 
 
 
 
 
Consumer other
1

 

 

 
1

 
1

 
7

 
$
317

 
$

 
$
543

 
$
860


During the three months ended December 31, 2013, new TDRs consisted of one recorded investment with a pre-modification balance of $222,000 and one post-modification investment with a balance of $229,000. Renewals or modifications of existing TDR loans consisted of six recorded investments with pre-renewal balances totaling $631,000 and post-renewal balances of $631,000.


31

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

The following table presents newly restructured and renewals or modifications of existing TDR loans by class that occurred during the six months ended December 31, 2013, by type of concession granted:
 
Number
of Contracts
 
Rate
Modification
 
Term
Modification
 
Combination
Modification
 
Total
Modifications
 
 
 
(Dollars in thousands)
Pre-modification outstanding recorded investment
 
 
 
 
 
 
 
 
 
One to four family
 
 
 
 
 
 
 
 
 
One to four family Olympic Peninsula
10

 
$
319

 
$

 
$
1,355

 
$
1,674

Commercial
 
 
 
 
 
 
 
 
 
Multifamily
5

 

 

 
609

 
609

Consumer
 
 
 
 
 
 
 
 
 
Home equity
2

 

 
30

 
43

 
73

Consumer other
1

 

 

 
1

 
1

 
18

 
$
319

 
$
30

 
$
2,008

 
$
2,357

Post-modification outstanding recorded investment
 
 
 
 
 
 
 
 
 
One to four family
 
 
 
 
 
 
 
 
 
One to four family Olympic Peninsula
10

 
$
317

 
$

 
$
1,374

 
$
1,691

Commercial
 
 
 
 
 
 
 
 
 
Multifamily
1

 

 

 
604

 
604

Consumer
 
 
 
 
 
 
 
 
 
Home equity
2

 

 
29

 
44

 
73

Consumer other
1

 

 

 
1

 
1

 
14

 
$
317

 
$
29

 
$
2,023

 
$
2,369


During the six months ended December 31, 2013, new TDRs consisted of nine recorded investments with pre-modification balances totaling $1.5 million and five post-modification investments with balances of $1.5 million. Renewals or modifications of existing TDR loans consisted of nine recorded investments with pre-renewal balances totaling $858,000 and post-renewal balances of $861,000.

The following is a summary of TDR loans that were modified within the 12 months prior to December 31, 2013, and for which there was a payment default during the three and six months ended December 31, 2013.
 
Number
of Contracts
 
Rate
Modification
 
Term
Modification
 
Combination
Modification
 
 
 
(Dollars in thousands)
One to four family Olympic Peninsula
1

 
$

 
$

 
$
217

 
 
 
 
 
 
 
 
Total
1

 
$

 
$

 
$
217




32

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 3 - Loans Receivable (continued)

No additional funds are committed to be advanced in connection with impaired loans at December 31, 2014.

The following table presents troubled debt restructured loans by class at the dates indicated by accrual and nonaccrual status.
 
December 31, 2014
 
June 30, 2014
 
Accrual
 
Nonaccrual
 
Total
 
Accrual
 
Nonaccrual
 
Total
 
(In thousands)
One to four family
 
 
 
 
 
 
 
 
 
 
 
One to four family Olympic Peninsula
$
3,622

 
$
1,490

 
$
5,112

 
$
3,941

 
$
1,529

 
$
5,470

One to four family other
279

 
178

 
457

 
281

 
188

 
469

Commercial
 
 
 
 


 
 
 
 
 


Multi-family
638

 

 
638

 
728

 

 
728

Commercial real estate
2,450

 
155

 
2,605

 
2,742

 
1,714

 
4,456

Commercial business
421

 

 
421

 
426

 

 
426

Consumer
 
 
 
 
 
 
 
 
 
 
 
Home equity
481

 
84

 
565

 
510

 
105

 
615

 
$
7,891

 
$
1,907

 
$
9,798

 
$
8,628

 
$
3,536

 
$
12,164



TDR loans may be upgraded in their classification and placed on accrual status once there is a sustained period of repayment performance, usually six months or longer, and there is a reasonable assurance that repayment will continue. First Federal allows reclassification of a troubled debt restructuring back into the general loan pool (as a non-troubled debt restructuring) if the borrower is able to refinance the loan at then-current market rates and meet all of the underwriting criteria of First Federal required of other borrowers. The refinance must be based on the borrower’s ability to repay the debt and no special concessions of rate and/or term are granted to the borrower.


33

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 4 - Real Estate Owned and Repossessed Assets

The following table presents the activity in real estate owned and repossessed assets for the periods shown:
 
Three Months Ended

Six Months Ended
 
December 31,
 
December 31,
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Beginning balance
$
650

 
$
1,638

 
$
810

 
$
2,265

Loans transferred to foreclosed assets
1,852

 
464

 
1,880

 
539

Sales
(643
)
 
(485
)
 
(795
)
 
(1,213
)
Write-downs
(31
)
 
(81
)
 
(84
)
 
(82
)
Net gain (loss) on sales
198

 
(48
)
 
215

 
(21
)
 
 
 
 
 
 
 
 
Ending balance
$
2,026

 
$
1,488

 
$
2,026

 
$
1,488


The following table presents the breakout of real estate owned and repossessed assets by type at the dates indicated:
 
December 31,

June 30,
 
2014

2014
 
 (In thousands)
One to four family residential properties
$
658

 
$
524

Land

 
220

Commercial real estate
1,368

 

Personal property

 
66

 
 
 
 
 
$
2,026

 
$
810




34

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 5 - Mortgage Servicing Rights

Loans serviced for FHLB, Fannie Mae (FNMA), and Freddie Mac (FHLMC) are not included in the accompanying consolidated balance sheets. The unpaid principal balances of serviced loans, primarily mortgage loans, were $218.5 million and $235.2 million at December 31, 2014 and June 30, 2014, respectively.

Mortgage servicing rights for the periods shown are as follows:
 
Three Months Ended
 
Six Months Ended
 
December 31,
 
December 31,
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Balance at beginning of period
$
1,204

 
$
1,353

 
$
1,266

 
$
1,434

Additions
19

 
22

 
40

 
63

Amortization
(84
)
 
(112
)
 
(167
)
 
(235
)
Valuation recovery

 

 

 
1

Balance at end of period
$
1,139

 
$
1,263

 
$
1,139

 
$
1,263


The aggregate change in valuation allowance for mortgage servicing rights for the periods shown are as follows:
 
Three Months Ended
 
Six Months Ended
 
December 31,
 
December 31,
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Balance at beginning of period
$

 
$

 
$

 
$
(1
)
Recoveries

 

 

 
1

Balance at end of period
$

 
$

 
$

 
$


The key economic assumptions used in determining the fair value of mortgage servicing rights at the dates indicated are as follows:
 
December 31,
 
June 30,
 
2014
 
2014
 
 
 
 
Constant prepayment rate
11.88
%
 
10.70
%
Weighted-average life (years)
5.8

 
6.3

Yield to maturity discount
9.62
%
 
9.99
%

The fair values of mortgage servicing rights were approximately $1.9 million and $2.2 million at December 31, 2014 and June 30, 2014, respectively.


35

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 5 - Mortgage Servicing Rights (continued)

The following represents servicing and late fees earned in connection with mortgage servicing rights and is included in the accompanying consolidated financial statements as a component of noninterest income for the periods shown:
 
Three Months Ended
 
Six Months Ended
 
December 31,
 
December 31,
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Servicing fees
$
142

 
$
154

 
$
290

 
$
306

Late fees
5

 
6

 
11

 
12




Note 6 - Deposits

The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2014 and June 30, 2014, was $71.7 million and $64.9 million, respectively. Deposits and weighted-average interest rates at the dates indicated are as follows:

 
Weighted-
Average
Interest
Rate
 
December 31, 2014
 
Weighted-
Average Interest Rate
 
June 30, 2014
 
(In thousands)
Savings
0.04
%
 
$
208,015

 
0.04
%
 
$
84,394

Transaction accounts
0.01
%
 
177,216

 
0.01
%
 
172,708

Insured money market accounts
0.18
%
 
216,234

 
0.18
%
 
209,605

Certificates of deposit and jumbo certificates
0.88
%
 
139,359

 
0.82
%
 
133,692

 
 
 
 
 
 
 
 
 
 
 
$
740,824

 
 
 
$
600,399

 
 
 
 
 
 
 
 
Weighted-average interest rate
 
 
0.23
%
 
 
 
0.25
%

The Bank held $128.8 million in deposits, concentrated mainly in savings accounts, as of December 31, 2014, attributable to deposits made in anticipation of participating in the Company's stock offering that was consummated on January 29, 2015.

Maturities of certificates at the dates indicated are as follows:
 
December 31, 2014
 
June 30, 2014
 
(In thousands)
Within one year or less
$
60,944

 
$
68,988

After one year through two years
39,827

 
31,108

After two years through three years
15,534

 
12,486

After three years through four years
8,619

 
6,689

After four years through five years
14,203

 
14,292

After five years
232

 
129

 
 
 
 
 
$
139,359

 
$
133,692



36

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 6 - Deposits (continued)

Deposits at December 31, 2014 and June 30, 2014, include $37.0 million and $38.1 million, respectively, in public fund deposits. Investment securities with a carrying value of $40.8 million and $37.4 million were pledged as collateral for these deposits at December 31, 2014 and June 30, 2014, 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:
 
Three Months Ended
 
Six Months Ended
 
December 31,
 
December 31,
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Savings
$
10

 
$
10

 
$
19

 
$
20

Transaction accounts
2

 
2

 
5

 
5

Insured money market accounts
97

 
88

 
191

 
176

Certificates of deposit and jumbo certificates
273

 
285

 
538

 
588

 
$
382

 
$
385

 
$
753

 
$
789




Note 7 - Borrowings

FHLB Borrowings
First Federal is a member of the FHLB. As a member, First Federal has a committed line of credit of up to 40% of total assets, subject to the amount of FHLB stock ownership and certain collateral requirements.

First Federal has entered into borrowing arrangements with the FHLB to borrow funds primarily under long-term, fixed-rate advance agreements. First Federal also has a short-term, variable-rate revolving cash management advance (CMA) which matures in February 2015. All borrowings are secured by pledged collateral consisting of single-family, home equity, and multi-family loans receivable in the amounts of $206.8 million and $209.7 million and investment securities with a carrying value of $8.6 million and $10.0 million at December 31, 2014 and June 30, 2014, respectively.

FHLB advances outstanding at the dates indicated were as follows:
 
December 31,
 
June 30,
 
2014
 
2014
 
(In thousands)
Long-term advances
$
89,924

 
$
89,924

CMA advance

 
15,100



37

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 7 - Borrowings (continued)

There was no CMA short-term, variable-rate advance activity during the three months ended December 31, 2014 and 2013, and, therefore, are not reflected in the following table. The maximum and average outstanding balances and average interest rates on CMA short-term, variable-rate advances were as follows for the periods shown:
 
Six Months Ended
 
Year Ended
 
December 31,
 
June 30,
 
2014
 
2013
 
2014
 
(Dollars in thousands)
Maximum outstanding at any month-end
$
1,000

 
$

 
$
31,000

Monthly average outstanding
167

 

 
7,967

Interest expense during the period
1

 

 
24

 
 
 
 
 
 
Weighted-average daily interest rates
 
 
 
 
 
Annual
0.30
%
 
%
 
0.29
%
Period End
0.27

 

 
0.30



At December 31, 2014, FHLB long-term, fixed-rate advances are scheduled to mature as follows:
 
Weighted-Average
Interest Rate
 
December 31,
2014
 
(Dollars in thousands)
Due on or before December 31, 2015
—%
 
$

Due on or before December 31, 2016
 

Due on or before December 31, 2017
 

Due on or before December 31, 2018
2.67
 
19,924

Thereafter
3.40
 
70,000

 
 
 
$
89,924


At June 30, 2014, FHLB long-term, fixed-rate advances are scheduled to mature as follows:
 
Weighted-Average
Interest Rate
 
June 30,
2014
 
(Dollars in thousands)
Due on or before June 30, 2015
—%
 
$

Due on or before June 30, 2016
 

Due on or before June 30, 2017
 

Due on or before June 30, 2018
2.71
 
6,924

Thereafter
3.28
 
83,000

 
 
 
$
89,924



38

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 7 - Borrowings (continued)

The maximum and average outstanding balances and average interest rates on FHLB long-term, fixed-rate advances were as follows for the periods shown:
 
Three Months Ended
 
Six Months Ended
 
Year Ended
 
December 31,
 
December 31,
 
June 30,
 
2014
 
2013
 
2014
 
2013
 
2014
 
(Dollars in thousands)
Maximum outstanding at any month-end
$
89,924

 
$
99,924

 
$
89,924

 
$
99,924

 
$
99,924

Monthly average outstanding
89,924

 
99,924

 
89,924

 
99,924

 
96,591

Interest expense during the period
733

 
826

 
1,467

 
1,652

 
3,163

 
 
 
 
 
 
 
 
 
 
Weighted-average interest rates
 
 
 
 
 
 
 
 
 
Annual
3.24
%
 
3.28
%
 
3.24
%
 
3.28
%
 
3.26
%
Period End
3.24

 
3.28

 
3.24

 
3.28

 
3.24


Note Payable
At December 31, 2014, Craft3 Development IV, LLC, a subsidiary of First Federal, held a fixed-rate promissory note from Craft3, Inc. in the amount of $109,000. Simple interest of 4.50% per annum is calculated on the outstanding principal balance and is due monthly. Interest expense of $1,000 was recorded during both the three months ended December 31, 2014 and 2013. Interest expense of $2,000 was recorded during both the six months ended December 31, 2014 and 2013. The entire unpaid principal balance plus any remaining interest due is payable on July 1, 2015.



Note 8 - Federal Taxes on Income

As a result of the bad debt deductions taken in years prior to 1988, retained earnings include accumulated earnings of approximately $6.4 million, on which federal income taxes have not been provided. If, in the future, this portion of retained earnings is used for any purpose other than to absorb losses on loans or on property acquired through foreclosure, federal income taxes may be imposed at the then-prevailing corporate tax rates. First Federal does not contemplate that such amounts will be used for any purpose that would create a federal income tax liability; therefore, no provision has been made.

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.

As of December 31, 2014 and June 30, 2014, the balance sheet included net deferred tax liabilities of $1.3 million and $1.1 million, respectively. Our primary deferred tax asset relates to the allowance for loan losses and our primary deferred tax liabilities relate to our FHLB stock and depreciation.

A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. First Federal evaluates whether its deferred tax assets will be realized and adjusts the amount of its valuation allowance, if necessary. There was no valuation allowance at December 31, 2014 or June 30, 2014.

39

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 8 - Federal Taxes on Income (continued)

First Federal began participating in the New Markets Tax Credit program for low-income communities in its fiscal year ended June 30, 2008, and continues to do so. First Federal will receive tax credits of approximately $1.9 million over seven years. Tax benefits related to these credits will be recognized for financial reporting purposes in different periods than the credits are recognized in First Federal’s income tax returns due to a yearly tax basis reduction resulting in a gain for income tax purposes at the end of the tax credit period. The financial reporting tax credit will total approximately $1.3 million over the seven-year period, representing the available tax credit of $1.9 million less the reduction of the tax gain of $655,000 calculated at First Federal’s current tax rate of 34%.

First Federal complied with the various regulatory provisions of the New Markets Tax Credit program and, therefore, will earn approximately $296,000 of credits that will be claimed on First Federal's current-year tax return. Additionally, as of December 31, 2014, there were tax credit carryforwards of $467,000 that begin to expire in 2021.

First Federal applies the provisions of FASB ASC 740 that require the application of a more-likely-than-not recognition criterion for the reporting of uncertain tax positions on its financial statements. First Federal had no unrecognized tax assets at December 31, 2014 and June 30, 2014. During the six months ended December 31, 2014 and the year ended June 30, 2014, First Federal recognized no interest and penalties. First Federal recognizes interest and penalties in income tax expense. First Federal files income tax returns in the U.S. federal jurisdiction and is no longer subject to U.S. federal income tax examinations by tax authorities for years ending before June 30, 2011.



Note 9 - Commitments and Contingencies

First Federal is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally represent a commitment to extend credit in the form of loans. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.

First Federal’s exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, is represented by the contractual notional amount of those instruments. First Federal uses the same credit policies in making commitments as it does for on-balance-sheet instruments. Management does not anticipate any material loss as a result of these transactions.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established by the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. First Federal evaluates each customer’s creditworthiness on a case-by-case basis. First Federal did not incur any significant losses on its commitments for the six months ended December 31, 2014 and the year ended June 30, 2014.

The following financial instruments were outstanding whose contract amounts represent credit risk at the dates indicated:
 
December 31,
June 30,
 
2014
 
2014
 
 (In thousands)
Commitments to grant loans
$
141

 
$
191

Standby letters of credit
285

 
260

Unfunded commitments under lines of credit or existing loans
36,712

 
38,538


Legal contingencies - Various legal claims may arise from time to time in the normal course of business, which, in the opinion of management, have no current material effect on First Federal’s consolidated financial statements.


40

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 9 - Commitments and Contingencies

Significant group concentrations of credit risk - Concentration of credit risk is the risk associated with a lack of diversification, such as having substantial loan concentrations in a specific type of loan within First Federal’s loan portfolio, thereby exposing First Federal to greater risks resulting from adverse economic, political, regulatory, geographic, industrial, or credit developments. Loans-to-one-borrower are subject to the state banking regulations general limitation of 20 percent of First Federal’s equity, excluding accumulated other comprehensive income. At December 31, 2014 and June 30, 2014, First Federal’s most significant concentration of credit risk was in loans secured by real estate. These loans totaled approximately $475.1 million and $475.8 million, or 95.0% and 94.4%, of First Federal’s total loan portfolio at December 31, 2014 and June 30, 2014, respectively. Real estate construction, including land acquisition and land development, commercial real estate, multifamily, home equity, and one to four family residential loans are included in the total loans secured by real estate for purposes of this calculation. After a period of decline the real estate market has begun to recover, which has helped stabilize nonperforming loans and the allowance for loan losses.

At December 31, 2014 and June 30, 2014, First Federal’s most significant investment concentration of credit risk was with the U.S. Government, its agencies, and Government Sponsored Enterprises (GSEs). First Federal’s exposure, which results from positions in securities issued by the U.S. Government, its agencies, and securities guaranteed by GSEs, was $211.8 million and $218.9 million, or 84.0% and 90.4%, of First Federal’s total investment portfolio (including FHLB stock) at December 31, 2014 and June 30, 2014, respectively.



Note 10 - 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 First Federal’s principal market. First Federal 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 First Federal’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.


41

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 10 - Fair Value Accounting and Measurement (continued)

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 a particular 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 fair valued on a recurring basis if fair value is measured regularly (i.e., daily, weekly, monthly, or quarterly). The following tables show First Federal’s assets and liabilities measured at fair value on a recurring basis at the dates indicated:
 
December 31, 2014
 
Quoted Prices in
Active Markets for
Identical Assets
 or Liabilities
 
Significant
Other
Observable
 Inputs
 
Significant
Unobservable
Inputs
 
 
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Total
 
(In thousands)
Securities available-for-sale
 
 
 
 
 
 
 
Municipal bonds
$

 
$
10,037

 
$

 
$
10,037

Agency bonds

 
8,766

 

 
8,766

ABS agency

 
9,816

 

 
9,816

ABS corporate

 
14,751

 

 
14,751

SBA

 
27,081

 

 
27,081

MBS agency

 
121,852

 

 
121,852

 
$

 
$
192,303

 
$

 
$
192,303

 
 
 
 
 
 
 
 

 
June 30, 2014
 
Quoted Prices in
Active Markets for
Identical Assets
or Liabilities
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
 
 
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Total
 
(In thousands)
Securities available-for-sale
 
 
 
 
 
 
 
Municipal bonds
$

 
$
7,525

 
$

 
$
7,525

ABS agency

 
10,140

 

 
10,140

SBA

 
28,944

 

 
28,944

MBS agency

 
132,363

 

 
132,363

 
$

 
$
178,972

 
$

 
$
178,972




42

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 10 - Fair Value Accounting and Measurement (continued)

Assets measured at fair value on a nonrecurring basis - Assets are considered to be fair 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 First Federal’s assets measured at fair value on a nonrecurring basis at the dates indicated:
 
December 31, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(In thousands)
Mortgage servicing rights
$

 
$

 
$
1,928

 
$
1,928

Impaired loans

 

 
12,203

 
12,203

Real estate owned and repossessed assets

 

 
2,026

 
2,026

 
 
 
 
 
 
 
 
 
$

 
$

 
$
16,157

 
$
16,157

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(In thousands)
Mortgage servicing rights
$

 
$

 
$
2,157

 
$
2,157

Impaired loans

 

 
14,733

 
14,733

Real estate owned and repossessed assets

 

 
810

 
810

 
 
 
 
 
 
 
 
 
$

 
$

 
$
17,700

 
$
17,700


The mortgage servicing rights measured at fair value totals presented in the previous table are evaluated at the tranche level and grouped into two categories--impaired and excess fair value. The impaired group is carried at fair value which was $0 at both December 31, 2014 and June 30, 2014. The remaining fair value at December 31, 2014 and June 30, 2014, of $1.9 million and $2.2 million, respectively, was attributable to the excess fair value group that is carried at amortized cost.


43

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 10 - Fair Value Accounting and Measurement (continued)

The following tables present the techniques used to value assets measured at fair value on a nonrecurring basis at the dates indicated:
 
December 31, 2014
 
Fair Value
 
Valuation
Technique
 
Unobservable Input
 
Range
(Weighted-Average)2
 
(In thousands)
 
 
 
 
 
 
Mortgage servicing rights
$
1,928

 
Discounted cash flows
 
Key assumptions1
 
N/A
Impaired loans
12,203

 
Market comparable
 
Discount to appraisal
 
0% - 25% (2%)
Real estate owned and repossessed assets
2,026

 
Market comparable
 
Discount to appraisal
 
0% - 8% (1%)
1
Key assumptions include estimated servicing revenues, servicing expenses, prepayment speeds, and discount rates.
2
Discount to appraisal disposition value.
 
June 30, 2014
 
Fair Value
 
Valuation
Technique
 
Unobservable Input
 
Range
(Weighted-Average)2
 
(In thousands)
 
 
 
 
 
 
Mortgage servicing rights
$
2,157

 
Discounted cash flows
 
Key assumptions1
 
N/A
Impaired loans
14,733

 
Market comparable
 
Discount to appraisal
 
0% - 35% (6%)
Real estate owned and repossessed assets
810

 
Market comparable
 
Discount to appraisal
 
0% - 10% (1%)
1 
Key assumptions include estimated servicing revenues, servicing expenses, prepayment speeds, and discount rates.
2 
Discount to appraisal disposition value.

44

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 10 - Fair Value Accounting and Measurement (continued)

The following tables present the carrying value and estimated fair value of financial instruments at the dates indicated:
 
December 31, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
(In thousands)
Financial assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
139,283

 
$
139,283

 
$

 
$

 
$

 
$

 
$
139,283

 
$
139,283

Investment securities available for sale

 

 
192,303

 
192,303

 

 

 
192,303

 
192,303

Investment securities held to maturity

 

 
49,854

 
51,217

 

 

 
49,854

 
51,217

Loans receivable, net
 
 
 
 
 
 
 
 
493,536

 
500,495

 
493,536

 
500,495

FHLB stock

 

 
9,843

 
9,843

 

 

 
9,843

 
9,843

Mortgage servicing rights, net

 

 

 

 
1,139

 
1,928

 
1,139

 
1,928

Bank-owned life insurance

 

 
18,089

 
18,089

 

 

 
18,089

 
18,089

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
$
601,465

 
$
601,465

 
$

 
$

 
$

 
$

 
$
601,465

 
$
601,465

Time deposits

 

 
139,359

 
139,698

 

 

 
139,359

 
139,698

Borrowings

 

 
90,033

 
93,110

 

 

 
90,033

 
93,110


 
June 30, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
(In thousands)
Financial assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
18,960

 
$
18,960

 
$

 
$

 
$

 
$

 
$
18,960

 
$
18,960

Investment securities available for sale

 

 
178,972

 
178,972

 

 

 
178,972

 
178,972

Investment securities held to maturity

 

 
53,244

 
53,982

 

 

 
53,244

 
53,982

Loans held for sale

 

 
613

 
613

 

 

 
613

 
613

Loans receivable, net

 

 

 

 
496,184

 
505,181

 
496,184

 
505,181

FHLB stock

 

 
10,047

 
10,047

 

 

 
10,047

 
10,047

Mortgage servicing rights, net

 

 

 

 
1,266

 
2,157

 
1,266

 
2,157

Bank-owned life insurance

 

 
18,066

 
18,066

 

 

 
18,066

 
18,066

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
$
466,707

 
$
466,707

 
$

 
$

 
$

 
$

 
$
466,707

 
$
466,707

Time deposits

 

 
133,692

 
134,162

 

 

 
133,692

 
134,162

Borrowings

 

 
105,133

 
107,584

 

 

 
105,133

 
107,584



45

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 10 - Fair Value Accounting and Measurement (continued)

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 First Federal. The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value:

Cash and cash equivalents - For short-term instruments, including cash and due from banks, and interest bearing deposits with banks, the carrying amount is a reasonable estimate of fair value.

Securities - Fair values for investment securities are primarily measured using information from a third-party pricing service. The pricing service uses evaluated 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 held for sale - For loans held for sale, carrying value approximates fair value.

Loans receivable, net - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type, including fixed and variable one to four family residential real estate, commercial, and consumer loans. There is an accurate and reliable secondary market for one to four family residential mortgage production, and available market benchmarks are used to establish discount factors for estimating fair value for these types of loans. Commercial and consumer loans use market benchmarks when available; however, due to the varied term structures and credit issues involved, they mainly rely on cash flow projections and repricing characteristics within the loan portfolio. These amounts are discounted further by embedded probable losses expected to be realized in the portfolio.

Valuations of impaired loans, real estate owned and repossessed assets are periodically performed by management, and the fair values of these loans are carried at the fair value of the underlying collateral less estimated costs to sell. Fair value of the underlying collateral may be determined using an appraisal performed by a qualified independent appraiser.

FHLB stock - For FHLB stock, carrying value approximates fair value.

Mortgage servicing rights - The estimated fair value of mortgage servicing rights is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income.

Bank-owned life insurance assets - Fair values of insurance policies owned are based on the insurance contract cash surrender value.

Deposits - The fair value of deposits with no stated maturity, such as non-interest bearing deposits, savings and interest checking accounts, and money market accounts, is equal to the amount payable on demand as of December 31, 2014 and June 30, 2014. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

Borrowings - The fair value of FHLB advances and other borrowings are calculated using a discounted cash flow method, adjusted for market interest rates and terms to maturity.

Off-balance-sheet financial instruments - Commitments to extend credit represent all off-balance-sheet financial instruments. The fair value of these commitments is not significant.



46

FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF PORT ANGELES AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 11 - Subsequent Event

On January 29, 2015, the Bank completed the planned mutual-to-stock conversion and became a wholly owned subsidiary of First Northwest Bancorp, Inc.. In this process, the Company raised approximately $117.8 million in net proceeds from the sale of 12,167,000 common shares in the initial public offering. From the gross proceeds, the Company made a capital contribution of approximately $58.5 million to the Bank.


ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
Certain matters discussed in this Quarterly Report on Form 10-Q constitute forward‑looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by 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; and
estimates of our risks and future costs and benefits.
These forward‑looking statements are subject to significant risks and uncertainties. Actual results may differ materially from those contemplated by the forward‑looking statements due to, among others, the following factors:
changes in general economic conditions, either nationally or in our market area, that are worse than expected;
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;
decreases 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, especially new costs associated with our operation as a public company;
whether our management team can implement our operational strategy;
because our management team has held their current positions for only a short period of time whether they can develop into a cohesive and unified senior management team;
our ability to successfully 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;

47


our success in opening new branches:
increases in premiums for deposit insurance;
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;
changes in consumer spending, borrowing and savings habits;
our ability to successfully manage our growth;
results of examinations of us by the Washington State Department of Financial Institutions, Department of Banks, the Federal Deposit Insurance Corporation, Federal Reserve, or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;
legislative or regulatory changes that adversely affect our business, including the effects of the Dodd-Frank Act and Basel III, changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules;
adverse changes in the securities markets;
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;
costs and effects of litigation, including settlements and judgments;
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 this prospectus.
Any of the forward‑looking statements that we make in this report and in other public 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 foresee. Any of the 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 in this report 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. In light of 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 Federal is a community-oriented financial institution primarily serving the North Olympic Peninsula region of Washington through our nine full-service banking offices. We offer a wide range of products and services focused on the lending and depository needs of the communities we serve. Historically, lending activities have been primarily directed toward the origination of first lien one- to four-family mortgage loans, and, to a lesser extent, commercial and multi-family real estate loans, construction and land loans (including lot loans), commercial business loans, and consumer loans, consisting primarily of home equity loans and lines of credit. During the past decade, recognizing our need to adapt to changing market conditions, we have revised our operating strategy to diversify our loan portfolio, expand our deposit product offerings and enhance our infrastructure. We have increased the origination of commercial real estate and multi-family real estate loans, and decreased reliance on originating and retaining longer-term, fixed-rate, residential mortgage loans. Since 2010, we have generally sold most newly originated and refinanced, conforming single-family owner-occupied mortgage loans into the secondary market, although in 2012, we began selectively retaining 30-year fixed-rate mortgages in the portfolio in an effort to enhance

48


our net interest income. We have historically offered traditional 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 our lending and investing activities.

As part of our planned expansion into new markets, we have secured a lease agreement for a proposed full-service branch located in Bellingham, Washington, subject to FDIC and DFI approval. The lease term will be for approximately 20 years with rent payments beginning at $7,500 per month at the time of branch opening, which is estimated to be during the quarter-ended December 2015. The proposed new branch will offer similar deposit, lending, and investment products and services and will utilize technology in the form of interactive teller machines similar to the Silverdale, WA full-service branch location we opened in June 2014.

On January 29, 2015, the Bank completed its mutual-to-stock conversion and became a wholly owned subsidiary of the Company. The Company raised approximately $117.8 million in net proceeds from the sale of 12,167,000 common shares in its initial public offering. From the proceeds the Company made a capital contribution of approximately $58.5 million to the Bank. The Company's stock trades on the NASDAQ under the ticker symbol "FNWB."
Common shares available in the initial public offering were oversubscribed by eligible depositors in the first priority. The ESOP, being in the second priority eligible to purchase stock in the initial public offering, will fill its order of 8% of the common stock, or 1,048,029 shares, in the open market. As of the close of the market on February 11, 2015, the ESOP had purchased 618,000, or 59.0%, of the total shares to be purchased at an average net price per share of $12.33.
First Federal is significantly 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 a number of factors, including interest rates paid on competing time deposits, available alternative investments, account maturities, and the overall level of personal income and savings. Lending activities are influenced by the demand for funds, the number and quality of lenders, and regional economic cycles.
Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Changes in levels of interest rates affect our net interest income. 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, 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 probable losses inherent in our loan portfolio. As a loan's risk rating improves, 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 interest income.

The noninterest expenses we incur in operating our business consist of salaries and employee benefits and expenses, occupancy and equipment expenses, federal deposit insurance premiums and regulatory assessments, data processing expenses, expenses related to real estate and personal property owned and other miscellaneous expenses.

Salaries and employee benefits consist primarily of salaries and wages paid to our employees, payroll taxes, expenses for health insurance, retirement plans and other employee benefits. Following the offering, we will recognize additional annual employee compensation expenses stemming from the adoption of new equity benefit plans. We cannot determine the actual amount of these new stock-related compensation and benefit expenses at this time because applicable accounting practices require that they be based on the fair market value of the shares of common stock at specific points in the future.

Our contribution to the foundation is a non-recurring operating expense that will reduce net income during the quarter ended March 31, 2015. The contribution to the foundation will result in a $5.6 million after-tax expense.

Beginning in fiscal year 2009 and continuing through much of fiscal year 2012, housing markets deteriorated in many of our market areas and we experienced significantly higher levels of delinquencies and nonperforming assets, primarily in our residential related loan portfolios. During this period, home sales activity was exceptionally slow and property values generally declined. As the effects of the recent recession became more evident and the pace of the recovery remained slow, our borrowers' ability to service their debt became more

49


difficult, which was reflected in our increased nonperforming asset totals. As a result, during these periods our provision for loan losses was significantly higher than historical levels. This higher than normal level of delinquencies and nonaccruals also had a material adverse effect on operating income as a result of foregone interest revenues, increased loan collection costs and carrying costs, loan charge-offs and valuation adjustments for real estate owned. Beginning in fiscal 2013, home sales activity and real estate values began to modestly improve along with general economic conditions, resulting in materially lower loan charge-offs and write-downs of real estate owned. As a result, during the years ended June 30, 2014 and 2013, and continuing during the six months ended December 31, 2014, our provision for loan losses and our real estate owned and impairment expense decreased significantly compared to prior comparable periods.

Critical Accounting Policies

There are no material changes to the critical accounting policies disclosed in First Northwest Bancorp.’s Prospectus dated November 12, 2014, as filed with the Securities and Exchange Commission pursuant to Securities Act Rule 424(b)(3) on November 25, 2014.

Comparison of Financial Condition at December 31, 2014 and June 30, 2014

Assets. Total assets increased $128.9 million, or 16.2%, to $924.2 million at December 31, 2014, from $795.3 million at June 30, 2014, primarily due to an increase of $120.3 million, or 633.2%, in cash and cash equivalents to $139.3 million at December 31, 2014, attributable to deposits made in anticipation of participating in the Company's initial public stock offering. Net loans, excluding loans held for sale, decreased $2.7 million, or 0.5%, to $493.5 million at December 31, 2014, from $496.2 million at June 30, 2014.

Gross loans, excluding loans held for sale, decreased $3.5 million, or 0.7%, to $500.3 million at December 31, 2014, from $503.8 million at June 30, 2014. The portfolio decline was primarily the result of a reduction in multi-family real estate loans, which declined during the six months ended December 31, 2014 by $7.8 million, or 17.3%, to $37.3 million at December 31, 2014 from $45.1 million at June 30, 2014. This decline in multi-family real estate loans was primarily attributed to $7.1 million of purchased loans serviced by others that paid off prior to maturity. We continue to reduce our reliance on purchased commercial and multi-family real estate loans and focus on organic growth in these portfolios of loans. Commercial real estate loans increased $3.8 million, or 3.0%, to $131.8 million at December 31, 2014 from $128.0 million at June 30, 2014. Commercial business loans decreased $1.2 million, or 6.9%, to $16.3 million at December 31, 2014, from $17.5 million at June 30, 2014. There was an increase in one- to four-family residential loans of $5.8 million, or 2.4%, during the six months ended December 31, 2014.

During the six months ended December 31, 2014, the Company originated $48.0 million of loans, of which $34.1 million, or 71.1%, were originated in the North Olympic Peninsula, $13.1 million, or 27.3%, in the Puget Sound region of Washington, and $760,000, or 1.6%, in other areas in Washington. In addition to loans originated during the six months ended December 31, 2014, the Company purchased a $10.2 million pool of one- to four-family residential loans located in the Puget Sound region of Washington.

Our allowance for loan losses declined $406,000, or 5.0%, from $8.1 million at June 30, 2014 to $7.7 million at December 31, 2014, and the allowance for loan losses as a percentage of total loans declined 0.1% from 1.6% at June 30, 2014, to 1.5% at December 31, 2014. The allowance remained relatively stable as the result of improving asset quality and decreases in nonperforming and classified loans during the six months ended December 31, 2014.

50


Loans receivable consisted of the following at the dates indicated:
 
December 31, 2014
 
June 30, 2014
 
(In thousands)
Real Estate:
 
 
 
One to four family
$
247,695

 
$
242,523

Multi-family
37,253

 
45,100

Commercial real estate
131,839

 
128,028

Construction and land
19,588

 
20,497

Total real estate loans
436,375

 
436,148

 
 
 
 
Consumer:
 
 
 
Home equity
38,440

 
40,064

Other consumer
9,212

 
10,697

Total consumer loans
47,652

 
50,761

 
 
 
 
Commercial business loans
16,299

 
17,532

 
 
 
 
Total loans
500,326

 
504,441

Less:
 
 
 
Net deferred loan fees
900

 
862

Premium on purchased loans, net
(1,776
)
 
(1,290
)
Loans held for sale

 
613

Allowance for loan losses
7,666

 
8,072

Total loans receivable, net
$
493,536

 
$
496,184


Nonperforming loans decreased $1.9 million, or 31.7%, to $4.1 million at December 31, 2014, from $6.0 million at June 30, 2014. Nonperforming commercial real estate loans decreased $1.7 million, and nonperforming one- to four-family residential loans decreased $140,000 during the six months ended December 31, 2014, partially offset by increases of $111,000 in nonperforming construction and land loans. Nonperforming loans to total loans declined from 1.2% at June 30, 2014 to 0.8% at December 31, 2014. Real estate owned and repossessed assets increased $1.2 million to $2.0 million at December 31, 2014, from $810,000 at June 30, 2014. The decrease in nonperforming commercial real estate loans and increase in real estate owned and repossessed assets was primarily a result of approximately $1.4 million in commercial real estate secured by a commercial real estate property located in Spokane Valley, Washington that was transferred to real estate owned during the quarter ended December 31, 2014. Our allowance for loan losses was $7.7 million and $8.1 million, or 1.5% and 1.6% of gross loans receivable, at December 31, 2014 and June 30, 2014, respectively. The allowance for loan losses as a percentage of nonaccruing loans increased 37.2% from 135.3% at June 30, 2014 to 185.6% at December 31, 2014.
At December 31, 2014, there were $9.8 million in restructured loans, of which $7.9 million were performing in accordance with their modified payment terms and returned to accrual status. Classified loans decreased by $3.0 million, or 21.6%, to $10.9 million at December 31, 2014, from $13.9 million at June 30, 2014.
Loans 30 days or more past due increased $2.6 million, or 92.9%, to $5.4 million at December 31, 2014, from $2.8 million at June 30, 2014, primarily due to select one- to four-family residential mortgages that pay one month behind their due date and become 30-59 days past due during months with 31 days.

51


The following table represents nonperforming assets and troubled debt restructurings ("TDRs") at the dates indicated.
 
December 31, 2014
 
June 30, 2014
 
(In thousands)
Nonaccruing loans:
 
 
 
Real estate loans:
 
 
 
One- to four-family
$
3,403

 
$
3,543

Commercial real estate
223

 
1,913

Construction and land
238

 
127

    Total real estate loans
3,864

 
5,583

 
 
 
 
Consumer loans:
 
 
 
Home equity
196

 
340

Other
71

 
41

    Total consumer loans
267

 
381

 
 
 
 
    Total nonaccruing loans
4,131

 
5,964

 
 
 
 
Real estate owned:
 
 
 
One- to four-family
658

 
524

Commercial real estate
1,368

 

Construction and land

 
220

    Total real estate owned
2,026

 
744

 
 
 
 
Repossessed automobiles and recreational vehicles

 
66

 
 
 
 
Total nonperforming assets
$
6,157

 
$
6,774

 
 
 
 
TDR loans:
 
 
 
One- to four-family
$
5,569

 
$
5,939

Multi-family
638

 
728

Commercial real estate
2,605

 
4,456

    Total real estate loans
8,812

 
11,123

 
 
 
 
Home equity
565

 
615

Commercial business
421

 
426

    Total restructured loans
$
9,798

 
$
12,164

 
 
 
 
Nonaccrual and 90 days or more past due loans as a
percentage of total loans
0.8
%
 
1.2
%
Nonperforming TDRs included in total restructured
loans above
$
1,907

 
$
3,536


At December 31, 2014, the securities portfolio increased $10.0 million, or 4.3%, to $242.2 million at December 31, 2014, from $232.2 million at June 30, 2014. Mortgage-backed securities represented the largest portion of our investment portfolio and were $155.3 million at December 31, 2014, a decrease of $13.4 million, or 7.9%, from $168.7 million at June 30, 2014, due to maturities and principal repayments. Other investment securities, including municipal bonds, were $86.9 million at December 31, 2014, an increase of $23.4 million, or 36.8% from $63.5 million at June 30, 2014.

Liabilities. Total liabilities increased $126.8 million, or 17.8%, to $841.1 million at December 31, 2014, from $714.3 million at June 30, 2014. This increase was primarily the result of deposit account balances increasing $140.4 million, or 23.4%, to $740.8 million at December 31, 2014, from $600.4 million at June 30, 2014, as a result of deposits made in anticipation of participating in the Bank's mutual to stock conversion. Transaction and savings account deposits increased $134.8 million, or 28.9%, to $601.5 million at December 31, 2014 from $466.7 million at June 30, 2014, while certificates of deposit increased $5.7 million, or 4.2%, during this period. The change in the mix of deposits also reflects the continued impact of the historically low-rate environment as depositors prefer the liquidity of savings and money market products as compared to time deposits.

52



Borrowings consisting primarily of long term advances for the Federal Home Loan Bank, decreased $15.1 million, or 14.4%, from $105.1 million at June 30, 2014 to $90.0 million at December 31, 2014, as Federal Home Loan Bank cash management advances were repaid. Total borrowings at December 31, 2014 consisted primarily of long term advances from the FHLB.

Equity. Total equity increased $2.0 million, or 2.5%, to $83.0 million at December 31, 2014, from $81.0 million at June 30, 2014. The increase was a result of $1.7 million in net income and a slight increase in other comprehensive income associated with changes in the market value of the available for sale investment portfolio.

Comparison of Results of Operations for the Three Months Ended December 31, 2014 and 2013

General. Net income for the three months ended December 31, 2014 was $882,000 compared to net income of $857,000 for the three months ended December 31, 2013, an increase of $25,000, or 2.9%. The increase in net income was primarily the result of a $223,000 increase in net interest income and a decrease in the provision for income taxes of $79,000 partially offset by decreases in noninterest income of $180,000 and increases in noninterest expense of $96,000.

Net Interest Income. Net interest income increased $223,000 to $5.6 million for the three months ended December 31, 2014, from $5.4 million for the three months ended December 31, 2013. The increase was the result of an increase in interest income coupled with a decrease in interest expense.

The net interest margin increased one basis point to 2.87% for the three months ended December 31, 2014, from 2.86% for the same period in 2013. The net interest margin remained stable primarily due to a decrease in the yield on average net loans receivable of 17 basis points offset by an increase of $16.0 million, or 3.4%, in the average balance of net loans receivable along with a 38 basis point improvement in the average yield on the mortgage-backed securities portfolio to 1.91% for the three months ended December 31, 2014 from 1.53% for the three months ended December 31, 2013. Net interest margin was also adversely affected by the substantial increase in cash and cash equivalents invested at nominal interest rates. Of the $223,000 increase in net interest income during the three months ended December 31, 2014 compared to the same period in 2013, $277,000 was the result of an increase in volume partially offset by a $54,000 decline from the changes in rates. The cost of average interest-bearing liabilities decreased eight basis points to 0.69% for the three months ended December 31, 2014, compared to 0.77% for the same period in the prior year, due primarily to the decreased cost of FHLB borrowings and a decline in certificates of deposit.

Interest Income. Total interest income increased $127,000, or 1.9%, to $6.7 million for the three months ended December 31, 2014 from $6.6 million for the comparable period in 2013. Interest income on loans decreased $14,000, or 0.2%, during the three months ended December 31, 2014, primarily reflecting a decrease in loan yields of 17 basis points for three months ended December 31, 2014 compared to the three months ended December 31, 2013, as higher yielding loans continued to pay off and were replaced with loans at lower interest rates.


Interest income on investment securities increased $61,000 to $330,000 for the three months ended December 31, 2014 compared to $269,000 for the three months ended December 31, 2013. The average balance of our investment securities increased $11.3 million to $71.2 million for the three months ended December 31, 2014 compared to $59.9 million for the three months ended December 31, 2013. The yield on investment securities for the three months ended December 31, 2014 increased five basis points due primarily to higher reinvestment rates available in 2014.

Interest income on mortgage backed securities increased $73,000 primarily due to an increase of 38 basis points in average yields from 1.53% for the three months ended December 31, 2013 to 1.91% for the three months ended December 31, 2014. The average balance of mortgage-backed securities decreased as cash flows were partially redeployed primarily to fund loan growth and, to a lesser extent, other investment securities.


53


 The following table compares average earning asset balances, associated yields, and resulting changes in interest income for the periods shown:
 
Three Months Ended December 31,
 
2014
 
2013
 
 
 
Average Balance
Outstanding
 
Yield
 
Average Balance
Outstanding
 
Yield
 
Increase/ 
 (Decrease) in
Interest Income
 
(Dollars in thousands)
Loans receivable, net
$
485,595

 
4.62
%
 
$
469,608

 
4.79
%
 
$
(14
)
Investment securities
71,213

 
1.85
 
 
59,867

 
1.80
 
 
61

Mortgage-backed securities
158,710

 
1.91
 
 
178,456

 
1.53
 
 
73

FHLB stock
9,920

 
0.08
 
 
10,305

 
0.08
 
 

Cash and due from banks
54,243

 
0.16
 
 
33,207

 
0.18
 
 
7

   Total interest-earning assets
$
779,681

 
3.45
 
 
$
751,443

 
3.51
 
 
$
127


Interest Expense. Total interest expense decreased $96,000, or 8.1%, to $1.1 million for the three months ended December 31, 2014, compared to $1.2 million for the three months ended December 31, 2013. Deposit costs decreased $3,000, or 0.8%, primarily due to a decline in the average balance of certificates of deposit, which resulted in a decrease in interest rates paid. The average balance of interest-bearing deposits increased $28.3 million, or 5.3%, to $560.5 million for the three months ended December 31, 2014 from $532.2 million at the three months ended December 31, 2013. This increase was attributable to increases in the average balances for transaction accounts of $1.6 million, savings accounts of $27.4 million, and money market accounts of $12.3 million partially offset by a $13.1 million decrease in the average balance of certificates of deposit. Contributing to the increase in money market accounts was a promotional rate offering to assist in our efforts to increase customer deposit balances in new and existing markets.

With rates at historically low levels there has been little incentive for depositors to extend maturities and reduce the liquidity associated with savings and money market products by renewing maturing certificates of deposit. The average cost of all deposit products decreased for the three months ended December 31, 2014, with certificates of deposit increasing by four basis points and savings accounts declining by one basis point respectively, while the cost of money market deposits and transaction accounts remained unchanged for the three months ended December 31, 2014 and 2013. Borrowing costs declined $93,000 to $734,000 for the three months ended December 31, 2014 from $827,000 for the same period last year due to the maturity of $10.0 million long-term FHLB advances and the use of less expensive borrowings on our FHLB CMA account for short-term business cash flow needs.

The following table details average balances, cost of funds and the change in interest expense for the periods shown:
 
Three Months Ended December 31,
 
2014
 
2013
 
Increase/ 
 (Decrease)
in Interest
Expense
 
Average Balance
Outstanding
 
Rate
 
Average Balance
Outstanding
 
Rate
 
 
(Dollars in thousands)
Savings accounts
$
110,366

 
0.04
%
 
$
83,002

 
0.05
%
 
$

Transaction accounts
105,785

 
0.01
 
 
104,143

 
0.01
 
 

Money market accounts
213,383

 
0.18
 
 
201,048

 
0.18
 
 
9

Certificates of deposit
130,951

 
0.83
 
 
144,030

 
0.79
 
 
(12
)
Borrowings
90,033

 
3.26
 
 
100,033

 
3.31
 
 
(93
)
   Total interest-bearing liabilities
$
650,518

 
0.69
 
 
$
632,256

 
0.77
 
 
$
(96
)

Provision for Loan Losses. There was no provision for loan losses during the three months ended December 31, 2014, compared to a small recapture of $1,000 for the three months ended December 31, 2013. This was primarily due to continued improvement in our asset quality as reflected in the decrease in nonperforming loans as a percent of loans, from 1.5% at December 31, 2013 to 0.8% at December 31, 2014. The improvements in

54


delinquencies and nonperforming loans are attributed to the improving economic conditions allowing some borrowers to improve their financial condition. Management considers the allowance for loan losses at December 31, 2014 to be adequate to cover probable losses inherent in the loan portfolio. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment or information available to them at the time of their examination.

The following table details activity and information related to the allowance for loan losses for the periods shown:
 
 
For the Three Months
Ended December 31,
 
 
2014
 
2013
 
 
(Dollars in thousands)
Provision for (recapture of) loan losses
 
$

 
$
(1
)
Net charge-offs
 
(317
)
 
(379
)
Allowance for loan losses
 
7,666

 
7,802

Allowance for losses as a percentage of total gross loans receivable at the end of this period
 
1.5
%
 
1.6
%
Total nonaccruing loans
 
4,131

 
7,179

Allowance for loan losses as a percentage of nonaccrual loans at end of period
 
185.6
%
 
108.7
%
Nonaccrual and 90 days or more past due loans as a percentage of total loans
 
0.8
%
 
1.5
%
Total loans
 
$
500,326

 
$
477,559


Noninterest Income. Noninterest income decreased $180,000, from $1.2 million for the three months ended December 31, 2013 to $979,000 for the three months ended December 31, 2014. Loan and deposit service fees decreased $88,000, or 9.6%, to $824,000 for the three months ended December 31, 2014, mainly due to lower fees related to income received on customer check orders, lower volumes of non-sufficient funds (NSF) activity, and income related to VISA transactions. Decreases in the gain on sale of loans of $110,000 during the three months ended December 31, 2014, compared to the same period in 2013, was attributable to a planned reduction in loan sales activity during the quarter in order to increase interest earned on loans receivable.

The following table provides a detailed analysis of the changes in the components of noninterest income for the periods shown:
 
 
Three Months
Ended December 31,
 
Increase (Decrease)
 
 
 
2014
 
2013
 
Amount
 
Percent
 
 
 
(Dollars in thousands)
 
Loan and deposit service fees
 
$
824

 
$
912

 
$
(88
)
 
(9.6
)
%
Mortgage servicing fees, net of amortization
 
60

 
42

 
18

 
42.9

 
Net gain on sale of loans
 
41

 
151

 
(110
)
 
(72.8
)
 
Increase in cash surrender value of bank-owned life insurance
 
(16
)
 
(25
)
 
9

 
(36.0
)
 
Other income
 
70

 
79

 
(9
)
 
(11.4
)
 
Total noninterest income
 
$
979

 
$
1,159

 
$
(180
)
 
(15.5
)
%

Noninterest Expense. Noninterest expense increased $96,000, or 1.8%, to $5.4 million for the three months ended December 31, 2014, compared to $5.3 million for the three months ended December 31, 2013. This increase was primarily due to an increase in compensation and benefits of $330,000, and data processing and occupancy and equipment expense of $84,000 and $30,000, respectively, partially offset by a $294,000 decline in

55


real estate owned and repossessed assets expense, net. Additional staffing has been added in connection with our branch expansion into Kitsap County, and the Company has increased staffing in the credit administration, production and other support areas to manage its growth and improve approval times for loans. As a result, full-time equivalent employees increased to 170 at December 31, 2014 from 165 at December 31, 2013. Compensation and benefits during the quarter ended December 31, 2014, also increased compared to the comparable period in 2013 as a result of additional accruals of $69,000 to the Company's pension benefit plan compared to accruals recorded in the comparable period in 2013, as well as a result of certain market rate and merit increase adjustments for employees and management. Expenses related to real estate owned and repossessed assets declined as the Company realized gains primarily on the sale of one- to four-family residential properties in excess of write-downs for the three and six months ended December 31, 2014 as compared to the same periods in 2013.

The following table provides an analysis of the changes in the components of noninterest expense for the periods shown:
 
 
Three Months Ended December 31,
 
Increase
(Decrease)
 
 
 
2014
 
2013
 
Amount
 
Percent
 
 
 
(Dollars in thousands)
 
Compensation and benefits
 
$
3,049

 
$
2,719

 
$
330

 
12.1

%
Real estate owned and repossessed assets (income) expense, net
 
(146
)
 
148

 
(294
)
 
(198.6
)
 
Data processing
 
622

 
538

 
84

 
15.6

 
Occupancy and equipment
 
768

 
738

 
30

 
4.1

 
Supplies, postage, and telephone
 
171

 
181

 
(10
)
 
(5.5
)
 
Regulatory assessments and state taxes
 
78

 
102

 
(24
)
 
(23.5
)
 
Advertising
 
144

 
147

 
(3
)
 
(2.0
)
 
Professional fees
 
128

 
194

 
(66
)
 
(34.0
)
 
FDIC insurance premium
 
131

 
130

 
1

 
0.8

 
Other
 
497

 
449

 
48

 
10.7

 
   Total
 
$
5,442

 
$
5,346

 
$
96

 
1.8

%

Provision for Income Tax. An income tax expense of $256,000 was recorded for net income for the three months ended December 31, 2014 compared to an income tax expense of $335,000 for the three months ended December 31, 2013. This was generally due to a decrease in income before taxes of $54,000.


Comparison of Results of Operations for the Six Months Ended December 31, 2014 and 2013

General. Net income for the six months ended December 31, 2014 was $1.7 million compared to net income of $1.5 million for the six months ended December 31, 2013, an increase of $194,000, or 12.6%. The increase in net income was primarily the result of a $616,000 increase in net interest income and a $432,000 decline in the provision for loan losses offset by a decrease in noninterest income of $180,000 and increases in noninterest expense of $647,000 and in the provision for income taxes of $27,000.

Net Interest Income. Net interest income increased $616,000 to $11.1 million for the six months ended December 31, 2014, from $10.5 million for the six months ended December 31, 2013. The increase was the result of an increase in interest income coupled with a decrease in interest expense.

Net interest margin increased 12 basis points to 2.91% for the six months ended December 31, 2014, from 2.79% for the same period in 2013, primarily due to the $24.4 million, or 5.3%, increase in average net loans receivable. The redistribution of interest-earning assets from investments to loans improved the yield, and increases in the yield on the investment portfolio more than offset a 19 basis point decrease in yield on the loan portfolio. Of the $616,000 increase in net interest income during the six months ended December 31, 2014 compared to the same period in 2013, $679,000 was the result of an increase in volume partially offset by a $63,000 decline from the changes in rates. The cost of average interest-bearing liabilities decreased seven basis points to 0.70% for the six months ended December 31, 2014, compared to 0.77% for the same period in the prior year, due primarily to the decreased cost of FHLB borrowings and a decline in the average balance of certificates of deposit.

56



Interest Income. Total interest income increased $396,000, or 3.1%, to $13.3 million for the six months ended December 31, 2014 from $13.0 million for the comparable period in 2013. Interest income on loans increased $117,000, or 1.1%, during the six months ended December 31, 2014, primarily reflecting an increase of $24.4 million in the average balance of net loans receivable outstanding compared to the comparable period in 2013. During the six months ended December 31, 2014, average loan yields decreased 19 basis points compared to the six months ended December 31, 2013, as higher yielding loans continued to pay off and were replaced with loans at lower interest rates.

Interest income on investment securities increased $92,000 to $647,000 for the six months ended December 31, 2014 compared to $555,000 for the six months ended December 31, 2013. The average balance of the investment securities increased $5.8 million to $67.1 million for the six months ended December 31, 2014 compared to $61.3 million for the six months ended December 31, 2013. The yield on investment securities for the six months ended December 31, 2014 increased 12 basis points due primarily to higher reinvestment rates available in 2014.

Interest income on mortgage backed securities increased $189,000 primarily due to an increase of 42 basis points in average yields from 1.47% for the six months ended December 31, 2013 to 1.89% for the six months ended December 31, 2014. The average balance of mortgage-backed securities decreased as cash flows were partially redeployed primarily to fund loan growth and, to a lesser extent, other investment securities.

 The following table compares average earning asset balances, associated yields, and resulting changes in interest income for the periods shown:
 
Six Months Ended December 31,
 
2014
 
2013
 
 
 
Average Balance
Outstanding
 
Yield
 
Average Balance
Outstanding
 
Yield
 
Increase/ 
 (Decrease) in
Interest Income
 
(Dollars in thousands)
Loans receivable, net
$
487,425

 
4.57
%
 
$
463,018

 
4.76
%
 
$
117

Investment securities
67,130

 
1.93
 
 
61,282

 
1.81
 
 
92

Mortgage-backed securities
162,028

 
1.89
 
 
183,250

 
1.47
 
 
189

FHLB stock
9,971

 
0.10
 
 
10,353

 
0.10
 
 

Cash and due from banks
38,469

 
0.14
 
 
35,532

 
0.16
 
 
(2
)
   Total interest-earning assets
$
765,023

 
3.49
 
 
$
753,435

 
3.44
 
 
$
396


Interest Expense. Total interest expense decreased $220,000, or 9.0%, to $2.2 million for the six months ended December 31, 2014, compared to $2.4 million for the six months ended December 31, 2013. Deposit costs decreased $36,000, or 4.6%, primarily due to a decline in the average balance of certificates of deposit, which resulted in a decrease in interest paid. The average balance of interest-bearing deposits increased $13.0 million, or 2.4%, to $546.1 million for the six months ended December 31, 2014 from $533.1 million for the six months ended December 31, 2013. This increase was attributable to increases in the average balances for transaction accounts of $2.1 million, savings accounts of $14.6 million, and money market accounts of $11.0 million partially offset by a decrease in the average balance of certificates of deposit of $14.6 million. With rates at historically low levels there has been little incentive for depositors to extend maturities and reduce the liquidity associated with savings and money market products by renewing maturing certificates of deposit. The average cost of all deposit products decreased for the six months ended December 31, 2014, with certificates of deposit decreasing by two basis points, while the cost of money market deposits and transaction accounts remained unchanged at 0.18% and 0.01% for the six months ended December 31, 2014 and 2013, respectively. Borrowing costs declined $184,000 to $1.5 million for the six months ended December 31, 2014 from $1.7 million for the same period last year due to the maturity of $10.0 million long-term FHLB advances and the use of less expensive borrowings on the FHLB CMA account for short-term business cash flow needs.


57


The following table details average balances, cost of funds and the change in interest expense for the periods shown:
 
Six Months Ended December 31,
 
2014
 
2013
 
Increase/ 
 (Decrease)
in Interest
Expense
 
Average Balance
Outstanding
 
Rate
 
Average Balance
Outstanding
 
Rate
 
 
(Dollars in thousands)
Savings accounts
$
97,675

 
0.04
%
 
$
83,124

 
0.05
%
 
$
(1
)
Transaction accounts
104,895

 
0.01
 
 
102,840

 
0.01
 
 

Money market accounts
212,009

 
0.18
 
 
201,031

 
0.18
 
 
15

Certificates of deposit
131,486

 
0.82
 
 
146,102

 
0.80
 
 
(50
)
Borrowings
90,742

 
3.24
 
 
100,033

 
3.31
 
 
(184
)
   Total interest-bearing liabilities
$
636,807

 
0.70
 
 
$
633,130

 
0.77
 
 
$
(220
)

Provision for Loan Losses. There was no provision for loan losses during the six months ended December 31, 2014, compared to $432,000 for the six months ended December 31, 2013. This was primarily due to improving asset quality as reflected in the decrease in nonperforming loans as a percent of loans from 1.5% at December 31, 2013 to 0.8% at December 31, 2014, as well as a decline in net charge-offs. The improvements in delinquencies and nonperforming loans are attributed to the improving economic conditions allowing some borrowers to improve their financial condition. The improvement in net charge-offs reflects the improvement in real estate values in our market areas.

The following table details activity and information related to the allowance for loan losses for the periods shown:
 
 
For the Six Months
Ended December 31,
 
 
2014
 
2013
 
 
(Dollars in thousands)
Provision for loan losses
 
$

 
$
432

Net (charge-offs) recoveries
 
(406
)
 
(604
)
Allowance for loan losses
 
7,666

 
7,802

Allowance for losses as a percentage of total gross loans receivable at the end of this period
 
1.5
%
 
1.6
%
Total nonaccruing loans
 
4,131

 
7,179

Allowance for loan losses as a percentage of nonaccrual loans at end of period
 
185.6
%
 
108.7
%
Nonaccrual and 90 days or more past due loans as a percentage of total loans
 
0.8
%
 
1.5
%
Total loans
 
$
500,326

 
$
477,559


Noninterest Income. Noninterest income decreased $180,000 from $2.3 million for the six months ended December 31, 2013 to $2.1 million for the six months ended December 31, 2014. Loan and deposit service fees decreased $114,000, or 6.4%, to $1.7 million for the six months ended December 31, 2014, mainly due to lower NSF fees on deposit accounts and lower fees related to income received on customer check orders. Decreases in the gain on sale of loans of $216,000 during the six months ended December 31, 2014, compared to the same period in 2013, was attributable to a planned reduction in loan sales activity during the period and decreases in the overall volume of originations of loans held for sale.

58



The following table provides a detailed analysis of the changes in the components of noninterest income for the periods shown:
 
 
Six Months
Ended December 31,
 
Increase (Decrease)
 
 
 
2014
 
2013
 
Amount
 
Percent
 
 
 
(Dollars in thousands)
 
Loan and deposit service fees
 
$
1,659

 
$
1,773

 
$
(114
)
 
(6.4
)
%
Mortgage servicing fees, net of amortization
 
133

 
75

 
58

 
77.3

 
Net gain on sale of loans
 
138

 
354

 
(216
)
 
(61.0
)
 
Net (loss) gain on sale of investment securities
 

 
(68
)
 
68

 
(100.0
)
 
Increase in cash surrender value of bank-owned life insurance
 
23

 
15

 
8

 
53.3

 
Other income
 
168

 
152

 
16

 
10.5

 
Total noninterest income
 
$
2,121

 
$
2,301

 
$
(180
)
 
(7.8
)
%

Noninterest Expense. Noninterest expense increased $647,000, or 6.3%, to $11.0 million for the six months ended December 31, 2014, compared to $10.3 million for the six months ended December 31, 2013. This increase was primarily due to an increase in compensation and benefits of $735,000, and data processing and occupancy and equipment expense of $200,000 and $115,000, respectively partially offset by a $224,000 decline in real estate owned and repossessed assets expense, net. Additional staffing has been added in connection with the branch expansion into Kitsap County, and the Company has increased the staffing in the credit administration, production and other support areas to manage its growth and improve approval times for loans. Compensation and benefits during the six months ended December 31, 2014 also increased compared to the comparable period in 2013 as a result of additional accruals of $215,000 to the Company's pension benefit plan compared to accruals recorded in the comparable period in 2013, as well as certain market rate and merit increase adjustments for employees and management.

The following table provides an analysis of the changes in the components of noninterest expense for the periods shown:
 
 
Six Months Ended December 31,
 
Increase
(Decrease)
 
 
 
2014
 
2013
 
Amount
 
Percent
 
 
 
(Dollars in thousands)
 
Compensation and benefits
 
$
6,089

 
$
5,354

 
$
735

 
13.7

%
Real estate owned and repossessed assets expenses, net
 
(62
)
 
162

 
(224
)
 
(138.3
)
 
Data processing
 
1,232

 
1,032

 
200

 
19.4

 
Occupancy and equipment
 
1,562

 
1,447

 
115

 
7.9

 
Supplies, postage, and telephone
 
331

 
368

 
(37
)
 
(10.1
)
 
Regulatory assessments and state taxes
 
163

 
209

 
(46
)
 
(22.0
)
 
Advertising
 
272

 
276

 
(4
)
 
(1.4
)
 
Professional fees
 
297

 
380

 
(83
)
 
(21.8
)
 
FDIC insurance premium
 
267

 
281

 
(14
)
 
(5.0
)
 
Other
 
808

 
803

 
5

 
0.6

 
   Total
 
$
10,959

 
$
10,312

 
$
647

 
6.3

%

Provision for Income Tax. An income tax expense of $555,000 was recorded for net income for the six months ended December 31, 2014 compared to an income tax expense of $528,000 for the six months ended December 31, 2013. This was generally due to an increase in income before taxes of $221,000.



59


Average Balances, Interest and Average Yields/Cost
The following table sets 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 December 31, 2014. Income and all average balances are monthly average balances, which management deems to be not materially different than daily averages. Nonaccruing loans have been included in the table as loans carrying a zero yield.
 
At December 31, 2014
 
Three Months Ended
December 31,
 
Six Months Ended
December 31,
 
 
2014
 
2013
 
2014
 
2013
 
Yield/
Rate
 
Average
Balance
Outstanding
 
Interest
Earned/
Paid
 
Yield/
Rate
 
Average
Balance
Outstanding
 
Interest
Earned/
Paid
 
Yield/
Rate
 
Average
Balance
Outstanding
 
Interest
Earned/
Paid
 
Yield/
Rate
 
Average
Balance
Outstanding
 
Interest
Earned/
Paid
 
Yield/
Rate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
(Dollars in thousands)
Loans receivable, net (1)
4.67
%
 
$
485,595

 
$
5,606

 
4.62
%
 
$
469,608

 
$
5,620

 
4.79
%
 
$
487,425

 
$
11,135

 
4.57
%
 
$
463,018

 
$
11,018

 
4.76
%
Investment securities
2.30

 
71,213

 
330

 
1.85

 
59,867

 
269

 
1.80

 
67,130

 
647

 
1.93

 
61,282

 
555

 
1.81

Mortgage-backed securities
2.01

 
158,710

 
757

 
1.91

 
178,456

 
684

 
1.53

 
162,028

 
1,533

 
1.89

 
183,250

 
1,344

 
1.47

FHLB dividends
0.10

 
9,920

 
2

 
0.08

 
10,305

 
2

 
0.08

 
9,971

 
5

 
0.10

 
10,353

 
5

 
0.10

Cash and cash equivalents
0.11

 
54,243

 
22

 
0.16

 
33,207

 
15

 
0.18

 
38,469

 
27

 
0.14

 
35,532

 
29

 
0.16

  Total interest-earning assets (2)
3.24

 
779,681

 
6,717

 
3.45

 
751,443

 
6,590

 
3.51

 
765,023

 
13,347

 
3.49

 
753,435

 
12,951

 
3.44

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Savings accounts
0.04

 
$
110,366

 
$
10

 
0.04

 
$
83,002

 
10

 
0.05

 
$
97,675

 
$
19

 
0.04

 
$
83,124

 
20

 
0.05

Transaction accounts
0.01

 
105,785

 
2

 
0.01

 
104,143

 
2

 
0.01

 
104,895

 
5

 
0.01

 
102,840

 
5

 
0.01

Money market accounts
0.18

 
213,383

 
97

 
0.18

 
201,048

 
88

 
0.18

 
212,009

 
191

 
0.18

 
201,031

 
176

 
0.18

Certificates of deposit
0.88

 
130,951

 
273

 
0.83

 
144,030

 
285

 
0.79

 
131,486

 
538

 
0.82

 
146,102

 
588

 
0.80

Total deposits
0.23

 
560,485

 
382

 
0.27

 
532,223

 
385

 
0.29

 
546,065

 
753

 
0.28

 
533,097

 
789

 
0.30

Borrowings
3.24

 
90,033

 
734

 
3.26

 
100,033

 
827

 
3.31

 
90,742

 
1,470

 
3.24

 
100,033

 
1,654

 
3.31

Total interest-bearing liabilities
0.55

 
650,518

 
1,116

 
0.69

 
632,256

 
1,212

 
0.77

 
636,807

 
2,223

 
0.70

 
633,130

 
2,443

 
0.77

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
 
 
$
5,601

 
 
 
 
 
$
5,378

 
 
 
 
 
$
11,124

 
 
 
 
 
$
10,508

 
 
Net interest rate spread
2.69

 


 
 
 
2.76

 
 
 
 
 
2.74

 
 
 
 
 
2.79

 
 
 
 
 
2.67

Net earning assets
 
 
$
129,163

 
 
 
 
 
$
119,187

 
 
 
 
 
$
128,216

 
 
 
 
 
$
120,305

 
 
 
 
Net interest margin (3)
 
 
 
 
 
 
2.87

 
 
 
 
 
2.86

 
 
 
 
 
2.91

 
 
 
 
 
2.79

Average interest-earning assets to average interest-bearing liabilities
 
 
119.9
%
 
 
 
 
 
118.9
%
 
 
 
 
 
120.1
%
 
 
 
 
 
119.0
%
 
 
 
 
(1) The average loans receivable, net balances include nonaccruing loans.
(2) Includes interest-bearing deposits (cash) at other financial institutions.
(3) Net interest income divided by average interest-earning assets.

60


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 due to the 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.

 
Three Months Ended December 31, 2014 vs. 2013
 
 
 
Six Months Ended December 31,
2014 vs. 2013
 
 
 
Increase
(Decrease)
Due to
 
Total
Increase
 
Increase
(Decrease)
Due to
 
Total
Increase
 
Volume
 
Rate
 
(Decrease)
 
Volume
 
Rate
 
(Decrease)
 
(In thousands)
Interest earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans receivable
$
191

 
$
(205
)
 
$
(14
)
 
$
581

 
$
(464
)
 
$
117

Investment and mortgage-backed securities
(25
)
 
159

 
134

 
(103
)
 
384

 
281

Other(1)
10

 
(3
)
 
7

 
2

 
(4
)
 
(2
)
    Total interest-earning assets
$
176

 
$
(49
)
 
$
127

 
$
480

 
$
(84
)
 
$
396

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Savings accounts
$
3

 
$
(3
)
 
$

 
$
4

 
$
(5
)
 
$
(1
)
Money market accounts
5

 
4

 
9

 
10

 
5

 
15

Certificates of deposit
(26
)
 
14

 
(12
)
 
(59
)
 
9

 
(50
)
Borrowings
(83
)
 
(10
)
 
(93
)
 
(154
)
 
(30
)
 
(184
)
   Total interest-bearing liabilities
$
(101
)
 
$
5

 
$
(96
)
 
$
(199
)
 
$
(21
)
 
$
(220
)
 
 
 
 
 
 
 
 
 
 
 
 
Net change in interest income
$
277

 
$
(54
)
 
$
223

 
$
679

 
$
(63
)
 
$
616


(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 December 31, 2014 and the year ended June 30, 2014, we engaged in no off-balance sheet transactions likely to have a material effect on the financial condition, results of operations or cash flows.

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Contractual Obligations

At December 31, 2014, our scheduled maturities of contractual obligations were as follows:
 
 
Within
1 Year
 
After 1 Year Through
3 Years
 
After 3 Years Through
5 Years
 

Beyond
5 Years
 

Total
Balance
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
 
$
60,944

 
$
55,361

 
$
22,822

 
$
232

 
$
139,359

FHLB advances
 

 

 
19,924

 
70,000

 
89,924

Operating leases
 
54

 
106

 
53

 

 
213

Borrower taxes and insurance
 
810

 

 

 

 
810

Deferred compensation
 
78

 
139

 

 
46

 
263

Total contractual obligations
 
$
61,886

 
$
55,606

 
$
42,799

 
$
70,278

 
$
230,569


Commitments and Off-Balance Sheet Arrangements

The following table summarizes our commitments and contingent liabilities with off-balance sheet risks as of December 31, 2014:
 
 
Amount of Commitment
Expiration - Per Period
 
 
Total
Amounts
Committed
 
Due in
One
Year
 
 
(In thousands)
Commitments to originate loans:
 
 
 
 
Fixed-rate
 
$
106

 
$
106

Adjustable-rate
 
35

 
35

Unfunded commitments under lines of credit or existing loans
 
36,712

 
36,712

Standby letters of credit
 
285

 
285

Total
 
$
37,138

 
$
37,138


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 the expected loan demand, expected deposit flows, the 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 December 31, 2014, cash and cash equivalents totaled $139.3 million. The amount of cash and cash equivalents held at December 31, 2014 was mainly due to deposits made in anticipation of participating in the Company's initial public offering. Securities classified as available-for-sale, whose aggregate market value exceeds cost, provide additional sources of liquidity and had a market value of $192.3 million at December 31, 2014. In addition, at December 31, 2014, we had excess FHLB stock of $5.7 million and have pledged collateral to support borrowings of $90.0 million. We have also established a borrowing arrangement with the Federal Reserve Bank of San Francisco; however, no collateral has been pledged as of December 31, 2014.


62


At December 31, 2014, we had $141,000 in loan commitments outstanding, and an additional $37.0 million in undisbursed loans and standby letters of credit.

Certificates of deposit due within one year of December 31, 2014 totaled $60.9 million, or 43.7% of certificates of deposit. The large percentage of certificates of deposit that mature within one year reflects customers' hesitancy to invest their funds for longer periods at historically low interest rates. Management believes, based on past experience, that a significant portion of our certificates of deposit will be renewed or rolled into money market accounts. If these maturing deposits are not renewed, however, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. We have the ability to attract and retain deposits by adjusting the interest rates offered. 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, which is presently comprised of nine full-service retail banking offices located throughout our primary market area, and the general cash flows from our existing lending and investment activities, will afford us sufficient long-term liquidity. For additional information, see the Consolidated Statements of Cash Flows in Item 1 of this Form 10-Q.

Capital Resources
First Federal is subject to minimum capital requirements imposed by the FDIC. Based on its capital levels at December 31, 2014, First Federal exceeded these requirements as of that date and continues to exceed them as of the date of this report. Consistent with our goals to operate a sound and profitable organization, our policy is for First Federal to maintain a “well-capitalized” status under the capital categories of the FDIC. Based on capital levels at December 31, 2014, First Federal was considered to be well-capitalized.

The following table shows the capital ratios of First Federal at December 31, 2014.
 

Actual
 
Minimum Capital
Requirements
 
Minimum Required
to Be Well-Capitalized
Under Prompt
Corrective
Action Provisions
 
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
 
 
 
 
(Dollars in thousands)
 
 
 
 
Tier 1 Capital to total adjusted assets(1)
$
81,390

 
10.0
%
$
32,624

 
4.0
%
$
40,779

 
5.0
%
Tier 1 Capital to risk-weighted assets(2)
81,390

 
18.8
 
N/A

 
 
 
26,014

 
6.0
 
Total Capital to risk-weighted assets(2)
86,840

 
20.0
 
34,685

 
8.0
 
43,357

 
10.0
 
______________
(1)
Based on total adjusted assets of $815.6 million.
(2)    Based on risk-weighted assets of $433.6 million.
On January 29, 2015, First Northwest Bancorp became the holding company for First Federal Savings and Loan Association of Port Angeles in connection with the completion of the Bank’s conversion from the mutual to the stock form of organization and the Company’s related public stock offering. In the offering, the Company sold 12,167,000 shares of common stock at a price of $10 per share, and received net offering proceeds of approximately $117.8 million. Following the offering and the contribution to the foundation the Company has 13,100,360 shares of common stock outstanding. From the proceeds, the Company made a capital contribution of approximately $58.5 million to the Bank. The Company’s stock trades on NASDAQ under the ticker symbol “FNWB.”

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.


63


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 Registration Statement (SEC Registration No. 333-185101).


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 December 31, 2014, 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 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 December 31, 2014, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. The Company also continued to implement suggestions from its internal auditor and independent auditors to strengthen existing controls.

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.


64


PART II - OTHER INFORMATION

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

For information regarding the Company’s risk factors, see “Risk Factors” in the Company’s prospectus dated November 12, 2014, filed with the Securities and Exchange Commission pursuant to Rule 424(b)(3) on November 25, 2014. As of December 31, 2014, the risk factors of the Company have not changed materially from those disclosed in the prospectus.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Nothing to report.

Item 3. Defaults Upon Senior Securities

Nothing to report.

Item 4. Mine Safety Disclosures

Nothing to report.

Item 5. Other Information

Nothing to report.

Item 6. Exhibits
2
Plan of Conversion of First Federal (1)
3.1
Articles of Incorporation of First Northwest Bancorp (1)
3.2
Articles of Amendment to the Articles of Incorporation of First Northwest Bancorp (1)
3.3
Bylaws of First Northwest Bancorp (1)
10.1
Form of First Federal Employee Severance Compensation Plan (1)
10.2
Form of Employment Agreement for Laurence J. Hueth, Regina M. Wood, Christopher A. Donohue and Kelly A. Liske (1)
10.3
Form of Change in Control Severance Agreement for Elaine T. Gentilo (1)
10.4
Severance Agreement between First Federal and Gina E. Lowman (1)
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 December 31, 2014, formatted in Extensible Business Reporting Language (XBRL): (1) Condensed Consolidated Statements of Financial Condition; (2) Condensed Consolidated Statements of Income; (3) Condensed Consolidated Statements of Comprehensive Income ; (4) Condensed Consolidated Statements of Cash Flows; and (5) Selected Notes to Condensed Consolidated Financial Statements *

*
Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
(1)
Filed as an exhibit to First Northwest's Registration Statement on Form S-1 (333-185101).


65


SIGNATURES

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.
 
 

 
FIRST NORTHWEST BANCORP
 
 
Date: February 13, 2015
  /s/ Laurence J. Hueth
 
Laurence J. Hueth 
 
President and Chief Executive Officer
 
(Principal Executive Officer)
 
 
 
 
Date: February 13, 2015
  /s/ Regina M. Wood
 
Regina M. Wood
 
Executive Vice President and Chief Financial Officer
 
(Principal Financial and Accounting Officer)



66


EXHIBIT INDEX

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 December 31, 2014, formatted in Extensible Business Reporting Language (XBRL): (1) Condensed Consolidated Statements of Financial Condition; (2) Condensed Consolidated Statements of Income; (3) Condensed Consolidated Statements of Comprehensive Income ; (4) Condensed Consolidated Statements of Cash Flows; and (5) Selected Notes to Condensed Consolidated Financial Statements *

*
Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.


67