FNWB

Business Context and Reporting Period

Company: First Northwest Bancorp (FNWB)
Reporting Period: Quarter and six months ended June 30, 2024
Business Overview: A Washington-based bank holding company operating primarily through its wholly-owned subsidiary, First Fed Bank. The bank provides commercial and consumer banking services in western Washington, focusing on mortgage, commercial real estate, construction, and consumer lending.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability Decline: Net income for the six months ended June 30, 2024, decreased to $1.81 million from $5.30 million in the same period of 2023. This was driven by a $4.1 million decrease in net interest income and a significant increase in the provision for credit losses.
• Margin Compression: Net interest margin (NIM) decreased 59 basis points year-over-year to 2.76% for the six-month period. The cost of funds increased 105 basis points to 2.81%, outpacing the 43 basis point increase in yield on earning assets to 5.49%.
• Provision Spike: The provision for credit losses on loans surged to $5.38 million for the six months ended June 30, 2024, compared to $315,000 in the prior year. This was due to reserves on individually evaluated loans, charge-offs from a purchased consumer loan program (Splash), and increased loss factors on commercial and multi-family loans.
• Noninterest Income Surge: Noninterest income increased 135.7% year-over-year to $9.54 million, primarily due to a $7.92 million pre-tax gain from the sale of six branch properties in a sale-leaseback transaction. This was partially offset by a $2.12 million loss on the sale of investment securities.
• Asset Quality Deterioration: Nonaccrual loans increased 62.3% to $30.3 million, driven by a $8.1 million commercial construction loan and several delinquent commercial business loans. Classified loans increased to $46.4 million.

Guidance, Outlook, and Management Commentary

• Strategic Actions: Management is actively managing interest rate risk by selling lower-yielding securities and purchasing higher-yielding floating-rate securities. The company also executed a sale-leaseback of six properties to optimize capital and reduce depreciation expenses, though it increased rent obligations.
• Cost Management: The company continues to focus on controlling operating expenses. A reduction-in-force impacting 9% of the workforce was announced for July 2024. Advertising expenses decreased significantly year-over-year.
• Liquidity and Capital: The bank remains "well capitalized" under FDIC guidelines. Liquidity is supported by $83.2 million in cash, $266.7 million in unpledged securities, and significant borrowing capacity at the FHLB ($257.6 million) and Federal Reserve ($17.0 million).
• Risks and Contingencies:
  • Credit Risk: Significant exposure to construction and land loans ($111.3 million) and commercial real estate. Management notes that 85% of nonaccrual loans are well-secured real estate loans.
  • Regulatory: The company is evaluating the impact of a proposed FDIC rule regarding brokered deposits, which could increase deposit insurance assessment costs.
  • Market Risk: Continued pressure on net interest margin due to an inverted yield curve and competitive deposit rates.

Investor Verification Checklist

• Provision Drivers: Verify the specific details and collateral status of the individually evaluated loans driving the $5.4 million provision increase.
• Construction Portfolio: Assess the concentration and risk ratings of the $111.3 million construction and land loan portfolio, particularly the $8.1 million nonaccrual relationship.
• Sale-Leaseback Impact: Confirm the long-term impact of the new lease liabilities ($12.2 million) and increased rent expense on future operating margins.
• Deposit Mix: Monitor the shift toward higher-cost brokered and money market deposits and the sustainability of the current cost of funds.
• Consumer Loan Charge-offs: Track the remaining exposure and charge-off rates of the purchased "Splash" unsecured consumer loan program.