10-K 1 fnwb-123118x10k.htm FORM 10-K Document
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2018
or
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _____ to _____

Commission File Number: 001-36741
FIRST NORTHWEST BANCORP
(Exact name of registrant as specified in its charter)
Washington
 
46-1259100
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer I.D. Number)
 
 
 
105 West 8th Street, Port Angeles, Washington
 
98362
(Address of principal executive offices)
 
(Zip Code)
 
 
 
Registrant's telephone number, including area code:
 
(360) 457-0461
 
 
 
Common Stock, par value $0.01 per share
 
The Nasdaq Stock Market LLC
(Title of 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 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

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
[x]
Non-accelerated filer
[ ]
Smaller reporting company
[ ]
 
 
 
 
 
 
Emerging growth company
[x]

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. [x]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes [ ] No [x]

At March 5, 2019, the registrant had 11,040,981 shares of common stock issued and outstanding. The aggregate market value of the voting stock held by non-affiliates of the registrant based on the closing price of such stock as quoted on The Nasdaq Stock Market, LLC as of June 30, 2018, was $177,347,297. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)

DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the registrant's Proxy Statement for the 2019 Annual Meeting of Shareholders are incorporated by reference into Part III.



FIRST NORTHWEST BANCORP
2018 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Forward-Looking Statements
Available Information
 
General
Market Area
Lending Activities
Asset Quality
Investment Activities
Deposit Activities and Other Sources of Funds
Subsidiary and Other Activities
Competition
Employees
How We Are Regulated
Taxation
Item 1B. Unresolved Staff Comments
 
General
Our Business and Operating Strategy
Critical Accounting Policies
New Accounting Pronouncements
Comparison of Financial Condition at December 31, 2018 and December 31, 2017
Comparison of Results of Operations for the Year Ended December 31, 2018 and Twelve Month Period Ended December 31, 2017
Comparison of Financial Condition at December 31, 2017 and June 30, 2017
Comparison of Results of Operations for the Six Months Ended December 31, 2017 and December 31, 2016
Average Balances, Interest and Average Yields/Cost
Rate/Volume Analysis
Asset and Liability Management and Market Risk
Liquidity Management
Off-Balance Sheet Activities
Contractual Obligations
Commitments and Off-Balance Sheet Arrangements

(Table of Contents continued on following page)

2


Capital Resources
Effect of Inflation and Changing Prices
Recent Accounting Pronouncements
 
Item 14. Principal Accounting Fees and Services
 
Item 16. Form 10-K Summary

As used in this report, the terms, “we,” “our,” and “us,” and “Company” refer to First Northwest Bancorp and its consolidated subsidiary, unless the context indicates otherwise. When we refer to “First Federal” or the “Bank” in this report, we are referring to First Federal Savings and Loan Association of Port Angeles, the wholly owned subsidiary of First Northwest Bancorp.



3


Forward-Looking Statements
Certain matters in this Form 10-K, including information included or incorporated by reference, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by the use of words such as “believes,” “expects,” “anticipates,” “estimates,” or similar expressions. Forward-looking statements include, but are not limited to:
statements of our goals, intentions and expectations;
statements regarding our business plans, prospects, growth and operating strategies;
statements regarding the quality of our loan and investment portfolios; and
estimates of our risks and future costs and benefits.
These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:
changes in general economic conditions, either nationally or in our market area, or the market areas where the collateral for our loans is located, that are worse than expected;
the credit risks of our lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;
fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market area;
a decrease in the secondary market demand for loans that we originate for sale;
management's assumptions in determining the adequacy of the allowance for loan losses;
our ability to control operating costs and expenses;
whether our management team can implement our operational strategy including but not limited to our loan growth;
our ability to successfully execute on merger and/or acquisition strategies and integrate any newly acquired assets, liabilities, customers, systems, and management personnel 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 successfully execute on growth strategies related to the home lending center and new branches;
staffing needs and associated expenses in response to product demand or the implementation of corporate strategies;
increases in premiums for deposit insurance;
the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;
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;
increased competitive pressures among financial services companies;
our ability to attract and retain deposits;
our ability to retain key members of our senior management team;
changes in consumer spending, borrowing and savings habits;

4


our ability to successfully manage our growth in compliance with regulatory requirements;
results of examinations of us by the Washington State Department of Financial Institutions, Department of Banks, the Federal Deposit Insurance Corporation, Federal Reserve Bank of San Francisco, or other regulatory authorities, which could result in restrictions that may adversely affect our liquidity and earnings;
legislative or regulatory changes that adversely affect our business;
adverse changes in the securities markets;
changes in accounting policies and practices, as may be adopted by the financial institutions regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board;
costs and effects of litigation, including settlements and judgments;
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;
inability of key third-party vendors to perform their obligations to us; and
other economic, competitive, governmental, regulatory and technical factors affecting our operations, pricing, products and services and other risks described elsewhere in our filings with the Securities and Exchange Commission, including this Form 10-K.
Any of these developments could have a material adverse impact on our financial position and our results of operations.
Any of the forward-looking statements that we make in this report and in other public statements we make may turn out to be wrong because of inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Any forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur, and you should not put undue reliance on any forward-looking statements.

Available Information
The Company provides an Investor Relations link on its website (www.ourfirstfed.com) to the Securities and Exchange Commission’s (“SEC”) website (www.sec.gov) for purposes of providing copies of its annual report to shareholders, Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and press releases. Other than an investor’s own Internet access charges, these filings are available free of charge and can also be obtained by calling the SEC at 1-800-SEC-0330. The information contained on the Company’s website is not included as part of, or incorporated by reference into, this Annual Report on Form 10-K.


5


PART I

Item 1. Business
General

First Northwest Bancorp ("First Northwest" or the "Company"), a Washington corporation formed on August 14, 2012, is the bank holding company for First Federal Savings and Loan Association of Port Angeles ("First Federal" or the "Bank").
    
At December 31, 2018, the Company had total assets of $1.3 billion, net loans of $863.9 million, total deposits of $940.3 million, and total shareholders' equity of $172.3 million. The Company's business activities are generally limited to passive investment activities and oversight of its investment in First Federal. Accordingly, the information set forth in this report, including consolidated financial statements and related data, relates primarily to First Federal.

First Northwest is a bank holding company subject to regulation by the Board of Governors of the Federal Reserve System (“Federal Reserve”). First Federal is examined and regulated by the Washington State Department of Financial Institutions, Division of Banks (“DFI”) and by the Federal Deposit Insurance Corporation (“FDIC”). First Federal is required to have certain reserves set by the Federal Reserve and is a member of the Federal Home Loan Bank of Des Moines (“FHLB” or “FHLB of Des Moines”), which is one of the eleven regional banks in the Federal Home Loan Bank System (“FHLB System”).

First Federal is a community-oriented financial institution serving Western Washington with offices in Clallam, Jefferson, Kitsap, King, and Whatcom counties. Our thirteen banking locations include ten full-service banking offices, two banking locations primarily serving our customers through the use of Interactive Teller Machines ("ITM"), and a Home Lending Center ("HLC"), which is focused on the origination of loans secured by one- to four-family residential properties.

We offer a wide range of products and services focused on the lending and depository needs of the communities we serve. Lending activities include the origination of first lien one- to four-family mortgage loans, commercial and multi-family real estate loans, construction and land loans (including lot loans), commercial business loans, and consumer loans, consisting primarily of home equity loans and lines of credit as well as automobile loans. Over the last five years we have significantly increased the origination of higher-yielding commercial real estate, multi-family real estate, and construction loans and more recently have increased our auto loan portfolio through our indirect lending and auto loan purchase programs. We offer traditional consumer and business deposit products, including transaction accounts, savings and money market accounts and certificates of deposit for individuals and businesses. Deposits are our primary source of funds for our lending and investing activities.

The executive office of the Company is located at 105 West 8th Street, Port Angeles, Washington 98362, and its telephone number is (360) 457-0461.

On July 25, 2017, the Board of Directors of First Northwest amended, in accordance with the Company’s Bylaws, the Company’s fiscal year to begin on January 1 and end on December 31 of each year. As a result of the change, this Form 10-K includes information for the six-month transition period from July 1, 2017 to December 31, 2017, and also contains unaudited information for the twelve-month period from January 1 to December 31, 2017, which compares more accurately to the 2018 presentation.

Market Area

We operate out of thirteen banking locations throughout western Washington. We have two banking locations, primarily serviced by an ITM, and five branch offices in Clallam County. We also have one branch office in Jefferson County, two branch offices in Kitsap County, two branch offices in Whatcom County, and our HLC is located in Seattle, in King County.

Clallam County has a population of approximately 75,474 and estimated median family income of $48,002 according to the latest information available from the U.S. Census Bureau. The economic base in Clallam County is dependent on government, healthcare, education, tourism, marine services, forest products, agriculture, and

6


technology industries. The primary employers in Clallam County include the Olympic Medical Center, Peninsula College, the Port Angeles School District, Clallam County government, Jamestown S'Klallam Tribe, Clallam Bay Corrections Center, and the Westport Shipyard. According to the U.S. Bureau of Labor Statistics, the unemployment rate for Clallam County was 6.9% at December 31, 2018, compared to 7.0% at December 31, 2017. The State of Washington average was 4.3%, and the national average was 3.9% at December 31, 2018. The average sales price of a residential home in Clallam County was $321,819 for the quarter ended December 31, 2018, a 7.4% increase compared to the quarter ended December 31, 2017, according to Paragon Olympic Listing Service. Residential sales volume decreased 2.6% for the quarter ended December 31, 2018 as compared to the quarter ended December 31, 2017, and inventory levels at December 31, 2018 were projected to be two months according to Paragon.

Jefferson County has a population of approximately 31,234 and estimated median family income of $51,842 according to the latest information available from the U.S. Census Bureau. The economic base in Jefferson County is dependent on government, healthcare, education, tourism, arts and culture, maritime and boat building, and small-scale manufacturing. The primary employers in Jefferson County include Port Townsend Paper, Jefferson Healthcare, Port Townsend School District, the Port Authority of Port Townsend and related marine trade, and the Jefferson County government. According to the U.S. Bureau of Labor Statistics, the unemployment rate for Jefferson County was 5.9% at December 31, 2018, compared to 6.2% at December 31, 2017. The average sales price of a residential home in Jefferson County was $417,604 for the quarter ended December 31, 2018, less than a 1.0% increase when compared to the quarter ended December 31, 2017, according to Northwest Multiple Listing Service (NMLS). Residential sales volume decreased 17.4% for the quarter ended December 31, 2018 as compared to the quarter ended December 31, 2017, and inventory levels at December 31, 2018 were projected to be two months according to NMLS.

Kitsap County has a population of approximately 266,414 and estimated median family income of $68,336 according to the latest information available from the U.S. Census Bureau. The economic base of Kitsap County is largely supported by the United States Navy through personnel stationed at Kitsap Naval Base along with other employers supporting the military. Private industries that support the economic base are healthcare, retail and tourism. Other primary employers in Kitsap County include the Department of Defense, Harrison Medical Center, Walmart, and Port Madison Enterprises, which owns and operates the Clearwater Casino and Resort, gas stations and other retail operations. According to the U.S. Bureau of Labor Statistics, the unemployment rate for Kitsap County was 4.9% at December 31, 2018, compared to 5.0% at December 31, 2017. The average sales price of a residential home in Kitsap County was $423,328 for the quarter ended December 31, 2018, a less than 1.0% increase when compared to the quarter ended December 31, 2017, according to NMLS. Residential sales volume decreased 13.6% for the quarter ended December 31, 2018 as compared to the quarter ended December 31, 2017, and inventory levels at December 31, 2018 were projected to be one month according to NMLS.

Whatcom County has a population of approximately 221,404 and estimated median family income of $56,419 according to the latest information available from the U.S. Census Bureau. The economic base of Whatcom County is largely supported by healthcare, education and crude oil refinery industries. There is some niche manufacturing and a large variety of other small businesses that create a well-rounded economy with a close proximity to the Canadian border bringing in shoppers seeking retail products and services. The primary employers in Whatcom County include PeaceHealth Medical Center, Western Washington University, Bellingham School District, and BP Cherry Point Refinery. According to the U.S. Bureau of Labor Statistics, the unemployment rate for Whatcom County was 5.0% at December 31, 2018, compared to 5.0% at December 31, 2017. The average sales price of a residential home in Whatcom County was $395,840 for the quarter ended December 31, 2018, an 8.0% increase compared to the quarter ended December 31, 2017, according to NMLS. Residential sales volume decreased 15.1% for the quarter ended December 31, 2018 as compared to the quarter ended December 31, 2017, and inventory levels at December 31, 2018 were projected to be two months according to NMLS.

King County has a population of approximately 2.2 million and estimated median family income of $83,571, according to the latest information available from the U.S. Census Bureau. The economic base of King County is largely supported by technology, services, and manufacturing industries. The primary employers in King County include Microsoft, Amazon, Boeing, Starbucks, and the King County government. According to the U.S. Bureau of Labor Statistics, the unemployment rate for King County was 3.3% at December 31, 2018, compared to 3.6% at December 31, 2017. The average sales price of a residential home in King County was $721,439 for the quarter ended December 31, 2018, a 5.3% increase compared to the quarter ended December 31, 2017, according to NMLS. Residential sales volume decreased 16.1% for the quarter ended December 31, 2018 as compared to the quarter ended December 31, 2017, and inventory levels at December 31, 2018 were projected to be two months according to NMLS.


7


Our business plan includes the intent to extend our operations throughout the Puget Sound Region. This region dominates the economy of the Pacific Northwest and is broadly defined as the area surrounding the inlet of the Pacific Ocean that extends into the northwestern section of the state of Washington. The population of this additional region (beyond our current market area) is approximately 2.2 million, or 29.7% of the state's population. The market area is a mix of urban, suburban and rural areas, with the Seattle metropolitan area harboring a well-developed urban area along the eastern portion of Puget Sound. The region extends from Whatcom County in the north on the Canadian border to Thurston and Pierce counties to the south. Other key metropolitan areas within the Puget Sound region include Bellingham (Whatcom County), Burlington (Skagit County), Everett (Snohomish County), Tacoma (Pierce County) and Olympia (Thurston County).

Key employment sectors include aerospace, military, information technology, clean technology, biotechnology, education, logistics, international trade, and tourism. The region is well known for the long-term presence of The Boeing Corporation and Microsoft, two major industry leaders. The military presence includes a number of large installations serving the U.S. Air Force, Army and Navy. Given the employment profile, the region's workforce is generally highly educated. Washington's geographic proximity to the Pacific Rim along with a deep water port has made it a center for international trade, which contributes significantly to the regional economy. The Washington ports make Washington the fourth largest exporting state in the nation, and the top five trading partners with Washington include China, Mexico, Canada, Japan and Korea. Tourism has also developed into a major industry for the area, due to the scenic beauty, temperate climate, and easy accessibility. Maritime industry employment, supported by the trade and fishing industries, is also an important employment sector.

For a discussion regarding the competition in our primary market area, see “Competition.”

Lending Activities

General. First Federal’s principal lending activities are concentrated in real estate secured loans with first lien one- to four-family mortgage, commercial, and multi-family loans. First Federal also makes construction and land loans (including lot loans), commercial business loans, and consumer loans, consisting primarily of automobile loans and home-equity loans and lines of credit.


8


Loan Portfolio Analysis

The following table represents information concerning the composition of our loan portfolio, excluding loans held for sale, by the type of loan at the dates indicated:
 
December 31,
 
June 30,
 
2018
 
2017
 
2017
 
2016
 
2015
 
2014
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$
336,178

 
38.7
%
 
$
355,391

 
45.2
%
 
$
328,243

 
44.7
%
 
$
308,471

 
49.3
%
 
$
256,696

 
52.0
%
 
$
241,910

 
48.0
%
Multi-family
82,331

 
9.5

 
73,767

 
9.4

 
58,101

 
7.9

 
46,125

 
7.4

 
33,086

 
6.6

 
45,100

 
8.9

Commercial real estate
253,235

 
29.1

 
202,956

 
25.8

 
202,038

 
27.5

 
161,182

 
25.7

 
125,623

 
25.4

 
128,028

 
25.4

Construction and land
54,102

 
6.2

 
71,145

 
9.0

 
71,630

 
9.8

 
50,351

 
8.0

 
19,127

 
3.9

 
20,497

 
4.1

Total real estate loans
725,846

 
83.5

 
703,259

 
89.4

 
660,012

 
89.9

 
566,129

 
90.4

 
434,532

 
87.9

 
435,535

 
86.4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
37,629

 
4.3

 
38,473

 
4.9

 
35,869

 
4.9

 
33,909

 
5.4

 
36,387

 
7.4

 
40,064

 
8.0

Auto and other consumer
87,357

 
10.0

 
28,106

 
3.6

 
21,043

 
2.9

 
9,023

 
1.5

 
8,198

 
1.7

 
10,697

 
2.1

Total consumer loans
124,986

 
14.3

 
66,579

 
8.5

 
56,912

 
7.8

 
42,932

 
6.9

 
44,585

 
9.1

 
50,761

 
10.1

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial business loans
18,898

 
2.2

 
16,303

 
2.1

 
17,073

 
2.3

 
16,924

 
2.7

 
14,764

 
3.0

 
17,532

 
3.5

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total loans
869,730

 
100.0
%
 
786,141

 
100.0
%
 
733,997

 
100.0
%
 
625,985

 
100.0
%
 
493,881

 
100.0
%
 
503,828

 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net deferred loan fees
292

 
 
 
724

 
 
 
904

 
 
 
1,182

 
 
 
840

 
 
 
862

 
 
Premium on purchased loans, net
(3,947
)
 
 
 
(2,454
)
 
 
 
(2,216
)
 
 
 
(2,280
)
 
 
 
(1,957
)
 
 
 
(1,290
)
 
 
Allowance for loan losses
9,533

 
 
 
8,760

 
 
 
8,523

 
 
 
7,239

 
 
 
7,111

 
 
 
8,072

 
 
Total loans, net
$
863,852

 
 
 
$
779,111

 
 
 
$
726,786

 
 
 
$
619,844

 
 
 
$
487,887

 
 
 
$
496,184

 
 


9


Fixed-Rate and Adjustable-Rate Loans

The following table shows the composition of our loan portfolio, excluding loans held for sale, in dollar amounts and in percentages by fixed rates and adjustable rates at the dates indicated:
 
December 31,
 
June 30,
 
2018
 
2017
 
2017
 
2016
 
2015
 
2014
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
Fixed-rate loans:
(Dollars in thousands)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$
214,359

 
24.5
%
 
$
219,511

 
27.9
%
 
$
215,706

 
29.4
%
 
$
198,984

 
31.8
%
 
$
182,299

 
36.8
%
 
$
172,801

 
34.3
%
Multi-family
20,756

 
2.4

 
19,786

 
2.5

 
1,370

 
0.2

 
9,596

 
1.5

 
7,979

 
1.6

 
2,281

 
0.5

Commercial real estate
75,637

 
8.7

 
58,656

 
7.5

 
38,423

 
5.2

 
46,082

 
7.4

 
36,880

 
7.5

 
46,199

 
9.2

Construction and land
36,208

 
4.2

 
23,791

 
3.0

 
21,582

 
2.9

 
17,399

 
2.7

 
14,132

 
2.9

 
12,575

 
2.5

Total real estate loans
346,960

 
39.8

 
321,744

 
40.9

 
277,081

 
37.7

 
272,061

 
43.4

 
241,290

 
48.8

 
233,856

 
46.5

Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
18,056

 
2.1

 
14,586

 
1.8

 
12,582

 
1.7

 
8,845

 
1.4

 
8,741

 
1.8

 
10,085

 
2.0

Other consumer
86,681

 
10.0

 
27,303

 
3.5

 
20,170

 
2.7

 
7,991

 
1.3

 
6,986

 
1.4

 
9,247

 
1.7

Total consumer loans
104,737

 
12.1

 
41,889

 
5.3

 
32,752

 
4.4

 
16,836

 
2.7

 
15,727

 
3.2

 
19,332

 
3.7

Commercial business loans
5,507

 
0.6

 
6,066

 
0.8

 
5,688

 
0.8

 
6,607

 
1.1

 
5,900

 
1.2

 
8,547

 
1.7

Total fixed-rate loans
457,204

 
52.5

 
369,699

 
47.0

 
315,521

 
42.9

 
295,504

 
47.2

 
262,917

 
53.2

 
261,735

 
51.9

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjustable-rate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
121,819

 
14.0

 
135,880

 
17.3

 
112,537

 
15.4

 
109,487

 
17.5

 
74,397

 
15.1

 
69,109

 
13.7

Multi-family
61,575

 
7.1

 
53,981

 
6.9

 
56,731

 
7.7

 
36,529

 
5.8

 
25,107

 
5.1

 
42,819

 
8.5

Commercial real estate
177,598

 
20.4

 
144,300

 
18.4

 
163,615

 
22.3

 
115,100

 
18.4

 
88,743

 
18.0

 
81,829

 
16.2

Construction and land
17,894

 
2.1

 
47,354

 
6.0

 
50,048

 
6.8

 
32,952

 
5.3

 
4,995

 
1.0

 
7,922

 
1.6

Total real estate loans
378,886

 
43.6

 
381,515

 
48.6

 
382,931

 
52.2

 
294,068

 
47.0

 
193,242

 
39.2

 
201,679

 
40.0

Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
19,573

 
2.3

 
23,887

 
3.0

 
23,287

 
3.2

 
25,064

 
4.0

 
27,646

 
5.6

 
29,979

 
6.0

Other consumer
676

 
0.1

 
803

 
0.1

 
873

 
0.1

 
1,032

 
0.2

 
1,212

 
0.2

 
1,450

 
0.3

Total consumer loans
20,249

 
2.4

 
24,690

 
3.1

 
24,160

 
3.3

 
26,096

 
4.2

 
28,858

 
5.8

 
31,429

 
6.3

Commercial business loans
13,391

 
1.5

 
10,237

 
1.3

 
11,385

 
1.6

 
10,317

 
1.6

 
8,864

 
1.8

 
8,985

 
1.8

Total adjustable-rate loans
412,526

 
47.5

 
416,442

 
53.0

 
418,476

 
57.1

 
330,481

 
52.8

 
230,964

 
46.8

 
242,093

 
48.1

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total loans
869,730

 
100.0
%
 
786,141

 
100.0
%
 
733,997

 
100.0
%
 
625,985

 
100.0
%
 
493,881

 
100.0
%
 
503,828

 
100.0
%
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net deferred loan fees
292

 
 
 
724

 
 
 
904

 
 
 
1,182

 
 
 
840

 
 
 
862

 
 
Premium on purchased loans, net
(3,947
)
 
 
 
(2,454
)
 
 
 
(2,216
)
 
 
 
(2,280
)
 
 
 
(1,957
)
 
 
 
(1,290
)
 
 
Allowance for loan losses
9,533

 
 
 
8,760

 
 
 
8,523

 
 
 
7,239

 
 
 
7,111

 
 
 
8,072

 
 
Total loans, net
$
863,852

 
 
 
$
779,111

 
 
 
$
726,786

 
 
 
$
619,844

 
 
 
$
487,887

 
 
 
$
496,184

 
 


10


Loan Maturity

The following table illustrates the contractual maturity of our loan portfolio at December 31, 2018. Mortgages that have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The total amount of loans due after December 31, 2019 that have fixed interest rates is $455.5 million, while the total amount of loans due after such date that have adjustable interest rates is $400.9 million. The table does not reflect the effects of unpredictable principal prepayments.

 
Within One Year (1)
 
After One Year Through Three Years
 
After Three Years Through Five Years
 
After Five Years Through Ten Years
 
Beyond Ten Years
 
Total
 
 
 
Weighted
 
 
 
Weighted
 
 
 
Weighted
 
 
 
Weighted
 
 
 
Weighted
 
 
 
Weighted
 
 
 
Average
 
 
 
Average
 
 
 
Average
 
 
 
Average
 
 
 
Average
 
 
 
Average
 
Amount
 
Rate
 
Amount
 
Rate
 
Amount
 
Rate
 
Amount
 
Rate
 
Amount
 
Rate
 
Amount
 
Rate
 
(Dollars in thousands)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$
17

 
5.31
%
 
$
180

 
6.30
%
 
$
709

 
3.85
%
 
$
23,730

 
3.47
%
 
$
311,542

 
4.05
%
 
$
336,178

 
4.01
%
Multi-family
113

 
4.96

 
7

 
5.89

 
19,546

 
3.95

 
49,218

 
4.45

 
13,447

 
5.41

 
82,331

 
4.48

Commercial real estate
676

 
5.01

 
14,232

 
4.97

 
45,141

 
4.69

 
191,928

 
4.63

 
1,258

 
3.47

 
253,235

 
4.65

Construction and land
3,237

 
6.55

 
481

 
6.04

 
4,745

 
6.81

 
18,076

 
5.19

 
27,563

 
4.81

 
54,102

 
5.23

Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
243

 
6.25

 
2,720

 
6.31

 
3,151

 
6.27

 
5,280

 
6.01

 
26,235

 
4.91

 
37,629

 
5.29

Other consumer
873

 
9.85

 
2,076

 
5.29

 
15,063

 
4.84

 
39,895

 
6.15

 
29,450

 
6.52

 
87,357

 
6.06

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial business loans
8,166

 
6.72

 
1,357

 
6.25

 
6,886

 
5.00

 
2,489

 
5.41

 

 

 
18,898

 
5.88

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total loans
$
13,325

 
 
 
$
21,053

 
 
 
$
95,241

 
 
 
$
330,616

 
 
 
$
409,495

 
 
 
$
869,730

 
 
_______________
(1) Includes demand loans, loans having no stated maturity, and overdraft loans.




11


Geographic Distribution of our Loans
The following table shows at December 31, 2018 the geographic distribution of our loan portfolio in dollar amounts and percentages.
 
North Olympic
Peninsula (1)
 
Puget Sound
Region (2)
 
Other Washington
 
Total in
Washington State
 
All Other States (3)
 
Total
 
Amount
 
% of Total
in Category
 
Amount
 
% of Total
in Category
 
Amount
 
% of Total in Category
 
Amount
 
% of Total
in Category
 
Amount
 
% of Total
in Category
 
Amount
 
% of Total
in Category
Real estate loans:
(Dollars in thousands)
One- to four-family
$
164,315

 
48.9
%
 
$
133,945

 
39.8
%
 
$
3,649

 
1.1
%
 
$
301,909

 
89.8
%
 
$
34,269

 
10.2
%
 
$
336,178

 
38.7
%
Multi-family
4,130

 
5.0

 
72,928

 
88.6

 
5,273

 
6.4

 
82,331

 
100.0

 

 

 
82,331

 
9.5

Commercial real estate
48,280

 
19.1

 
184,227

 
72.7

 
20,728

 
8.2

 
253,235

 
100.0

 

 

 
253,235

 
29.1

Construction and land
16,029

 
29.6

 
38,073

 
70.4

 

 

 
54,102

 
100.0

 

 

 
54,102

 
6.2

Total real estate loans
232,754

 
32.1

 
429,173

 
59.1

 
29,650

 
4.1

 
691,577

 
95.3

 
34,269

 
4.7

 
725,846

 
83.5

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
33,945

 
90.2

 
3,670

 
9.8

 
14

 

 
37,629

 
100.0

 

 

 
37,629

 
4.3

Other consumer
18,316

 
20.9

 
25,063

 
28.7

 
930

 
1.1

 
44,310

 
50.7

 
43,047

 
49.3

 
87,357

 
10.0

Total consumer loans
52,261

 
41.8

 
28,733

 
23.0

 
944

 
0.8

 
81,939

 
65.6

 
43,047

 
34.4

 
124,986

 
14.3

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial business loans
8,378

 
44.3

 
10,216

 
54.1

 

 

 
18,594

 
98.4

 
304

 
1.6

 
18,898

 
2.2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total loans
$
293,393

 
33.8
%
 
$
468,122

 
53.8
%
 
$
30,594

 
3.5
%
 
$
792,110

 
91.1
%
 
$
77,620

 
8.9
%
 
$
869,730

 
100.0
%
____________
(1) Includes Clallam and Jefferson counties.
(2) Includes Kitsap, Mason, Thurston, Pierce, King, Snohomish, Skagit, Whatcom, and Island counties.
(3) Includes loans located primarily in California and Ohio.


12


One- to Four-Family Real Estate Lending. At December 31, 2018, one- to four-family residential mortgage loans (excluding loans held for sale) totaled $336.2 million, or 38.7%, of our total loan portfolio, including $34.3 million, or 10.2%, of loans secured by properties outside the state of Washington, primarily in the states of California and Ohio. We originate both fixed and adjustable-rate residential loans, which can be sold in the secondary market or retained in our portfolio, and supplement originations with loan purchases from time to time, depending on our balance sheet objectives. Residential loans are underwritten to either secondary market standards for sale or to internal underwriting standards, which may not meet Federal Home Loan Mortgage Corporation ("Freddie Mac") and Federal National Mortgage Association ("Fannie Mae") eligibility requirements.

Fixed-rate residential mortgages are offered with repayment terms between 10 and 30 years, priced off of Freddie Mac posted daily pricing indications adjusted for economic and competitive considerations. Adjustable-rate residential mortgage products with similar amortization terms are also offered, with an interest rate that is typically fixed for an initial period ranging from 1 to 7 years with annual adjustments thereafter. Future interest rate adjustments include periodic caps of no more than 2% and lifetime caps of 5% to 6% above the initial interest rate, with no borrower prepayment restrictions.

Adjustable-rate mortgage loans could increase credit risk when interest rates rise. An increase to the borrower's loan payment may affect the borrower's ability to repay and could increase the probability of default. To mitigate this risk to both the borrower and First Federal, adjustable rate loans contain both periodic and lifetime interest rate caps, limiting the amount of payment changes. In addition, depending on market conditions, we may underwrite the borrower at a higher interest rate and payment amount than the initial rate. We do not offer adjustable-rate mortgages with deep discount teaser rates. At December 31, 2018, the average interest rate on our adjustable-rate mortgage loans was approximately 31.7% under the fully indexed rate. As of December 31, 2018, we had $121.8 million, or 14.0%, of adjustable-rate residential mortgage loans in our residential loan portfolio.

The underwriting process considers a variety of factors including credit history, debt to income ratios, property type, loan to value ratio, and occupancy. For loans with over 80% loan to value ratios, we typically require private mortgage insurance, which reduces our exposure to loss in the event of a loan default. Credit risk is also mitigated by obtaining title insurance, hazard insurance, and flood insurance. Residential mortgage loans which require appraisals are appraised by independent fee appraisers.

In connection with rules and regulations issued by the Consumer Financial Protection Bureau ("CFPB"), defining qualified mortgage loans based on the borrower’s ability to repay the loan, we believe that generally all of our mortgage loans originated meet this standard.

First Federal does not actively engage in subprime mortgage lending, either through advertising, marketing, underwriting and/or risk selection, and has no established program to originate or purchase subprime mortgage loans.

Commercial and Multi-Family Real Estate Lending. At December 31, 2018, $253.2 million, or 29.1%, and $82.3 million, or 9.5%, of our total loan portfolio was secured by commercial and multi-family real estate property, respectively. At December 31, 2018, we have identified $37.9 million of our commercial real estate portfolio as owner-occupied commercial real estate and $297.7 million is secured by income producing, or non-owner-occupied, commercial real estate. Substantially all of our commercial real estate and multi-family loans are secured by properties located in Washington State.

These loans are generally priced at a higher rate of interest than one- to four-family residential loans, to compensate for the greater risk associated with higher loan balances and the complexity of underwriting and monitoring. Repayment on loans secured by commercial or multi-family properties is dependent on successful management by the property owner to create sufficient net operating income to meet debt service requirements. Changes in economic and real estate market conditions can affect net operating income, capitalization rates, and ultimately the valuation and marketability of the collateral. As a result, we analyze market data including vacancy rates, absorption percentages, leasing rates, and competing projects under development. Interest rate, occupancy and capitalization rate stress testing are required as part of our underwriting analysis. If the borrower is a corporation, we generally require and obtain personal guarantees from the corporate principals, which include underwriting of their personal financial statements, tax returns, cash flows and individual credit reports, which provides us with additional support and a secondary source for repayment of the debt.

We offer both fixed- and adjustable-rate loans on commercial and multi-family real estate, which may include balloon payments. As of December 31, 2018, we had $177.6 million in adjustable-rate commercial real

13


estate loans and $61.6 million in adjustable-rate multi-family loans. Commercial and multi-family real estate loans with adjustable rates generally adjust after an initial period of three to five years and have maturity dates of three to ten years. Amortization terms are generally limited to terms up to 25 years on commercial real estate loans and up to 30 years on multi-family loans. Adjustable-rate multi-family residential and commercial real estate loans are generally priced to market indices with appropriate margins, which may include the U.S. Constant Maturity Treasury Rate, London Interbank Offered Rate ("LIBOR"), The Wall Street Journal prime rate, or other acceptable index. Substantially all adjustable-rate commercial and multi-family real estate loans are subject to a floor rate, and the weighted average floor rate on these loans was 4.33% at December 31, 2018. Of all of the adjustable-rate commercial loans, 44.9% are subject to a ceiling rate, and the weighted average ceiling rate on those loans was 10.2% at December 31, 2018.

The maximum loan to value ratio for commercial and multi-family real estate loans is typically limited to 75% of the appraiser opinion of market value. The minimum debt service coverage ratio is 1.20x for non-owner-occupied and owner-occupied properties. We require independent appraisals or evaluations on all loans secured by commercial real estate from an approved appraisers list.

We require most of our commercial and multi-family real estate loan borrowers to submit annual financial statements and/or rent rolls on the subject property, as well as personal financial statements of borrowers and guarantors. These properties may also be subject to annual inspections to support that the appropriate maintenance is being performed by the owner/borrower. All commercial real estate loans over $1.0 million are reviewed at least annually. The loan and its borrowers and/or guarantors are subject to an annual risk certification verifying that the loan is properly risk rated based upon covenant compliance and other terms as provided for in the loan agreements. While this process does not prevent loans from becoming delinquent, it does provide us with the opportunity to better identify problem loans in a timely manner and to work with the borrower prior to the loan becoming delinquent.


14


The following table provides information on multi-family and commercial real estate loans by type at the dates indicated:
 
December 31,
 
June 30,
 
2018
 
2017
 
2017
 
2016
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
(Dollars in thousands)
Non-owner occupied
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Multi-family
$
74,511

 
22.2
%
 
$
72,137

 
26.1
%
 
$
58,101

 
22.3
%
 
$
46,125

 
22.3
%
Office building
52,290

 
15.6

 
30,344

 
11.0

 
7,386

 
2.8

 
12,510

 
6.0

Hospitality
51,134

 
15.3

 
23,741

 
8.6

 
29,455

 
11.3

 
19,293

 
9.3

Retail
50,409

 
15.0

 
42,798

 
15.5

 
50,398

 
19.4

 
42,637

 
20.6

Mixed use
24,293

 
7.2

 
11,205

 
4.0

 
11,000

 
4.2

 

 

Self-storage
11,641

 
3.5

 
17,007

 
6.1

 
17,343

 
6.7

 
15,086

 
7.3

Health care
10,186

 
3.0

 
9,581

 
3.5

 
9,001

 
3.5

 
13,837

 
6.7

Warehouse
6,028

 
1.8

 
6,433

 
2.3

 
16,301

 
6.3

 
12,940

 
6.2

Manufacturing
3,765

 
1.1

 
3,857

 
1.4

 
3,900

 
1.5

 

 

Vehicle dealership
2,560

 
0.8

 
2,658

 
1.0

 

 

 
1,689

 
0.8

Other non-owner occupied
10,833

 
3.2

 
11,178

 
4.0

 
11,178

 
4.3

 
7,391

 
3.6

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total non-owner occupied
297,650
 
88.7

 
230,939

 
83.5

 
214,063

 
82.3

 
171,508

 
82.8

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Health care
11,586

 
3.5

 
11,892

 
4.3

 
12,105

 
4.7

 
7,925

 
3.8

Vehicle dealership
7,705

 
2.3

 
8,096

 
2.9

 
6,241

 
2.4

 
9,424

 
4.5

Office building
4,335

 
1.3

 
9,726

 
3.5

 
9,906

 
3.8

 
2,271

 
1.1

Warehouse
2,997

 
0.9

 
1,687

 
0.6

 
842

 
0.3

 
178

 
0.1

Retail
2,801

 
0.9

 
2,957

 
1.1

 
3,499

 
1.3

 
2,396

 
1.2

Manufacturing
2,150

 
0.6

 
2,983

 
1.1

 
3,037

 
1.2

 
3,387

 
1.6

Mixed use
1,429

 
0.4

 
1,797

 
0.6

 
1,597

 
0.6

 
1,041

 
0.5

Hospitality
486

 
0.1

 
1,077

 
0.4

 
1,093

 
0.4

 

 

Other owner-occupied
4,427

 
1.3

 
5,569

 
2.0

 
7,756

 
3.0

 
9,177

 
4.4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total owner occupied
37,916

 
11.3

 
45,784

 
16.5

 
46,076

 
17.7

 
35,799

 
17.2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Summary by type
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Multi-family
74,511

 
22.2

 
72,137

 
26.1

 
58,101

 
22.3

 
46,125

 
22.3

Office building
56,625

 
16.9

 
40,070

 
14.5

 
17,292

 
6.6

 
14,781

 
7.1

Retail
53,210

 
15.9

 
45,755

 
16.6

 
53,897

 
20.7

 
45,033

 
21.8

Hospitality
51,620

 
15.4

 
24,818

 
9.0

 
30,548

 
11.7

 
19,293

 
9.3

Mixed use
25,722

 
7.6

 
13,002

 
4.6

 
12,597

 
4.8

 
1,041

 
0.5

Health care
21,772

 
6.5

 
21,473

 
7.8

 
21,106

 
8.2

 
21,762

 
10.5

Self-storage
11,641

 
3.5

 
17,007

 
6.1

 
17,343

 
6.7

 
15,086

 
7.3

Vehicle dealership
10,265

 
3.1

 
10,754

 
3.9

 
6,241

 
2.4

 
11,113

 
5.3

Warehouse
9,025

 
2.7

 
8,120

 
2.9

 
17,143

 
6.6

 
13,118

 
6.3

Manufacturing
5,915

 
1.7

 
6,840

 
2.5

 
6,937

 
2.7

 
3,387

 
1.6

Other non-owner occupied
10,833

 
3.2

 
11,178

 
4.0

 
11,178

 
4.3

 
7,391

 
3.6

Other owner-occupied
4,427

 
1.3

 
5,569

 
2.0

 
7,756

 
3.0

 
9,177

 
4.4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total multi-family and commercial real estate
$
335,566

 
100.0
%
 
$
276,723

 
100.0
%
 
$
260,139

 
100.0
%
 
$
207,307

 
100.0
%


15


If we foreclose on a multi-family or commercial real estate loan, the marketing and liquidation period can be a lengthy process with substantial holding costs. Vacancies, deferred maintenance, repairs and market stigma can result in real or perceived losses for the time it takes to return the property to profitability. Depending on the individual circumstances, initial charge-offs and subsequent losses on commercial real estate loans can be unpredictable and substantial.

The average outstanding loan size in our commercial real estate portfolio, including multi-family loans, was $1.7 million as of December 31, 2018. We generally target individual commercial and multi-family real estate loans between $1.0 million and $5.0 million to small and mid-size owners and investors in our market areas as well as other parts of Washington. We will also make commercial and multi-family real estate loans in other states if we have a pre-existing relationship with the borrower.

Our three largest commercial and multi-family borrowing relationships, including loan balances outstanding and unused commitments, at December 31, 2018 consisted of an $18.5 million relationship secured by multi-family construction in King County, a $15.9 million relationship secured by multi-family real estate and multi-family construction in Pierce and King counties, and a $14.9 million relationship secured by multi-family construction and multi-family real estate in Kitsap and King counties.

Construction and Land Lending. Our construction and land loans decreased $17.0 million, or 23.9%, to $54.1 million, or 6.2% of the total loan portfolio at December 31, 2018 compared to $71.1 million at December 31, 2017. At December 31, 2018, the undisbursed portion of construction loans in process totaled $57.0 million compared to $59.4 million at December 31, 2017.

First Federal offers an “all-in-one” residential custom construction loan product, which upon completion of construction will be held in our loan portfolio. We also originate construction loans for certain commercial real estate projects. These projects include, but are not limited to, subdivisions, multi-family, retail, office/warehouse, hotel, and office buildings. Underwriting criteria on these loans include, but are not limited to, minimum debt service coverage requirements of 1.20 or better, loan to value limitations, pre-leasing requirements, construction cost over-run contingency reserves, interest and absorption period reserves, occupancy, capitalization rates and interest rate stress testing, as well as other underwriting criteria.

Construction loan applications generally require architectural and working plans, a material specifications list, a detailed cost breakdown and a construction contract. Construction loan advances are based on progress payments for “work in place” based on detailed line item construction budgets. Independent construction inspectors are used to evaluate the construction draw request relative to the progress and “work in place.” Our construction administrator reviews all construction projects, inspection reports and construction loan advance requests to ensure they are appropriate and in compliance with all loan conditions. Other risk management tools include title insurance, date down endorsements or periodic lien inspections prior to the payment of construction loan advances. In some cases, general contractors may be required to provide sub-contractor lien releases for any work performed prior to the filing of our deed of trust or prior to each construction loan advance.

Custom and speculative construction valuations are based on the assumption that the project will be built in accordance with plans and specifications submitted to us at the time of the loan application. The appraiser takes into consideration the proposed design and market appeal of the improvements, based on current market conditions and demand for homes, although the improvements may not be completed for six to twelve months or longer, depending on the complexity of the plans and specifications and market conditions.

Land acquisition, development and construction loans are available to local contractors and developers for the purpose of holding and/or developing residential building sites and homes when market conditions warrant such activity. Land acquisition loans are secured by a first lien on the property and are generally limited to 65% of the acquisition price or the appraised value, whichever is less. Development land loans are generally limited to 75% of the discounted appraised value based on the projected lot sale absorption rate and associated carry and liquidation costs of the developed lots and homes. Underwriting criteria for acquisition and development loans include evidence of preliminary plat approval, compliance with state and Federal environmental protection and disclosure laws, engineering plans, detailed cost breakdowns and marketing plans. These loans have been limited to projects within the North Olympic Peninsula and Puget Sound region. Other risk management tools include title insurance, feasibility and market absorption reports.

The success of land acquisition, development and construction lending is dependent upon successful completion of the project and the sale or leasing of the property for repayment of the loan. Because of the

16


uncertainties inherent in the estimates related to construction costs, the market value of the completed project, the demand for the property at completion, the rates of interest paid, and other factors, actual results may vary and can have a significant adverse impact on the value and marketability of the collateral.

At December 31, 2018, the average construction commitment for single-family residential construction was $424,000, for multi-family construction was $3.3 million and for commercial real estate construction was $4.3 million. The largest construction commitments for multi-family and commercial real estate were $9.4 million and $9.7 million, respectively, at December 31, 2018.

Substantially all of our land acquisition, development and construction lending 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, as is the case for acquisition and development loans. When original interest reserves set up at origination are exhausted, no additional reserves are permitted unless the loan is re-analyzed and it is determined that the additional reserves are appropriate.

Because an incomplete construction project is difficult to sell in the event of default, we may be required to advance additional funds and/or contract with another builder in order to complete construction. There is a risk that we may not fully recover unpaid loan funds and associated construction and liquidation costs under these circumstances. Speculative construction loans carry additional risk associated with identifying an end-purchaser for the finished project.

We also originate individual lot loans, which are secured by a first lien on the property, for borrowers who are planning to build on the lot within the next five years. Generally, these loans have a maximum loan to value ratio of 75% for improved lands (legal access, water and power) and 50% to 65% for unimproved land. The interest rate on these loans is fixed with a 20-year amortization and a five-year term.

At the dates indicated, the composition of our construction and land portfolio was as follows:
 
December 31,
 
June 30,
 
2018
 
2017
 
2017
 
2016
 
2015
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
One- to four-family residential
$
17,319

 
$
9,560

 
$
13,426

 
$
4,512

 
$
3,438

Multi-family residential
17,348

 
22,256

 
26,105

 
12,301

 
3,358

Commercial real estate
11,008

 
22,748

 
17,139

 
18,846

 
400

Land
8,427

 
16,581

 
14,960

 
14,692

 
11,931

Total construction and land
$
54,102

 
$
71,145

 
$
71,630

 
$
50,351

 
$
19,127


Our construction and land loans are geographically disbursed throughout the state of Washington and, as a result, these loans are susceptible to risks that may be different depending on the location of the project. We manage all of our construction lending by utilizing a licensed third party vendor to assist us in monitoring our construction projects, with construction loan proceeds disbursed periodically as construction progresses and as inspections by our approved third party vendor warrant them.

17



The following tables show our construction commitments by type and geographic concentration at the dates indicated:
<
December 31, 2018
Olympic
Peninsula
 
Puget Sound
Region
 
Other
Washington
 
Total
 
(In thousands)
Construction Commitment
 
 
 
 
 
 
 
 
One- to four-family residential
$
16,814

 
$
18,550

 
$

 
$
35,364

 
Multi-family residential

 
45,313

 

 
45,313

 
Commercial real estate
1,868

 
20,147

 

 
22,015

 
Total commitment
$
18,682

 
$
84,010

 
$

 
$
102,692

 
 
 
 
 
 
 
 
 
Construction Funds Disbursed
 
 
 
 
 
 
 
 
One- to four-family residential
$
8,321

 
$
8,998