First Northwest Bancorp — FY2018 Form 10-K Summary
Business context and reporting period
First Northwest Bancorp is the holding company for First Federal Savings and Loan Association of Port Angeles, a community bank serving Western Washington through 13 locations and a Seattle Home Lending Center. The audited fiscal year ended December 31, 2018. The company changed its fiscal year-end from June 30 to December 31, so the prior comparable full-year results for 2017 are unaudited twelve-month figures; the six months ended December 31, 2017 represent a transition period.
Financial condition and results
| Metric | FY2018 / Dec. 31, 2018 | Prior comparable period / Dec. 31, 2017 |
|---|---|---|
| Total assets | $1.259 billion | $1.216 billion |
| Net loans | $863.9 million | $779.1 million |
| Total deposits | $940.3 million | $885.0 million |
| Borrowings | $136.6 million | $144.1 million |
| Shareholders’ equity | $172.3 million | $177.0 million |
| Net interest income | $36.8 million | $33.6 million |
| Net income | $7.1 million | $4.9 million |
| Diluted EPS | $0.68 | $0.46 |
| Net interest margin | 3.20% | 3.21% |
| Return on average assets | 0.58% | 0.44% |
| Return on average equity | 4.09% | 2.76% |
| Efficiency ratio | 76.9% | 78.8% |
Interest income increased 15.7% to $45.8 million, primarily from loan growth and higher loan yields. Interest expense increased 49.9% to $9.0 million as deposit and borrowing costs rose. The provision for loan losses was $1.2 million versus $700,000. Noninterest income decreased 8.3% to $5.9 million, largely because 2017 included a $768,000 bank-owned life insurance death benefit. Noninterest expense increased 4.0% to $32.9 million, reflecting compensation, branch expansion, occupancy, data processing and other growth-related costs. The effective tax burden declined because 2017 included a $1.1 million deferred-tax-asset revaluation related to the Tax Cuts and Jobs Act and 2018 benefited from the 21% federal tax rate.
For the fourth quarter of 2018, unaudited net income was $2.1 million, or $0.21 diluted EPS, compared with a $114,000 net loss, or $(0.01) diluted EPS, in the fourth quarter of 2017. Fourth-quarter net interest income was $9.4 million and the provision for loan losses was $272,000.
Loans, asset quality, liquidity and capital
- Total loans increased 10.6% to $869.7 million. Commercial real estate and multifamily loans increased 21.3% to $335.6 million, while auto and other consumer loans increased 211.0% to $87.4 million. One- to four-family loans declined 5.4% to $336.2 million, and construction and land loans declined 23.9% to $54.1 million.
- The portfolio remained concentrated in real estate loans, which represented 83.5% of total loans. Commercial and multifamily real estate exposure was 38.6% of total loans, increasing credit sensitivity to property values, occupancy, capitalization rates and borrower cash flows.
- Nonperforming assets increased to $1.8 million from $1.6 million but remained 0.1% of total assets. Nonperforming loans were $1.7 million, or 0.2% of total loans. Classified loans declined to $3.4 million from $6.7 million, and troubled debt restructurings declined to $3.7 million from $4.9 million.
- The allowance for loan losses increased to $9.5 million, or 1.1% of total loans. Net charge-offs were $401,000, primarily associated with consumer loans. Management stated that the allowance was adequate, while noting that estimates could change and regulators could require additional reserves.
- Cash and cash equivalents were $26.3 million. Available-for-sale securities had a fair value of $263.0 million, providing a significant additional liquidity source. Total investment securities declined 10.0% to $306.5 million.
- Deposits increased 6.2%; certificates of deposit represented 27.8% of deposits, and $148.1 million of certificates matured within one year. The company had no brokered deposits.
- FHLB borrowings totaled $136.6 million, including $60.0 million of long-term advances. Pledged collateral supported $236.1 million of borrowing capacity, leaving $99.5 million available.
- Net cash from operating activities was $13.3 million. Investing activities used $60.7 million, primarily for loan growth, while financing activities provided $36.9 million, principally from deposit growth. Cash and cash equivalents declined $10.5 million during the year.
- First Federal remained well capitalized. Its CET1 ratio was 17.04%, Tier 1 risk-based capital ratio was 17.04%, total risk-based capital ratio was 18.21%, and leverage ratio was 11.47%, all well above regulatory minimums.
Material changes and unusual items
- The company shifted its earning-asset mix toward higher-yielding commercial real estate, multifamily and auto lending while reducing investment securities and residential mortgage balances.
- Shareholders’ equity declined 2.7%, primarily because of $10.0 million of share repurchases, $3.2 million of after-tax accumulated other comprehensive losses related to available-for-sale securities, and $335,000 of dividends, partly offset by net income.
- The company repurchased 623,813 shares at an average cost of $16.03 per share during 2018 and paid a $0.03 per-share cash dividend.
- Available-for-sale securities had $6.7 million of unrealized losses at year-end; management concluded these losses were not other-than-temporary, and no OTTI losses were recorded.
- The company adopted revenue-recognition and financial-instrument accounting updates without a material effect. It adopted the new lease standard on January 1, 2019 and recorded approximately $3.9 million of right-of-use assets and lease liabilities.
Outlook, commentary and risks
Management intends to continue strategic and opportunistic growth, expand in the Puget Sound region, increase higher-yielding commercial and consumer lending, attract core deposits and maintain strong asset quality. No quantitative earnings or revenue guidance is provided.
- Primary risks include commercial real estate and multifamily concentration, construction lending, large borrower concentrations, rapid loan growth, purchased and geographically dispersed loans, and increased indirect auto exposure.
- Rising interest rates could increase deposit and borrowing costs faster than asset yields and compress net interest income. Management’s sensitivity analysis estimated that a 300-basis-point rate increase would reduce projected net interest income by 16.8% under its assumptions.
- Liquidity depends on deposit retention, loan and securities repayments, securities sales and FHLB funding. Significant certificate maturities within one year could require higher-cost replacement funding if deposits are not renewed.
- CECL becomes effective for the company’s first fiscal year after December 15, 2019. Management had not yet estimated the implementation impact on the allowance for credit losses.
- Other risks include regulatory and capital requirements, LIBOR replacement, competition, branch expansion costs, third-party servicing and vendors, cybersecurity, fraud, litigation and the potential for additional pension-plan contributions.
Important facts for investors to verify
- Reconcile the audited FY2018 results with the unaudited twelve-month 2017 comparison, recognizing the fiscal-year change and transition period.
- Monitor commercial real estate, multifamily, construction and indirect auto delinquency trends as these portfolios grow.
- Assess deposit repricing, certificate renewals, FHLB borrowing costs and the effect on net interest margin.
- Evaluate the adequacy of the allowance under the CECL methodology and the potential effect of future regulatory examinations.
- Review liquidity coverage for $148.1 million of certificates maturing within one year and $99.7 million of loan and standby commitments.
- Track unrealized securities losses, accumulated other comprehensive losses and capital effects under changing interest rates.
- Confirm the sustainability of earnings excluding the prior-year unusual BOLI death benefit and tax-related effects.