Business Context and Reporting Period
First Northwest Bancorp is the holding company for First Federal Savings and Loan Association of Port Angeles, a community-oriented bank serving Western Washington. The unaudited Form 10-Q covers the three and nine months ended September 30, 2018. The company changed its fiscal year-end from June 30 to December 31 effective December 31, 2017; therefore, management cautions that the reported periods are not necessarily indicative of future results.
Key Financial Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Net income | $1.9 million, versus $1.8 million | $5.0 million, versus $5.1 million |
| Diluted EPS | $0.19, versus $0.17 | $0.47, versus $0.47 |
| Net interest income | $9.3 million, versus $8.5 million | $27.4 million, versus $25.1 million |
| Net interest margin | 3.25%, versus 3.20% | 3.21%, versus 3.24% |
| Provision for loan losses | $197,000, versus none | $902,000, versus $500,000 |
| Noninterest income | $1.4 million, versus $1.7 million | $4.3 million, versus $5.1 million |
| Noninterest expense | $8.1 million, versus $7.8 million | $24.7 million, versus $23.2 million |
At September 30, 2018, total assets were $1.24 billion, loans receivable were $845.8 million, deposits were $931.6 million, borrowings were $121.5 million, and shareholders’ equity was $171.9 million. Equity represented 13.9% of total assets. Book value per share was $15.18.
Nine-month net cash provided by operating activities was $11.9 million, compared with $8.9 million in the prior-year period. Investing activities used $40.8 million, primarily because of a $61.3 million increase in loans, while financing activities provided $17.4 million. Cash and cash equivalents declined to $25.3 million from $36.8 million at December 31, 2017.
The allowance for loan losses was $9.3 million, or 1.1% of total loans. Nonperforming loans were $2.5 million, or 0.3% of total loans, and nonperforming assets were $2.5 million. The bank reported that it exceeded all regulatory capital requirements and remained well capitalized, with a 11.6% Tier 1 leverage ratio and an 18.6% total risk-based capital ratio.
Material Changes Versus Prior Period
- Total loans increased $59.7 million, or 7.6%, from December 31, 2017, driven principally by commercial real estate, auto and other consumer, and multifamily lending. Auto and other consumer loans increased $41.9 million, supported by indirect lending and specialty auto loan purchase programs.
- Total investment securities decreased $29.4 million, or 8.6%, to $311.0 million as the company sold and allowed securities to mature while emphasizing loan growth and asset-mix improvement.
- Deposits increased $46.6 million, or 5.3%, while FHLB borrowings declined $22.6 million, or 15.7%.
- Third-quarter net income increased 8.6%, primarily because higher loan balances and yields increased net interest income. The nine-month net income decline of 1.5% reflected higher operating expenses, higher loan-loss provisions, and lower noninterest income.
- Interest expense increased 44.9% in the third quarter and 46.3% for the nine-month period, reflecting higher deposit and borrowing costs in a rising-rate environment. The nine-month net interest margin declined three basis points despite higher net interest income.
- Nine-month noninterest income declined 15.5%, largely because the prior-year period included $768,000 of income from a bank-owned life insurance death benefit. Third-quarter noninterest income also declined because of lower loan-sale gains, mortgage servicing fees, and investment-security results.
- Shareholders’ equity declined $5.1 million, primarily from a $4.3 million after-tax decline in accumulated other comprehensive income related to unrealized securities losses and $6.9 million of common-stock repurchases. The company repurchased 423,213 shares during the first nine months.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management expects continued growth-related investment and higher noninterest expenses as it expands its geographic footprint, lending operations, personnel, technology, and infrastructure. No quantitative earnings guidance was provided.
- Management considers overall credit quality strong and views recent changes in nonperforming loans as normal fluctuations. However, nonperforming loans increased 61.1% from year-end, and the allowance coverage ratio declined to 377.5% from 570.7%.
- Certificates of deposit totaling $153.9 million, or 61.3% of total certificates, mature within one year. Failure to renew these deposits could require higher-cost deposits or borrowings. Time deposits exceeding the FDIC insurance limit totaled $101.7 million.
- Liquidity consisted of $25.3 million of cash and cash equivalents, $267.1 million of unpledged available-for-sale securities, FHLB funding capacity, and an established Federal Reserve borrowing arrangement. Unfunded commitments under lines of credit and existing loans totaled $104.6 million; total commitments, including loan-originations and standby letters of credit, were $105.4 million.
- Construction commitments totaled $113.3 million, including $63.1 million of undisbursed commitments. Construction lending is concentrated in Washington and carries exposure to project execution, real estate values, and regional economic conditions.
- The company will adopt lease accounting guidance on January 1, 2019 and expects to record approximately $9 million of right-of-use assets and lease liabilities related to office and equipment leases. It does not expect a material income-statement impact.
- The company is preparing for the current expected credit loss model, effective for the company in 2020. Preliminary testing did not indicate an expected increase in the allowance, but implementation depends on models, assumptions, and estimates.
- A quarterly cash dividend of $0.03 per share was declared on October 24, 2018, payable December 14, 2018.
- Management identified no material changes to previously disclosed market risks or risk factors, no material legal proceedings, and no material changes in internal control over financial reporting. Disclosure controls were deemed effective.
Important Facts for Investors to Verify
- Whether loan growth, particularly in auto, commercial real estate, multifamily, and construction lending, remains profitable as funding costs rise.
- Trends in deposit pricing, certificate-of-deposit renewals, uninsured deposits, and reliance on FHLB borrowings.
- Whether nonperforming loans and classified assets stabilize and whether the allowance remains adequate under changing credit conditions.
- The effect of unrealized securities losses and interest-rate movements on accumulated other comprehensive income, capital, and liquidity.
- The sustainability of earnings excluding the prior-year bank-owned life insurance death benefit and other securities- and loan-sale gains.
- The ultimate impact of lease accounting and CECL implementation on reported assets, liabilities, reserves, capital, and earnings.