First Northwest Bancorp 10-Q

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements Certain matters discussed in this Quarterly Report on Form 10-Q constitute forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by the use of words such as "believes," "expects," "anticipates," "estimates" or similar expressions. Forward-looking statements include, but are not limited to: • statements of our goals, intentions and expectations; • statements regarding our business plans, prospects, growth and operating strategies; • statements regarding the quality of our loan and investment portfolios; and • estimates of our risks and future costs and benefits. These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors: • risks associated with lending and potential adverse changes in the credit quality of loans in our portfolio; • legislative or regulatory changes, including increased insurance rates and assessments or expanded consumer protection regulations, responses to recent events in the banking industry, interest rates along the yield curve, and inflation, which could adversely affect the Company's business; • continued depressed market demand for mortgage and Small Business Administration loans that we originate for sale; • changes in monetary and fiscal policies including interest rate policies of the Federal Reserve and the relative differences between short and long-term interest rates, deposit interest rates, our net interest margin and funding sources; • our ability to control operating costs and expenses; • whether our management team can succeed in implementing our operational strategy, including but not limited to our ability to achieve higher net interest income and noninterest revenue growth; • our ability to successfully execute on growth strategies related to our entry into new markets and delivery channels, including banking as a service; • our ability to develop user-friendly digital applications to serve existing customers and attract new customers; • 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; • pressures on liquidity, including as a result of withdrawals of customer deposits or declines in the value of our investment portfolio; • increased competitive pressures among financial services companies, particularly from non-traditional banking entities such as challenger banks, fintech, and mega technology companies; • our ability to attract and retain deposits at a reasonable cost relative to the market; • changes in consumer spending, borrowing and savings habits, resulting in reduced demand for banking products and services, particularly in the event of a recession that affects our market areas; • results of examinations by our primary or other regulatory authorities, as well as a consent order we entered into with the Federal Deposit Insurance Corporation, could have an adverse impact on our business and operations; • disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions; • risks related to overall economic conditions, including the impact on the economy of an elevated interest rate environment and geopolitical instability, including the wars in Ukraine and the Middle East; • any failure of key third-party vendors to perform their obligations to us; • risks related to natural disasters, including droughts, fires, floods, earthquakes, pandemics, and other unexpected events; • the effects of any reputational damage to the Company resulting from any of the foregoing; and • other economic, competitive, governmental, regulatory and technical factors affecting our operations, pricing, products and services and other risks described elsewhere in our filings with the Securities and Exchange Commission, including this Form 10-Q and the Company's 2023 Form 10-K. Any of the forward-looking statements that we make in this report and in other statements we make may turn out to be wrong because of inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot anticipate or predict. Any forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. Due to these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur, and you should not put undue reliance on any forward-looking statements. 35 Table of Contents General First Northwest is a bank holding company and a financial holding company and is engaged in banking activities through its wholly owned subsidiary, First Fed Bank, as well as certain non-banking financial activities. Non-financial investments include several limited partnership investments, including a 33.3% interest in The Meriwether Group, LLC ("MWG"). The Company's business activities are generally focused on passive investment activities and oversight of the activities of First Fed. The Company also entered into partnerships to strategically invest in fintech-related businesses. First Fed Bank is a community-oriented financial institution founded in 1923 in Port Angeles, Washington. We have 18 locations including 12 full-service branches, three business centers and three administration centers in Clallam, Jefferson, King, Kitsap, and Whatcom counties. First Fed’s business and operating strategy is focused on building sustainable earnings by delivering a full array of financial products and services for individuals, small business, and commercial customers. Lending activities include the origination of first lien one-to-four family mortgage loans, commercial and multi-family real estate loans, residential and commercial construction and land loans, commercial business loans, SBA loans, and consumer loans, consisting primarily of home equity loans and lines of credit. Over the last five years, we have significantly increased the origination of commercial real estate, multi-family real estate, construction, and commercial business loans, and have increased our consumer loan portfolio through our manufactured home and auto loan purchase programs. We offer traditional consumer and business deposit products, including transaction accounts, savings and money market accounts and certificates of deposit ("CDs") for individuals and businesses. Deposits are our primary source of funding for our lending and investing activities. First Northwest's limited partnership investments include Canapi Ventures Fund, LP; BankTech Ventures, LP; and JAM FINTOP Blockchain, LP. These limited partnerships invest in fintech-related businesses with a focus on developing digital solutions applicable to the banking industry. In 2022, First Northwest acquired a 33.3% interest in MWG, a boutique investment bank and consulting firm focused on providing entrepreneurs with resources to help them succeed. Also in 2022, the Company acquired a 25% equity interest as a general partner in Meriwether Group Capital, LLC ("MWGC"), which provides financial advice for borrowers and capital for the Meriwether Group Capital Hero Fund LP ("Hero Fund"). The Hero Fund is a private commercial lender focused on lower-middle market businesses, primarily in the Pacific Northwest. First Northwest also has a limited partnership investment in the Hero Fund. MWG also holds a 20% general partner interest in MWGC. First Northwest is impacted by prevailing economic conditions as well as government policies and regulations concerning, among other things, monetary and fiscal affairs, housing and financial institutions. Deposit flows are influenced by several factors, including interest rates paid on competing deposits, alternative investment options available to our customers, account maturities, the number and quality of our deposit originators, digital delivery systems, branding and customer acquisition, and the overall level of personal income and savings in the markets where we do business. Lending activities are influenced by the demand and pricing for loan funds, our credit policies, the number and quality of our lenders and credit underwriters, digital delivery systems, branding and customer acquisition, and regional economic cycles. Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income earned on our loans and investments and interest expense paid on our deposits and borrowings. Changes in our asset and liability mix, market and portfolio interest rates and cash flows from existing assets and liabilities affect our net interest income. A secondary source of income for the Company is noninterest income, which includes revenue earned from providing products and services, including service charges on deposit accounts, late and other charges on loans, mortgage banking income, loan sales and servicing income, interest rate swap fee income, earnings from bank-owned life insurance, investment services income, gains and losses from sales of securities, and changes in the market value of our equity and partnership investments. An offset to net interest income is the provision for credit losses, which represents the periodic charge to operations that is required to adequately provide for losses inherent in our investment, loan and unfunded commitment portfolios through the ACL. A recapture of previously recognized provision for credit losses may be added to net income if the underlying assumptions driving anticipated loss rates within the CECL model improve, such as the United States unemployment and gross domestic product metrics; lowered qualitative factor adjustments to reflect improvements in the nonaccrual and past due status or upgrades in risk ratings of a particular loan segment; lower loan or unfunded commitment balances, or receipt of recoveries for amounts previously charged off. Noninterest expenses incurred in operating our business consist of salaries and employee benefit costs, occupancy and equipment expenses, federal deposit insurance premiums and regulatory assessments, data processing expenses, marketing and other customer acquisition expenses, legal and other professional fees, expenses related to real estate and personal property owned, and other expenses. 36 Table of Contents Critical Accounting Policies There are no material changes to the critical accounting policies from those disclosed in the Company's 2023 Form 10-K. Comparison of Financial Condition at March 31, 2024 and December 31, 2023 Assets . Total assets increased to $2.24 billion, or 1.7%, at March 31, 2024, from $2.2 billion at December 31, 2023. Cash and cash equivalents decreased by $45.8 million, or 37.2%, to $77.4 million as of March 31, 2024, compared to $123.2 million as of December 31, 2023. Cash decreased during the current year as the Bank deployed funds into higher-yielding investment securities and loans. Investment securities increased $30.3 million, or 10.3%, to $326.0 million at March 31, 2024, from $295.6 million at December 31, 2023. Investment security purchases during the first quarter of 2024 totaled $45.3 million, carrying an estimated weighted-average yield of 6.3% with a weighted-average life of 5.6 years. The purchases were partially offset by payment activity and a portfolio market value decrease of $749,000. Our recent investments have primarily been floating rate securities to take advantage of higher short-term rates above those offered on cash and to reduce our liability sensitivity. The investment portfolio, including mortgage-backed securities, had an estimated projected average life of 7.8 years as of March 31, 2024, compared to 7.7 years as of December 31, 2023, and had an estimated average repricing term of 5.7 years as of March 31, 2024, compared to 6.3 years as of December 31, 2023, based on the interest rate environment at those times. The effective duration of the investment portfolio was 4.4 years at March 31, 2024, compared to 4.8 years at December 31, 2023. We believe prepayment activity may continue to slow if interest rates continue to rise, extending the projected duration and causing deterioration to the market value of our securities portfolio. Included in MBS non-agency are $29.9 million of commercial mortgage-backed securities ("CMBS"), of which 93.3% are in "A" tranches and the remaining 6.7% are in "B" tranches. Our largest exposure is to long-term care facilities, which comprises 65.3%, or $19.5 million, of our private label CMBS securities. All of the CMBS bonds have credit enhancements ranging from 29% to 99%, with a weighted-average credit enhancement of 56%, that further reduces the risk of loss on these investments. The investment portfolio was composed of 55.6% in amortizing securities at March 31, 2024, compared to 52.0% at December 31, 2023. The projected average life of our securities may vary due to prepayment activity, particularly in the mortgage-backed securities portfolio, which is impacted by prevailing market interest rates. Securities are bought and sold to manage liquidity, improve long-term portfolio yields and manage interest rate risk in the portfolio. For additional information, see Note 2 of the Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q. Net loans, excluding loans held for sale, increased $50.3 million to $1.69 billion at March 31, 2024, from $1.64 billion at December 31, 2023. During the three months ended March 31, 2024, commercial business loans increased $24.0 million, including an increase in our participation in the Northpointe Bank Mortgage Purchase Program from $9.5 million last quarter to $15.0 million at the current quarter end, $8.7 million of Bankers Healthcare group loans and organic originations partially offset by repayments. Auto and other consumer loans increased $19.7 million during the current quarter with $13.4 million of new Woodside auto loan purchases and a pool purchase of Triad manufactured home loans totaling $5.1 million, partially offset by payment activity. Multi-family loans increased $6.4 million during the current quarter. The increase was primarily the result of $12.7 million of construction loans converting into permanent amortizing loans, partially offset by scheduled payments. One-to-four family loans increased $5.5 million during the current quarter as a result of $10.4 million in residential construction loans that converted to permanent amortizing loans, partially offset by payments received. Home equity loan outstanding balances increased $3.0 million over the previous quarter due to draws on new and existing line of credit commitments and $833,000 from home equity loan production. Commercial real estate loans decreased $2.9 million during the current quarter compared to the previous quarter due to a reclassification of $2.9 million to multi-family along with payoffs and scheduled payments exceeding originations. 37 Table of Contents Construction and land loans decreased $4.3 million, or 3.3%, to $125.4 million at March 31, 2024, from $129.7 million at December 31, 2023, with $14.5 million converting into fully amortizing loans, partially offset by draws on new and existing loan commitments. Construction loans in the portfolio are geographically dispersed throughout western Washington and one loan in Oregon. We manage construction lending by utilizing a licensed third-party vendor to assist us in monitoring our higher-risk projects while internal staff monitor the progress toward completion of our lower-risk projects. We continue to monitor the impact of inflation and consumer demand in the current interest rate environment on completion of the projects currently in the portfolio. As of the date of this report, we have no reason to believe that any of the projects in process will not be completed. At March 31, 2024, 51% of construction commitments were for one-to-four family residential properties, which are anticipated to convert into amortizing loans upon completion. We monitor real estate values and general economic conditions in our market areas, in addition to assessing the strength of our borrowers, including their equity contributions to a project, to prudently underwrite construction loans. We continually assess our lending strategies across all product lines and markets where we do business to improve earnings while also prudently managing credit risk. 38 Table of Contents The following tables show our construction commitments by type and geographic concentrations at the dates indicated: March 31, 2024 North Olympic Peninsula (1) Puget Sound Region (2) Other Washington Oregon Idaho Total (In thousands) Construction Commitment One-to-four family residential $ 11,225 $ 70,764 $ 4,521 $ 540 $ — $ 87,050 Multi-family residential — 52,675 6,226 — — 58,901 Commercial real estate — 23,858 — — — 23,858 Total commitment $ 11,225 $ 147,297 $ 10,747 $ 540 $ — $ 169,809 Construction Funds Disbursed One-to-four family residential $ 4,961 $ 50,566 $ 3,525 $ 176 $ — $ 59,228 Multi-family residential — 42,971 3,082 — — 46,053 Commercial real estate — 13,492 — — — 13,492 Total disbursed $ 4,961 $ 107,029 $ 6,607 $ 176 $ — $ 118,773 Undisbursed Commitment One-to-four family residential $ 6,264 $ 20,198 $ 996 $ 364 $ — $ 27,822 Multi-family residential — 9,704 3,144 — — 12,848 Commercial real estate — 10,366 — — — 10,366 Total undisbursed $ 6,264 $ 40,268 $ 4,140 $ 364 $ — $ 51,036 Land Funds Disbursed One-to-four family residential $ 3,119 $ 3,039 $ 91 $ — $ — $ 6,249 Commercial real estate — 845 — — — 845 Total disbursed for land $ 3,119 $ 3,884 $ 91 $ — $ — $ 7,094 (1) Includes Clallam and Jefferson counties. (2) Includes Kitsap, Mason, Thurston, Pierce, King, Snohomish, Skagit, Whatcom, and Island counties. December 31, 2023 North Olympic Peninsula (1) Puget Sound Region (2) Other Washington Oregon Idaho Total (In thousands) Construction Commitment One-to-four family residential $ 10,260 $ 54,320 $ 6,489 $ 540 $ — $ 71,609 Multi-family residential — 78,196 11,076 — — 89,272 Commercial real estate — 17,332 1 — — 17,333 Total commitment $ 10,260 $ 149,848 $ 17,566 $ 540 $ — $ 178,214 Construction Funds Disbursed One-to-four family residential $ 3,790 $ 34,725 $ 5,065 $ 175 $ — $ 43,755 Multi-family residential — 61,288 5,879 — — 67,167 Commercial real estate — 11,849 — — — 11,849 Total disbursed $ 3,790 $ 107,862 $ 10,944 $ 175 $ — $ 122,771 Undisbursed Commitment One-to-four family residential $ 6,470 $ 19,595 $ 1,424 $ 365 $ — $ 27,854 Multi-family residential — 16,908 5,197 — — 22,105 Commercial real estate — 5,483 1 — — 5,484 Total undisbursed $ 6,470 $ 41,986 $ 6,622 $ 365 $ — $ 55,443 Land Funds Disbursed One-to-four family residential $ 3,310 $ 3,002 $ 272 $ — $ — $ 6,584 Commercial real estate — 845 — — — 845 Total disbursed for land $ 3,310 $ 3,847 $ 272 $ — $ — $ 7,429 (1) Includes Clallam and Jefferson counties. (2) Includes Kitsap, Mason, Thurston, Pierce, King, Snohomish, Skagit, Whatcom, and Island counties. 39 Table of Contents During the three months ended March 31, 2024, the Company added $50.0 million of organic loan originations and commitments to the portfolio, of which $36.1 million, or 72.1%, were located in the Puget Sound region, $10.4 million, or 20.8%, in the North Olympic Peninsula, $448,000, or 0.9%, in other areas throughout Washington State, and $3.1 million, or 6.1%, in other states. The Company purchased an additional $18.1 million in auto loans, $13.8 million in manufactured home loans, and $9.1 million in commercial business loans to borrowers located throughout the United States during the three months ended March 31, 2024. We will continue to strategically evaluate opportunities to acquire assets through wholesale channels in order to supplement organic originations and increase net interest income. The Northpointe Bank Mortgage Purchase Program ("Northpointe MPP") also provides a temporary source of additional interest income but is dependent on demand for funding, with repayment of advances to this program typically occurring within 30 days or less. The total loan portfolio was composed of 78.6% organic originations and 21.4% purchased loans at March 31, 2024. The ACLL increased to $18.0 million at March 31, 2024, as the Company recorded a $1.2 million provision for credit loss on loans for the three-month period. Net charge-offs were $791,000 for the three-month period. The ACLL as a percentage of total loans was 1.05% and 1.10% at March 31, 2024 and December 31, 2023, respectively. Nonaccrual loans increased $837,000, or 4.5%, to $19.5 million at March 31, 2024, from $18.6 million at December 31, 2023, primarily attributable to two delinquent commercial business loans with an aggregate total of $1.1 million and a $708,000 multi-family loan placed on nonaccrual due to credit concerns, partially offset by a $544,000 payment received on the commercial construction loan previously placed on nonaccrual and a $591,000 single family residence loan that was paid off during the current quarter. Nonaccrual loans to total loans was 1.14% at March 31, 2024, compared to 1.12% at December 31, 2023. The ACLL as a percentage of nonaccrual loans decreased to 92% at March 31, 2024, down from 94% at December 31, 2023. Classified loans increased $1.1 million to $36.2 million at March 31, 2024, from $35.1 million at December 31, 2023, due to the downgrade of the three loans during the first quarter as noted above. A $14.4 million construction loan relationship, which became a classified loan in the fourth quarter of 2022, and a $9.3 million commercial loan relationship which became classified in the fourth quarter of 2023, account for 66% of the classified loan balance at March 31, 2024. The Bank has exercised legal remedies, including the appointment of a third-party receivership and foreclosure actions, to liquidate the underlying collateral to satisfy the real estate loans in the two relationships. Proceeds from the sale of a unit in the construction loan relationship during the first quarter of 2024 were used to the paydown principal of the related loan balance. Loan charge-offs are concentrated mainly in purchased unsecured consumer loans. Charged-off balances related to loans purchased through the Splash Financial unsecured consumer loan program totaled $713,000 during the current quarter, or 85% of gross charge-offs. The Bank's participation in the program was discontinued in 2023. Total Splash loan balances of $6.0 million and $7.3 million were included in Auto and Other Consumer loans at March 31, 2024 and December 31, 2023, respectively. We believe the ACLL is adequate to absorb the known and inherent risks of loss in the overall loan portfolio as of March 31, 2024. Loans receivable, excluding loans held for sale, consisted of the following at the dates indicated : Increase (Decrease) March 31, 2024 December 31, 2023 Amount Percent (In thousands) Real Estate: One-to-four family $ 383,905 $ 378,432 $ 5,473 1.4 % Multi-family 339,538 333,094 6,444 1.9 Commercial real estate 385,130 387,983 (2,853 ) (0.7 ) Construction and land 125,347 129,691 (4,344 ) (3.3 ) Total real estate loans 1,233,920 1,229,200 4,720 0.4 Consumer: Home equity 72,391 69,403 2,988 4.3 Auto and other consumer 268,834 249,130 19,704 7.9 Total consumer loans 341,225 318,533 22,692 7.1 Commercial business loans 136,297 112,295 24,002 21.4 Total loans 1,711,442 1,660,028 51,414 3.1 Less: Derivative basis adjustment 710 — 710 100.0 Allowance for credit losses on loans 17,958 17,510 448 2.6 Loans receivable, net $ 1,692,774 $ 1,642,518 $ 50,256 3.1 40 Table of Contents The following table represents nonperforming assets at the dates indicated. Increase (Decrease) March 31, 2024 December 31, 2023 Amount Percent (In thousands) Nonaccrual loans: Real estate loans: One-to-four family $ 1,237 $ 1,844 $ (607 ) (32.9 )% Multi-family 708 — 708 100.0 Commercial real estate 22 28 (6 ) (21.4 ) Construction and land 14,440 14,986 (546 ) (3.6 ) Total real estate loans 16,407 16,858 (451 ) (2.7 ) Consumer loans: Home equity 121 123 (2 ) (1.6 ) Auto and other consumer 1,012 786 226 28.8 Total consumer loans 1,133 909 224 24.6 Commercial business 1,941 877 1,064 121.3 Total nonaccrual loans $ 19,481 $ 18,644 $ 837 4.5 Nonaccrual and 90 days or more past due loans as a percentage of total loans 1.64 % 1.12 % 0.52 % 46.4 In the first quarter of 2024, the Bank changed the classification of assets related to the six properties included in the Sale Agreement with Mountainseed to properties held for sale on the Consolidated Balance Sheets. The Bank received the full sales price of $14.7 million. It is expected that proceeds of the sale transaction will be deployed into interest-earning assets or used to pay down advances. First Fed is leasing back the six properties sold to Mountainseed under agreements with initial terms of 15 years with one 15-year renewal option each. The leases, recorded in the second quarter of 2024, resulted in an increase of $12.2 million to both other assets and other liabilities for the related right-of-use assets and lease liabilities created by the contracts, respectively. Liabilities. Total liabilities increased to $2.08 billion at March 31, 2024, from $2.04 billion at December 31, 2023, due to an increase in borrowings of $50.5 million. partially offset by a decrease in deposits of $10.3 million. Deposit balances decreased $10.3 million to $1.67 billion at March 31, 2024 from $1.68 billion at December 31, 2023. During first quarter of 2024, total retail deposit balances increased $5.2 million while brokered deposit balances decreased $15.4 million. Within retail deposit balances, an increase in money market accounts of $33.2 million and demand deposit accounts of $2.0 million was partially offset by a decrease in retail CDs of $24.5 million and savings accounts of $5.6 million. Increases in demand and money market accounts were driven by customer behavior as they sought out higher rates offered as CD specials matured. We utilize brokered CDs as an additional funding source to provide liquidity, manage cost of funds, reduce reliance on FHLB advances, and manage interest rate risk. Overall, the current rate environment continues to contribute to greater competition for deposits with additional deposit rate specials offered to attract new funds. FHLB advances increased $47.0 million, or 17.1% to $322.0 million at March 31, 2024, from $275.0 million at December 31, 2023. We increased both short-term and long-term advances to provide additional balance sheet liquidity and fund loan growth. Equity . Total shareholders' equity decreased $2.8 million to $160.5 million for the three months ended March 31, 2024. The Company recorded year-to-date net income of $396,000 and a $730,000 increase in the fair market value of derivatives, net of taxes. Increases were offset by an increase in the after-tax unrealized loss on available-for-sale investments securities of $588,000, $671,000 of dividends declared and $3.0 million for the cost of repurchased shares. Year-to-date, we repurchased 214,132 shares of common stock under the October 2020 stock repurchase plan at an average price of $14.03 per share for a total of $3.0 million, with no shares remaining in the current share repurchase program. In April 2024, the Board of Directors authorized a new buyback plan of up to 10% of shares outstanding. 41 Table of Contents Comparison of Results of Operations for the Three Months Ended March 31, 2024 and 2023 General. Net income attributable to the Company was $396,000 for the three months ended March 31, 2024, compared to $3.5 million for the three months ended March 31, 2023. A $3.9 million decrease in net interest income after provision for credit losses and a $146,000 decrease in noninterest income was offset by a $568,000 decrease in noninterest expense. Net Interest Income. Net interest income decreased $2.4 million to $13.9 million for the three months ended March 31, 2024, from $16.3 million for the three months ended March 31, 2023. This decrease was mainly the result of higher rates paid on interest-bearing liabilities, which increased 133 basis points to 3.14% for the three months ended March 31, 2024, compared to 1.81% for the same period in the prior year. This was due to higher rates paid on all deposits and borrowings and an increase in the average balances of CDs and borrowings. The cost of total deposits increased 131 basis points to 2.43% for the three months ended March 31, 2024, compared to 1.12% for the same period in 2023. The average yield on interest-earning assets increased 47 basis points to 5.42% for the three months ended March 31, 2024, compared to 4.95% for the same period last year, due primarily to higher yields on variable-rate assets and new loan originations. Total cost of funds increased 121 basis points to 2.74% for the three months ended March 31, 2024, from 1.53% for the same period in 2023. The net interest margin decreased 70 basis points to 2.76% for the three months ended March 31, 2024, from 3.46% for the same period in 2023. While increases in the cost of funding currently outpace the growth of the yield on interest-earning assets, the Company has taken measures to reverse interest rate margin compression. Organic loan production was augmented with higher-yielding purchased loans through established third-party relationships. Lower yielding investment securities were sold at a loss in December 2023 and $45.3 million of higher-yielding security investments were purchased during the first quarter of 2024. Income on the Bank's fair value hedging agreements on securities increased quarter-over-quarter by $157,000. The fair value hedge on loans established mid-quarter brought in $173,000 for the first quarter of 2024. Interest Income. Total interest income increased $4.0 million, or 17.4%, to $27.3 million for the three months ended March 31, 2024, from $23.3 million for the comparable period in 2023, primarily due to higher yields on interest-earning assets. Interest and fees on loans receivable increased $3.3 million, to $22.8 million for the three months ended March 31, 2024, from $19.5 million for the three months ended March 31, 2023, primarily due to an increase in average loan yields to 5.51% for the three months ended March 31, 2024, from 5.16% for the same period in 2023, coupled with an increase in the average balance of net loans receivable of $127.1 million compared to the first quarter of 2023. The loan portfolio has grown through our renewed short-term participation in the Northpointe MPP, draws on new and existing business lines of credit, originations of multi-family real estate loans, and purchases of auto, manufactured home, and purchased Bankers Healthcare Group commercial loans. Loan yields increased over the prior year due to higher rates on new originations as well as the repricing of variable rate loans tied to the Prime Rate or other indices. The yield earned on investment securities also increased 82 basis points to 4.75% compared to the same period in 2023, as increases in floating bond rates, sales of lower-yielding bonds, purchases of new bonds at higher yields and a reduction in amortization of premium costs as prepayment speeds slow down have all positively impacted investment securities income. The yield on interest-earning deposits in banks also increased to 5.57% from 4.63% for the comparable period in 2023, benefitting from increases in rates paid on excess balances held at the FRB. The following table compares average earning asset balances, associated yields, and resulting changes in interest income for the periods shown: Three Months Ended March 31, 2024 2023 Average Balance Outstanding Yield Average Balance Outstanding Yield Increase in Interest Income (Dollars in thousands) Loans receivable, net $ 1,661,420 5.51 % $ 1,534,312 5.16 % $ 3,263 Investment securities 307,490 4.75 328,364 3.93 450 FHLB stock 12,328 9.20 11,175 6.97 90 Interest-earning deposits in banks 46,583 5.57 35,420 4.63 241 Total interest-earning assets $ 2,027,821 5.42 % $ 1,909,271 4.95 % $ 4,044 42 Table of Contents Interest Expense. Total interest expense increased $6.4 million, or 92.0%, to $13.4 million for the three months ended March 31, 2024, compared to $7.0 million for the three months ended March 31, 2023. The increase over the first quarter of 2023 was the result of an increase in the cost of deposits to 2.43% from 1.12% in same period one year ago along with higher volumes of CDs. A shift in the deposit mix from no or low-cost transaction and money market accounts to a higher volume of CDs resulted in higher costs of deposits. Borrowing expense increased due to an average balance increase of $20.7 million and an increase in the cost of advances, primarily FHLB advances, compared to the same period in 2023. Average deposit account balances were composed of 85% in interest-bearing deposits and 15% in noninterest-bearing deposits at March 31, 2024, compared to 81% and 19%, respectively, at March 31, 2023. During the three months ended March 31, 2024, interest expense increased on CDs due to an increase in the average balances of $195.7 million, along with an increase in the average rates paid of 135 basis points, compared to the three months ended March 31, 2023. During the same period, the average balances of money market accounts decreased $56.6 million, offset by a 135 basis point average rate increase, resulting in an increase to interest expense. The average cost of interest-bearing deposit accounts increased to 2.86% for the three months ended March 31, 2024, from 1.37% for the three months ended March 31, 2023, due to changes to the deposit mix, driven by customer preferences and the use of higher-rate promotional products designed to retain existing deposits and generate new deposits. The mix of customer deposit balances shifted from non-maturity accounts towards higher cost term certificate products. Customer CDs represented 28.4% and 22.8% of customer deposits at March 31, 2024 and 2023, respectively. The following table details average balances, cost of funds and the change in interest expense for the periods shown: Three Months Ended March 31, 2024 2023 Average Balance Outstanding Rate Average Balance Outstanding Rate Increase (Decrease) in Interest Expense (Dollars in thousands) Interest-bearing demand deposits $ 165,379 0.45 % $ 187,288 0.42 % $ (7 ) Money market accounts 377,505 2.08 434,057 0.73 1,173 Savings accounts 235,784 1.63 219,366 0.70 577 Certificates of deposit, retail 437,525 4.13 293,488 2.59 2,623 Certificates of deposit, brokered 205,923 4.94 154,230 2.99 1,393 Advances 252,912 4.60 232,189 3.90 662 Subordinated debt 39,446 4.02 39,365 4.06 — Total interest-bearing liabilities $ 1,714,474 3.14 % $ 1,559,983 1.81 % $ 6,421 Provision for Credit Losses. The Company recorded a $970,000 provision for credit losses in the three months ended March 31, 2024. A provision for credit losses on loans of $1.2 million was the result of an increase in the loss factors applied to residential real estate and commercial business loans, growth in the commercial business loan portfolio and additional charge-offs from the Splash unsecured consumer loan program, partially offset by a decrease in the loss factors applied to Woodside auto and construction loans. A recapture of $269,000 due to a lower loss factor applied to unfunded commitment balances further offset the provision for credit losses on loans recorded during the current quarter. This compares to a $500,000 loan loss provision recapture for the three months ended March 31, 2023. While the ACLL as a percentage of nonaccrual loans at period end has decreased significantly compared to the same period in 2023, a large portion of the nonaccrual loan balance is comprised of well-secured real estate loans which the Company believes will be sufficient to repay the loans in full upon sale of the underlying collateral. 43 Table of Contents The following table details activity and information related to the allowance for credit losses on loans and reserve for unfunded commitments for the periods shown: Three Months Ended March 31, 2024 2023 (Dollars in thousands) Provision for (recapture of) credit losses on loans $ 1,239 $ (515 ) Net charge-offs (791 ) (944 ) Allowance for credit losses on loans 17,958 17,396 Allowance for losses as a percentage of gross loans receivable at period end 1.05 % 1.10 % Total nonaccrual loans 19,481 2,633 Allowance for credit losses on loans as a percentage of nonaccrual loans at period end 92 % 661 % Nonaccrual and 90 days or more past due loans as a percentage of total loans 1.64 % 0.17 % Total loans receivable $ 1,711,442 $ 1,579,464 (Recapture of) provision for credit losses on unfunded commitments $ (269 ) $ 15 Reserve for unfunded commitments 548 1,336 Unfunded loan commitments 148,736 202,720 Noninterest Income. Noninterest income decreased $146,000, or 6.3%, to $2.2 million for the three months ended March 31, 2024, from $2.3 million for the three months ended March 31, 2023. The decrease was primarily due to lower servicing asset valuation and gain on sale of loans, partially offset by an unrealized gain on partnership investments. Saleable mortgage loan production and related gains continued to be impacted by higher market rates on mortgage loans compared to the prior year. The conversion of lower-yielding BOLI policies was initiated in the first quarter of 2024 and is expected to be finalized in the third quarter. The following table provides a detailed analysis of the changes in the components of noninterest income for the periods shown: Three Months Ended March 31, Increase (Decrease) 2024 2023 Amount Percent (Dollars in thousands) Loan and deposit service fees $ 1,102 $ 1,141 $ (39 ) (3.4 )% Sold loan servicing fees and servicing rights mark-to-market 219 493 (274 ) (55.6 ) Net gain on sale of loans 52 176 (124 ) (70.5 ) Increase in cash surrender value of bank-owned life insurance 243 226 17 7.5 Other income 572 298 274 91.9 Total noninterest income $ 2,188 $ 2,334 $ (146 ) (6.3 )% Noninterest Expense. Noninterest expense decreased $568,000, or 3.8%, to $14.3 million for the three months ended March 31, 2024, compared to $14.9 million for the three months ended March 31, 2023. The decrease in expenses compared to the first quarter of 2023 is mainly due to lower advertising costs and a $218,000 reduction in the accrual for a civil money penalty assessed by the FDIC. The civil money penalty was originally accrued for in the fourth quarter of 2023. The Company continues to focus on controlling compensation expense and reducing advertising and other discretionary spending while the net interest margin compression persists, given higher market rates and an inverted yield curve. The following table provides an analysis of the changes in the components of noninterest expense for the periods shown: Three Months Ended March 31, Increase (Decrease) 2024 2023 Amount Percent (Dollars in thousands) Compensation and benefits $ 8,128 $ 7,837 $ 291 3.7 % Data processing 1,944 2,038 (94 ) (4.6 ) Occupancy and equipment 1,240 1,209 31 2.6 Supplies, postage, and telephone 293 355 (62 ) (17.5 ) Regulatory assessments and state taxes 513 389 124 31.9 Advertising 309 1,041 (732 ) (70.3 ) Professional fees 910 806 104 12.9 FDIC insurance premium 386 257 129 50.2 Other expense 580 939 (359 ) (38.2 ) Total noninterest expense $ 14,303 $ 14,871 $ (568 ) (3.8 )% 44 Table of Contents Provision for Income Tax. An income tax expense of $447,000 was recorded for the three months ended March 31, 2024, compared to $825,000 for the three months ended March 31, 2023, due to a year-over-year decrease in income before taxes of $3.4 million. The current year provision also includes a tax penalty estimate for the early surrender of a BOLI contract. The provision includes accruals for both federal and state income taxes. For additional information, see Note 7 of the Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q. Average Balances, Interest and Average Yields/Cost The following tables set forth, for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin (otherwise known as net yield on interest-earning assets), and the ratio of average interest-earning assets to average interest-bearing liabilities. Also presented is the weighted average yield on interest-earning assets, rates paid on interest-bearing liabilities and the net spread as of March 31, 2024 and 2023. Income and all average balances are monthly average balances, which management deems to be not materially different than daily averages. Nonaccrual loans have been included in the table as loans carrying a zero yield. Three Months Ended March 31, 2024 2023 Average Interest Average Interest Balance Earned/ Yield/ Balance Earned/ Yield/ Outstanding Paid Rate Outstanding Paid Rate (Dollars in thousands) Interest-earning assets: Loans receivable, net (1) (2) $ 1,661,420 $ 22,767 5.51 % $ 1,534,312 $ 19,504 5.16 % Investment securities 307,490 3,632 4.75 328,364 3,182 3.93 FHLB dividends 12,328 282 9.20 11,175 192 6.97 Interest-earning deposits in banks 46,583 645 5.57 35,420 404 4.63 Total interest-earning assets (3) 2,027,821 27,326 5.42 1,909,271 23,282 4.95 Noninterest-earning assets 138,366 140,939 Total average assets $ 2,166,187 $ 2,050,210 Interest-bearing liabilities: Interest-bearing demand deposits $ 165,379 $ 187 0.45 $ 187,288 $ 194 0.42 Money market accounts 377,505 1,949 2.08 434,057 776 0.73 Savings accounts 235,784 953 1.63 219,366 376 0.70 Certificates of deposit, retail 437,525 4,494 4.13 293,488 1,871 2.59 Certificates of deposit, brokered 205,923 2,529 4.94 154,230 1,136 2.99 Total interest-bearing deposits (4) 1,422,116 10,112 2.86 1,288,429 4,353 1.37 Advances 252,912 2,892 4.60 232,189 2,230 3.90 Subordinated debt 39,446 394 4.02 39,365 394 4.06 Total interest-bearing liabilities 1,714,474 13,398 3.14 1,559,983 6,977 1.81 Noninterest-bearing deposits (4) 249,283 294,235 Other noninterest-bearing liabilities 40,563 36,673 Total average liabilities 2,004,320 1,890,891 Average equity 161,867 159,319 Total average liabilities and equity $ 2,166,187 $ 2,050,210 Net interest income $ 13,928 $ 16,305 Net interest rate spread 2.28 3.14 Net earning assets $ 313,347 $ 349,288 Net interest margin (5) 2.76 3.46 Average interest-earning assets to average interest-bearing liabilities 118.3 % 122.4 % (1) The average loans receivable, net balances include nonaccrual loans. (2) Interest earned on loans receivable includes net deferred costs of $171,000 and $88,000 for the three months ended March 31, 2024 and 2023, respectively. (3) Includes interest-earning deposits (cash) at other financial institutions. (4) Cost of all deposits, including noninterest-bearing demand deposits, was 2.43% and 1.12% for the three months ended March 31, 2024 and 2023, respectively. (5) Net interest income divided by average interest-earning assets. 45 Table of Contents Rate/Volume Analysis The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to outstanding balances and changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate. Three Months Ended March 31, 2024 Compared to March 31, 2023 Increase (Decrease) Due to Volume Rate Total Increase (Decrease) (In thousands) Interest-earning assets: Loans receivable, net $ 1,724 $ 1,539 $ 3,263 Investments (191 ) 641 450 FHLB stock 21 69 90 Other (1) 131 110 241 Total interest-earning assets $ 1,685 $ 2,359 $ 4,044 Interest-bearing liabilities: Interest-bearing demand deposits $ (21 ) $ 14 $ (7 ) Money market accounts (98 ) 1,271 1,173 Savings accounts 30 547 577 Certificates of deposit, retail 938 1,685 2,623 Certificates of deposit, brokered 390 1,003 1,393 Advances 211 451 662 Subordinated debt — — — Total interest-bearing liabilities $ 1,450 $ 4,971 $ 6,421 Change in net interest income $ 235 $ (2,612 ) $ (2,377 ) (1) Includes interest-earning deposits (cash) at other financial institutions. Off-Balance Sheet Activities In the normal course of operations, First Fed 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 three months ended March 31, 2024 and the year ended December 31, 2023, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows. 46 Table of Contents Contractual Obligations At March 31, 2024, our scheduled maturities of contractual obligations were as follows: Within After 1 Year Through After 3 Years Through Beyond Total 1 Year 3 Years 5 Years 5 Years Balance (In thousands) Certificates of deposit $ 493,494 $ 72,095 $ 45,515 $ — $ 611,104 FHLB advances 257,000 55,000 10,000 — 322,000 Line of credit 10,000 — — — 10,000 Subordinated debt obligation — — — 39,455 39,455 Operating leases 916 1,859 1,525 3,076 7,376 Borrower taxes and insurance 2,398 — — — 2,398 Deferred compensation 126 292 214 863 1,495 Total contractual obligations $ 763,934 $ 129,246 $ 57,254 $ 43,394 $ 993,828 Commitments and Off-Balance Sheet Arrangements The following table summarizes our commitments and contingent liabilities with off-balance sheet risks as of March 31, 2024: Amount of Commitment by Expiration Within After 1 Year Through After 3 Years Through Beyond Total Amounts 1 Year 3 Years 5 Years 5 Years Committed (In thousands) Commitments to originate loans: Variable-rate $ 330 $ — $ — $ — $ 330 Unfunded commitments under lines of credit 17,347 11,306 3,791 63,654 96,098 Unfunded commitments under existing construction loans 19,553 14,977 760 15,748 51,038 Unfunded commitments under existing maritime loans — — — 1,600 1,600 Standby letters of credit 3,605 58 — 200 3,863 Unfunded commitments under partnership agreements 3,659 — — — 3,659 Total commitments $ 44,494 $ 26,341 $ 4,551 $ 81,202 $ 156,588 Liquidity Management Liquidity is the ability to meet current and future short-term and long-term financial obligations. Our primary sources of funds consist of investment security principal and interest payments, customer and brokered deposit inflows, loan repayments and maturities, sales of securities, and borrowings from the FHLB. While maturities and scheduled amortization of loans and securities are usually predictable sources of funds, deposit flows, calls of investment securities and borrowed funds, and prepayments on loans and investment securities are greatly influenced by general interest rates, economic conditions and competition, which can cause those sources of funds to fluctuate. Management regularly adjusts our investments in liquid assets based upon an assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our liquidity management, 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 March 31, 2024, cash and cash equivalents totaled $77.4 million and unpledged securities classified as available-for-sale had a market value of $284.8 million. The Bank pledged collateral of $595.8 million to support borrowings from the FHLB, with a remaining borrowing capacity of $213.0 million at March 31, 2024. The Bank also has an established discount window borrowing arrangement with the FRB, for which available-for-sale securities with a market value of $18.2 million were pledged as of March 31, 2024, providing a borrowing capacity of $17.4 million, which the Bank has not borrowed against to-date. First Northwest has a $20.0 million borrowing arrangement with NexBank which is secured by First Northwest's personal property assets (with certain exclusions), including all the outstanding shares of First Fed, cash, loans receivable, and limited partnership investments. The remaining borrowing capacity of the NexBank line of credit was $10.0 million at March 31, 2024. 47 Table of Contents At March 31, 2024, we had $330,000 in commitments to originate new loans, $3.9 million in standby letters of credit and $148.7 million in undisbursed loans, including $51.0 million in undisbursed construction loan commitments and $1.6 million in undisbursed maritime fabrication loan commitments. CDs due within one year as of March 31, 2024, totaled $493.5 million, or 80.8% of CDs with a weighted-average rate of 4.42%. If these maturing deposits are not renewed, we will seek other sources of funds, including other CDs, non-maturity deposits, and borrowings. We have the ability to attract and retain deposits by adjusting the interest rates offered as well as through sales and marketing efforts in the markets we serve. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on CDs. We believe that our branch network, and the general cash flows from our existing lending and investment activities, will provide adequate short-term and long-term liquidity. For additional information, see the Consolidated Statements of Cash Flows in Item 1 of this Form 10-Q. First Fed has a diversified deposit base with approximately 59% of deposit account balances held by consumers, 29% held by business and public fund depositors, and 12% in brokered deposits. The average deposit account balance, excluding brokered and public fund accounts, was $27,000 at March 31, 2024. We estimate that 20-25% of our customer deposit balances are over the $250,000 FDIC insurance limit, representing less than 5% of deposit customers. Management believes that maintaining a diversified deposit base is an important factor in managing and maintaining adequate levels of liquidity. The Company is a separate legal entity from the Bank and provides for its own liquidity. At March 31, 2024, the Company, on an unconsolidated basis, had liquid assets of $587,000. In addition to its operating expenses, the Company is responsible for paying dividends declared, if any, to its shareholders, and for Company stock repurchases, interest payments on subordinated notes held at the Company level, payments on the NexBank revolving credit facility, and commitments to limited partnership investments. The Company may receive dividends or capital distributions from the Bank, although there may be regulatory limitations on the ability of the Bank to pay dividends. Capital Resources At March 31, 2024, shareholders' equity totaled $160.5 million, or 7.2% of total assets. Our book value per share of common stock was $17.00 at March 31, 2024, compared to $16.99 at December 31, 2023. At March 31, 2024, the Bank exceeded all regulatory capital requirements and was considered "well capitalized" under FDIC regulatory capital guidelines. The following table provides the capital requirements and actual results for First Fed at March 31, 2024. Actual Minimum Capital Requirements Minimum Required to be Well-Capitalized Amount Ratio Amount Ratio Amount Ratio (Dollars in thousands) Tier 1 leverage capital (to average assets) $ 212,829 9.7 % $ 87,400 4.0 % $ 109,250 5.0 % Common equity tier 1 (to risk-weighted assets) $ 212,829 12.6 76,223 4.5 110,100 6.5 Tier 1 risk-based capital (to risk-weighted assets) $ 212,829 12.6 101,631 6.0 135,508 8.0 Total risk-based capital (to risk-weighted assets) $ 229,860 13.6 135,508 8.0 169,385 10.0 In order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses, the Bank must maintain common equity tier 1 capital ("CET1") at an amount greater than the required minimum levels plus a capital conservation buffer of 2.5%. 48 Table of Contents Effect of Inflation and Changing Prices The consolidated financial statements and related financial data presented in this report have been prepared according to GAAP, 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 companies in many other industries, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than do general levels of inflation. Although inflation expectations do affect interest rates, interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. Item 3. Quantitative and Qualitative Disclosures about Market Risk There has not been any material change in the market risk disclosures contained in the 2023 Form 10-K.