FIRST FINANCIAL NORTHWEST, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)

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Forward-looking statements

Certain matters discussed in this Quarterly Report on Form 10-Q 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 allowance for loan and lease losses;
•changes in general economic conditions, either nationally or in our market
areas, including as a result of employment levels and labor shortages, and the
effects of inflation, a potential recession or slowed economic growth caused by
increasing oil prices and supply chain disruptions;
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•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 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 allowance for loan
and lease 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;
•our ability to execute 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
as a result of COVID-19;
•the availability of resources to address changes in laws, rules, or regulations
or to respond to regulatory actions;
•the quality and composition of our securities portfolio and the impact of any
adverse changes in the securities markets, including market liquidity;
•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;
•the effects of climate change, severe weather events, natural disasters,
pandemics, epidemics and other public health crises, acts of war or terrorism,
and other external events on our business; and
•other economic, competitive, governmental, regulatory, and technological
factors affecting our operations, pricing, products and services, and other
risks detailed in our Form 10-K for the year ended December 31, 2021 ("2021
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-Q 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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Insight

First Financial Northwest Bank ("the Bank") is a wholly-owned subsidiary of
First Financial Northwest, Inc. ("the Company") and, as such, comprises
substantially all of the activity for the Company. First Financial Northwest
Bank was a community-based savings bank until February 4, 2016, when the Bank
converted to a Washington chartered commercial bank reflecting the commercial
banking services it now provides to its customers. The Bank primarily serves
King, Pierce, Snohomish, and Kitsap counties, Washington, through its
full-service banking office and headquarters in Renton, Washington, as well as
seven retail branches in King County, Washington, five retail branches in
Snohomish County, Washington, and two retail branches in Pierce County,
Washington.

The Bank's business consists predominantly of attracting deposits from the
general public, combined with borrowing from the FHLB and raising funds in the
wholesale market (which may include brokered deposits), then utilizing these
funds to originate one-to-four family residential, multifamily, commercial real
estate, construction/land, business, and consumer loans. The Bank's strategic
initiatives seek to diversify our loan portfolio and broaden growth
opportunities within our current risk tolerance levels and asset/liability
objectives. We anticipate that construction/land lending will continue to be a
strong element of our total loan portfolio in future periods. We will continue
to take a disciplined approach in our construction/land lending by concentrating
our efforts on residential loans to builders known to us, including multifamily
loans to developers with proven success in this type of construction. These
loans typically mature in 12 to 24 months and funding is usually not fully
disbursed at origination, therefore the impact to net loans receivable is
generally minimal in the short term. We have also geographically expanded our
loan portfolio through loan purchases or loan participations of commercial and
multifamily real estate loans and consumer classic car loans that are outside of
our primary market area. Through our efforts to geographically diversify our
loan portfolio with direct loan originations, loan participations, or loan
purchases, our portfolio includes loans in 47 other states and the District of
Columbia, with the largest concentrations at September 30, 2022, in California,
Oregon, Texas, Florida and Alabama of $38.0 million, $14.1 million, $12.0
million, $10.1 million and $8.0 million, respectively.

The Bank's strategic initiatives seek to diversify our loan portfolio and
broaden growth opportunities within our current risk tolerance levels and
asset/liability objectives. The Bank has created a SBA department, and has
affiliated with a SBA partner to process our SBA loans while the Bank retains
the credit decisions. This enables us to be active in lending to small
businesses until our volumes are high enough to support the investment in
necessary infrastructure. When volumes support our becoming a SBA preferred
lender, we will apply for that status which would provide the Bank with
delegated loan approval as well as closing and most servicing and liquidation
authority, enabling the Bank to make loan decisions more rapidly. In addition,
the Bank plans to increase originations of the business loan portfolio, which
may include business lines of credit, business term loans or equipment
financing. In conjunction with the growth of business loans, the Bank seeks to
service these customers with their business deposits as well.

Our primary source of revenue is interest income, which is the income that we
earn on our loans and investments. Interest expense is the interest that we pay
on our deposits and borrowings. Net interest income is the difference between
interest income and interest expense. Changes in levels of interest rates affect
interest income and interest expense differently and, thus, impacts our net
interest income and net interest margin. First Financial Northwest Bank is
currently slightly liability-sensitive, meaning our interest-earning liabilities
reprice at a faster rate than our interest-bearing assets. During 2022, we
continued to see quarterly improvements in the net interest margin. During the
quarter ended September 30, 2022, net interest margin was 3.65%, compared to
3.33% in the same quarter last year. Since March 2022, in response to inflation,
the Federal Open Market Committee ("FOMC") of the Federal Reserve System has
increased the target range for the federal funds rate by 300 basis points,
including 150 basis points during the third quarter of 2022, to a range of 3.00%
to 3.25%. If the FOMC continues to raise the targeted federal funds rate in an
effort to curb inflation, which appears likely based on recent communications
and interest rate forecasts, we expect the Company's loan yields and yields from
variable rate interest earning assets will continue to improve, albeit at a
potentially slower pace than the anticipated rate of increase in the cost of
interest-bearing liabilities.

An offset to net interest income is the provision for loan losses, or the
recapture of the provision for loan losses, that is required to establish the
ALLL at a level that adequately provides for probable losses inherent in our
loan portfolio. As our loan portfolio increases, or due to an increase for
probable losses inherent in our loan portfolio, our ALLL may increase, resulting
in a decrease to net interest income after the provision. Improvements in loan
risk ratings, increases in property values, or receipt of recoveries of amounts
previously charged off may partially or fully offset any required increase to
ALLL due to loan growth or an increase in probable loan losses.

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Noninterest income is generated from various loan or deposit fees, increases in
the cash surrender value of BOLI, and revenue earned on our wealth management
services. This income is increased or partially offset by any net gain or loss
on sales of investment securities.

Our noninterest expenses consist primarily of salaries and employee benefits,
professional fees, regulatory assessments, occupancy and equipment, and other
general and administrative expenses. Salaries and employee benefits consist
primarily of the salaries and wages paid to our employees, including commissions
and bonuses, payroll taxes, expenses for retirement, and other employee
benefits. Professional fees include legal services, auditing and accounting
services, computer support services, and other professional services in support
of strategic plans. Occupancy and equipment expenses, which are the fixed and
variable costs of buildings and equipment, consist primarily of lease expenses,
real estate taxes, depreciation expenses, maintenance, and costs of utilities.
Also included in noninterest expense is the change to the Company's unfunded
commitment reserve which is reflected in general and administrative expenses.
This unfunded commitment reserve expense can vary significantly each quarter,
based on the amount believed by management to be sufficient to absorb estimated
probable losses related to unfunded credit facilities, and reflects changes in
the amounts that the Company has committed to fund but has not yet disbursed.

Information related to COVID-19

The Company maintains its commitment to supporting its community and customers
during the COVID-19 pandemic and remains focused on keeping its employees safe
and the Bank running effectively to serve its customers. As of September
30, 2022, all Bank branches are open with normal hours. The Bank will continue
to monitor branch access and occupancy levels in relation to cases and close
contact scenarios and follow governmental restrictions and public health
authority guidelines.

Critical accounting policies

  Our significant accounting policies are fundamental to understanding our
results of operations and financial condition because they require that we use
estimates and assumptions that may affect the value of our assets or liabilities
and our financial results. These policies are critical because they require
management to make difficult, subjective, and complex judgments about matters
that are inherently uncertain and because it is likely that materially different
amounts would be reported under different conditions or by using different
assumptions. These policies govern the ALLL, the valuation of OREO, and the
calculation of deferred taxes, the right-of-use asset and lease liability on our
operating leases, fair values, and other-than-temporary impairments on the
market value of investments and derivatives. These policies and estimates are
described in further detail in Part II, Item 7 Management's Discussion and
Analysis of Financial Condition and Results of Operations and Note 1, Summary of
Significant Accounting Policies in the 2021 Form 10-K. There have not been any
material changes in the Company's critical accounting policies and estimates as
compared to the disclosure contained in the 2021 Form 10-K.
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Comparison of the financial situation at September 30, 2022 and December 31, 2021

Total assets were $1.48 billion at September 30, 2022, an increase of 4.1%, from
$1.43 billion at December 31, 2021. The following table details the $58.0
million net change in the composition of our assets at September 30, 2022 from
December 31, 2021.

                                                       Balance at              Balance at
                                                      September 30,           December 31,            Change from
                                                          2022                    2021             December 31, 2021        Percent Change
                                                                                     (Dollars in thousands)
Cash on hand and in banks                           $        9,684          $       7,246          $        2,438                    33.6  %
Interest-earning deposits with banks                        15,227                 66,145                 (50,918)                  (77.0)
Investments available-for-sale, at fair value              221,278                168,948                  52,330                    31.0
Investments held-to-maturity, at amortized cost              2,438                  2,432                       6                     0.2
Loans receivable, net                                    1,143,348              1,103,461                  39,887                     3.6
FHLB stock, at cost                                          7,712                  5,465                   2,247                    41.1
Accrued interest receivable                                  6,261                  5,285                     976                    18.5
Deferred tax assets, net                                     2,355                    850                   1,505                   177.1

Premises and equipment, net                                 21,608                 22,440                    (832)                   (3.7)
BOLI, net                                                   36,064                 35,210                     854                     2.4
Prepaid expenses and other assets                           13,605                  3,628                   9,977                   275.0
ROU, net                                                     3,260                  3,646                    (386)                  (10.6)
Goodwill                                                       889                    889                       -                       -
Core deposit intangible, net                                   582                    684                    (102)                  (14.9)
Total assets                                        $    1,484,311          $   1,426,329          $       57,982                     4.1  %



Interest-earning deposits with banks. Our interest-earning deposits with banks,
consisting primarily of funds held at the Federal Reserve Bank of San Francisco
("FRB"), decreased by $50.9 million during the nine months ended September 30,
2022. Excess cash earning a nominal yield was deployed into higher yielding
loans receivable and securities.

Investments available-for-sale. Our investments available-for-sale portfolio
increased by $52.3 million during the nine months ended September 30, 2022.
During this period, the Bank purchased available-for-sale investment securities
that included $40.0 million of fixed rate U.S. Treasury bonds with remaining
maturities of approximately two years. In addition, the Bank purchased $37.8
million of mortgage-backed securities, $3.0 million of asset-backed securities,
$4.0 million in corporate securities, and $5.2 million in Community Reinvestment
Act qualified municipal and mortgage-backed securities. During the nine months
ended September 30, 2022, $1.0 million of investments available-for-sale were
called, $2.8 million matured, and there were no sales.

The effective duration of the investments available-for-sale at September 30,
2022 was 3.59%, compared to 3.54% at December 31, 2021. Effective duration
measures the anticipated percentage change in the value of an investment
security (or portfolio) in the event of a 100 basis point change in market
yields. Since the Bank's portfolio includes securities with embedded options
(including call options on bonds and prepayment options on mortgage-backed
securities), management believes that effective duration is an appropriate
metric to use as a tool when analyzing the Bank's investment securities
portfolio, as effective duration incorporates assumptions relating to such
embedded options, including changes in cash flow assumptions as interest rates
change.

Loans receivable. Net loans receivable increased $40.0 million during the nine
months ended September 30, 2022, primarily due to growth in one-to-four family
residential, multifamily and consumer loans of $64.3 million, $2.6 million, and
$12.8 million, respectively. Partially offsetting these increases,
construction/land loans decreased $20.8 million, business loans decreased $14.5
million due primarily to a $9.6 million decrease in PPP loans combined with a
$3.7 million decrease in aircraft loans, and commercial real estate loans
decreased $5.9 million. A total of $20.7 million of multifamily
construction/land loans
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converted to permanent multi-family loans in accordance with the loan's terms
during the nine months ended September 30, 2022.
At September 30, 2022 and December 31, 2021, the Bank's construction/land loans
totaled 49.1% and 59.7% of total capital plus surplus, respectively, and total
non-owner occupied commercial real estate was 354.6% and 384.0% of total capital
plus surplus, respectively. The Bank has set aggregate concentration guidelines
that total commercial real estate, including residential, non-residential, and
construction/land loans, should not exceed 550% of total capital plus surplus.
Our concentration guideline for construction/land loans is to limit these loans
to 100% of total capital plus surplus. The concentration of construction/land
loans is calculated using the funded balance of these loans and consequently can
fluctuate based on the timing of construction draws and loan payoffs. Management
reviews estimated construction draws and loan payoffs and adjusts loan
originations based on these estimates to achieve compliance with our
construction guidelines. Our commercial and multifamily real estate and
construction/land loan portfolios are subject to ongoing credit reviews
performed by both independent loan review staff, as well as an external
third-party review firm to assist with identifying potential adverse trends and
risks in the portfolio allowing management to initiate timely corrective action,
as necessary. Such reviews also assist with ensuring loan risk grades are
accurately assigned and thereby properly accounted for in the ALLL. The review
places emphasis on large borrowing relationships, stress testing, compliance
with loan covenants, as well as other risk factors warranting enhanced review.
The following table presents a breakdown of our multifamily, commercial and
construction loans by collateral type at September 30, 2022 and December 31,
2021. Total commercial real estate loans and construction/land loans are net of
$0 and $46.4 million of LIP, respectively, at September 30, 2022, as compared to
$89,000 and $43.3 million of LIP, respectively, at December 31, 2021.
                                                      September 30, 2022                                     December 31, 2021
                                                                      % of Total in                                         % of Total in
                                              Amount                    Portfolio                   Amount                    Portfolio
                                                                     (In thousands)
Multifamily residential                $         132,755                       100.0  %       $        130,146                       100.0  %

Non-residential:
Retail                                           137,417                        33.2  %                138,463                        33.0  %
Office                                            84,768                        20.5                    90,727                        21.6
Hotel / motel                                     56,715                        13.7                    64,854                        15.5
Storage                                           34,069                         8.3                    32,990                         7.9
Mobile home park                                  23,531                         5.7                    20,636                         4.9
Warehouse                                         19,934                         4.8                    17,724                         4.2
Nursing home                                      12,452                         3.0                    12,713                         3.0
Other non-residential                             44,600                        10.8                    41,310                         9.9
Total non-residential                            413,486                       100.0  %                419,417                       100.0  %

Construction/land:
One-to-four family residential                    41,606                        57.3  %                 34,677                        37.1  %
Multifamily                                       15,500                        21.3                    37,194                        39.8
Commercial                                             -                           -                     6,189                         6.6
Land                                              15,518                        21.4                    15,395                        16.5
Total construction/land                           72,624                       100.0  %                 93,455                       100.0  %
Total multifamily residential,
non-residential and construction/land
loans                                  $         618,865                                      $        643,018



Included in total construction/land loans at September 30, 2022, are $15.5
million of multifamily loans that will roll over to permanent loans at the
completion of their construction period in accordance with the terms of the
construction/land loan. At December 31, 2021, construction/land loans included
$37.2 million of multifamily loans and $6.2 million of commercial real estate
loans that will roll over to permanent loans at the completion of their
construction period in accordance with the terms of the construction/land loan.
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To assist in our strategic initiatives for loan growth and to achieve geographic
diversification, the Bank originates and purchases loans and utilize loan
participations with the underlying collateral located within areas of Washington
State outside our primary market area or in other states. The Bank's goal with
respect to loan participations is to locate a selling bank that is unable to
make an entire loan due to legal or lending concentration limitations. Sellers
of these loans are reviewed for management/lending experience, financial
condition, asset quality metrics, and regulatory matters. Loans acquired through
participation or purchase must meet the Bank's underwriting and risk guidelines.
During the nine months ended September 30, 2022, the Bank purchased $40.3
million of loans and loan participations to borrowers located in Washington and
other states, including $9.1 million of commercial real estate loans, $2.9
million of one-to-four family residential loans, $5.9 million of business loans
and $22.5 million of consumer loans secured by classic/collectible automobiles.

The majority of our loan portfolio continues to be secured by properties located
in our primary market area, however a significant amount is secured by
properties in other areas of Washington, in California, and in other states. At
September 30, 2022, total loans secured by collateral located in California
represented 3.3% of our total loans, and total loans secured by collateral
located outside the states of California and Washington represented 10.3% of our
total loans. The following table details geographic concentrations in our loan
portfolio:
                                                                                              At September 30, 2022
                                   One-to-Four
                                     Family                                     Commercial
                                   Residential            Multifamily          Real Estate           Construction/Land          Business          Consumer             Total
                                                                                                 (In thousands)
King County                     $      345,427          $     75,577          $   249,488          $           71,137          $ 21,667          $  9,178          $   772,474
Pierce County                           41,788                10,548               27,297                           -               255               941               80,829
Snohomish County                        33,252                 7,542               14,225                         860             4,352               948               61,179
Kitsap County                            4,672                     5                  732                           -                 -                 -                5,409
Other Washington Counties               16,563                27,590               34,651                         627               238             1,322               80,991
California                                 820                 9,573               17,978                           -                 -             9,626               37,997
Outside Washington
and California (1)                       6,913                 1,920               69,115                           -             5,542            35,604              119,094
Total loans                     $      449,435          $    132,755          $   413,486          $           72,624          $ 32,054          $ 57,619          $ 1,157,973


_______________
(1) Includes loans in Oregon, Texas, Florida and Alabama of $14.1 million, $11.9
million, $10.1 million and $8.0 million, respectively, and loans in 42 other
states and the District of Columbia.

The ALLL decreased to $14.7 million at September 30, 2022, from $15.7 million at
December 31, 2021, and represented 1.27% and 1.40% of total loans receivable at
September 30, 2022, and December 31, 2021, respectively. The ALLL consists of
two components, the general allowance and the specific allowance. The ALLL
decrease was primarily due to a $900,0000 recapture of provision for loan losses
during the nine months ended September 30, 2022, reflecting a decrease in the
general allowance. The ALLL general allowance primarily decreased as a result of
$14.4 million of loans downgraded to substandard, resulting in these loans
removed from the calculation of the general allowance for loan losses. An
individual analysis of these loans for required specific reserves was instead
performed which indicated no additional specific allowance was needed. The $14.4
million of downgrades included a $6.4 million participation interest in
commercial loans secured by medical rehabilitation facilities and a $6.3 million
participation interest in a loan secured by a senior housing/assisted living
facility previously downgraded to special mention in the quarter ended March 31,
2022. Each of these loans were negatively impacted by the COVID-19 pandemic. In
addition, a $1.7 million multifamily loan was downgraded based on a financial
review of the borrower, who also has multiple other previously downgraded
substandard loans. Changes in the composition of our loan portfolio also
impacted the ALLL, with growth in one-to-four family residential, consumer and
multifamily loans and a decline in construction/land loans impacting the
analysis. The $1.2 million balance of PPP loans was omitted from the ALLL
calculation at September 30, 2022, as these loans are fully guaranteed by the
SBA. Management expects that the remaining PPP borrowers will seek full or
partial forgiveness of their loan obligations from the SBA, which in turn will
reimburse the Bank for the amount forgiven.
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To September 30, 2022total specific allowances decreased by $5,000 since
December 31, 2021 following the amortization of the concession previously granted on an existing TDR. For more information, see “Comparison of operating results for the three months ended September 30, 2022and 2021 – Allowance for Loan Losses” discussed below.

We believe that the ALLL at September 30, 2022, was adequate to absorb the
probable and inherent risks of loss in the loan portfolio at that date. While we
believe the estimates and assumptions used in our determination of the adequacy
of the allowance are reasonable, there can be no assurance that such estimates
and assumptions will be proven correct in the future, that the actual amount of
future losses 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 allowance
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 the loan portfolio. In
addition, the determination of the amount of our ALLL is subject to review by
bank regulators as part of the routine examination process, which 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. Uncertainties relating to
our ALLL are heightened as a result of the risks surrounding the COVID-19
pandemic as described in further detail in Part 1, Item 1A of our 2021
Form 10-K.

As we work with our borrowers who face difficult financial circumstances, we
explore various options available to minimize our risk of loss. At times, the
best option for our customers and the Bank is to modify the loan for a period of
time, usually one year or less. Certain loan modifications are accounted for as
TDRs. These modifications have included a reduction in interest rate on the loan
for a period of time, advancing the maturity date of the loan, or allowing
interest-only payments for a specific time frame. These modifications are
granted only when there is a reasonable and attainable restructured loan plan
that has been agreed to by the borrower and is considered to be in the Bank's
best interest.

The following table presents a breakdown of our TDRs on the dates indicated, which were all efficient and in a situation of regularization:

                                           September 30, 2022         December 31, 2021          Nine Month Change
                                                                    (Dollars in thousands)

Performing TDRs:
One-to-four family residential            $           1,825          $          2,107          $             (282)

Total TDRs                                $           1,825          $          2,107          $             (282)
% TDRs classified as performing                       100.0  %              

100.0%



  Our TDRs decreased $282,000 at September 30, 2022, compared to December 31,
2021 as a result of principal repayments. At September 30, 2022, there were no
committed but undisbursed funds in connection with our TDRs. The largest TDR
relationship at September 30, 2022, totaled $648,000 and was secured by
non-owner occupied one-to-four family properties located in Pierce County.

  Loans are considered past due if a scheduled principal or interest payment is
due and unpaid for 30 days or more. At September 30, 2022, past due loans
totaled $406,000, representing 0.04% of total loans receivable. At December 31,
2021, past due loans totaled $255,000, representing 0.02% of total loans
receivable.

  Nonaccrual loans are loans that are 90 days or more delinquent or other loans
which, in management's opinion, the borrower is unable to meet scheduled payment
obligations. Our credit quality remains strong as nonaccrual (nonperforming)
loans remained low at $232,000, representing 0.02% of total assets at
September 30, 2022. There were no nonaccrual loans at December 31, 2021.

We will continue to focus our efforts on working with borrowers to bring any
past due loans current. By taking ownership of the underlying collateral if
needed, we can generally convert non-earning assets into earning assets on a
more timely basis than may otherwise be the case. Our success in this area is
reflected by our low nonperforming assets.

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OREO. OREO includes properties acquired by the Bank through foreclosure or
acceptance of a deed in lieu of foreclosure. At September 30, 2022, and December
31, 2021, the Bank had no OREO properties and no real estate secured loans in
the foreclosure process.

  Intangible assets. The balance of goodwill was $889,000 at both September 30,
2022 and December 31, 2021. Goodwill was calculated as the excess purchase price
of the branches acquired in August 2017 (the "Branch Acquisition") over the fair
value of the assets acquired and liabilities assumed.

  The core deposit intangible ("CDI") recorded as part of the Branch Acquisition
represents the fair value of the customer relationships on the acquired
noninterest-bearing demand, interest-bearing demand, savings, and money market
accounts. The CDI balance was $582,000 at September 30, 2022 and $684,000 at
December 31, 2021. The initial ratio of CDI to the acquired balances of core
deposits was 2.23%. The CDI amortizes into noninterest expense on an accelerated
basis over ten years.

Deposits. The deposit accounts consisted of the following:

                                                   Balance at            Balance at
                                                  September 30,         December 31,            Change from
                                                      2022                  2021             December 31, 2021        Percent Change
                                                                                (Dollars in thousands)
Noninterest-bearing demand                       $    118,842          $    117,751          $        1,091                     0.9  %
Interest-bearing demand                                95,767                97,907          $       (2,140)                   (2.2)
Savings                                                24,625                23,146          $        1,479                     6.4
Money market                                          572,137               624,543          $      (52,406)                   (8.4)
Certificates of deposit, retail                       268,528               294,127          $      (25,599)                   (8.7)
Brokered deposits                                      69,537          $          -          $       69,537                       -
                                                 $  1,149,436          $  1,157,474          $       (8,038)                   (0.7)



During the first nine months of 2022, deposits decreased $8.0 million to $1.15
billion at September 30, 2022, compared to $1.16 billion at December 31, 2021.
Declines in money market accounts and retail certificates of deposit of $52.4
million and $25.6 million, respectively, were partially offset by $44.5 million
of brokered certificates of deposit and $25.0 million of brokered
interest-bearing demand deposits. We increased our reliance on brokered deposits
and wholesale funds this year to fund the reduction in deposits and assets
growth. The Bank continues to consider multiple funding alternatives in addition
to customer deposits, including wholesale markets, brokered deposits, and the
national deposit market.

To September 30, 2022 and December 31, 2021we held $60.1 million and $60.6 million in public funds, respectively, mainly in retail certificates of deposit and money market accounts.

Advances. We use advances from the FHLB as an alternative funding source to
manage interest rate risk, to leverage our balance sheet and to supplement our
deposits. Total FHLB advances were $150.0 million and $95.0 million at
September 30, 2022, and December 31, 2021, respectively. At September 30, 2022,
the Bank's advances included $55.0 million of overnight advances and
$35.0 million of fixed-rate three-month advances that renew quarterly, and $60.0
million of fixed-rate one-month advances that renew monthly. The $95.0 million
of one-month and three-month advances are utilized in cash flow hedge
agreements, as described below. At September 30, 2022, all of our FHLB advances
were due to reprice in less than two months.

Cash Flow Hedge. To assist in our interest rate risk management efforts, the
Bank has entered into multiple interest rate swap agreements with qualified
institutions. Each interest rate swap agreement qualifies as a cash flow hedge
of the variability of future interest payments attributable to the changes in
one-month or three-month LIBOR rates. The objective of the cash flow hedge is to
offset the variability of cash flows due to the rollover of the Bank's FHLB, or
other fixed rate advances, for one-month or three-months, respectively, for the
term of the agreement. The agreements allow for a substitute index to be used if
LIBOR is unavailable.

The following table presents details of the Bank's interest rate swap agreements
as of September 30, 2022. For each interest rate swap agreement listed, the Bank
has secured a fixed-rate FHLB advance for the notional amount that reprices at
the same frequency as the corresponding interest rate swap. The Bank pays a
fixed interest rate to the counterparty and in return,
                                       45

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receives a floating interest rate based on the index noted in the table below.
The original term of these interest rate swap agreements range from four to
eight years.

                                                                                  Fixed rate paid to            Index rate received
  Notional amount             Start Date                Maturity Date                counterparty                from counterparty             Repricing Frequency
                                                                       (Dollars in thousands)
$         15,000               9/27/2019                  9/27/2024                            1.440  %            1-month LIBOR                     monthly
          10,000              11/20/2019                 11/20/2023                            1.585               3-month LIBOR                    quarterly
          15,000               3/2/2020                   3/2/2026                             0.911               1-month LIBOR                     monthly
          15,000               3/2/2020                   3/2/2027                             0.937               1-month LIBOR                     monthly
          15,000               3/2/2020                   3/2/2028                             0.984               1-month LIBOR                     monthly
          15,000              10/25/2021                 10/25/2028                            0.793               3-month LIBOR                    quarterly
          10,000              10/25/2021                 10/25/2029                            0.800               3-month LIBOR                    quarterly



A change in the net fair value of these cash flow hedges is recognized as an
other asset or other liability on the balance sheet with the tax-effected
portion of the change included in other comprehensive income. At September 30,
2022 and December 31, 2021, we recognized fair value assets of $11.1 million and
$1.5 million, respectively, as a result of the increase in market value of the
interest rate swap agreements.

The Bank has confirmed its adherence to the Interbank Offered Rate Fallbacks
Protocol ("Protocol") as published by the International Swaps and Derivatives
Association ("ISDA") to prepare for the cessation of LIBOR by June 30, 2023. The
Protocol, effective January 25, 2021, provides a mechanism for parties to
bilaterally amend their existing derivative transaction to incorporate ISDA's
fallback terms, providing for a clear transition from LIBOR to SOFR.

  Stockholders' Equity. Total stockholders' equity had virtually no change,
remaining at $157.9 million at both September 30, 2022 and December 31, 2021.
Stockholders' equity during the nine months ended September 30, 2022, reflects
net income of $10.0 million partially offset by dividends paid of $3.2 million,
$2.0 million in stock based compensation and share repurchases totaling $1.4
million. In addition, stockholders' equity was adversely impacted by unrealized
losses in securities available-for-sale of $19.2 million and unrealized gains on
the fair value of cash flow hedges of $9.6 million, reflecting increases in
market interest rates during the period, resulting in a $7.6 million accumulated
other comprehensive loss, net of tax. As part of the strategy to increase
shareholder value, the Company's Board of Directors authorized a stock
repurchase plan that began on February 18, 2022, and expired on September 16,
2022, for the repurchase of up to 455,000 shares. At September 30, 2022, the
Company had repurchased 61,913 shares under this repurchase plan at an average
price of $16.22 per share. On September 28, 2022, the Company's Board of
Directors approved another stock repurchase plan authorizing the repurchase of
up to 5% of the Company's outstanding stock, or approximately 456,000 shares.
This plan will commence on or about October 31, 2022 and will expire no later
than March 17, 2023.

The following table shows the cash dividends paid per share and the corresponding payout ratio for the periods indicated:

                                   Three Months Ended September 30,                 Nine Months Ended September 30,
                                       2022                    2021                    2022                    2021

Dividend declared per common
share                          $          0.12            $      0.11          $          0.36            $      0.33
Dividend payout ratio (1)                 27.4    %              32.4  %                  32.4    %              32.7  %


______________

(1) Dividends paid per common share divided by basic earnings per common share.

                                       46

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Comparison of operating results for the three months ended September 30, 2022
and 2021

General. Net income for the three months ended September 30, 2022, was $3.9
million, or $0.43 per diluted share compared to $3.2 million, or $0.34 per
diluted share for the three months ended September 30, 2021. Net income
increased $747,000 primarily due to a $2.0 million increase in interest income
that more than offset a $675,000 increase in interest expense. In addition, a
$400,000 recapture of provision for loan losses was recognized for the three
months ended September 30, 2022, as compared to a $100,000 provision for loan
losses for the three months ended September 30, 2021. Partially offsetting these
improvements, noninterest expense increased $681,000.

Net interest income. Net interest income for the three months ended
September 30, 2022increase $1.3 million at $12.7 million of $11.4 million
for the three months ended September 30, 2021the increase in interest income having exceeded that of interest charges.

Interest income increased by $2.0 million for the three months ended
September 30, 2022, as compared to the same period in 2021, including a $1.1
million increase in loan interest income due to an increase in average loan
yields and an increase of $38.1 million in the average balance of loans
receivable between the periods. The average loan yield increased to 4.77% for
the three months ended September 30, 2022, from 4.54% for the three months ended
September 30, 2021. The increase in the average yield on loans was largely due
to the impact of interest rates on variable rate loans as well as new loans
being originated at higher interest rates.

Interest income from investment securities increased $791,000, primarily due to
an increase in the average yield of both taxable and non-taxable investment
securities and secondarily to a $37.0 million increase in the average balance of
taxable investment securities. The average yield of taxable securities increased
126 basis points to 2.98% while the average yield on non-taxable securities
increased 41 basis points to 2.22% for the three months ended September 30,
2022, as compared to the same quarter in 2021. The increase in average yields on
investment securities during the current quarter, reflects the lagging benefit
of variable rate interest-earning assets beginning to reprice higher to market
interest rates and the purchase of higher yielding securities in 2022.

Interest income from interest-earning deposits increased $101,000 for the three
months ended September 30, 2022, as compared to the three months ended
September 30, 2021. During these comparative periods, the average yield
increased to 2.02% for the three months ended September 30, 2022, from 0.14% for
the three months ended September 30, 2021. The higher average yield from these
deposits was primarily a result of increases to the target range for federal
funds between periods. Excess cash was invested in higher interest-earning
assets, resulting in a $44.1 million decrease in the average balance of
interest-earning deposits for the three months ended September 30, 2022, as
compared to the same period in 2021.

The increase in interest income was partially offset by a $675,000 increase in
deposit interest expense for the three months ended September 30, 2022, as
compared to the three months ended September 30, 2021. The average rate paid on
interest-bearing deposits increased to 0.87% for the three months ended
September 30, 2022, as compared to 0.63% for the three months ended
September 30, 2021, primarily attributed to increases in cost of money market
accounts due to recent market interest rate increases and the utilization of
higher cost brokered deposits. The average balance of interest-bearing deposits
increased $39.5 million for the three months ended September 30, 2022, as
compared to the same period in 2021 primarily reflecting a $69.5 million
increase in the average balance of brokered deposit and a $23.8 million increase
in money market accounts, partially offset by a $49.2 million decrease in the
average balance of retail certificates of deposit.

Interest expense from borrowings decreased $39,000 for the three months ended
September 30, 2022, as compared to the three months ended September 30, 2021,
primarily due to a decrease of $14.7 million in the average balance which was
partially offset by a six basis point increase in cost. At September 30, 2022,
our borrowings are comprised of $95.0 million of FHLB advances matched to
fixed-rate interest rate swap agreements, and $55.0 million in overnight
advances obtained this quarter.

The Company's net interest margin increased to 3.65% for the three months ended
September 30, 2022, from 3.33% for the three months ended September 30, 2021.
This increase was primarily due to the 50 basis point increase in the average
yield on interest-earning assets outpacing the 22 basis point increase in the
average cost of interest bearing liabilities between periods. These increases
reflect higher market interest rates due to recent increases in the target range
for federal funds, including a 150 basis points increase during the third
quarter of 2022, to a range of 3.00% to 3.25%. For more information on this, see
"How We Measure the Risk of Interest Rate Changes" in Item 3 of this report.
                                       47

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The following table presents the effects of changing rates and volumes on our
net interest income during the periods indicated. Information is provided with
respect to: (1) effects on interest income attributable to changes in volume
(changes in volume multiplied by prior rate); and (2) effects on interest income
attributable to changes in rate (changes in rate multiplied by prior volume).
Changes in rate/volume are allocated proportionately to the changes in rate and
volume.

                                                                 Three 

Months ended September 30, 2022

Compared to September 30, 2021

                                                                         Net Change in Interest
                                                              Rate                Volume              Total
                                                                             (In thousands)
Interest-earning assets:
Loans receivable, net                                    $        674          $      436          $   1,110
Investment securities, taxable                                    625                 160                785
Investment securities, non-taxable                                 24                 (18)                 6
Interest-earning deposits with banks                              116                 (15)               101
FHLB stock                                                          6                  (7)                (1)
Total net change in income on interest-earning assets           1,445                 556              2,001

Interest-bearing liabilities:
Interest-bearing demand                                           131                  (1)               130
Savings                                                             -                   -                  -
Money market                                                      533                  17                550
Certificates of deposit, retail                                  (122)               (184)              (306)
Brokered deposits                                                 340                   -                340
Borrowings                                                         14                 (53)               (39)
Total net change in expense on interest-bearing
liabilities                                                       896                (221)               675
Total net change in net interest income                  $        549          $      777          $   1,326






                                       48
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The following table compares detailed average balances, related interest income
or interest expense, associated yields and rates, and the resulting net interest
margin for the three months ended September 30, 2022 and 2021. Average balances
have been calculated using the average daily balances during the period.
Interest and dividends are not reported on a tax equivalent basis. Nonaccrual
loans are included in the average balance of net loans receivable and are
considered to carry a zero yield.

                                                                                           Three Months Ended September 30,
                                                                          2022                                                          2021
                                                    Average             Interest             Yield /              Average             Interest             Yield /
                                                    Balance           Earned / Paid            Cost               Balance           Earned / Paid            Cost
                                                                                                (Dollars in thousands)
Assets
Loans receivable, net                            $ 1,132,233          $   13,618                 4.77  %       $ 1,094,124          $   12,508                 4.54  %
Investment securities, taxable                       197,228               1,480                 2.98              160,230                 695         

1.72

Investment securities, non-taxable                    23,016                 129                 2.22               27,031                 123          

1.81

Interest-earning deposits with
banks                                                 24,565                 125                 2.02               68,618                  24                 0.14
FHLB stock                                             5,923                  83                 5.56                6,465                  84                 5.15
Total interest-earning assets                      1,382,965              15,435                 4.43            1,356,468              13,434                 3.93
Noninterest earning assets                            87,851                                                        80,333
Total average assets                             $ 1,470,816                                                   $ 1,436,801

Liabilities and Stockholders' Equity
Interest-bearing demand                          $   102,377          $      151                 0.59  %       $   108,578          $       21                 0.08  %
Savings                                               24,619                   2                 0.03               22,939                   2                 0.03
Money market                                         592,331                 959                 0.64              568,494                 409                 0.29
Certificates of deposit, retail                      267,300                 874                 1.30              316,529               1,180                 1.48
Brokered deposits                                     69,452                 340                 1.94                    -                   -                    -
Total interest-bearing deposits                    1,056,079               2,326                 0.87            1,016,540               1,612                 0.63
Borrowings                                           105,272                 392                 1.48              120,000                 431                 1.42
Total interest-bearing liabilities                 1,161,351               2,718                 0.93            1,136,540               2,043         

0.71

Noninterest bearing liabilities                      150,950                                                       138,369
Average equity                                       158,515                                                       161,892
Total average liabilities and equity             $ 1,470,816                                                   $ 1,436,801
Net interest income                                                   $   12,717                                                    $   11,391
Net interest margin                                                                              3.65  %                                                       3.33  %



Provision 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. 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 allowance is
                                       49

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established in the ALLL for the loan. The amount of the specific allowance 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 substandard or placed on
nonaccrual status are deemed to be collateral based loans. 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 allowance 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.

During the three months ended September 30, 2022, management evaluated the
adequacy of the ALLL and concluded that a $400,000 recapture of provision for
loan losses was appropriate. This recapture was primarily attributed to the
downgrade to substandard of a $6.3 million participant interest in a loan
secured by a senior housing/assisted living facility previously downgraded to
special mention in the quarter ended March 31, 2022. This loan was analyzed for
impairment to determine if a specific allowance was required. The analysis
concluded that no losses were anticipated, resulting in a decrease to the
general allowance which offset the increase due to our loan growth, resulting in
the recapture of provision for loan losses. In comparison, a $100,000 of
provision for loan losses was made in the three months ended September 30, 2021.
For more information, see Note 5 - Loans Receivable--ALLL.

  Noninterest Income. Noninterest income decreased $221,000 to $778,000 for the
quarter ended September 30, 2022, as compared to the quarter ended September 30,
2021.

The following table presents a detailed analysis of the variations in the components of non-interest income:

                                     Three Months           Three Months          Change from Three
                                   Ended September        Ended September           Months Ended
                                       30, 2022               30, 2021           September 30, 2021           Percent Change
                                                                      (Dollars in thousands)

BOLI income                        $         243          $         377          $           (134)                     (35.5) %
Wealth management revenue                     89                     64                        25                       39.1
Deposit related fees                         245                    228                        17                        7.5
Loan related fees                            195                    300                      (105)                     (35.0)
Other                                          6                     30                       (24)                     (80.0)
Total noninterest income           $         778          $         999          $           (221)                     (22.1)



  During the three months ended September 30, 2022, as compared to the three
months ended September 30, 2021, BOLI income decreased $134,000, as $161,000 in
death benefits proceeds was recognized in the three months ended September 30,
2021. Also contributing to the decrease in noninterest income was the $105,000
decrease in loan related fees, including a $131,000 decrease in loan prepayment
fees.

  Noninterest Expense. Noninterest expense increased $681,000 to $9.0 million
for the three months ended September 30, 2022, from $8.3 million for the three
months ended September 30, 2021.















                                       50
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The following table presents a detailed analysis of the variations of the components of non-interest expenses:

                                                                                                          Change from Three
                                                   Three Months Ended         Three Months Ended            Months Ended
                                                   September 30, 2022         September 30, 2021         September 30, 2021           Percent Change
                                                                                         (Dollars in thousands)
Salaries and employee benefits                    $           5,417          $           4,856          $              561                      11.6  %
Occupancy and equipment                                       1,188                      1,116                          72                       6.5
Professional fees                                               549                        502                          47                       9.4
Data processing                                                 675                        626                          49                       7.8

Regulatory assessments                                          105                        121                         (16)                    (13.2)
Insurance and bond premiums                                     112                        106                           6                       5.7
Marketing                                                        92                         64                          28                      43.8
Other general and administrative                                876                        942                         (66)                     (7.0)
Total noninterest expense                         $           9,014          $           8,333          $              681                       8.2



During the three months ended September 30, 2022, salaries and employee benefits
increased $561,000 as compared to the three months ended September 30, 2021,
primarily due to higher than normal vacancies in staffing in the year ago
quarter as 10 open positions were filled during the current quarter and higher
incentive commissions were paid for one-to-four family residential loan
originations. Occupancy and equipment expense increased $72,000, due primarily
to the $64,000 increase in facilities and equipment maintenance. Other general
and administrative expenses decreased $66,000, due primarily to a $207,000 loss
on sale of OREO properties for the three months ended September 30, 2021, which
offset increased postage, subscription, conference attendance, and business
entertainment related expenses this quarter as business generating opportunities
continue to increase.

Federal income tax expense. The provision for federal income tax has been increased to
$935,000 for the three months ended September 30, 2022compared to $758,000
for the same period in 2021, mainly due to a $924,000 increase in income before provision for federal income tax.

Comparison of operating results for the nine months ended September 30, 2022 and 2021

General. Net income for the nine months ended September 30, 2022 was $10.0
million, or $1.10 per diluted share as compared to net income of $9.5 million,
or $0.99 per diluted share for the nine months ended September 30, 2021. The
increase in net income was primarily the result of a $2.5 million improvement in
net interest income and a $600,000 increase in the recapture of provision for
loan losses outpacing the $2.3 million increase in noninterest expense and
$208,000 decline in noninterest income between the periods.

Net Interest Income. Net interest income for the nine months ended September 30,
2022 was $35.9 million, as compared to $33.4 million for the same period in
2021, due to both increases in interest income and decreases in interest expense
between the periods.

Interest income increased by $1.4 million for the nine months ended September
30, 2022, as compared to the same period in 2021, including a $1.2 million
increase from investment securities. The average loan yield decreased slightly
to 4.52% for the nine months ended September 30, 2022, compared to 4.61% in the
nine months ended September 30, 2021. The $785,000 adverse impact to interest
income from this decrease in the average yield on loans was more than offset by
an increase of $906,000 resulting from the $26.2 million increase in average
loan balances. The average loan yield for the nine months ended September 30,
2021, was positively impacted by significantly higher net deferred fee
recognition from the forgiveness of PPP loans, totaling $1.6 million as compared
to $247,000 in the current nine month period. In addition, the prior year period
included $394,000 in interest and late charges received from the payoff of a
$2.0 million nonperforming loan.

Interest income from investment securities increased $1.2 million, primarily as
a result of an increase in both the average yield and average balance of taxable
investment securities. The average yield of taxable securities increased 64
basis points to 2.48% for the nine months ended September 30, 2022, from 1.84%
for the nine months ended September 30, 2021. The average balance of taxable
investment securities increased $21.9 million for the nine months ended
September 30, 2022, as compared to the same period in 2021.
                                       51

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Interest income from interest-earning deposits had a $128,000 increase for the
nine months ended September 30, 2022, as compared to the same period in 2021,
with an increase in average yield to 0.76% from 0.11%, partially offset by a
$29.7 million decrease in the average balance of these deposits between periods.

Deposit interest expense decreased by $800,000 for the nine months ended
September 30, 2022, as compared to the nine months ended September 30, 2021. The
average cost of interest-bearing deposits decreased 12 basis points between the
periods primarily due to a shift in balances from higher cost certificates of
deposit into money market accounts. Interest expense for retail certificates of
deposit decreased $2.0 million due to a decrease of $81.9 million in the average
balance and a 46 basis point reduction in the average cost between periods.
Partially offsetting this improvement, interest expense on money market accounts
increased $609,000 due primarily to a nine basis point increase in the average
cost and an increase of $77.1 million in the average balance between periods.
Further, brokered deposit interest expense totaled $381,000 in the nine months
ended September 30, 2022, compared to none in the prior year period. During the
nine months ended September 30, 2022, we supplemented our funding needs with an
average balance of $28.4 million of brokered deposits.

Interest expense on borrowings declined $257,000 for the nine months ended
September 30, 2022, as compared to the nine months ended September 30, 2021. The
average cost of borrowings decreased to 1.32% for the nine months ended
September 30, 2022, from 1.41% for the nine months ended September 30, 2021, and
the average balance decreased by $18.4 million between periods. Reductions in
both the average balance and cost of borrowings were primarily due to the
repayment of $25.0 million in FHLB advances due to a maturing interest rate swap
agreement, and the $25.0 million of fixed rate FHLB advances secured at lower
rates upon the onset of $25.0 million of previously contracted forward-starting
interest rate swap agreements in October 2021.
The Company's net interest margin increased to 3.54% for the nine months ended
September 30, 2022, from 3.34% for the nine months ended September 30, 2021.
This increase was due primarily to the improvement in both interest income from
interest-earning assets and interest expense from interest-bearing liabilities,
as outlined above. For more information on this, see "How We Measure the Risk of
Interest Rate Changes" in Item 3 of this Form 10-Q.


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The following table details the change in net interest income due to changes in yield or cost, or changes in the average balance of the related asset or liability:


                                                                 Nine 

Months ended September 30, 2022

Compared to September 30, 2021

                                                                        Net Change in Interest
                                                              Rate               Volume             Total
                                                                            (In thousands)
Interest-earning assets:
  Loans receivable, net                                  $      (785)       

$906 $121

  Investment securities, taxable                                 838                301              1,139
Investment securities, non-taxable                                38                 (2)                36
  Interest-earning deposits with banks                           153                (25)               128
  FHLB stock                                                       7                (26)               (19)
Total net change in income on interest-earning assets            251              1,154              1,405

Interest-bearing debts:

  Interest-bearing demand                                        154                 (3)               151
  Savings                                                          -                  1                  1
  Money market                                                   431                178                609
  Certificates of deposit, retail                               (945)            (1,041)            (1,986)
  Brokered deposits                                              381                  -                381
  Borrowings                                                     (63)              (194)              (257)
Total net change in expense on interest-bearing
liabilities                                                      (42)            (1,059)            (1,101)
Total net change in net interest income                  $       293          $   2,213          $   2,506




                                       53
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The following table compares detailed average balances, associated yields and
rates, and the resulting changes in interest and dividend income or expense for
the nine months ended September 30, 2022 and 2021. Nonaccrual loans are included
in the average balance of net loans receivable and are considered to carry a
zero yield.

                                                                                                Nine Months Ended September 30,
                                                                            2022                                                               2021
                                                                            Interest                                                           Interest
                                                  Average Balance        

Return or cost earned/paid Average balance Return or cost earned/paid

                                                                                                    (Dollars in thousands)

Assets

Loans receivable, net                           $      1,121,642          $   37,893                 4.52  %       $      1,095,380          $   37,772                 4.61  %
Investment securities, taxable                           173,562               3,225                 2.48                   151,646               2,086                 1.84
Investment securities, non-taxable                        23,532                 370                 2.10                    23,660                 334                 1.89
Interest-earning deposits with
banks                                                     32,051                 181                 0.76                    61,722                  53                 0.11
FHLB stock                                                 5,767                 228                 5.29                     6,454                 247                 5.12
Total interest-earning assets                          1,356,554              41,897                 4.13                 1,338,862              40,492                 4.04
Noninterest earning assets                                85,575                                                             79,674
Total average assets                            $      1,442,129                                                   $      1,418,536

Liabilities and Stockholders' Equity
Interest-bearing demand                         $        102,509          $      221                 0.29  %       $        106,857          $       70                 0.09  %
Savings                                                   23,856                   5                 0.03                    21,201                   4                 0.03
Money market                                             602,742               1,825                 0.40                   525,615               1,216                 0.31
Certificates of deposit, retail                          274,813               2,550                 1.24                   356,707               4,536                 1.70
Brokered deposits                                         28,407                 381                 1.79                         -                   -                    -
Total interest-bearing deposits                        1,032,327               4,982                 0.65                 1,010,380               5,826                 0.77
Borrowings                                               101,740               1,006                 1.32                   120,165               1,263                 1.41
Total interest-bearing liabilities                     1,134,067               5,988                 0.71                 1,130,545               7,089                 0.84
Noninterest bearing liabilities                          149,523                                                            127,997
Average equity                                           158,539                                                            159,994
Total average liabilities and equity            $      1,442,129                                                   $      1,418,536
Net interest income                                                       $   35,909                                                         $   33,403
Net interest margin                                                                                  3.54  %                                                            3.34  %



Provision for Loan Losses. During the nine months ended September 30, 2022,
management evaluated the adequacy of the ALLL and concluded that a recapture of
provision for loan losses in the amount of $900,000 was appropriate for the
period. This recapture was primarily due to $14.4 million of loans downgraded to
substandard, resulting in these loans being removed from the calculation of the
general allowance for loan losses. An individual analysis of these loans for
required specific reserves was instead performed which indicated no additional
specific allowance was needed. For additional information, see "Comparison of
Financial Condition at September 30, 2022, and December 31, 2021 - Loans
Receivable" discussed above.

Changes in the composition of our loan portfolio, with growth in one-to-four
family residential, consumer and multifamily loans and a decline in
construction/land loans with over $20.0 million of these loans converting to
permanent multifamily loans during the period, and reduced balances in higher
risk construction/land development loans also contributed to the recapture of
provision for the nine months ended September 30, 2022. In comparison, a
recapture of provision for loan losses in the amount of $300,000 was recognized
for the nine months ended September 30, 2021, primarily the result of downgrades
to substandard of $10.5 million of loans. These loans, secured by a bowling
alley, roller skating and restaurant location, and a separate hostel business
were adversely impacted by the COVID-19 pandemic and are included in substandard
                                       54

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loans at September 30, 2021. Our impairment analysis on these properties showed
no anticipated loss on them, resulting in a decline of general allowance and
recapture of provision. For more information, see Note 5 - Loans Receivable -
ALLL.


The following table presents certain credit ratios at the periods indicated and for each of the components of the calculation of the ratios.

                                                                   At or 

For the nine months ended September 30,

                                                                           2022                         2021
                                                                               (Dollars in thousands)
ALLL as a percent of total loans                                                 1.27    %                   1.35  %
ALLL at period end                                              $              14,726            $         15,057
Total loans outstanding                                                     1,157,973                   1,117,358

Non-accrual loans as a percentage of total loans outstanding at
period end                                                                       0.02    %                      -  %
Total non-accrual loans                                         $                 232            $              -
Total loans outstanding                                                     1,157,973                   1,117,358

ALLL as a percent of non-accrual loans at period end                         6,347.41    %                       n/a
ALLL at period end                                              $              14,726            $         15,057
Total non-accrual loans                                                           232                           -

Net collections over the period to average outstanding loans: Residential one-family to four-family:

                                                     -    %                   0.05  %
Net recoveries during period                                    $                   6            $            183
Average loans receivable, net (1)                                             419,839                     372,679
Multifamily:                                                                        -    %                      -  %
Net recoveries during period                                    $                   -            $              -
Average loans receivable, net (1)                                             133,552                     140,172
Commercial:                                                                         -    %                      -  %
Net recoveries during period                                    $                   -            $              -
Average loans receivable, net (1)                                             409,784                     375,575
Construction/land development:                                                      -    %                      -  %
Net recoveries during period                                    $                   -            $              -
Average loans receivable, net (1)                                              74,738                      98,031
Business:                                                                           -    %                      -  %
Net recoveries during period                                    $                   -            $              -
Average loans receivable, net (1)                                              32,991                      68,297
Consumer:                                                                       (0.07)   %                      -  %
Net recoveries during period                                    $                 (37)           $              -
Average loans receivable, net (1)                                              50,738                      40,626
Total loans:                                                                        -    %                   0.02  %
Net recoveries during period                                                      (31)                        183
Average loans receivable, net (1)                                           1,121,642                   1,095,380


_______________

(1) Average loans receivable, net balances, includes unearned loans and deferred charges.


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Noninterest Income. Noninterest income decreased $208,000 to $2.5 million for
the nine months ended September 30, 2022, as compared to $2.7 million for the
nine months ended September 30, 2021. The following table provides a detailed
analysis of the changes in the components of noninterest income:

                                                                                              Change from
                                     Nine Months Ended          Nine Months Ended          Nine Months Ended
                                     September 30, 2022         September 30, 2021         September 30, 2021         Percent Change
                                                                          (Dollars in thousands)

BOLI income                         $             782          $             891          $            (109)                  (12.2) %
Wealth management revenue                         276                        391                       (115)                  (29.4)
Deposit related fees                              705                        654                         51                     7.8
Loan related fees                                 748                        714                         34                     4.8
Other                                              17                         86                        (69)                  (80.2)
Total noninterest income            $           2,528          $           2,736          $            (208)                    7.6



Wealth management revenue decreased $115,000 for the nine months ended September
30, 2022, as compared to the same period in 2021, primarily due to a reduction
in sales, impacted in part by reduced sales personnel and staff turnover. Also
contributing to the decrease in noninterest income, BOLI income decreased
$109,000, primarily as a result of $161,000 of death benefit proceeds received
in 2021 with no similar proceeds received in 2022. Partially offsetting these
decreases, deposit related fees increased $51,000 primarily from debit card
related service fees reflecting increased usage as businesses reopened and the
economy improved in our markets.

Noninterest Expense. Noninterest expense increased $2.3 million to $26.9 million
for the nine months ended September 30, 2022, as compared to $24.7 million for
the same period in 2021.

The following table presents a detailed analysis of the variations of the components of non-interest expenses:

                                                                                                            Change from
                                                   Nine Months Ended         Nine Months Ended           Nine Months Ended
                                                  September 30, 2022         September 30, 2021         September 30, 2021           Percent Change
                                                                                        (Dollars in thousands)
Salaries and employee benefits                    $         16,156          $          14,863          $            1,293                      8.7  %
Occupancy and equipment                                      3,621                      3,403                         218                      6.4
Professional fees                                            1,732                      1,423                         309                     21.7
Data processing                                              2,044                      2,003                          41                      2.0
Regulatory assessments                                         295                        356                         (61)                   (17.1)
Insurance and bond premiums                                    354                        341                          13                      3.8
Marketing                                                      226                        116                         110                     94.8
Other general and administrative                             2,497                      2,146                         351                     16.4
Total noninterest expense                         $         26,925          $          24,651          $            2,274                      9.2



During the nine months ended September 30, 2022, as compared to the same period
in 2021, salaries and employee benefits increased $1.3 million primarily due to
an increase in the number of employees, with higher than normal vacancies in
staffing in the year ago period, and higher incentive commissions paid for
increased production of one-to-four family residential loans paid in the current
period. Occupancy and equipment expense increased $218,000 during the nine
months ended September 30, 2022, due primarily to an $126,000 increase in
facilities and equipment maintenance, office improvements of $55,000, and
increased lease rental expense of $41,000 between the periods. Professional fees
increased $309,000 for the nine months ended September 30, 2022, as compared to
the same prior year period, due in part to fees paid to human resources
                                       56

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recruiters to attract employees in this competitive employment environment,
along with $167,000 in regulatory examination fees paid in the nine months ended
September 30, 2022, with no comparable expenses in the nine months ended
September 30, 2021. Marketing expense increased $110,000 primarily due to
increased marketing/promotional campaigns. Other general and administrative
expense increased $351,000, due to increases in travel expenses, postage
relating to the aforementioned marketing expenses, subscription and business
entertainment related expenses as business generating opportunities increased
this year. Partially offsetting these increases was a $61,000 decrease to
regulatory assessments primarily due to the true-up of estimated expenses.

  Federal Income Tax Expense. The federal income tax provision increased
$117,000 for the nine months ended September 30, 2022, primarily as a result of
a $624,000 increase in income before federal income taxes for the nine months
ended September 30, 2022, as compared to the same period in 2021.

Cash and capital resources

We are required to have sufficient cash flow in order to maintain proper
liquidity to ensure a safe and sound operation. We maintain cash flows above the
minimum level believed to be adequate to meet the requirements of normal
operations, including potential deposit outflows. On a daily basis, we review
and update cash flow projections to ensure that adequate liquidity is
maintained.

Our primary sources of funds are customer deposits, scheduled loan and
investment repayments, including interest payments, maturing loans and
investment securities, and advances from the FHLB. These funds, together with
equity, are used to fund loans, acquire investment securities and other assets,
and fund continuing operations. While maturities and the scheduled amortization
of loans are a predictable source of funds, deposit flows and mortgage
prepayments are greatly influenced by the level of interest rates, economic
conditions and competition. We believe that our current liquidity position, and
our forecasted operating results are sufficient to fund all of our existing
commitments.

Liquidity management is both a daily and long-term function of business
management. Excess liquidity is generally invested in short-term investments
such as overnight deposits or agency or mortgage-backed securities. On a longer
term basis, we maintain a strategy of investing in various lending products. We
use our sources of funds primarily to meet ongoing commitments, to pay maturing
certificates of deposit and withdrawals on other deposit accounts, to fund loan
commitments, and to maintain our portfolio of investment securities. At
September 30, 2022, the undisbursed portion of construction LIP and unused
portion of lines of credit totaled $46.4 million and $30.6 million,
respectively. Certificates of deposit scheduled to mature in one year or less at
September 30, 2022, totaled $174.6 million. Management's policy is to maintain
deposit rates at levels that are competitive with other local financial
institutions. Based on historical experience, we believe that a significant
portion of maturing certificates of deposit will remain with First Financial
Northwest Bank.

We measure our liquidity based on our ability to fund our assets and to meet
liability obligations when they come due. Liquidity (and funding) risk occurs
when funds cannot be raised at reasonable prices or in a reasonable time frame
to meet our normal or unanticipated obligations. We regularly monitor the mix
between our assets and our liabilities to manage effectively our liquidity and
funding requirements.

When retail deposits are not sufficient to provide the funds for our assets, or
if other sources are available with more favorable rates or structure, we use
alternative funding sources. These sources include, but are not limited to,
advances from the FHLB, wholesale funding, brokered deposits, federal funds
purchased, and dealer repurchase agreements, as well as other short-term
alternatives. We may also liquidate assets to meet our funding needs. During the
third quarter of 2022, we supplemented our funding with $69.5 million in
brokered deposits as their rates and terms were deemed most appropriate to
achieve our asset/liability objectives. At September 30, 2022, brokered deposits
consisted of $44.5 million of brokered certificates of deposit and $25.0 million
of interest-bearing demand deposits. At September 30, 2022 the Bank maintained
credit facilities with the FHLB totaling $654.6 million, subject to qualifying
collateral limits that reduced our pledged collateral to $426.5 million, with an
outstanding balance of $150.0 million. As further funding sources, we also had
the ability to borrow $75.7 million from the FRB, and $75.0 million from unused
lines of credit with other financial institutions, with no balance outstanding
from these sources at September 30, 2022. For additional information, see the
Consolidated Statements of Cash Flows in Item 1 of this report.

On a monthly basis, we estimate our liquidity sources and needs for the next twelve months. We also determine funding concentrations and our needs for funding sources other than deposits. This information is used by our Asset/Liability Management Committee to forecast funding needs and investment opportunities.

                                       57

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We incur capital expenditures on an ongoing basis to expand and improve our
product offerings, enhance and modernize our technology infrastructure, and to
introduce new technology-based products to compete effectively in our markets.
We evaluate capital expenditure projects based on a variety of factors,
including expected strategic impacts (such as forecasted impact on revenue
growth, productivity, expenses, service levels and customer retention) and our
expected return on investment. The amount of capital investment is influenced
by, among other things, current and projected demand for our services and
products, cash flow generated by operating activities, cash required for other
purposes and regulatory considerations.

Based on our current capital allocation objectives, during the remainder of
fiscal 2022 we expect cash expenditures of $432,000 for capital investment in
property, plant and equipment. In addition, we currently expect to continue our
current practice of paying quarterly cash dividends on our common stock subject
to our Board of Directors' discretion to modify or terminate this practice at
any time and for any reason without prior notice. Our current quarterly common
stock dividend rate is $0.12 per share, as approved by our Board of Directors,
which we believe is a dividend rate per share which enables us to balance our
multiple objectives of managing and investing in the Bank, and returning a
substantial portion of our cash to our shareholders. Assuming continued payment
during 2022 at this rate of $0.12 per share, our average total dividend paid
each quarter would be approximately $1.1 million, based on the number of our
current outstanding shares (which assumes no increases or decreases in the
number of shares, except in connection with the anticipated vesting of currently
outstanding equity awards).

At September 30, 2022, we project that our fixed commitments for the remainder
of the fiscal year ending December 31, 2022, will include (i) $214,000 of
operating lease payments and (ii) other future obligations and accrued expenses
of $23.5 million. At September 30, 2022, $95.0 million of our $150.0 million in
FHLB borrowings were short-term and tied to interest rate swap agreements and
are expected to be renewed as they mature during 2022. We believe that our
liquid assets combined with the available lines of credit provide adequate
liquidity to meet our current financial obligations for at least the next 12
months.

Our total stockholders' equity was $157.9 million at September 30, 2022.
Consistent with our goal to operate a sound and profitable financial
organization we actively seek to maintain the Bank as a "well capitalized"
institution in accordance with regulatory standards. As of September 30, 2022,
First Financial Northwest Bank exceeded all regulatory capital requirements.
Regulatory capital ratios for First Financial Northwest Bank were as follows as
of September 30, 2022: Total capital to risk-weighted assets was 15.49%; Tier 1
capital and Common equity tier 1 capital to risk-weighted assets was 14.24%; and
Tier 1 capital to total assets was 10.43%. At September 30, 2022, First
Financial Northwest Bank met the financial ratios to be considered
well-capitalized under the regulatory guidelines. In addition, the Bank is
required to maintain a capital conservation buffer consisting of additional
Common equity Tier 1 capital greater than 2.5% of risk-weighted assets above the
required minimum regulatory capital levels in order to avoid limitations on
paying dividends, engaging in share repurchases, and paying discretionary
bonuses based on percentages of eligible retained income that could be utilized
for such actions. At September 30, 2022, the Bank's capital conservation buffer
was 7.49%. See Item 1. "Business - How We Are Regulated - Regulation and
Supervision of First Financial Northwest Bank - Capital Requirements" included
in the 2021 Form 10-K for additional information regarding regulatory capital
requirements for the Bank.

The Accumulated Other Comprehensive Income ("AOCI") component of capital
includes a variety of items, including the value of our available-for-sale
investment securities portfolio and the value of our derivative instruments, net
of tax. We model various interest rate scenarios that could impact these
elements of AOCI and believe that we have sufficient capital to withstand the
estimated potential fluctuations in a variety of interest rate environments.

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