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. The filing is a Form 10-K for the fiscal year ended June 30, 2017, not a 2016 fourth-quarter filing. The company subsequently changed its fiscal year-end to December 31, with a transition period from July 1 through December 31, 2017.
First Federal operates 12 banking locations and focuses on residential, commercial real estate, construction, commercial business, consumer lending, and deposit products. Management’s strategy emphasizes loan growth, commercial and construction lending, core-deposit growth, and expansion throughout the Puget Sound region.
Key Financial Metrics
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Total assets | $1.088 billion | $1.010 billion | Up 7.7% |
| Net loans receivable | $726.8 million | $619.8 million | Up 17.3% |
| Total deposits | $823.8 million | $723.3 million | Up 13.9% |
| Total shareholders’ equity | $177.7 million | $189.7 million | Down 6.3% |
| Net interest income | $31.6 million | $27.4 million | Up 15.5% |
| Net interest margin | 3.18% | 2.98% | Up 20 basis points |
| Net income | $5.1 million | $4.0 million | Up 27.5% |
| Diluted EPS | $0.46 | $0.33 | Up $0.13 |
| Return on average assets | 0.48% | 0.41% | Improved |
| Return on average equity | 2.81% | 2.09% | Improved |
| Efficiency ratio | 78.7% | 83.1% | Improved |
Total interest income increased to $36.8 million from $32.2 million, while interest expense increased to $5.2 million from $4.8 million. The improvement in net interest income was driven primarily by higher average loan balances and a greater proportion of loans within earning assets.
The provision for loan losses increased to $1.3 million from $233,000. Net recoveries were $24,000 in FY2017 versus net charge-offs of $105,000 in FY2016. Noninterest income was essentially unchanged at $6.2 million, although the mix changed materially: FY2017 included a $768,000 bank-owned life insurance death benefit and higher gains on loan sales, while FY2016 included a $1.6 million gain on securities sales.
Net cash provided by operating activities was $1.1 million, compared with $10.6 million in FY2016. Investing activities used $80.3 million, primarily reflecting $108.4 million of net loan originations and repayments, partly offset by securities cash flows. Financing activities provided $80.8 million, including a $100.5 million increase in deposits. Cash and cash equivalents increased to $24.3 million from $22.7 million.
Loan Portfolio, Asset Quality, Debt and Liquidity
- Gross loans increased to $734.0 million. Real estate loans represented 89.9% of the portfolio, including $328.2 million of one- to four-family loans, $202.0 million of commercial real estate loans, $71.6 million of construction and land loans, and $58.1 million of multifamily loans.
- Commercial real estate and multifamily loans totaled $260.1 million, or 35.4% of total loans, compared with $207.3 million in FY2016. Construction and land loans increased 42.1% to $71.6 million.
- The allowance for loan losses increased to $8.5 million, but remained 1.2% of gross loans. Management considered the allowance adequate, while noting that estimates remain subject to economic conditions and regulatory review.
- Nonperforming assets declined to $2.0 million, or 0.2% of total assets, from $3.3 million, or 0.3%. Nonperforming loans declined to $1.9 million, or 0.3% of total loans.
- Restructured loans totaled $6.1 million, of which $5.5 million were performing and accruing. The company also identified $10.7 million of accruing loans with elevated credit concerns.
- Total investment securities declined 13.4% to $280.5 million as securities cash flows were used to fund loan growth. Available-for-sale securities had $1.7 million of unrealized losses at June 30, 2017; no other-than-temporary impairment was recognized.
- Borrowings declined to $77.4 million from $80.7 million, consisting of $60.0 million of long-term FHLB advances and $17.4 million of overnight advances.
- The company had $24.3 million of cash and cash equivalents, $228.6 million of available-for-sale securities, $170.0 million of remaining FHLB borrowing capacity, and $68.7 million of commitments and standby letters of credit.
- Certificates of deposit totaled $211.5 million, with $106.4 million maturing within one year. Management expects a significant portion to renew but noted that nonrenewal could increase funding needs.
Material Changes Versus the Prior Comparable Period
- Loan growth accelerated, particularly in commercial real estate, multifamily, construction and land, and indirect auto lending.
- Deposits increased $100.5 million, including a 32.9% increase in certificates of deposit, supporting loan growth and reducing reliance on securities.
- Net interest margin expanded from 2.98% to 3.18%, primarily because loans earned more than the securities they replaced.
- Provision expense increased by approximately $1.0 million as the portfolio expanded, despite improved delinquency and nonperforming-asset measures.
- Noninterest expense increased 6.7% to $29.8 million, mainly because compensation and benefits increased 18.7% as the company expanded its branch, home-lending, and commercial-banking infrastructure.
- Shareholders’ equity declined despite net income because the company repurchased 1.16 million shares for $16.5 million and recorded a $2.3 million after-tax decline in accumulated other comprehensive income.
- The company purchased $10.0 million of additional bank-owned life insurance and recognized a $768,000 death benefit.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management did not provide formal earnings or revenue guidance. It expects continued strategic growth in commercial real estate, multifamily, construction and land lending, additional deposit growth, and continued expansion in western Washington. A Bainbridge Island branch was expected to open by January 31, 2018.
- The principal credit risk is the increasing concentration in commercial real estate, multifamily, construction and land lending. These loans have larger balances and repayment depends substantially on property cash flows, occupancy, collateral values and economic conditions.
- At June 30, 2017, real estate loans represented approximately 95% of the loan portfolio. The company also has geographic exposure outside its historic market, including purchased residential loans in California and Ohio.
- Interest-rate risk is significant because deposits and borrowings generally reprice faster than longer-duration loans and securities. Management’s modeling indicated that a 300-basis-point rate increase could reduce projected net interest income by 8.4% and economic value of equity by 3.0%; a 100-basis-point decrease could reduce projected net interest income by 5.2%.
- Growth and new branches are expected to increase operating expenses and may not become profitable for several years. Management also expects continued costs associated with personnel, technology and regulatory compliance.
- The allowance for loan losses could prove insufficient, particularly because substantial portions of the commercial and construction portfolios are relatively unseasoned and have not been tested through a severe downturn.
- The company will adopt the current expected credit loss standard, or CECL, for fiscal years beginning after December 15, 2019. Management did not anticipate an increase in the allowance from preliminary implementation work, but the assessment remained ongoing.
- The company was categorized as well capitalized. At June 30, 2017, the bank’s total risk-based capital ratio was 20.4%, CET1 ratio was 19.2%, and Tier 1 leverage ratio was 13.2%; consolidated ratios were 25.6%, 24.4%, and 16.5%, respectively.
- No material legal proceedings were reported, and management concluded that disclosure controls and internal control over financial reporting were effective.
Most Important Facts for Investors to Verify
- Confirm that the requested period is FY2017, because the supplied filing is not a 2016 Q4 report.
- Assess whether rapid growth in commercial real estate, multifamily, construction and land loans is generating adequate risk-adjusted returns.
- Review loan concentrations, the $10.7 million of other loans of concern, and the adequacy of the $8.5 million allowance under adverse real estate and economic scenarios.
- Monitor deposit pricing and the refinancing or runoff of the $106.4 million of certificates of deposit maturing within one year.
- Evaluate the effect of rising rates on net interest margin, deposit costs, securities values, loan demand and borrower repayment capacity.
- Reconcile shareholder returns with the $16.5 million stock repurchase program, the absence of dividends, and the company’s capital and liquidity needs.
- Verify subsequent filings for the fiscal-year transition, Bainbridge Island branch performance, CECL implementation, and any changes in regulatory capital or asset quality.