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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the Fiscal Year Ended December 31, 2021
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number: 001-33652
 
FIRST FINANCIAL NORTHWEST, INC.
(Exact name of registrant as specified in its charter)
 
Washington26-0610707
(State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification Number)
  
201 Wells Avenue South, Renton, Washington
98057
(Address of principal executive offices)(Zip Code)
  
Registrant’s telephone number, including area code:
(425) 255-4400
  
Securities registered pursuant to Section 12(b) of the Act: 
  
Common Stock, $0.01 par value per shareThe Nasdaq Stock Market LLC
(Title of Each Class)(Name of Each Exchange on Which Registered)
 
Securities registered pursuant to Section 12(g) of the Act:
None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes         No   X   
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes         No   X   
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   X    No         
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes   X     No       

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer Accelerated filer  Non-accelerated filerX
Smaller reporting companyXEmerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. _____

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes         No    ☑  

The aggregate market value of the Common Stock outstanding held by nonaffiliates of the Registrant based on the closing sales price of the Registrant’s Common Stock as quoted on The Nasdaq Stock Market LLC on June 30, 2021, was $127,362,869 (8,406,790 shares at $15.15 per share). For purposes of this calculation, common stock held only by executive officers, the employee stock ownership plan and directors of the Registrant is considered to be held by affiliates. As of March 8, 2022, the Registrant had 9,128,460 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Registrant’s definitive Proxy Statement for the 2022 Annual Meeting of Shareholders are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated. The 2022 Proxy Statement will be filed with the U.S. Securities and Exchange Commission within 120 days after the end of the fiscal year to which this report relates.



FIRST FINANCIAL NORTHWEST, INC.
2021 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
  
 
 
  
  
  
  
  
  
  
  
    Human Capital
  
  
  
 
 
 
 
 
 
 [Reserved]
 
Overview
  
  
    Comparison of Financial Condition at December 31, 2021, and December 31, 2020
  
  
  
  
  
  
  Liquidity and Capital Resources
  
 
 
 
 
 
Item 9C.Disclosure Regarding Foreign Jurisdictions that Prevent Inspections
i


 
 
 
 
 Principal Accounting Fees and Services
 
Item 16.Form 10-K Summary
  
 
 

ii


Forward-Looking Statements
Certain matters discussed in this Annual Report on Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to:

potential adverse impacts to economic conditions in our local market areas, other markets where the Company has lending relationships, or other aspects of the Company’s business operations or financial markets, generally, resulting from the ongoing novel coronavirus of 2019 (COVID-19) and any governmental or societal responses thereto;
the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs, that may be affected by deterioration in the housing and commercial real estate markets, and may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our reserves;
changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources;
uncertainty regarding the future of the London Interbank Offered Rate ("LIBOR"), and the potential transition away from LIBOR toward new interest rate benchmarks;
fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas;
results of examinations of us by the Federal Reserve Bank of San Francisco (“FRB”) and our bank subsidiary by the Federal Deposit Insurance Corporation (“FDIC”), the Washington State Department of Financial Institutions, Division of Banks (“DFI”) or other regulatory authorities, including the possibility that any such regulatory authority may initiate an enforcement action against the Company or the Bank which could require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements or restrictions on us, any of which could adversely affect our liquidity and earnings;
our ability to pay dividends on our common stock;
our ability to attract and retain deposits;
our ability to control operating costs and expenses;
the use of estimates in determining the fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;
difficulties in reducing risk associated with the loans on our balance sheet;
staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges;
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;
our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments;
our ability to implement a branch expansion strategy;
our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired or may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;
our ability to manage loan delinquency rates;
costs and effects of litigation, including settlements and judgments;
increased competitive pressures among financial services companies;
changes in consumer spending, borrowing and savings habits;
legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, including the interpretation of regulatory capital or other rules, including as a result of Basel III;
iii


the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) and the implementing regulations;
the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
adverse changes in the securities markets;
inability of key third-party providers to perform their obligations to us;
changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; including as a result of the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act") and the Consolidated Appropriations Act, 2021 (“CAA, 2021”);
the economic impact of war or any terrorist activities; and
other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services, and other risks detailed in this Form 10-K and our other reports filed with the U.S. Securities and Exchange Commission (“SEC”).

Any of the forward-looking statements that we make in this Form 10-K and in the other public reports and statements we make may turn out to be wrong because of the inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Because of these and other uncertainties, our actual future results may be materially different from those expressed in any forward‑looking statements made by or on our behalf. Therefore, these factors should be considered in evaluating the forward‑looking statements, and undue reliance should not be placed on such statements. We undertake no responsibility to update or revise any forward-looking statements.

As used throughout this report, the terms “Company”, “we”, “our”, or “us” refer to First Financial Northwest, Inc. and its consolidated subsidiaries, including First Financial Northwest Bank and First Financial Diversified Corporation.
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Internet Website

The information contained on our website, www.ffnwb.com, is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. Other than an investor’s own Internet access charges, we make available free of charge through our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports, proxy statements and other SEC filings on our investor relations page. All of our reports, proxy statements, and other SEC filings are posted as soon as reasonably practicable after they are electronically filed with the SEC and are also available free of charge at the SEC’s website at www.sec.gov.
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PART I
Item 1.  Business

General

First Financial Northwest, Inc. (“First Financial Northwest” or the “Company”), a Washington corporation, was formed on June 1, 2007, for the purpose of becoming the holding company for First Financial Northwest Bank (“the Bank”) in connection with the Bank’s conversion from a mutual holding company structure to a stock holding company structure which was completed on October 9, 2007. At December 31, 2021, the Company had total assets of $1.43 billion, net loans of $1.10 billion, deposits of $1.16 billion and stockholders’ equity of $157.9 million. First Financial Northwest’s business activities generally are limited to passive investment activities and oversight of its investment in First Financial Northwest Bank. Accordingly, the information set forth in this report, including consolidated financial statements and related data, relates primarily to First Financial Northwest Bank.

The Bank was organized in 1923 as a Washington state-chartered savings and loan association, converted to a federal mutual savings and loan association in 1935 and to a Washington state-chartered mutual savings bank in 1992. In 2002, First Savings Bank reorganized into a two-tier mutual holding company structure, became a stock savings bank, and the wholly-owned subsidiary of First Financial of Renton, Inc. In connection with the 2002 conversion, First Savings Bank changed its name to First Savings Bank Northwest. Subsequently, in August 2015, the Bank changed its name to First Financial Northwest Bank to better reflect the commercial banking services it provides beyond those typically provided by a traditional savings bank. In February 2016, the Bank officially changed its charter from a Washington chartered stock savings bank to a Washington chartered commercial bank.

First Financial Northwest became a bank holding company, after converting from a savings and loan holding company on March 31, 2015, and is subject to regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board” or “Federal Reserve”) through the FRB. The change was consistent with First Financial Northwest Bank’s shift in focus from a traditional savings and loan association towards a full service, commercial bank. Additionally, First Financial Northwest Bank is examined and regulated by the DFI and by the FDIC. First Financial Northwest Bank is required to maintain reserves at a level set by the Federal Reserve Board. The Bank is a member of the Federal Home Loan Bank (“FHLB”) of Des Moines, which is one of the 11 regional banks in the Federal Home Loan Bank System (“FHLB System”). For additional information, see “How We are Regulated - Regulation and Supervision of First Financial Northwest Bank - Federal Home Loan Bank System.”

In February 2016, First Financial Northwest Bank converted its charter from a community-based savings bank to a commercial bank as a way of better serving its customer needs. The Bank’s largest concentration of customers is in King County, with additional concentrations in Snohomish, Pierce, and Kitsap counties, Washington. The Bank is headquartered in Renton, in King County, where it has a full-service branch as well as a smaller branch located in a commercial development known as “The Landing”. The Bank has additional smaller branches in King County located in Bellevue, Woodinville, Bothell, Kent, and Kirkland, and opened a new smaller branch in Issaquah in March 2021. In Snohomish County, Washington, the Bank has five additional smaller branches located in Mill Creek, Edmonds, Clearview, Smokey Point, and Lake Stevens. In addition, the Bank has two Pierce County, Washington smaller branches, located in University Place and Gig Harbor. These smaller branches are focused on efficiency through the extensive use of the latest banking technology. First Financial Northwest Bank’s business consists of attracting deposits from the public and utilizing these funds to originate one-to-four family residential, multifamily, commercial real estate, construction/land, business and consumer loans.

During the last two years the Bank participated in the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”), a guaranteed unsecured loan program enacted under the CARES Act to provide near-term relief to help small businesses impacted by COVID-19 sustain operations. The PPP ended on May 31, 2021. Under this program we funded 723 applications totaling $77.7 million of loans in our market areas and began processing applications for loan forgiveness in the fourth quarter of 2020. At December 31, 2021, there were 67 PPP loans outstanding totaling $10.8 million, as compared to 372 PPP loans totaling $41.3 million at December 31, 2020.

The principal executive office of First Financial Northwest is located at 201 Wells Avenue South, Renton, Washington, 98057; our telephone number is (425) 255-4400.
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Market Area

    We consider our primary market area to be the Puget Sound Region that consists primarily of King, Snohomish, Pierce and, to a lesser extent, Kitsap counties. During 2021, the region experienced continued strong appreciation in residential real estate prices. Price appreciation was strongest in areas outside the Seattle core and in less expensive areas. Price appreciation in more expensive areas of King County such as Kirkland and Bellevue have also strengthened over 2021 due to low interest rates and population growth. Home prices in King, Pierce, Snohomish and Kitsap counties have continued to experience price appreciation similar to the national trend. Lower mortgage rates helped stimulate demand in 2021 with sales up compared to 2020. The number of homes listed for sale in King, Pierce, Snohomish and Kitsap counties continued to drop throughout 2021 and at year end are down from December 31, 2020. The declines range from 10% in Pierce County to a decline of 64% in King County, and all four counties have less than one month of inventory available.

King County has the largest population of any county in the state of Washington and covers approximately 2,100 square miles. It has a population of approximately 2.27 million residents and a median household income of approximately $95,000, according to U.S. Census estimates. King County has a diversified economic base with many nationally recognized firms including Boeing, Microsoft, Amazon, Starbucks, Nordstrom, Costco and Paccar. According to the Washington State Employment Security Department, the unemployment rate for King County was 3.2% at December 31, 2021, compared to 6.8% at December 31, 2020, and the national average of 3.9% at December 31, 2021. The median sales price of a residential home in King County for December of 2021 was $749,000, an increase of 10.8% from December 2020, according to the Northwest Multiple Listing Service ("MLS"). Residential sales volumes increased 15.6% in 2021 compared to 2020 and inventory levels as of December 31, 2021 were at 0.3 months according to the MLS.

Pierce County, covering approximately 1,700 square miles, has the second largest population of any county in the state of Washington. It has approximately 921,000 residents and a median household income of approximately $72,100, according to U.S. Census estimates. The Pierce County economy is diversified with the presence of military-related government employment (Joint Base Lewis-McChord), transportation and shipping employment (Port of Tacoma), and aerospace-related employment (Boeing). According to the Washington State Employment Security Department, the unemployment rate for Pierce County was 4.1% in December 2021, compared to 7.6% at year-end 2020. The median sales price of a residential home in Pierce County was $515,000 for December of 2021, a 19.8% increase compared to December 2020, according to the MLS. Residential sales volumes increased by 12.3% in 2021 compared to 2020 and inventory levels as of December 31, 2021 were at 0.3 months according to the MLS.

Snohomish County has the third largest population of any county in the state of Washington and covers approximately 2,090 square miles. It has approximately 828,000 residents and a median household income of approximately $86,700, according to U.S. Census estimates. The economy of Snohomish County is diversified with the presence of military-related government employment (Naval Station Everett), aerospace-related employment (Boeing), and retail trade. According to the Washington State Employment Security Department, the unemployment rate for Snohomish County was 3.8% in December 2021 compared to 7.8% in December 2020. The median sales price of a residential home in Snohomish County was $680,000 for December of 2021, a 27.1% increase compared to December of 2020, according to the MLS. Residential sales volumes rose by 9.4% in 2021 compared to 2020 and inventory levels as of December 31, 2021 were at 0.2 months according to the MLS.

Kitsap County has the seventh largest population of any county in the state of Washington and covers approximately 395 square miles. It has approximately 276,000 residents and a median household income of approximately $75,400, according to U.S. Census estimates. The Kitsap County economy is diversified with the presence of military-related government employment (Naval Base Kitsap, Puget Sound Naval Shipyard), health care, retail trade and education. According to the Washington State Employment Security Department, the unemployment rate for Kitsap County was 3.3% in December 2021, compared to 6.3% for December of 2020. The median sales price of a residential home was $500,000 for December of 2021, an increase of 17.4% over December of 2020, according to the MLS. Residential sales volumes increased by 11.0% in 2021 compared to 2020 and inventory levels as of December 31, 2021 were at 0.4 months according to the MLS.

For a discussion regarding competition in our primary market area, see “- Competition” later in Item 1 of this report.

Lending Activities

General. We focus our lending activities primarily on loans secured by commercial real estate, construction/land, first mortgages on one-to-four family residences, multifamily, and business lending. We offer a variety of secured consumer loans,
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including savings account loans, auto loans and home equity loans that include lines of credit and second mortgage term loans. As of December 31, 2021, our net loan portfolio totaled $1.1 billion and represented 77.4% of our total assets.

Our current loan policy generally limits the maximum amount of loans we can make to one borrower to 15% of the Bank’s total capital and surplus, or $24.5 million at December 31, 2021. Exceptions to this policy are allowed only with the prior approval of the Board of Directors and if the borrower exhibits financial strength or sufficient, measurable compensating factors exist after consideration of the loan-to-value ratio, borrower’s financial condition, net worth, credit history, earnings capacity, debt service coverage, installment obligations, and current payment history. The regulatory limit of loans we can make to one borrower is 20% of total capital and surplus, or $32.7 million, at December 31, 2021. At this date, our single largest lending relationship, totaled $26.2 million.

Loan Maturity and Repricing. The following table sets forth certain information at December 31, 2021, regarding the amount of total loans in our portfolio based on their contractual terms to maturity, not including prepayments.
Within One YearAfter One Year Through Five YearsAfter Five Years Through Fifteen YearsBeyond Fifteen YearsTotal
 (In thousands)
Real estate:     
   One-to-four family residential$8,390 $6,976 $20,353 $349,397 $385,116 
   Multifamily5,975 36,176 66,544 21,451 130,146 
   Commercial36,778 141,954 228,466 12,219 419,417 
   Construction/land40,567 52,888 — — 93,455 
Total real estate91,710 237,994 315,363 383,067 1,028,134 
Business9,502 32,350 4,738 — 46,590 
Consumer2,307 42,496 44,812 
Total Loans$101,219 $272,651 $362,597 $383,069 $1,119,536 
    
    
    The following table sets forth the amount of total loans due after December 31, 2022, with fixed or adjustable interest rates.
 Fixed-RateAdjustable-RateTotal
 (In thousands)
Real estate:   
   One-to-four family residential$143,719 $233,007 $376,726 
   Multifamily38,682 85,489 124,171 
   Commercial163,215 219,424 382,639 
Construction/land39,041 13,847 52,888 
Total real estate384,657 551,767 936,424 
Business18,065 19,023 37,088 
Consumer36,249 8,556 44,805 
Total Loans$438,971 $579,346 $1,018,317 
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Geographic Distribution of our Loans. The following table shows the geographic distribution of our loan portfolio in dollar amounts and percentages at December 31, 2021.
Puget Sound Region (1)
Other Washington CountiesTotal in Washington State
All Other States (2)
Total
Amount% of Total in CategoryAmount% of Total in CategoryAmount% of Total in CategoryAmount% of Total in CategoryAmount% of Total in Category
Real estate:(Dollars in thousands)
One-to-four family
    residential
$365,044 94.8 %$15,908 4.1 %$380,952 98.9 %$4,164 1.1 %$385,116 100.0 %
Multifamily83,362 64.1 31,501 24.2 114,863 88.3 15,283 11.7 130,146 100.0 %
Commercial293,403 70.0 41,684 9.9 335,087 79.9 84,330 20.1 419,417 100.0 %
Construction/land93,455 100.0 — — 93,455 100.0 — — 93,455 100.0 %
Total real estate835,264 81.2 89,093 8.7 924,357 89.9 103,777 10.1 1,028,134 100.0 %
Business39,826 85.4 674 1.4 40,500 86.9 6,090 13.1 46,590 100.0 %
Consumer10,191 22.7 424 0.9 10,615 23.7 34,197 76.3 44,812 100.0 %
Total Loans$885,281 79.0 %$90,191 8.1 %$975,472 87.1 %$144,064 12.9 %$1,119,536 100.0 %
____________
(1) Includes King, Snohomish, Pierce and Kitsap counties.
(2) Includes loans in California, Oregon, Texas, Florida, Alabama, 38 other states and Washington, D.C.

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One-to-Four Family Residential Lending. As of December 31, 2021, $385.1 million, or 34.4% of our total loan portfolio consisted of loans secured by one-to-four family residences.

First Financial Northwest Bank is a traditional portfolio lender when it comes to financing residential home loans. In 2021, we originated $124.2 million and purchased $1.7 million in one-to-four family residential loans. At December 31, 2021, $185.3 million, or 48.1% of our one-to-four family residential portfolio consisted of owner occupied loans with the remaining $199.8 million, or 51.9% consisting of non-owner occupied loans. In addition, at December 31, 2021, $146.4 million, or 38.0% of our one-to-four family residential loan portfolio consisted of fixed-rate loans. Substantially all of our one-to-four family residential loans require monthly principal and interest payments.

Our fixed-rate, one-to-four family residential loans are generally originated with 15 to 30 year terms, although such loans typically remain outstanding for substantially shorter periods, particularly in the current low interest rate environment. We also originate hybrid loans with initial fixed-rate terms of five to ten years that convert to variable-rate which adjusts annually thereafter. In addition, substantially all of our one-to-four family residential loans contain due-on-sale clauses that allow us to declare the unpaid amount due and payable upon the sale of the property securing the loan. Typically, we enforce these due‑on‑sale clauses to the extent permitted by law and as a standard course of business. The average period of time a loan is outstanding is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates, and the interest rates payable on outstanding loans.

Our lending policy generally limits the maximum loan-to-value ratio on mortgage loans secured by one-to-four family residential properties to FDIC limits. Generally, our one-to-four family loans do not exceed 80% loan-to-value based on the lower of the purchase price or appraised value at the time of loan origination. Properties securing our one-to-four family residential loans are appraised by independent appraisers approved by us. We require the borrowers to obtain title insurance and if necessary, flood insurance. We generally do not require earthquake insurance due to competitive market factors.

Loans secured by rental properties represent potentially higher risk and, as a result, we adhere to more stringent underwriting guidelines. Of primary concern in non-owner occupied real estate lending is the consistency of rental income of the property. Payments on loans secured by rental properties depend primarily on the tenants’ continuing ability to pay rent to the property owner, the character of the borrower or, if the property owner is unable to find a tenant, the property owner’s ability to repay the loan without the benefit of a rental income stream. In addition, successful operation and management of non-owner occupied properties, including property maintenance standards, may affect repayment. As a result, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. We request that borrowers and loan guarantors, if any, provide annual financial statements, a budget factoring in a rental income cash flow analysis of the borrower as well as the net operating income of the property, information concerning the borrower’s expertise, credit history and profitability, and the value of the underlying property. These loans are generally secured by a first mortgage on the underlying collateral property along with an assignment of rents and leases. If the borrower has multiple rental property loans with us, the loans are typically not cross‑collateralized. At December 31, 2021, there were no one-to-four family loans in nonaccrual status.

Multifamily and Commercial Real Estate Lending. As of December 31, 2021, $130.1 million, or 11.6% of our total loan portfolio was secured by multifamily and $419.4 million, or 37.5% of our loan portfolio was secured by commercial real estate properties. Our commercial real estate loans are typically secured by retail shopping centers, office buildings, hotels or motels, mini-storage facilities, mobile home parks, warehouses, and nursing homes. Commercial real estate and multifamily loans are subject to similar underwriting standards and processes. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate.

Typically, multifamily and commercial real estate loans have higher balances, are more complex to evaluate and monitor, and involve a greater degree of risk than one-to-four-family residential loans. In an attempt to compensate for and mitigate this risk, these loans are generally priced at higher interest rates than one-to-four family residential loans and generally have a maximum loan-to-value ratio of 80% of the lesser of the appraised value or purchase price. We generally require loan guarantees by any parties with a property ownership interest of 20% or more. If the borrower is a corporation or partnership, we generally require personal guarantees from the principals based upon a review of their personal financial statements and individual credit reports.

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The following table presents a breakdown of our multifamily and commercial real estate loan portfolio at December 31, 2021, and 2020:
December 31, 2021December 31, 2020
Amount% of Total in PortfolioAmount% of Total in Portfolio
(Dollars in thousands)
Multifamily real estate:
Multifamily, general$130,146 100.0 %$125,328 91.7 %
Micro-unit apartments— — 11,366 8.3 
Total multifamily$130,146 100.0 %$136,694 100.0 %
Commercial real estate:
Retail$138,463 33.0 %$114,117 29.6 %
Office90,727 21.6 84,311 22.0 
Hotel / motel64,854 15.5 69,304 18.0 
Storage32,990 7.9 33,671 8.7 
Mobile home park20,636 4.9 28,094 7.3 
Warehouse17,724 4.2 17,484 4.5 
Nursing home12,713 3.0 12,868 3.3 
Other non-residential41,310 9.9 25,416 6.6 
Total non-residential$419,417 100.0 %$385,265 100.0 %

The average loan size in our multifamily and commercial real estate loan portfolios was $904,000 and $2.0 million, respectively, as of December 31, 2021. At this date, $46.8 million, or 35.9%, of our multifamily loans and $126.0 million, or 30.0%, of our commercial real estate loans were located outside of the Puget Sound Region. We currently target individual multifamily and commercial real estate loans between $1.0 million and $5.0 million. The largest multifamily loan as of December 31, 2021, was a 74-unit apartment complex with a net outstanding principal balance of $12.0 million located in King County, Washington, which was performing in accordance with its loan repayment terms at that date. As of December 31, 2021, the largest commercial real estate loan had a net outstanding balance of $15.5 million that was secured by a retail facility located in King County, Washington, which was performing in accordance with its loan repayment terms at that date.

The credit risk related to multifamily and commercial real estate loans is considered to be greater than the risk related to one-to-four family residential loans because the repayment of multifamily and commercial real estate loans typically is dependent on the income stream from the real estate securing the loan as collateral and the successful operation of the borrower’s business, that can be significantly affected by adverse conditions in the real estate markets or in the economy. For example, if the cash flow from the borrower’s project is reduced due to leases not being obtained or renewed, the borrower’s ability to repay the loan may be impaired. In addition, many of our multifamily and commercial real estate loans are not fully amortizing and contain large balloon payments upon maturity. These balloon payments generally require the borrower to either refinance or occasionally sell the underlying property in order to make the balloon payment.

If we foreclose on a multifamily or commercial real estate loan, our holding period for the collateral typically is longer than for one-to-four family residential mortgage loan foreclosures because there are fewer potential purchasers of the collateral. Our multifamily and commercial real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, if we make any errors in judgment in the collectability of our multifamily or commercial real estate loans, any resulting charge-offs may be larger on a per loan basis than those incurred in our one-to-four family residential or consumer loan portfolios. At December 31, 2021, there were no commercial real estate loans or multifamily loans on nonaccrual status. The $2.1 million multifamily loan on nonaccrual status at December 31, 2020, was paid off in 2021 and we did not incur a loss on this loan. There were no multifamily or commercial real estate loans past due 90 days or more and still accruing interest at December 31, 2021. In addition, there were no multifamily or commercial real estate loans charged-off during the years ended December 31, 2021, and 2020.

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Construction/Land Loans. We originate construction/land loans primarily to residential builders for the construction of single-family residences, condominiums, townhouses, multifamily properties and residential developments located in our market area. Land loans include land non-development loans for the purchase or refinance of unimproved land held for future residential development, improved residential lots held for speculative investment purposes or lines of credit secured by land, and land development loans. Construction/land loans to builders generally require the borrower to have an existing relationship with the Bank and a proven record of successful projects. At December 31, 2021, our total construction/land loans increased to $93.5 million, or 8.4% of our total loan portfolio, from $92.2 million, or 8.3% of our total loans, at December 31, 2020. The Company’s strategic plan projects slight growth in construction loan origination activity in 2022 in support of our loan growth. The Bank’s lending policy sets forth the guideline that the balance of our net acquisition, development, and construction loans and deferred fees and costs, not exceed 100% of the Bank’s total capital plus surplus. The Bank was in compliance with this policy at December 31, 2021, with a balance equal to 59.7% of the Bank’s total capital plus surplus. Management intends to maintain levels near below this guideline, however the uncertainty of the timing associated with construction loan draws occasionally results in the actual concentration exceeding the guideline. There were no construction/land loans classified as nonaccrual at either December 31, 2021 or 2020. There were no construction/land loan charge-offs during the years ended December 31, 2021, and 2020. At December 31, 2021, the loans in process (“LIP”) balance on construction/land loans was $43.3 million.

Following is the composition of our total construction/land loan portfolio, that are net of LIP, at the dates indicated. All of the loans represented were performing:
 December 31,
 20212020
 (In thousands)
Construction speculative:  
One-to-four family residential$34,677 $33,396 
Total construction speculative34,677 33,396 
Construction permanent: (1)
Multifamily37,194 51,215 
Commercial real estate6,189 5,783 
Total construction permanent43,383 56,998 
Land:
Land development2,485 — 
Land non-development12,910 1,813 
Total land15,395 1,813 
Total construction/land loans$93,455 $92,207 
_____________
(1) Includes loans where the builder does not intend to sell the property after the construction phase is completed.

    The following table includes construction/land loans by county at December 31, 2021:
CountyLoan BalancePercent of Construction/Land Loan Balance
 (Dollars in thousands)
King$90,373 96.7 %
Snohomish2,253 2.4 
Kitsap829 0.9 
Total$93,455 100.0 %

Loans to finance the construction of single-family homes, subdivisions and land loans are generally offered to builders in our primary market areas. Loans that are termed “speculative” are those where the builder does not have, at the time of loan origination, a signed contract with a buyer for the home or lot who has a commitment for permanent financing with either us or another lender. The buyer may be identified either during or after the construction period, with the risk that the builder may
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have to fund the debt service on the speculative loan along with real estate taxes and other carrying costs for the project for a significant period of time after completion of the project until a buyer is identified. The maximum loan-to-value ratio applicable to these loans is generally 100% of the actual cost of construction, provided that the loan-to-completed value does not exceed 80%, with approval required from the Chief Credit Officer (“CCO”) for loan-to-value ratios over 80%. In addition, a minimum of 20% verified equity is generally also required. Verified equity refers to cash equity invested in the project. Development plans are required from builders prior to committing to the loan. We require that builders maintain adequate title insurance and other appropriate insurance coverage, and, if applicable, appropriate environmental data report(s) that the land is free of hazardous or toxic waste. While maturity dates for residential construction loans are largely a function of the estimated construction period of the project and typically do not exceed one year, land loans generally are for 12 to 18 months. Substantially all of our residential construction loans have adjustable-rates of interest based on The Wall Street Journal prime rate. During the term of construction, the accumulated interest on the loan is either added to the principal of the loan through an interest reserve or billed monthly. At December 31, 2021, the LIP balance on construction/land loans included $4.4 million set aside for interest reserves. When these loans exhaust their original reserves set up at origination, no additional reserves are permitted unless the loan is re-analyzed and it is determined that the additional reserves are appropriate, based on the updated analysis. Construction loan proceeds are disbursed periodically as construction progresses and as inspections by our approved inspectors warrant. At December 31, 2021, our three largest construction/land loans consisted of multifamily construction/land loans of $14.4 million, $8.4 million, and $6.3 million. All three loans will rollover to a permanent loan upon completion of the construction period and all three properties are located in King County.

Certain of our residential construction loans to borrowers for one-to-four family, non-owner occupied residences are structured to be converted to fixed-rate permanent loans at the end of the construction phase with one closing for both the construction loan and the permanent financing. Prior to making a commitment to fund a construction loan, we require an appraisal of the post‑construction value of the project by an independent appraiser. During the construction phase, which may last 12 to 24 months, an approved inspector or designated Bank employee makes periodic inspections of the construction site to certify construction has reached the stated percentage of completion. Typically, disbursements are made in monthly draws and interest-only payments are required. At December 31, 2021, there were no loans requiring a rollover to a permanent loan with the Bank at the completion of the construction phase.

We also make construction loans for commercial development projects. The projects include multifamily, retail, office, warehouse, hotels and office buildings. These loans typically have an interest-only payment phase during construction and generally convert to permanent financing when construction is complete. Disbursement of funds is at our sole discretion and is based on the progress of construction. The Bank uses an independent third party or Bank employee to conduct monthly inspections to certify that construction has reached the stated percentage of completion and that previous disbursements are reflected in the degree of work performed to date. Generally, the maximum loan-to-value ratio applicable to these loans is 90% of the actual cost of construction or 80% of the prospective value at completion. At December 31, 2021, $37.2 million and $6.2 million of multifamily and commercial real estate construction loans, respectively, will rollover to permanent loans with the Bank at the end of their construction period.

Land development loans are generally made to builders for preparation of a building site and do not include the construction of buildings on the property. The maximum loan-to-value ratio for these loans is 75% based on the lower of the purchase price or appraised value at the time of loan origination. Land non-development loans are generally for raw land where we do not finance the cost of preparing the site for building and are subject to a maximum loan‑to‑value ratio of 65% based on the lower of the purchase price or appraised value at the time of loan origination.

Our construction/land loans are based upon estimates of costs in relation to values associated with the completed project. Construction/land lending involves additional risks when compared with permanent residential lending because funds are advanced upon the collateral for the project based on an estimate of costs that will produce a future value at completion. Because of the uncertainties inherent in estimating construction costs, time needed to complete the building phase, as well as the market value of the completed project and the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the completed project loan-to-value ratio. Changes in the demand for new housing, longer completion times due to supply chain issues, and higher than anticipated building costs may cause actual results to vary significantly from those estimated. For these reasons, this type of lending also typically involves higher loan principal amounts and is often concentrated with a small number of builders. These loans often involve the disbursement of funds with repayment substantially dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of a completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. Because construction loans require active monitoring of the building process, including cost comparisons and on-site
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inspections, these loans are more difficult and costly to monitor. Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly increasing the end-purchasers’ borrowing costs, thereby reducing the overall demand for the project. Properties under construction are often difficult to sell and typically must be completed in order to be successfully sold which also complicates the process of working out problem construction loans. This may require us to advance additional funds and/or contract with another builder to complete construction. Furthermore, in the case of speculative construction loans, there is the added risk associated with identifying an end-purchaser for the finished project. Land loans also pose additional risk because of the lack of income being produced by the property and the potential illiquid nature of the collateral. These risks can also be significantly influenced by supply and demand conditions.

Business Lending. Business loans (including PPP loans) totaled $46.6 million, or 4.1% of the loan portfolio at December 31, 2021. Conventional business loans (loans other than PPP loans) are generally secured by business equipment, accounts receivable, inventory or other property. Loan terms typically vary from one to five years. The interest rates on such loans are either fixed-rate or adjustable-rate. The interest rates for the adjustable‑rate loans are indexed to the prime rate published in The Wall Street Journal plus a margin. Our business lending policy includes credit file documentation and requires analysis of the borrower’s background, capacity to repay the loan, the adequacy of the borrower’s capital and collateral, as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower’s past, present and future cash flows is also an important aspect of our credit analysis. We generally obtain personal guarantees on our conventional business loans. The largest conventional business loan had an outstanding balance of $18.1 million at December 31, 2021 and was performing according to its repayment terms. At December 31, 2021, we did not have any business loans delinquent in excess of 90 days or in nonaccrual status.

As a result of the COVID-19 pandemic, the CARES Act was enacted and authorized the SBA to temporarily guarantee loans under a new loan program called the Paycheck Protection Program. The CAA, 2021, which was signed into law on December 27, 2020 renewed and extended the PPP until May 31, 2021, the final expiration date for PPP lending. Beginning in the second quarter of 2020, we began to offer PPP loans which are fully guaranteed by the SBA, to existing customers and those in the community who have not had a banking relationship with us in the past. The SBA guarantees 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower's PPP loan, including any accrued interest, is eligible to be forgiven and repaid by the SBA if the borrower meets the PPP conditions. The great majority of our SBA PPP loans have been forgiven by the SBA in accordance with the terms of the program. We earn 1% interest on PPP loans as well as a fee from the SBA to cover processing costs, which is amortized over the life of the loan and recognized fully at payoff or forgiveness. The maturity date of the SBA PPP loan is either two or five years from the date of loan origination. Under this program, as of December 31, 2021, there were 67 PPP loans outstanding totaling $10.8 million. As of December 31, 2021, a total of 661 PPP loans totaling $66.6 million had been approved for forgiveness. The Bank expects the majority of its remaining PPP borrowers will seek full or partial forgiveness of their loan obligations. For additional information regarding these loans, see Item 1A. Risk Factors- “Risks Related to Our Lending- Loans originated under the SBA Paycheck Protection Program subject us to credit, forgiveness and guarantee risk.” The Bank also originates loans under other SBA lending programs, which are partially guaranteed by the SBA. At December 31, 2021, the Bank’s portfolio included $839,000 of these SBA loans, of which $659,000 is guaranteed by the SBA. At that date, these SBA loans were not held for sale, however, the Company may elect to sell off the guaranteed portion of these loans in the future.

At December 31, 2021, the Bank’s aircraft loan portfolio had an outstanding balance of $6.1 million, or 13.0% of total business loans. These loans are collateralized by new or used, single‑engine piston aircraft to light jets for business or personal use. Our aircraft loans will generally range in size from $250,000 to $3.0 million with the primary focus of our underwriting guidelines on the asset value of the collateral rather than the ability of the borrower to repay the loan. The average loan size in our aircraft loan portfolio was $553,000 at December 31, 2021, and the largest loan was $2.2 million. For additional information regarding these loans, see Item 1A. Risk Factors- “Risks Related to Our Lending - We engage in aircraft and classic car financing transactions, in which high-value collateral is susceptible to potential catastrophic loss. If any of these transactions becomes nonperforming, we could suffer a loss on some or all of our value in the assets.”

Repayments of conventional business loans are often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value. Our business loans, other than aircraft and PPP loans, are originated primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any. As a result, in the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The collateral securing business loans may depreciate over time, may be difficult to appraise, or may fluctuate in value based on the success of the business.

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Consumer Lending. We offer a limited variety of consumer loans to our customers, consisting primarily of home equity loans and savings account loans. Generally, consumer loans have shorter terms to maturity and higher interest rates than one‑to‑four family residential loans. Consumer loans are offered with both fixed and adjustable interest rates and with varying terms. At December 31, 2021, consumer loans were $44.8 million, or 4.0% of the total loan portfolio.

At December 31, 2021, the largest component of the consumer loan portfolio consisted of purchased indirect consumer loans to finance classic and collectible cars with a balance of $35.9 million, or 80.0% of the total consumer loan portfolio. Due to the unique nature of these cars, the estimated value often does not align with listed values, therefore, approval of the loan is based on the borrower’s ability to repay. These fixed rate loans typically have maturity periods of three to fifteen years. The Bank intends to grow this portfolio of loans up to an internal limit of $50.0 million. Included in these loans are classic cars, defined as a vehicle in excess of 25 years old, and collectible cars, with a retail price in excess of $150,000. At December 31, 2021, our largest car loan was $755,000 and the average loan size was $80,000. For additional information regarding these loans see Item 1A. Risk Factors- “Risks Related to Our Lending - We engage in aircraft and classic or collectible car financing transactions, in which high-value collateral is susceptible to potential catastrophic loss. If any of these transactions becomes nonperforming, we could suffer a loss on some or all of our value in the assets.”

At December 31, 2021, home equity loans, primarily home equity lines of credit totaled $8.5 million, or 18.9% of the total consumer loan portfolio. The home equity lines of credit include $2.0 million of equity lines of credit in first lien position and $6.4 million of second liens on residential properties. At December 31, 2021, unfunded commitments on our home equity lines of credit totaled $15.0 million. Home equity loans are made for purposes such as the improvement of residential properties, debt consolidation and education expenses. At origination, the loan-to-value ratio is generally 90% or less, when taking into account both the balance of the home equity loans and the first mortgage loan. Home equity loans are originated on a fixed-rate or adjustable-rate basis. The interest rate for the adjustable-rate second lien loans is indexed to the prime rate published in The Wall Street Journal and may include a margin. Home equity loans generally have a 10 to 30 year term, with a 10 year draw period, and either convert to principal and interest payments with no further draws or require a balloon payment due at maturity.

Consumer loans entail greater risk than one-to-four family residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability and are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on these loans. Home equity lines of credit have greater credit risk than one-to-four family residential mortgage loans because they are generally secured by mortgages subordinated to the existing first mortgage on the property that we may or may not hold in our portfolio. We do not have private mortgage insurance coverage on these loans. Classic car loans have greater risk than other consumer loans primarily due to their high value which may fluctuate significantly. Adjustable-rate loans may experience a higher rate of default in a rising interest rate environment due to the increase in payment amounts when interest rates reset higher. If current economic conditions deteriorate for our borrowers and their home prices fall, we may also experience higher credit losses from this loan portfolio. For our home equity loans that are in a second lien position, it is unlikely that we will be successful in recovering our entire loan principal outstanding in the event of a default. At December 31, 2021, no consumer loans were in nonaccrual status. At that date, a $179,000 classic auto loan was delinquent between 30-59 days. During the year ended December 31, 2021, less than $1,000 of consumer loans were charged off. For the year ended December 31, 2020, a $2,000 unsecured line of credit was charged off.

    
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Loan Solicitation and Processing. Our consumer and residential mortgage loan originations are generated through the Bank and from time to time through outside brokers and correspondent relationships we have established with select mortgage companies or other financial institutions. We originate multifamily, commercial real estate, construction/land and business loans primarily using the Bank’s loan officers, with referrals coming from builders, brokers and existing customers.

Upon receipt of a loan application from a prospective borrower, we obtain a credit report and other data to verify specific information relating to the loan applicant’s employment, income, and credit standing. All real estate loans requiring an appraisal are done by our internal appraisal department or an independent third-party appraiser. All appraisers are approved by us, and their credentials are reviewed annually, as is the quality of their appraisals.

We use a multi-level approval matrix which establishes lending targets and tolerance levels depending on the loan type being approved. The matrix also sets minimum credit standards and approval limits for each of the loan types.

Lending Authority. The Directors’ Loan Committee consists of at least three members of the Board of Directors. The Directors’ Loan Committee recommends for approval by the Board of Directors exceptions to the aggregate loan limit to one borrower of 15% of total capital plus surplus, or $24.5 million at December 31, 2021. The Board of Directors approves exceptions to such aggregate loan limit to one borrower up to 20% of total capital plus surplus, or $32.7 million at December 31, 2021.
 
Officer Lending Authority. Individual signing authority has been delegated to two lending officers. Our Senior Credit Approval Officer (“SCAO”) has authority from the Board of Directors to approve loans and aggregate relationships up to and including $8.0 million. The Board of Directors has given our CCO authority to approve credit to one borrower not to exceed the legal lending limit of 20% of total capital plus surplus.

    Loan Originations, Servicing, Purchases, Sales and Repayments. For the years ended December 31, 2021, 2020, and 2019, our total loan originations and purchases were $363.0 million, $317.9 million, and $396.8 million, respectively.

    One-to-four family residential loans are generally originated in accordance with FDIC guidelines, with the exception of our special community development loans originated to satisfy compliance with the Community Reinvestment Act. Our loans are underwritten by designated real estate loan underwriters internally in accordance with standards as provided by our Board-approved loan policy. We require title insurance on all loans and fire and casualty insurance on all secured loans and home equity loans where real estate serves as collateral. Flood insurance is also required on all secured loans when the real estate is located in a flood zone.

























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The following table shows total loans originated, purchased, repaid and other changes during the years indicated.
 Year Ended December 31,
 202120202019
(In thousands)
Loan originations:  
Real estate:  
One-to-four family residential$124,220 $107,609 $91,811 
Multifamily20,976 27,873 39,967 
Commercial62,552 33,588 74,283 
Construction/land72,825 62,444 109,989 
Total real estate280,573 231,514 316,050 
Business (1)
26,029 59,001 10,031 
Consumer1,852 5,308 24,325 
Total loans originated308,454 295,823 350,406 
Loan purchases and participations:
One-to-four family residential1,665 1,467 653 
Multifamily251 — 28 
Commercial32,374 1,208 17,408 
Construction/land— — 8,727 
Business— — — 
Consumer20,290 19,390 19,553 
Total loan purchases and participations (2)
54,580 22,065 46,369 
Principal repayments(342,945)(352,460)(308,849)
Charge-offs— (2)— 
Loans transferred to other real estate owned (“OREO”)— — — 
Change in LIP(16,457)29,746 (3,117)
Change in net deferred fees, and ALLL(753)(3,052)749 
Net increase (decrease) in loans$2,879 2879000$(7,880)-7880000$85,558 
_______________
(1) Includes $25.6 million and $52.1 million in PPP loans originated during 2021 and 2020, respectively.
(2) Totals include $8.2 million, $0 and $8.4 million in loan participations during 2021, 2020 and 2019, respectively.

Loan Origination and Other Fees. In some instances, we receive loan origination fees on real estate-related products. Loan fees generally represent a percentage of the principal amount of the loan and are paid by the borrower. The amount of fees charged to the borrower on one-to-four family residential loans and multifamily and commercial real estate loans can range from 0% to 2%. In addition to the 1.0% interest earned on PPP loans, the SBA paid processing fees for PPP loans of either 1%, 3%, or 5%, based on the size of the loan. Banks were not authorized to collect any fees from the loan applicants. United States generally accepted accounting principles (“GAAP”) require that certain fees received, net of certain origination costs, be deferred and amortized over the contractual life of the loan. Net deferred fees or costs associated with loans that are prepaid or sold are recognized in income at the time of prepayment or sale. We had $418,000 and $1.7 million of net deferred loan fees at December 31, 2021, and 2020, respectively.

Loan purchases generally include a premium, which is deferred and amortized into interest income with net deferred fees over the contractual life of the loan. During 2021, total premiums of $1.6 million, or 3.4% of the purchased principal, were paid on purchased loans. In comparison, premiums of $790,000, or 3.6% of the purchased principal were paid on purchased loans during 2020.

One-to-four family residential and consumer loans are generally originated without a prepayment penalty. However, the majority of our one-to-four family residential loans held in the name of an entity, and multifamily and commercial real estate loans have prepayment penalties associated with the loans. Most of the multifamily and commercial real estate loan originations with interest rates fixed for the first five years will adjust thereafter and have a prepayment penalty of 2% to 3% of
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the principal balance in year one, with decreasing penalties in subsequent years. Longer initial fixed rate terms generally have correspondingly longer prepayment penalty periods.

Asset Quality

As of December 31, 2021, we had $255,000 of loans past due 30 days or more. These loans represented 0.02% of total loans receivable. We generally assess late fees or penalty charges on delinquent loans of up to 5.0% of the monthly payment. The borrower is given up to a 15 day grace period from the due date to make the loan payment.

The Company actively manages delinquent loans and non performing assets by aggressively pursuing the collection of debts and marketing saleable properties we foreclosed or repossessed, work-outs of classified assets and loan charge-offs. We handle collection procedures internally or with the assistance of outside legal counsel. Late charges are incurred when the loan exceeds 10 to 15 days past due depending upon the loan product. When a delinquent loan is identified, corrective action takes place immediately. The first course of action is to determine the cause of the delinquency and seek cooperation from the borrower in resolving the issue. Additional corrective action, if required, will vary depending on the borrower, the collateral, if any, and whether the loan requires specific handling procedures as required by the Washington State Deed of Trust Act. If the borrower is chronically delinquent and all reasonable means of obtaining payments have been exhausted, we will seek to foreclose on the collateral securing the loan according to the terms of the security instrument and applicable law.

Construction/land, commercial real estate, and multifamily loans generally have larger individual loan amounts that have a greater single impact on asset quality in the event of delinquency or default. During 2020, the CARES Act and regulatory agencies provided guidance around the modification of loans as a result of the COVID-19 pandemic and outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined by the CARES Act and related regulatory guidance prior to any relief are not troubled debt restructured loans (“TDRs”) through January 1, 2022. Loans subject to payment forbearance under the Bank's COVID-19 loan modification program were not reported as delinquent or as a TDR during the forbearance time period. As of December 31, 2021, there were no loans on active deferral, compared to $45.2 million, or 4.0% of total loans outstanding at December 31, 2020. All loans that had previously been granted modifications have returned to regular scheduled payments. We continue to monitor our loan portfolio and believe additions to nonperforming loans, charge-offs, provisions for loan losses, and/or OREO are possible in the future, particularly if the housing market and other economic conditions decline, including as a result of COVID-19.
            
        Nonperforming Loans. When a loan becomes 90 days past due, we generally place the loan on nonaccrual status unless the credit is well secured and in the process of collection. Loans may be placed on nonaccrual status prior to being 90 days past due if there is an identified problem such as an impending foreclosure or bankruptcy or if the borrower is unable to meet their scheduled payment obligations. At December 31, 2021, we had no nonaccrual loans, as the $2.1 million nonaccrual multifamily loan at December 31, 2020, paid off during 2021 with no loss incurred by the Bank.
    
    Other Real Estate Owned. Real estate acquired by us as a result of foreclosure or by deed-in-lieu of foreclosure is classified as OREO until it is sold. When the property is acquired, it is recorded at the lower of its cost or fair market value of the property, less selling costs. We had no OREO properties at December 31, 2021, as the $454,000 of OREO at December 31, 2020, was sold in 2021, resulting in a $207,000 loss on sale reported on the Company’s Consolidated Income Statement. Our special assets department’s primary focus is the prompt and effective management of our troubled, nonperforming assets, and expediting their disposition to minimize any potential losses. During 2021 and 2020, we did not foreclose or accept deeds-in-lieu of foreclosure on any loans. In the future, we may experience foreclosure, deed-in-lieu of foreclosure, and short sale activity while we work with our nonperforming loan customers to minimize our loss exposure.
 
    Because of our structure, we believe we are able to make decisions regarding offers on OREO and the real estate underlying our nonperforming loans very quickly compared to larger institutions where decisions could take six to twelve months. This distinction has historically worked to our benefit in reducing our nonperforming assets and disposing of OREO.

Troubled Debt Restructured Loans. We account for certain loan modifications or restructurings as TDRs. In general, the modification or restructuring of a debt is considered a TDR if, for economic or legal reasons related to the borrower’s financial difficulties, we grant a concession to the borrower that we would not otherwise consider. These loans are all considered to be impaired loans. At December 31, 2021, we had $2.1 million in TDRs as compared to $3.9 million at December 31, 2020.

The largest TDR relationship at December 31, 2021 was a $915,000 one-to-four family rental property located in Pierce County. At December 31, 2021, there was no LIP in connection with our TDRs.
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The following table summarizes our total TDRs:
 December 31,
 20212020
 (In thousands)
Performing TDRs:  
   One-to-four family residential$2,107 $2,627 
   Commercial real estate— 1,242 
Total performing TDRs2,107 3,869 
Total TDRs$2,107 $3,869 
 
Classified Assets. Federal regulations provide for the classification of lower quality loans and other assets as substandard, doubtful or loss. An asset is considered substandard if it is inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged. Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions and values. Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.

When we classify problem assets as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent. General allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities, but unlike specific allowances, have not been specifically allocated to particular problem assets. When an insured institution classifies problem assets as a loss, it is required to charge-off those assets in the period in which they are deemed uncollectible. Our determinations as to the classification of our assets and the amount of our valuation allowances are subject to review by the FDIC and the DFI that can order the establishment of additional loss allowances or the charge-off of specific loans against established loss reserves. Assets that do not currently expose us to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated as special mention. At December 31, 2021, special mention loans totaled $12.3 million including a $4.7 million office building and $6.4 million in loans to one borrower for two rehabilitation facilities that were all downgraded during 2021. The impact to these businesses from the COVID-19 pandemic is expected to be temporary. As vacancies are filled at the office building and patient volumes at the rehabilitation facilities return, we believe these businesses will stabilize. At December 31, 2021, these loans were current on their payments and were in compliance with their original loan terms.
 
In connection with the filing of periodic reports with the FDIC and in accordance with our loan policy, we regularly review the problem loans in our portfolio to determine whether any loans require classification in accordance with applicable regulations. The increase in our classified loans during the year ended December 31, 2021 was primarily the result of $34.0 million of commercial real estate loans downgraded to substandard, partially offset by the payoff of a $2.1 million multifamily loan that was on nonaccrual status at December 31, 2020. The downgrades included a $15.0 million hotel loan that was previously changed to impaired status when it was downgraded to special mention in December 2020. Continued reduced occupancy due to the COVID-19 pandemic warranted further downgrade to substandard in 2021. In addition, downgrades included an $8.4 million office building loan, and two loans to one borrower including a $6.6 million loan secured by a hostel business and a $4.0 million loan secured by a facility housing bowling, roller skating and restaurant operations. All substandard loans at December 31, 2021, were classified as impaired and evaluated for a specific allowance. The impairment analysis on these properties showed no anticipated loss on these loans.

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Classified loans consisting solely of substandard loans, were as follows at the dates indicated:
 December 31,
 20212020
 (In thousands)
One-to-four family residential$— $527 
Multifamily— 2,104 
Commercial real estate34,030 — 
Consumer179 — 
Total classified loans$34,209 $2,631 
 
Allowance for Loan Losses. Management recognizes that loan losses may occur over the life of a loan and that the ALLL must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Management reviews the adequacy of the ALLL on a quarterly basis. Our methodology for analyzing the ALLL consists of two components: general and specific allowances. The general allowance is determined by applying factors to our various groups of loans. Management considers factors such as charge-off history, policy and underwriting standards, the current and expected economic conditions, the nature and volume of the loan portfolio, management’s experience level, the level of problem loans, our loan review and grading systems, the value of underlying collateral, geographic and loan type concentrations, and other external factors such as competition, legal, and regulatory requirements in assessing the ALLL. Loans classified as substandard or placed on nonaccrual status are deemed to be collateral based loans. Specific allowances result when management performs an impairment analysis on a loan when management believes that all contractual amounts of principal and interest will not be paid as scheduled. Based on this impairment analysis, if the recorded investment in the loan is less than the market value of the collateral less costs to sell (“market value”), a specific reserve is established in the ALLL for the loan. The amount of the specific reserve is computed using current appraisals, listed sales prices, and other available information less costs to complete, if any, and costs to sell the property. This analysis is inherently subjective as it relies on estimates that are susceptible to significant revision as more information becomes available or as future events differ from predictions. Loans classified as a TDR due to the borrower being granted a rate concession are analyzed by discounted cash flow analysis. The amount of the specific reserve on these loans is calculated by comparing the present value of the anticipated repayments under the restructured terms to the recorded investment in the loan.

When determining the appropriate ALLL during 2021, management took into consideration the continued impact of the COVID-19 pandemic on such factors as the national and state unemployment rates and related trends, the expiration of previous financial assistance provided by the government, consumer spending levels and trends, industries significantly impacted by the COVID-19 pandemic, a review of the Bank's largest commercial loan relationships, and the Bank's COVID-19 loan modification program. See also “Allowance for Loan Losses” in Item 7. Critical Accounting Policies, and Item 8. Note 1 - Summary of Significant Accounting Policies later in this report.

Based on this review, management decreased historical loss factors and qualitative factors for certain loan categories during the year ended December 31, 2021, as the economic impact as a result of the COVD-19 pandemic was not as severe as previously expected. Management will continue to closely monitor economic conditions and will work with borrowers as necessary to assist them through this challenging economic climate. If economic conditions worsen, and if government programs do not provide adequate relief to borrowers, it is possible the Bank's ALLL will need to increase in future periods. Uncertainties relating to our ALLL are heightened as a result of the risks surrounding the COVID-19 pandemic as described in further detail in Item 1A. Risk Factors- “Risks Related to Macroeconomic Conditions-The COVID-19 pandemic has impacted the way we conduct business which may adversely impact our financial results and those of our customers. The ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.”
 
Quarterly, our Board of Directors’ Internal Asset Review Committee reviews and recommends approval of the allowance for loan losses and any provision or recapture of provision for loan losses, and the full Board of Directors approves the provision or recapture after considering the Committee’s recommendation. The ALLL is increased by the provision for loan losses which is charged against current period earnings. If the analysis of our loan portfolio indicates the risk of loss is less than the balance of the ALLL, a recapture of provision for loan losses is added to current period earnings.

For the year ended December 31, 2021, we recorded a $300,000 provision for loan losses, as compared to a $1.9 million provision for loan losses for the year ended December 31, 2020. The provision for loan losses in 2021 was
15




primarily a result of a $2.1 million increase in net loans receivable, and a change in composition of our loan portfolio as $30.4 million in repaid PPP loans omitted from our loan loss allowance analysis were replaced with other loans included in the analysis, which offset the decreased historical loss factors and qualitative factors for certain loan categories discussed above. At December 31, 2021, the $10.8 million remaining balance of PPP loans was omitted from the ALLL calculation as these loans are fully guaranteed by the SBA and management expects that the majority of remaining PPP borrowers will seek full or partial forgiveness of their loan obligations from the SBA within a short time frame, which will in turn reimburse the Bank for the amount forgiven. In addition, the provision for loan losses was impacted by the $14.7 million increase during 2021 in impaired loans evaluated for specific reserves and omitted from the general reserve calculation used to calculate the ALLL and provision for loan losses. As noted above, our individual evaluation of our impaired loans indicated no additional specific reserve was needed. This reduction to the general allowance was partially offset by the downgrade to special mention of $11.1 million in loans, as discussed above, resulting in a slight increase to our ALLL. The ALLL was $15.7 million, or 1.40% of total loans at December 31, 2021, as compared to $15.2 million, or 1.36% at December 31, 2020. The level of the ALLL is based on estimates and the ultimate losses may vary from the estimates. Management reviews the adequacy of the ALLL on a quarterly basis.
 
A loan is considered impaired when, based on current information and events, it is probable we will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, market conditions, rent rolls, and the borrower’s and guarantor’s, if any, financial strength. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and shortfalls on a case‑by‑case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower’s prior payment record and the amounts of the shortfall in relation to the principal and interest owed. Loans are evaluated for impairment on a loan-by-loan basis. As of December 31, 2021 and 2020, impaired loans were $36.1 million and $21.4 million, respectively. The increase in 2021 was primarily due to $19.0 million of the $34.0 million of commercial real estate loans downgraded to substandard in 2021. The $15.0 million hotel loan was classified as impaired prior to 2021. These increases were partially offset by the payoff in 2021 of the $2.1 million multifamily impaired loan on nonaccrual status at December 31, 2020. At December 31, 2021, these impaired loans were well collateralized and the Bank does not expect to incur losses on these loans.

The following table summarizes the distribution of the ALLL by loan category, at the dates indicated.
 December 31,
 202120202019
 Loan
Balance
Allowance
 by Loan Category
Percent of Loans
to Total Loans
Loan
Balance
Allowance
 by Loan Category
Percent of Loans
to Total Loans
Loan
Balance
Allowance
 by Loan Category
Percent of Loans
to Total Loans
Real estate:(Dollars in thousands)
  One-to-four
    family residential
$385,116 $3,214 34.4 %$381,960 $3,181 34.2 %$372,528 $3,034 33.2 %
  Multifamily130,146 1,279 11.6 136,694 1,366 12.2 172,915 1,607 15.4 
  Commercial real
     estate
419,417 6,615 37.5 385,265 6,127 34.5 395,152 4,559 35.2 
  Construction/land93,455 2,064 8.3 92,207 2,189 8.3 113,665 2,222 10.1 
Total real estate1,028,134 13,172 91.8 996,126 12,863 89.2 1,054,260 11,422 93.9 
Business46,590 1,112 4.2 80,663 1,242 7.2 37,779 1,140 3.4 
Consumer44,812 1,373 4.0 40,621 1,069 3.6 30,199 656 2.7 
Total$1,119,536 $15,657 100.0 %$1,117,410 $15,174 100.0 %$1,122,238 $13,218 100.0 %

Based on its comprehensive analysis, management believes that the ALLL as of December 31, 2021 was adequate to absorb the probable and inherent losses in the loan portfolio at that date. While we believe the estimates and assumptions used in our determination of the adequacy of the ALLL are reasonable, there can be no assurance that such estimates and assumptions will be proven correct in the future, or that the actual amount of future provisions will not exceed the amount of past provisions, or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. Future additions to the ALLL may become necessary based upon changing economic conditions, the level of problem loans, business conditions, credit concentrations, increased loan balances or changes in the underlying collateral of
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the loan portfolio. In addition, the determination of the amount of the ALLL is subject to review by bank regulators as part of the routine examination process that may result in the establishment of additional loss reserves or the charge-off of specific loans against established loss reserves based upon their judgment of information available to them at the time of their examination. A further decline in national and local economic conditions, as a result of the COVID-19 pandemic or other factors, could result in a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and results of operations.

The following table shows certain credit ratios at and for the periods indicated and each component of the ratio’s calculations.
 At or For the Year Ended December 31,
202120202019
 (Dollars in thousands)
ALLL as a percent of total loans1.40 %1.36 %1.18 %
ALLL at period end$15,657 $15,174 $13,218 
Total loans outstanding1,119,536 1,117,410 1,122,238 
Non-accrual loans as a percentage of total loans outstanding at period end— %0.19 %0.01 %
Total non-accrual loans$— $2,104 $95 
Total loans outstanding1,119,536 1,117,410 1,122,238 
ALLL as a percent of non-accrual loans at period endn/a721.20 %13,913.68 %
ALLL at period end$15,657 $15,174 $13,218 
Total non-accrual loans— 2,104 95 
Net recoveries during period to average loans outstanding:
One-to-four family residential:0.05%0.05%0.05%
Net recoveries during period$183 $28 $73 
Average loans receivable, net (1)
374,796 379,068 356,075 
Multifamily:— %— %— %
Net recoveries during period$— $— $45 
Average loans receivable, net (1)
139,298 83,825 166,672 
Commercial:— %0.01 %— %
Net recoveries during period$— $30 $— 
Average loans receivable, net (1)
382,341 383,807 377,120 
Construction/land development:— %— %— %
Net recoveries during period$— $— $— 
Average loans receivable, net (1)
97,494 167,445 106,856 
Business:— %— %— %
Net recoveries during period$— $— $— 
Average loans receivable, net (1)
63,263 68,118 34,244 
Consumer:— %(0.01)%0.26 %
Net recoveries during period$— $(2)$53 
Average loans receivable, net (1)
41,580 38,626 20,400 
Total loans:0.02 %— %0.02 %
Net recoveries during period$183 $56 $171 
Average loans receivable, net (1)
1,098,772 1,120,889 1,061,367 
_______________
(1) The average loans receivable, net balances, include nonaccruing loans and deferred fees.
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Investment Activities

General. Under Washington State law, commercial banks are permitted to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, banker’s acceptances, repurchase agreements, federal funds, commercial paper, investment grade corporate debt securities, and obligations of states and their political sub-divisions.

The Investment, Asset/Liability Committee (“ALCO”), consisting of the Chief Executive Officer, Chief Financial Officer, and Controller of First Financial Northwest Bank, other members of management and the Board of Directors, has the authority and responsibility to administer our investment policy, monitor portfolio strategies, and recommend appropriate changes to policy and strategies to the Board of Directors. On a monthly basis, management reports to the Board a summary of investment holdings with respective market values and all purchases and sales of investment securities. The Chief Financial Officer has the primary responsibility for the management of the investment portfolio and considers various factors when making decisions, including the marketability, maturity, liquidity, and tax consequences of proposed investments. The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.

The general objectives of the investment portfolio are to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low, and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk.

At December 31, 2021, our investment portfolio consisted principally of mortgage-backed securities, municipal bonds, U.S. government agency obligations, and corporate bonds. From time to time, investment levels may increase or decrease depending upon yields available on investment opportunities and management’s projected demand for funds for loan originations, net deposit flows, and other activities. At December 31, 2021, and 2020, the Bank held three annuity contracts, totaling $2.4 million, as held-to-maturity investments. These annuity contracts were purchased to satisfy the benefit obligation associated with certain supplemental executive retirement plan agreements. At December 31, 2019, there were no investments held to maturity.

Mortgage-Backed Securities. The mortgage-backed securities in our portfolio were primarily comprised of Fannie Mae, Freddie Mac, and Ginnie Mae issued mortgage-backed securities. These issuers guarantee the timely payment of principal and interest in the event of default. In addition, at December 31, 2021, our mortgage-backed securities included $11.3 million of other “private label” mortgage-backed securities. The mortgage-backed securities portfolio had a weighted-average yield of 1.73% at December 31, 2021.

U.S. Government Agency Obligations. The agency securities in our portfolio were comprised of Fannie Mae, Freddie Mac, Ginnie Mae, SBA and FHLB agency securities. These issuers guarantee the timely payment of principal and interest in the event of default. At December 31, 2021, the portfolio of government agency securities had a weighted-average yield of 1.00%.

The guarantees of the SBA, as a U.S. government agency and Ginnie Mae, as part of a U.S. government agency are backed by the full faith and credit of the United States. Fannie Mae, Freddie Mac, and the Federal Home Loan Banks are U.S. government-sponsored entities. Although their guarantees are not backed by the full faith and credit of the United States, they may borrow from the U.S. Treasury, which has taken other steps to ensure these U.S. government-sponsored entities can fulfill their financial obligations.

    Corporate Bonds. The corporate bond portfolio is comprised of both fixed and variable rate securities issued by various financial institutions. At December 31, 2021, the corporate bond portfolio had a weighted-average yield of 3.78%.

Municipal Bonds. The municipal bond portfolio is comprised of taxable and tax-exempt municipal bonds. The pre-tax weighted-average yield on the municipal bond portfolio was 2.06% at December 31, 2021.

    Federal Home Loan Bank Stock. As a member of the FHLB Des Moines, we are required to own capital stock. The required amount of capital stock is based on a percentage of our previous year-end assets and our outstanding FHLB advances. The redemption of any excess stock we hold is at the discretion of the FHLB Des Moines. During 2021, our FHLB of Des Moines stock holdings decreased by $945,000, primarily as a result of the $25.0 million decrease in our FHLB advances during
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2021. The carrying value of our FHLB of Des Moines stock totaled $5.5 million at December 31, 2021. During the years ended December 31, 2021 and 2020, we received FHLB of Des Moines cash dividends of $332,000 and $320,000, respectively.
    
During the year ended December 31, 2021, gross proceeds from the call, maturity and sale of investments was $20.0 million, with net realized gains of $32,000.

Management reviews investment securities on an ongoing basis for the presence of other than temporary impairment (“OTTI”) or permanent impairment, taking into consideration current market conditions, fair value in relationship to cost, extent and nature of the change in fair value, issuer rating changes and trends, whether management intends to sell a security or if it is likely that we will be required to sell the security before recovery of the amortized cost basis of the investment, which may be maturity, and other factors. For debt securities, if management intends to sell the security or it is likely that we will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If management does not intend to sell the security and it is not likely that we will be required to sell the security, but management does not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate, depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (loss). Impairment losses related to all other factors are presented as separate categories within other comprehensive income (loss). There were no losses related to OTTI at December 31, 2021 and 2020. For additional information regarding our investments, see Note 2 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.

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The table below sets forth information regarding the carrying value and weighted-average yield by contractual maturity of our investment portfolio at December 31, 2021. Mortgage-backed securities are presented in the totals column as a result of the variable nature of their principal reductions. The weighted average yields were calculated by multiplying each carrying value by its yield and dividing the sum of these results by the total carrying values. Yields on tax-exempt investments are not calculated on a fully tax equivalent basis.
 December 31, 2021
 Within One YearAfter One Year
Through Five Years
After Five
Through Ten Years
ThereafterTotals
Carrying
Value
Weighted-
Average
Yield
Carrying
Value
Weighted-
Average
Yield
Carrying
Value
Weighted-
Average
Yield
Carrying
Value
Weighted-
Average
Yield
Carrying
Value
Weighted-
Average
Yield
 (Dollars in thousands)
Available-for-sale:
Mortgage-backed securities$— — %$— — %$— — %$— — %$60,753 1.73 %
Municipal bonds— — — — 3,862 2.21 32,604 2.05 36,466 2.06 
U.S. government agencies404 2.62 50 5.77 2,169 1.09 38,811 0.97 41,434 1.00 
Corporate bonds— — 8,542 4.29 21,753 3.58 — — 30,295 3.78 
Total available-for-sale$404 2.62 %$8,592 4.30 %$27,784 3.21 %$71,415 1.44 %$168,948 1.99 %


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Deposit Activities and Other Sources of Funds

General. Deposits and loan repayments are the major sources of our funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions. Borrowings from the FHLB are used to supplement the availability of funds from other sources and also as a source of term funds to assist in the management of interest rate risk.

Our deposit composition reflects a mixture of various deposit products. We rely on marketing activities, customer service, and the availability of a broad range of products and services to attract and retain customer deposits.

Deposits. We offer a competitive range of deposit products within our market area, including noninterest bearing accounts, interest-bearing demand accounts, money market accounts, statement savings accounts, and certificates of deposit. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit, and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the development of long-term profitable customer relationships, current market interest rates, current maturity structures, deposit mix, preferences of our customers, and the profitability of acquiring customer deposits compared to alternative funding sources. As part of our strategy to shift our deposit mix to lower cost funds, we continued to better align our pricing with competitors in our local market to meet our goals. To supplement local deposits, funds are also generated as needed through national brokered certificates of deposit. The Bank had no brokered certificates of deposits at both December 31, 2021 and 2020, as compared to $94.5 million at December 31, 2019. Continued growth in retail deposits with our expanded branch network allowed the Bank to reduce brokered deposits upon maturity as a source of funds. In the future, the Bank may utilize brokered deposits again to supplement our retail deposits and assist in our interest rate risk management efforts.

The following table sets forth our total deposit activity for the years indicated.
Year Ended December 31,
202120202019
(In thousands)
Total deposits, beginning balance$1,093,633$1,033,534$939,032
Increase in retail deposits63,841154,57197,855
Decrease in brokered funds(94,472)(3,353)
Net increase in deposits63,84160,09994,502
Total deposits, ending balance$1,157,474$1,093,633$1,033,534

At December 31, 2021, deposits totaled $1.2 billion. We had $637.1 million of deposit accounts greater than the FDIC insurance amount of $250,000, or 55.0% of our total deposits. Of this amount, $75.9 million were retail certificates of deposit. At December 31, 2020, $543.0 million, or 49.7%, of deposit accounts were greater than $250,000. At December 31, 2021, we held $60.6 million in public funds, of which $42.8 million exceeded $250,000. Under Washington State law, in order to participate in the public funds program, we are required to pledge eligible securities of a minimum of 50% of the public deposits in excess of $250,000.
















21




The following table sets forth information regarding our certificates of deposit and other deposits at December 31, 2021. Certificates of deposit are categorized by their original term.
Weighted-Average Interest RateProduct TermCategoryAmountPercentage
of Total
Deposits
(Dollars in thousands)
— %N/ANoninterest bearing demand deposits$117,751 10.2 %
0.08 N/AInterest-bearing demand97,907 8.5 
0.03 N/ASavings23,146 2.0 
0.25 N/AMoney market624,543 54.0 
  Certificates of deposit, retail
0.34 Three months or less 256 — 
— Over three through six months 60 — 
0.18 Over six through twelve months 55,768 4.8 
1.50 Over twelve months 238,043 20.5 
1.25  Total certificates of deposit, retail294,127 25.3 
Total deposits$1,157,474 100.0 %

Certificates of Deposit. The following table sets forth the amount and remaining maturities of certificates of deposit at December 31, 2021.
Within
One Year
After One Year Through Two YearsAfter Two Years Through Three YearsAfter Three Years Through Four YearsThereafterTotal
 (In thousands)
0.00 - 1.00%$95,905 $44,911 $26,632 $6,163 $2,765 $176,376 
1.01 - 2.00%12,335 4,456 3,109 1,364 — 21,264 
2.01 - 3.00%29,361 16,436 11,712 — — 57,509 
3.01 - 4.00%7,736 30,184 1,058 — — 38,978 
Total$145,337 $95,987 $42,511 $7,527 $2,765 $294,127 

The following table provides the uninsured portion by account of our certificates of deposit at December 31, 2021, by their remaining maturity period.
Maturity PeriodCertificates of Deposit
 (In thousands)
Three months or less$5,176 
Over three months through six months9,749 
Over six months through twelve months23,003 
Over twelve months37,956 
Total$75,884 


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Deposits by Type. The following table sets forth the deposit balances by the types of accounts we offered at the dates indicated.
 December 31,
 202120202019
AmountPercent of TotalAmountPercent of TotalAmountPercent of Total
(Dollars in thousands)
Noninterest bearing$117,751 10.2 %$91,285 8.3 %$52,849 5.1 %
Interest-bearing demand97,907 8.5 108,182 9.9 65,897 6.4 
Savings23,146 2.0 19,221 1.8 17,447 1.7 
Money market624,543 54.0 465,369 42.5 377,766 36.6 
Certificates of deposit, retail:
0.00 - 1.00%176,376 15.2 93,570 8.6 7,400 0.7 
1.01 - 2.00%21,264 1.8 86,145 7.9 131,252 12.7 
2.01 - 3.00%57,509 4.9 180,733 16.5 230,405 22.3 
3.01 - 4.00%38,978 3.4 49,128 4.5 56,046 5.4 
Total certificates of deposit, retail294,127 25.3 409,576 37.5 425,103 41.1 
Certificates of deposit, brokered
0.00 - 1.00%— — — — — — 
1.01 - 2.00%— — — — 70,510 6.8 
2.01 - 3.00%— — — — 23,962 2.3 
Total certificates of deposit, brokered— — — — 94,472 9.1 
Total deposits$1,157,474 100.0 %$1,093,633 100.0 %$1,033,534 100.0 %

Borrowings. Customer deposits are the primary source of funds for our lending and investment activities. We use advances from the FHLB and to a lesser extent federal funds (“Fed Funds”) purchased to supplement our supply of lendable funds, to meet short-term deposit withdrawal requirements and to provide longer term funding to assist in the management of our interest rate risk by matching the duration of selected loan and investment maturities.

As a member of the FHLB, we are required to own capital stock in the FHLB and are authorized to apply for advances on the security of that stock and certain of our mortgage loans, provided that certain creditworthiness standards have been met. Advances are individually made under various terms pursuant to several different credit programs, each with its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. We maintain a credit facility with the FHLB that provides for immediately available advances, subject to acceptable collateral. At December 31, 2021, our remaining FHLB credit capacity was $553.1 million and outstanding advances from the FHLB totaled $95.0 million. In addition, at December 31, 2021, we had supplemental funding sources of $84.8 million available at the FRB and $75.0 million available between two correspondent financial institutions.

Other than our utilization of interest rate swaps, we do not currently participate in other hedging programs, stand-alone contracts for interest rate caps or floors or other activities involving the use of off-balance sheet derivative financial instruments, however, these options are evaluated on occasion. As of December 31, 2021, we had seven interest rate swaps with an aggregate notional amount of $95.0 million and a fair value gain of $1.5 million as compared to six interest rate swaps with an aggregate notional amount of $120.0 million and a fair value loss of $2.9 million at December 31, 2020. In October 2021, a $50.0 million interest rate swap agreement matured and was partially replaced with two interest rate swap agreements with an aggregate notional of $25.0 million that were included in the fair value loss reported at December 31, 2020. For additional information, see Item 1A. Risk Factors -“Risks Related to Market and Interest Rate Changes - If the interest rate swaps we entered into prove ineffective, it could result in volatility in our operating results, including potential loses, which could have a material adverse effect on our results of operations and cash flows,” Item 7. “Management’s Discussion and Analysis of
23




Financial Condition and Results of Operations - Asset and Liability Management,” and Note 11 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.

Subsidiaries and Other Activities

First Financial Northwest, Inc. First Financial Northwest has two wholly-owned subsidiaries, First Financial Northwest Bank and First Financial Diversified Corporation. First Financial Diversified previously held a small portfolio of loans. Subsequent to these loans paying off in 2019, the company has had minimal activity.

First Financial Northwest Bank. First Financial Northwest Bank is a community-based commercial bank. The Bank primarily serves the greater Puget Sound region of King and to a lesser extent, Pierce, Snohomish and Kitsap Counties, Washington through our full-service banking office in Renton, Washington and fourteen additional branches in King, Pierce and Snohomish Counties, Washington. We are in the business of attracting deposits from the public and utilizing those deposits to originate loans.

Competition

    The Bank operates in the highly competitive Puget Sound region of Western Washington. We face competition in originating loans and attracting deposits within our geographic market area. The competitive environment is impacted by changes in the regulatory environment, technology and product delivery systems as well as consolidation in the industry creating larger, more diversified competitors. We compete by consistently delivering high-quality personal service to our customers that results in a high level of customer satisfaction.

The Bank attracts deposits primarily through its branch office system. The competition is primarily from commercial banks, savings institutions and credit unions in the same geographic area. Based on the most current FDIC market share data dated June 30, 2021, the top five banks in the Seattle-Tacoma-Bellevue metropolitan statistical area (comprised of Bank of America, JP Morgan Chase, Wells Fargo, US Bancorp and KeyBank) controlled 72% of the deposit market. In addition to the FDIC insured competitors, credit unions, insurance companies and brokerage firms also compete for consumer deposit relationships. The Bank’s share of aggregate deposits in the market area is less than 1%.

Our competition for loans comes principally from commercial banks, mortgage brokers, thrift institutions, credit unions and finance companies. Several other financial institutions compete with us for banking business in our market area. These institutions have substantially more resources than the Bank and, as a result, are able to offer a broader range of services, such as trust departments and enhanced retail services. Among the advantages of some of these institutions are their ability to make larger loans, initiate extensive advertising campaigns, access lower cost funding sources, and allocate their investable assets in regions of highest yield and demand. The challenges posed by such large competitors may impact our ability to originate loans secure low cost deposits, and establish product pricing levels that support our net interest margin goals that may limit our future growth and earnings potential.

Human Capital

First Financial Northwest Bank continually strives to recruit the most talented, motivated employees in their respective fields. By providing opportunities for personal and professional growth coupled with an environment that values teamwork and work-life balance, we are able to attract and retain outstanding individuals. We pride ourselves on providing excellent benefits, competitive salaries and the opportunity for participation in the company's long-term success.

Workforce. At December 31, 2021, we had 144 full-time employees. Our employees are not represented by any collective bargaining group. First Financial Northwest Bank is committed to providing equality of opportunity in all aspects of employment through a comprehensive affirmative action plan that is updated annually. As of December 31, 2021, our workforce was 59.7% female and 40.3% male, and women held 55.4% of the Bank’s management roles. The average tenure of mid-level officers and managers is 4.7 years and the average tenure of executive / senior level officers is 8.7 years. The ethnicity of our workforce was 57.6% White, 24.3% Asian, 3.5% Black, 0.7% Native Hawaiian or Other Pacific Islander, 0.7% Two or More Races, and 13.2% undisclosed.

The following chart depicts the percentage of self-identified females and minorities in our workforce at December 31, 2021, by job classification as defined by the Equal Employment Opportunity Commission (“EEOC”):

24


Job ClassificationFemale
Minority (1)
Distribution by EEOC Job Classification
Executive / Senior level officers38.5%25.0%9.0%
Mid-level officers and managers59.631.336.1
Professionals46.437.519.4
Sales workers57.166.74.9
Technicians33.32.1
Administrative support80.531.328.5
Total59.7%33.6%100.0%
__________
(1) Includes employees self-disclosed as Asian, Black, Native Hawaiian or Other Pacific Islander, or Two or More Races.

Benefits. The Company provides competitive comprehensive benefits to employees. The Company values the health and well-being of its employees and strives to provide programs to support this. Benefit programs available to eligible employees may include 401(k) savings plan, employee stock ownership plan, health and life insurance, employee assistance program, paid holidays, paid time off, and other leave as applicable.

Board of directors. The Company’s board of directors is comprised of the Company’s Chief Executive Officer and Chief Financial Officer and six non-employee directors. The non-employee directors are represented by 50% female and 17% minority.

Response to COVID-19 pandemic. As an essential business, the Company responded quickly to implement procedures to assist employees in navigating the challenging impact from the pandemic, as well as protect the safety of both employees and customers. The Company has transitioned to a hybrid remote work model where eligible positions may arrange with their manager to work partially or fully remote. Safety measures implemented early in the COVID-19 pandemic continue to be followed to protect employees working on site, which included installation of protective partitions and fully equipping locations with personal safety supplies. Employees who experienced a reduction in hours due to reduced branch operating hours continued to receive their full pay. Additional sick time was authorized for employees impacted directly by the COVID-19 virus. The Company will continue to follow any Washington state mandates and make adjustments to support employees and prioritize employee safety.

Training and education. The Company recognizes that the skills and knowledge of its employees are critical to the success of the organization, and promotes training and continuing education as an ongoing function for employees. The Bank’s compliance training program provides annual training courses to assure that all employees and officers know the rules applicable to their jobs.

How We Are Regulated

The following is a brief description of certain laws and regulations that are applicable to First Financial Northwest and First Financial Northwest Bank. On March 31, 2015, First Financial Northwest converted from a registered savings and loan holding company to a bank holding company. As a bank holding company, First Financial Northwest is subject to examination and supervision by, and is required to file certain reports with the FRB. First Financial Northwest also is subject to the rules and regulations of the SEC under the federal securities laws. First Financial Northwest Bank, which changed its charter from a Washington-chartered savings bank to a Washington-chartered commercial bank effective on February 11, 2016, is subject to regulation and oversight by the DFI, the applicable provisions of Washington law and by the regulations of the DFI adopted thereunder. First Financial Northwest Bank also is subject to regulation and examination by the FDIC, which insures its deposits to the maximum extent permitted by law.

The laws and regulations governing us may be amended from time to time by the relevant legislative bodies and regulators. Any such legislative action or regulatory changes in the future could adversely affect us. We cannot predict whether any such changes may occur.


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Regulation and Supervision of First Financial Northwest Bank

General. As a state-chartered commercial bank, First Financial Northwest Bank is subject to applicable provisions of Washington state law and regulations of the DFI in addition to federal law and regulations of the FDIC applicable to state banks that are not members of the Federal Reserve System. State law and regulations govern First Financial Northwest Bank’s ability to take deposits and pay interest, to make loans on or invest in residential and other real estate, to make consumer loans, to invest in securities, to offer various banking services to its customers and to establish branch offices. Under state law, commercial banks in Washington also generally have all of the powers that federal commercial banks have under federal laws and regulations. First Financial Northwest Bank is subject to periodic examination by and reporting requirements of the DFI.

Insurance of Accounts and Regulation by the FDIC. First Financial Northwest Bank’s deposits are insured up to $250,000 per separately insured deposit ownership right or category by the Deposit Insurance Fund (“DIF”) of the FDIC. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions.

    The FDIC assesses deposit insurance premiums quarterly on each FDIC-insured institution applied to its deposit base, which is its average consolidated total assets minus its Tier 1 capital. No institution may pay a dividend if it is in default on its federal deposit insurance assessment. Total base assessment rates currently range from 3 to 30 basis points subject to certain adjustments. The FDIC has authority to increase insurance assessments, and any significant increases may have an adverse effect on the operating expenses and results of operations of the Company. Management cannot predict what assessment rates will be in the future. In a banking industry emergency, the FDIC may also impose a special assessment. The Bank paid $476,000 in FDIC assessments for the year ending December 31, 2021.

As insurer, the FDIC is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. The FDIC also may prohibit any insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the DIF. The FDIC also has the authority to take enforcement actions against banks and savings associations. Management is not aware of any existing circumstances which would result in termination of the Bank's deposit insurance.

Standards for Safety and Soundness. Each federal banking agency, including the FDIC, has adopted guidelines establishing general standards relating to internal controls, information and internal audit systems; loan documentation; credit underwriting; interest rate risk exposure; asset growth; asset quality; earnings; and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director, or principal shareholder. If the FDIC determines that an institution fails to meet any of these guidelines, it may require an institution to submit to the FDIC an acceptable plan to achieve compliance. Management of the Bank is not aware of any conditions relating to these safety and soundness standards which would require submission of a plan of compliance.

Capital Requirements. Federally insured financial institutions, such as First Financial Northwest Bank, and their holding companies, are required to maintain a minimum level of regulatory capital.

First Financial Northwest Bank is subject to capital regulations adopted by the FDIC, which establish minimum required ratios for a common equity Tier 1 (“CET1”) capital to risk-based assets ratio, a Tier 1 capital to risk-based assets ratio, a total capital to risk-based assets ratio and a Tier 1 capital to total assets leverage ratio. The capital standards require the maintenance of the following minimum capital ratios: (i) a CET1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. Consolidated regulatory capital requirements identical to those applicable to subsidiary banks generally apply to bank holding companies. However, the Federal Reserve has provided a “Small Bank Holding Company” exception to its consolidated capital requirements, and bank holding companies with less than $3.0 billion of consolidated assets are not subject to the consolidated holding company capital requirements unless otherwise directed by the Federal Reserve.

The Economic Growth, Regulatory Relief and Consumer Protection Act (“EGRRCPA”), enacted in May 2018, required the federal banking agencies, including the FDIC, to establish for institutions with assets of less than $10 billion a “community bank leverage ratio” or “CBLR” of between 8 to 10%. Institutions with capital meeting or exceeding the ratio and otherwise complying with the specified requirements (including off-balance sheet exposures of 25% or less of total assets and trading assets and liabilities of 5% or less of total assets) and electing the alternative framework are considered to comply with
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the applicable regulatory capital requirements, including the risk-based requirements. The CBLR was established at 9% Tier 1 capital to total average assets, effective January 1, 2020. A qualifying institution may opt in and out of the community bank leverage ratio framework on its quarterly call report. An institution that temporarily ceases to meet any qualifying criteria is provided with a two-quarter grace period to again achieve compliance. Failure to meet the qualifying criteria within the grace period or maintain a leverage ratio of 8% or greater requires the institution to comply with the generally applicable capital requirements. Although the Bank qualified to make this election, as of December 31, 2021, management has not elected to use the CBLR as the Bank’s margin above the current minimum levels to be well-capitalized is greater than our margin would be under the CBLR.

In addition to the minimum CET1, Tier 1, and total capital ratios, the capital regulations require a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses.
 
To be considered “well capitalized,” a depository institution must have a Tier 1 risk-based capital ratio of at least 8%, a total risk-based capital ratio of at least 10%, a CET1 capital ratio of at least 6.5% and a leverage ratio of at least 5%, and not be subject to an individualized order, directive or agreement under which its primary federal banking regulator requires it to maintain a specific capital level. As of December 31, 2021, First Financial Northwest Bank met the requirements to be “well capitalized” and met the fully phased-in capital conservation buffer requirement.
        
    The table below sets forth First Financial Northwest Bank’s capital position at December 31, 2021 and 2020, based on FDIC thresholds to be well-capitalized.
 December 31,
 20212020
 AmountRatioAmountRatio
 (Dollars in thousands)
Bank equity capital under GAAP$149,563 $140,114 
Tier 1 leverage capital$147,816 10.34 %$140,319 10.29 %
Tier 1 leverage capital requirement71,489 5.00 68,189 5.00 
Excess$76,327 5.34 %$72,130 5.29 %
Common equity tier 1$147,816 14.23 %$140,319 14.32 %
Common equity tier 1 capital requirement 67,536 6.50 63,705 6.50 
Excess$80,280 7.73 %$76,614 7.82 %
Tier 1 risk-based capital$147,816 14.23 %$140,319 14.32 %
Tier 1 risk-based capital requirement83,121 8.00 78,406 8.00 
Excess$64,695 6.23 %$61,913 6.32 %
Total risk-based capital$160,840 15.48 %$152,610 15.57 %
Total risk-based capital requirement103,901 10.00 98,008 10.00 
Excess$56,939 5.48 %$54,602 5.57 %

    The FDIC also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of particular risks or circumstances.

    For a complete description of First Financial Northwest Bank’s required and actual capital levels on December 31, 2021, see Note 14 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.

The Financial Accounting Standards Board has adopted a new accounting standard for GAAP that will be effective for us for our first fiscal year beginning after December 15, 2022. This standard, referred to as Current Expected Credit Loss, or CECL, requires FDIC-insured institutions and their holding companies (banking organizations) to recognize credit losses
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expected over the life of certain financial assets. CECL covers a broader range of assets than the current method of recognizing credit losses and generally results in earlier recognition of credit losses. Upon adoption of CECL, a banking organization must record a one-time adjustment to its credit loss allowances as of the beginning of the fiscal year of adoption equal to the difference, if any, between the amount of credit loss allowances under the current methodology and the amount required under CECL. For a banking organization, implementation of CECL is generally likely to reduce retained earnings, and to affect other items, in a manner that reduces its regulatory capital.

The federal banking regulators (the Federal Reserve, the Office of the Comptroller of the Currency and the FDIC) have adopted a rule that gives a banking organization the option to phase in over a three-year period the day-one adverse effects of CECL on its regulatory capital.

Prompt Corrective Action. Federal statutes establish a supervisory framework for FDIC-insured institutions based on five capital categories:  well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution’s category depends upon where its capital levels are in relation to relevant capital measures. The well-capitalized category is described above. An institution that is not well capitalized is subject to certain restrictions on brokered deposits, including restrictions on the rates it can offer on its deposits, generally. To be considered adequately capitalized, an institution must have the minimum capital ratios described above. Any institution which is neither well capitalized nor adequately capitalized is considered undercapitalized. The previously referenced final rule establishing an elective “community bank leverage ratio” regulatory capital framework provides that a qualifying institution whose capital exceeds the community bank leverage ratio and opts to use that framework will be considered “well capitalized” for purposes of prompt corrective action.

Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by First Financial Northwest Bank to comply with applicable capital requirements would, if unremedied, result in progressively more severe restrictions on its activities and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels and, ultimately, the appointment of the FDIC as receiver or conservator. Banking regulators will take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for their review may be dependent on compliance with capital requirements.

At December 31, 2021, First Financial Northwest Bank was categorized as “well capitalized” under the prompt corrective action regulations of the FDIC. For additional information, see Note 14 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.

    Federal Home Loan Bank System. First Financial Northwest Bank is a member of the FHLB of Des Moines, one of 11 regional FHLBs that administer the home financing credit function of savings institutions. The FHLBs are subject to the oversight of the Federal Housing Finance Agency (“FHFA”) and each FHLB serves as a reserve or central bank for its members within its assigned region. The FHLBs are funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System and make loans or advances to members in accordance with policies and procedures established by the Board of Directors of the FHLB, which are subject to the oversight of the FHFA. All advances from the FHLB of Des Moines are required to be fully secured by sufficient collateral as determined by the FHLB of Des Moines. In addition, all long-term advances are required to provide funds for residential home financing. See “Business – Deposit Activities and Other Sources of Funds – Borrowings.”

    As a member, the Bank is required to purchase and maintain stock in the FHLB of Des Moines based on the Bank's asset size and level of borrowings from the FHLB. At December 31, 2021, the Bank held $5.5 million in FHLB of Des Moines stock that was in compliance with the holding requirements. The FHLB pays dividends quarterly, and First Financial Northwest Bank received $332,000 in dividends during the year ended December 31, 2021.

    The FHLBs continue to contribute to low- and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have adversely affected the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB of Des Moines stock in the future. A reduction in value of First Financial Northwest Bank’s FHLB of Des Moines stock may result in a decrease in net income and possibly capital.

Commercial Real Estate Lending Concentrations. The federal banking agencies have issued guidance on sound risk management practices for concentrations in commercial real estate lending. The particular focus is on exposure to commercial
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real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be sensitive to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is not to limit a bank’s commercial real estate lending but to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance directs the FDIC and other federal bank regulatory agencies to focus their supervisory resources on institutions that may have significant commercial real estate loan concentration risk. A bank that has experienced rapid growth in commercial real estate lending, has notable exposure to a specific type of commercial real estate loan, or is approaching or exceeding the following supervisory criteria may be identified for further supervisory analysis with respect to real estate concentration risk:

Total reported loans for construction, land development and other land represent 100% or more of the bank’s total regulatory capital; or

Total commercial real estate loans (as defined in the guidance) represent 300% or more of the bank’s total regulatory capital and the outstanding balance of the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months.

The guidance provides that the strength of an institution’s lending and risk management practices with respect to such concentrations will be taken into account in supervisory guidance on evaluation of capital adequacy. As of December 31, 2021, First Financial Northwest Bank’s aggregate recorded loan balances for construction, land development and land loans were 59.7% of regulatory capital. In addition, at December 31, 2021, First Financial Northwest Bank’s loans on commercial real estate, as defined by the FDIC, were 384.0% of regulatory capital.

Activities and Investments of Insured State-Chartered Financial Institutions. Federal law generally limits the activities and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. An insured state bank is not prohibited from, among other things, (1) acquiring or retaining a majority interest in a subsidiary, (2) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank’s total assets, (3) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors’, trustees’ and officers’ liability insurance coverage or bankers’ blanket bond group insurance coverage for insured depository institutions and (4) acquiring or retaining the voting shares of a depository institution owned by another FDIC-insured institution if certain requirements are met.

Under the law of Washington State, Washington chartered savings banks may exercise any of the powers of Washington-chartered commercial banks, national banks and federally-chartered savings banks, subject to the approval of the Director of the DFI in certain situations. In addition, Washington state-chartered commercial and savings banks may charge the maximum interest rate allowable for loans and other extensions of credit by federally-chartered financial institutions to Washington residents.

Environmental Issues Associated With Real Estate Lending. The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) is a federal statute that generally imposes strict liability on all prior and present “owners and operators” of sites containing hazardous waste. However, Congress acted to protect secured creditors by providing that the term “owner and operator” excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this “secured creditor exemption” has been the subject of judicial interpretations that have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan. To the extent that legal uncertainty exists in this area, all creditors, including First Financial Northwest Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs that often are substantial and can exceed the value of the collateral property.

Federal Reserve System. The Federal Reserve requires all depository institutions to maintain reserves at specified levels against their transaction accounts, primarily checking accounts. In response to the COVID-19 pandemic, the Federal Reserve reduced reserve requirement ratios to zero percent effective on March 26, 2020, to support lending to households and businesses. At December 31, 2021, the Bank was in compliance with the reserve requirements in place at that time.

Affiliate Transactions. First Financial Northwest and First Financial Northwest Bank are separate and distinct legal entities. First Financial Northwest (and any non-bank subsidiary of First Financial Northwest) is an affiliate of First Financial Northwest Bank. Federal laws strictly limit the ability of banks to engage in certain transactions with their affiliates. Transactions deemed to be a “covered transaction” under Section 23A of the Federal Reserve Act and between a bank and an affiliate are limited to 10% of the bank’s capital plus surplus and, with respect to all affiliates, to an aggregate of 20% of the
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bank’s capital plus surplus. Further, covered transactions that are loans and extensions of credit generally are required to be secured by eligible collateral in specified amounts. Federal law also requires that covered transactions and certain other transactions listed in Section 23B of the Federal Reserve Act between a bank and its affiliates be on terms as favorable to the bank as transactions with nonaffiliates. For additional information, see “– Regulation and Supervision of First Financial Northwest – Limitations on Transactions with Affiliates” below.

In addition, Sections 22(g) and (h) of the Federal Reserve Act place restrictions on loans to executive officers, directors and principal shareholders. Under Section 22(h), loans to a director, executive officer or greater than 10% shareholder of a bank and certain affiliated interests, generally may not exceed, together with all other outstanding loans to such person and affiliated interests, 15% of the institution’s unimpaired capital plus surplus. Section 22(h) also requires that loans to directors, executive officers and principal shareholders be made on terms substantially the same as offered in comparable transactions to other persons unless the loans are made pursuant to a benefit or compensation program that (1) is widely available to employees of the institution and (2) does not give preference to any director, executive officer or principal shareholder, or certain affiliated interests, over other employees of the bank. Section 22(h) also requires prior board approval for certain loans. In addition, the aggregate amount of extensions of credit by a bank to all insiders cannot exceed the bank’s unimpaired capital plus surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers. At December 31, 2021, First Financial Northwest Bank was in compliance with these restrictions.

Community Reinvestment Act. First Financial Northwest Bank is subject to the provisions of the Community Reinvestment Act of 1977 (“CRA”), which require the appropriate federal bank regulatory agency to assess a bank’s performance under the CRA in meeting the credit needs of the community serviced by the bank, including low and moderate income neighborhoods. The regulatory agency’s assessment of the bank’s record is made available to the public. Further, a bank’s CRA performance must be considered in connection with a bank’s application, to among other things, establish a new branch office that will accept deposits, relocate an existing office or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. An unsatisfactory rating may be the basis for denial of certain applications. First Financial Northwest Bank received an “outstanding” rating during its most recent CRA examination.

Dividends. The amount of dividends payable by First Financial Northwest Bank to First Financial Northwest depends upon First Financial Northwest Bank’s earnings and capital position, and is limited by federal and state laws, regulations and policies. According to Washington law, First Financial Northwest Bank may not declare or pay a cash dividend on its capital stock if it would cause its net worth to be reduced below (1) the amount required for liquidation accounts or (2) the net worth requirements, if any, imposed by the Director of the DFI. In addition, dividends may not be declared or paid if First Financial Northwest Bank is in default in payment of any assessments due to the FDIC. Dividends on First Financial Northwest Bank’s capital stock may not be paid in an aggregate amount greater than the aggregate retained earnings of First Financial Northwest Bank, without the approval of the Director of the DFI. Dividends payable by the Bank can be limited or prohibited if the Bank does not meet the capital conservation buffer requirement.

The amount of dividends actually paid during any one period is affected by First Financial Northwest Bank’s policy of maintaining a strong capital position. Federal law further restricts dividends payable by an institution that does not meet the capital conservation buffer requirement and provides that no insured depository institution may pay a cash dividend if it would cause the institution to be “undercapitalized,” as defined in the prompt corrective action regulations. Moreover, the federal bank regulatory agencies also have the general authority to limit the dividends paid by insured banks if such payments are deemed to constitute an unsafe and unsound practice.

Privacy Standards and Cybersecurity. The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 modernized the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. Federal banking agencies, including the FDIC, have adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards under the supervision of the board of directors. These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third parties in the provision of financial services. These regulations require First Financial Northwest Bank to disclose its privacy policy, including informing consumers of its information sharing practices and informing consumers of their rights to opt out of certain practices. In addition, other federal and state cybersecurity and data privacy laws and regulations may expose First Financial Northwest Bank to risk and result in certain risk management costs. In addition, on November 18, 2021, the federal banking agencies announced the adoption of a final rule providing for new notification requirements for banking organizations and their service providers for significant cybersecurity incidents. Specifically, the new rule requires a banking organization to notify its primary federal regulator as soon as possible, and no later than 36 hours after, the banking organization determines that a
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“computer-security incident” rising to the level of a “notification incident” has occurred. Notification is required for incidents that have materially affected or are reasonably likely to materially affect the viability of a banking organization’s operations, its ability to deliver banking products and services, or the stability of the financial sector. Service providers are required under the rule to notify affected banking organization customers as soon as possible when the provider determines that it has experienced a computer-security incident that has materially affected or is reasonably likely to materially affect the banking organization’s customers for four or more hours. Compliance with the new rule is required by May 1, 2022. Non-compliance with federal or similar state privacy and cybersecurity laws and regulations could lead to substantial regulatory imposed fines and penalties, damages from private causes of action and/or reputational harm.

    Anti-Money Laundering and Customer Identification.  The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act) was signed into law on October 26, 2001. The USA PATRIOT Act and the Bank Secrecy Act requires financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts, and, effective in 2018, the beneficial owners of accounts. Bank regulators are directed to consider a holding company’s effectiveness in combating money laundering when ruling on Bank Holding Company Act and Bank Merger Act applications.

Other Consumer Protection Laws and Regulations. The Dodd-Frank Act established the Consumer Financial Protection Bureau (“CFPB”) and empowered it to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws. First Financial Northwest Bank is subject to consumer protection regulations issued by the CFPB, but as a financial institution with assets of less than $10 billion, First Financial Northwest Bank is generally subject to supervision and enforcement by the FDIC with respect to its compliance with federal consumer financial protection laws and CFPB regulations.

First Financial Northwest Bank is subject to a broad array of federal and state consumer protection laws and regulations that govern almost every aspect of its business relationships with consumers. While not exhaustive, these laws and regulations include the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Right to Financial Privacy Act, the Home Ownership and Equity Protection Act, the Consumer Leasing Act, the Fair Credit Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st Century Act, laws governing flood insurance, laws governing consumer protections in connection with the sale of insurance, federal and state laws prohibiting unfair and deceptive business practices and various regulations that implement some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans and providing other services. Failure to comply with these laws and regulations can subject First Financial Northwest Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil liability, criminal penalties, punitive damages and the loss of certain contractual rights.

Regulation and Supervision of First Financial Northwest

General. First Financial Northwest, as sole shareholder of First Financial Northwest Bank, is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to comprehensive regulation by the Federal Reserve under the Bank Holding Company Act of 1956, as amended (“BHCA”), and the regulations of the FRB. Accordingly, First Financial Northwest is required to file semi-annual reports with the Federal Reserve and provide additional information as the Federal Reserve may require. The Federal Reserve may examine First Financial Northwest, and any of its subsidiaries, and charge First Financial Northwest for the cost of the examination. The Federal Reserve also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. First Financial Northwest is also required to file certain reports with, and otherwise comply with the rules and regulations of the SEC.

The Bank Holding Company Act.  Under the BHCA, First Financial Northwest is supervised by the Federal Reserve. The Federal Reserve has a policy that a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary bank and may not conduct its operations in an unsafe or unsound manner. In addition, the Dodd-Frank Act and earlier Federal Reserve policy provide that a bank holding company should serve as a source of strength to its subsidiary bank by having the ability to provide financial assistance to its subsidiary bank during periods of financial distress
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to the bank. A bank holding company’s failure to meet its obligation to serve as a source of strength to its subsidiary bank will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve’s regulations or both. No regulations have yet been proposed by the Federal Reserve to implement the source of strength provisions required by the Dodd-Frank Act. First Financial Northwest and any subsidiaries that it may control are considered “affiliates” within the meaning of the Federal Reserve Act, and transactions between First Financial Northwest Bank and affiliates are subject to numerous restrictions. With some exceptions, First Financial Northwest and its subsidiaries are prohibited from tying the provision of various services, such as extensions of credit, to other services offered by First Financial Northwest or by its affiliates.

Acquisitions.  The BHCA prohibits a bank holding company, with certain exceptions, from acquiring ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. Under the BHCA, the Federal Reserve may approve the ownership of shares by a bank holding company in any company, the activities of which the Federal Reserve has determined to be so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto. These activities include:  operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers’ checks and U.S. Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers. The Federal Reserve must approve the acquisition (or acquisition of control) of a bank or other FDIC-insured depository institution by a bank holding company, and the appropriate federal banking regulator must approve a bank’s acquisition (or acquisition of control) of another bank or other FDIC-insured institution.

Acquisition of Control of a Bank Holding Company. Under federal law, a notice or application must be submitted to the appropriate federal banking regulator if any person (including a company), or group acting in concert, seeks to acquire “control” of a bank holding company. An acquisition of control can occur upon the acquisition of 10% or more of the voting stock of a bank holding company or as otherwise defined by federal regulations. In considering such a notice or application, the Federal Reserve takes into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that acquires control becomes subject to regulation as a bank holding company. Depending on circumstances, a notice or application may be required to be filed with appropriate state banking regulators and may be subject to their approval or non-objection.

Regulatory Capital Requirements. As discussed above, pursuant to the “Small Bank Holding Company” exception, effective August 30, 2018, bank holding companies with less than $3 billion in consolidated assets were generally no longer subject to the Federal Reserve’s capital regulations, which are generally the same as the capital regulations applicable to First Financial Northwest Bank. At the time of this change, First Financial Northwest was considered “well capitalized” (as defined for a bank holding company), with a total risk-based capital ratio of 10.0% or more and a Tier 1 risk-based capital ratio of 8.0% or more, and was not subject to an individualized order, directive or agreement under which the Federal Reserve requires it to maintain a specific capital level.

Restrictions on Dividends. The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies which expresses its view that a bank holding company must maintain an adequate capital position and generally should not pay cash dividends unless the company’s net income for the past year is sufficient to fully fund the cash dividends and that the prospective rate of earnings appears consistent with the company’s capital needs, asset quality, and overall financial condition.  The Federal Reserve policy statement also indicates that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Under Washington corporate law, First Financial Northwest generally may not pay dividends if after that payment it would not be able to pay its liabilities as they become due in the usual course of business, or its total assets would be less than its total liabilities. The capital conservation buffer requirement can also limit dividends. For additional information, see Item 1.A. “Risk Factors – Risks Related to Regulatory and Compliance Matters-Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions” in this report.

Stock Repurchases.  A bank holding company, except for certain “well-capitalized” and highly rated bank holding companies, is required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding twelve months, is equal to 10% or more of its consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order or any condition imposed by, or written
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agreement with, the Federal Reserve. During the year ended December 31, 2021, First Financial Northwest repurchased 704,950 shares of its common stock.

Federal Securities Laws. First Financial Northwest’s common stock is registered with the SEC u