UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549


FORM
10-Q





[X]
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For the
quarterly period ended March 31, 2009





or





[  ]
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
      the transition period from _____ to
_____





Commission File
Number:  001-33652





FIRST FINANCIAL NORTHWEST,
    INC.(Exact
      name of registrant as specified in its
charter)





Washington
            
            26-0610707(State
      or other jurisdiction of incorporation
            
            (I.R.S.
      Employeror
      organization)
            
            I.D.
      Number)





201 Wells Avenue South, Renton,
      Washington
            
            98057(Address
      of principal executive offices)
            
            (Zip
      Code)





Registrant’s
telephone number, including area code: (425)
255-4400





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.    Yes [ X ]    No
[  ]





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).    Yes [   ]    No
[   ]





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.




Large accelerated filer     [ 
       ]
            Accelerated filer     [ X ]
            Non-accelerated filer     [
        ]
            Smaller reporting company     [
        ]







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











Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date:  As of May 6, 2009,
20,363,120 shares of the issuer’s common stock, $0.01 par value per share, were
outstanding.






2





FIRST
FINANCIAL NORTHWEST, INC.


FORM
10-Q


TABLE
OF CONTENTS








PART
      1 - FINANCIAL INFORMATIONPageItem
      1 - Consolidated Financial Statements (Unaudited)
              4Item
      2 - Management’s Discussion and Analysis of Financial
      Conditionand
      Results of Operations
              20Item
      3 - Quantitative and Qualitative Disclosures About Market
    Risk
              33Item
      4 - Controls and Procedures
              37PART
      II - OTHER INFORMATIONItem
      1 - Legal Proceedings
              38Item
      1A - Risk Factors
              38Item
      2 - Unregistered Sales of Equity Securities and Use of
      Proceeds
              38Item
      3 - Defaults upon Senior Securities
              38Item
      4 - Submission of Matters to a Vote of Security Holders
              38Item
      5 - Other Information
              39Item
      6 - Exhibits
              39SIGNATURES
              40







3


Item
1.  Consolidated Financial Statements (Unaudited)


FIRST FINANCIAL NORTHWEST, INC.
      AND SUBSIDIARIESConsolidated Balance
      Sheets(Dollars in thousands, except
      share data)(Unaudited)March 31,
                                
                                
                                December
31,Assets
                                
                                2009
                                
                                
                                2008Cash on hand and in
      banks
                                
                                $
                                2,532
                                
                                
                                $
                                3,366Interest-bearing
      deposits
                                
                                
                                31,776
                                
                                
                                
                                600Federal funds
      sold
                                
                                
                                3,105
                                
                                
                                
                                1,790Investments available for
      sale
                                
                                
                                140,644
                                
                                
                                
                                149,323Loans receivable, net of allowance
      of $14,294 and $16,982
                                
                                
                                1,031,186
                                
                                
                                
                                1,035,181Premises and equipment,
      net
                                
                                
                                13,182
                                
                                
                                
                                13,026Federal Home Loan Bank stock, at
      cost
                                
                                
                                7,413
                                
                                
                                
                                7,413Accrued interest
      receivable
                                
                                
                                5,794
                                
                                
                                
                                5,532Deferred tax assets,
      net
                                
                                
                                8,577
                                
                                
                                
                                9,266Goodwill
                                
                                
                                14,206
                                
                                
                                
                                14,206Prepaid expenses and other
      assets
                                
                                
                                3,367
                                
                                
                                
                                4,737Total
assets
                                
                                $
                                1,261,782
                                
                                
                                $
                                1,244,440Liabilities and Stockholders' EquityDeposits
                                
                                $
                                821,186
                                
                                
                                $
                                791,483Advances from the Federal Home
      Loan Bank
                                
                                
                                148,150
                                
                                
                                
                                156,150Advance payments from borrowers
      for taxesand
    insurance
                                
                                
                                4,758
                                
                                
                                
                                2,745Accrued interest
      payable
                                
                                
                                494
                                
                                
                                
                                478Federal income tax
      payable
                                
                                
                                94
                                
                                
                                
                                336Other
      liabilities
                                
                                
                                3,736
                                
                                
                                
                                3,140Total
      liabilities
                                
                                
                                978,418
                                
                                
                                
                                954,332Commitments
      and contingenciesStockholders'
      EquityPreferred stock, $0.01 par value;
      authorized 10,000,000shares, no shares issued or
      outstanding
                                
                                
                                —
                                
                                
                                
                                —Common stock, $0.01 par value;
      authorized 90,000,000shares; issued and outstanding
      20,363,120 and21,293,368 shares at March
      31, 2009 andDecember 31,
      2008
                                
                                
                                204
                                
                                
                                
                                213Additional paid-in
      capital
                                
                                
                                195,110
                                
                                
                                
                                202,167Retained earnings, substantially
      restricted
                                
                                
                                101,887
                                
                                
                                
                                102,358Accumulated other comprehensive
      income, net of tax
                                
                                
                                1,398
                                
                                
                                
                                887Unearned Employee Stock Ownership
      Plan (ESOP) shares
                                
                                
                                (15,235
                                )
                                
                                
                                (15,517
                                )Total stockholders'
      equity
                                
                                
                                283,364
                                
                                
                                
                                290,108Total liabilities and
      stockholders' equity
                                
                                $
                                1,261,782
                                
                                
                                $
                                1,244,440See accompanying notes to
      consolidated financial statements.


4


FIRST FINANCIAL NORTHWEST, INC.
      AND SUBSIDIARIESConsolidated Statements of
      Income(Dollars in thousands, except
      share data)(Unaudited)Three Months
      EndedMarch
31,2009
                                        
                                        2008Interest
    incomeLoans, including
      fees
                                        $
                                        15,123
                                        
                                        $
                                        15,069Investments available for
      sale
                                        
                                        1,625
                                        
                                        
                                        1,653Federal funds sold and
      interest-bearing deposits with banks
                                        2
                                        
                                        
                                        536Dividends on Federal Home Loan
      Bank stock
                                        
                                        —
                                        
                                        
                                        11Total interest
      income
                                        $
                                        16,750
                                        
                                        $
                                        17,269Interest
      expenseDeposits
                                        
                                        
                                        7,329
                                        
                                        
                                        8,079Federal Home Loan Bank
      advances
                                        
                                        1,246
                                        
                                        
                                        1,029Total interest
      expense
                                        $
                                        8,575
                                        
                                        $
                                        9,108Net interest
      income
                                        
                                        8,175
                                        
                                        
                                        8,161Provision for loan
      losses
                                        
                                        1,544
                                        
                                        
                                        —Net interest income after
      provision for loan losses
                                        $
                                        6,631
                                        
                                        $
                                        8,161Noninterest
      incomeNetgainon sale of
      investments
                                        
                                        76
                                        
                                        
                                        1,373Other
                                        
                                        
                                        
                                        54
                                        
                                        
                                        (10)Total noninterest
      income
                                        $
                                        130
                                        
                                        $
                                        1,363Noninterest
      expenseSalaries and employee
      benefits
                                        
                                        3,039
                                        
                                        
                                        1,761Occupancy and
      equipment
                                        
                                        350
                                        
                                        
                                        294Professional
      fees
                                        
                                        307
                                        
                                        
                                        295Data
    processing
                                        
                                        144
                                        
                                        
                                        113FDIC/OTS
      assessments
                                        
                                        682
                                        
                                        
                                        30Other general and
      administrative
                                        
                                        622
                                        
                                        
                                        393Total noninterest
      expense
                                        $
                                        5,144
                                        
                                        $
                                        2,886Income before provision for
      federal income taxes
                                        1,617
                                        
                                        
                                        6,638Provision for federal income
      taxes
                                        
                                        421
                                        
                                        
                                        2,166Net income
                                        $
                                        1,196
                                        
                                        $
                                        4,472Basic earnings per
      share
                                        $
                                        0.06
                                        
                                        $
                                        0.21Diluted earnings per
      share
                                        $
                                        0.06
                                        
                                        $
                                        0.21See accompanying notes to
      consolidated financial
statements.


5


FIRST FINANCIAL NORTHWEST,
      INC.AND
      SUBSIDIARIESConsolidated Statements of
      Stockholders' Equity and Comprehensive IncomeFor the Three Months Ended March
      31, 2009(Dollars in thousands, except
      share data)(Unaudited)AccumulatedAdditional
                                  
                                  
                                  
                                  Other
                                  
                                  Unearned
                                  
                                  TotalCommon
                                  
                                  Paid-in
                                  
                                  Retained
                                  
                                  Comprehensive
                                  
                                  ESOP
                                  
                                  Stockholders'Shares
                                  
                                  
                                  Stock
                                  
                                  Capital
                                  
                                  Earnings
                                  
                                  Income, net of
      tax
                                  Shares
                                  
                                  EquityBalances at December 31,
      2008
                                  21,293,368
                                  
                                  $
                                  213
                                  $
                                  202,167
                                  $
                                  102,358
                                  $
                                  887
                                  $
                                  (15,517)
                                  $
                                  290,108Comprehensive
      income:Net income
                                  
                                  —
                                  
                                  
                                  —
                                  
                                  —
                                  
                                  1,196
                                  
                                  —
                                  
                                  —
                                  
                                  1,196Change in fair value of
      investmentsavailable for sale, net of tax of
      $276
                                  —
                                  
                                  
                                  —
                                  
                                  —
                                  
                                  —
                                  
                                  511
                                  
                                  —
                                  
                                  511Total comprehensive
      income
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  1,707Cash dividend declared and paid
      ($0.085 per share)
                                  —
                                  
                                  
                                  —
                                  
                                  —
                                  
                                  (1,667)
                                  
                                  —
                                  
                                  —
                                  
                                  (1,667)Purchase and retirement of common
      stock
                                  (930,248)
                                  
                                  
                                  (9)
                                  
                                  (7,524)
                                  
                                  —
                                  
                                  —
                                  
                                  —
                                  
                                  (7,533)Compensation related to stock
      optionsand restricted stock
      awards
                                  —
                                  
                                  
                                  —
                                  
                                  515
                                  
                                  —
                                  
                                  —
                                  
                                  —
                                  
                                  515Allocation of 28,212 ESOP
      shares
                                  —
                                  
                                  
                                  —
                                  
                                  (48)
                                  
                                  —
                                  
                                  —
                                  
                                  282
                                  
                                  234Balances at March 31,
      2009
                                  20,363,120
                                  
                                  $
                                  204
                                  $
                                  195,110
                                  $
                                  101,887
                                  $
                                  1,398
                                  $
                                  (15,235)
                                  $
                                  283,364See accompanying notes to
      consolidated financial
statements.


6


FIRST FINANCIAL NORTHWEST,
      INC.AND
      SUBSIDIARIESConsolidated Statements of Cash
      Flows(In
    thousands)(Unaudited)Three months
      endedMarch
31,2009
                      
                      2008Cash flows from operating
      activities:Net income
                      $
                      1,196
                      $
                      4,472Adjustments to reconcile net
      income tonet cash provided by operating
      activities:Provision for loan
      losses
                      
                      1,544
                      
                      —Depreciation and amortization of
      premises and equipment
                      197
                      
                      183Net amortization of premiums and
      discounts on investments
                      146
                      
                      157ESOP
expense
                      
                      234
                      
                      188Compensation expense related to
      stock options and restricted stock awards
                      515
                      
                      —Net realizedgain on investments available for
      sale
                      
                      (76)
                      
                      (1,373)Mutual fund
      dividends
                      
                      —
                      
                      (69)Loss from disposal of
      equipment
                      
                      —
                      
                      22Deferred federal income
      taxes
                      
                      412
                      
                      178Changes in operating assets and
      liabilities:Other
assets
                      
                      1,370
                      
                      (500)Accrued interest
      receivable
                      
                      (262)
                      
                      279Accrued interest
      payable
                      
                      16
                      
                      (48)Other
      liabilities
                      
                      596
                      
                      1,670Federal income
      taxes
                      
                      (242)
                      
                      1,088Net cash provided by operating
      activities
                      $
                      5,646
                      $
                      6,247Cash flows from investing
      activities:Proceeds from sales of
      investments
                      
                      6,853
                      
                      62,551Principal repayments on
      investments available for sale
                      
                      7,215
                      
                      8,868Purchases of investments available
      for sale
                      
                      (4,671)
                      
                      (14,113)Net increase (decrease) in loans
      receivable
                      
                      2,451
                      
                      (42,929)Purchases of Federal Home Loan
      Bank stock
                      
                      —
                      
                      (179)Purchases of premises and
      equipment
                      
                      (353)
                      
                      (22)Net cash provided by investing
      activities
                      $
                      11,495
                      $
                      14,176Balance, carried
      forward
                      $
                      17,141
                      $
                      20,423










7


FIRST FINANCIAL NORTHWEST,
      INC.AND
      SUBSIDIARIESConsolidated Statements of Cash
      Flows(In
    thousands)(Unaudited)Three months
      endedMarch 31,2009
                              
                              2008Balance, brought
      forward
                              $
                              17,141
                              $
                              20,423Cash flows from financing
      activities:Net increase in
      deposits
                              
                              29,703
                              
                              35,771Advances from the Federal Home
      Loan Bank
                              
                              15,000
                              
                              102,000Repayments of advances from the
      Federal Home Loan Bank
                              (23,000)
                              
                              (88,000)Net increase in advance payments
      from borrowers for taxes and insurance
                              2,013
                              
                              3,436Repurchase and retirement of
      common stock
                              
                              (7,533)
                              
                              —Dividends
    paid
                              
                              (1,667)
                              
                              —Net cash provided by financing
      activities
                              $
                              14,516
                              $
                              53,207Net increase in
      cash
                              
                              31,657
                              
                              73,630Cash and cash
      equivalents:Beginning of
      period
                              
                              5,756
                              
                              11,577End of
    period
                              $
                              37,413
                              $
                              85,207Supplemental disclosures of cash
      flow information:Cash paid during the period
      for:Interest
                              $
                              8,559
                              $
                              9,155Federal income
      taxes
                              $
                              450
                              $
                              900Noncash
      transactions:Transfer from investments held to
      maturity toinvestments available for
      sale
                              $
                              —
                              $
                              80,410See accompanying notes to
      consolidated financial statements.


8




FIRST
FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
 SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


Note
1 – Description of Business





First Financial Northwest, Inc. (“First Financial Northwest” or “the Company”),
a Washington corporation, was formed on June 1, 2007 for the purpose of becoming
the holding company for First Savings Bank Northwest (“First Savings Bank” or
the “Bank”) in connection with the conversion from a mutual holding company
structure to a stock holding company structure.  The mutual to stock
conversion was completed on October 9, 2007 through the sale and issuance of
22,852,800 shares of common stock by First Financial Northwest including
1,692,800 shares contributed to our charitable foundation, the First Financial
Northwest Foundation, Inc. that was established in connection with the mutual to
stock conversion. First Financial Northwest’s business activities generally are
limited to passive investment activities and oversight of its investment in
First Savings Bank.  Accordingly, the information presented in this
Form 10-Q, including the consolidated unaudited financial statements and related
data, relates primarily to First Savings Bank.





First Savings Bank was organized in 1923 as a Washington state chartered savings
and loan association, converted to a federal mutual savings and loan association
in 1935, and converted to a Washington state chartered mutual savings bank in
1992.  In 2002, First Savings Bank reorganized into a two-tier mutual
holding company structure, became a stock savings bank and became the
wholly-owned subsidiary of First Financial of Renton, Inc. In connection with
the mutual to stock conversion in 2007, First Savings Bank changed its name to
First Savings Bank Northwest.





First Savings Bank is a community-based savings bank primarily serving King and
to a lesser extent, Pierce, Snohomish and Kitsap counties, Washington through
our full-service banking office located in Renton, Washington.  Our
business strategy has included an emphasis on one-to-four family residential
mortgage and commercial real estate lending.  First Savings Bank’s
business consists of attracting deposits from the public and utilizing these
deposits to originate one-to-four family, multifamily, construction/land
development, commercial real estate and consumer loans.





Note
2 – Basis of Presentation





The
accompanying unaudited interim consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission.  Accordingly, they do not include all of the information
and footnotes required by U.S. generally accepted accounting principles for
complete financial statements.  These unaudited consolidated financial
statements should be read in conjunction with the Company’s Annual Report on
Form 10-K for the year ended December 31, 2008 as filed with the Securities and
Exchange Commission.  In our opinion, all adjustments (consisting only
of normal recurring adjustments) considered necessary for a fair presentation of
the consolidated financial statements in accordance with accounting principles
generally accepted in the United States of America (“GAAP”) have been
included.  All significant inter-company balances and transactions
among the Company and its subsidiaries have been eliminated in consolidation.
Operating results for the three months ended March 31, 2009 are not necessarily
indicative of the results that may be expected for the year ended December 31,
2009.  In preparing the unaudited consolidated financial statements,
we are required to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues, and expense. Actual results could
differ from those estimates.  Material estimates that are particularly
susceptible to significant change relate to the determination of the allowance
for losses on loans, valuation of real estate acquired in connection with
foreclosures or in satisfaction of loans and goodwill.




Certain amounts in the unaudited
consolidated financial statements for prior periods have been reclassified to
conform to the current unaudited financial statement
presentation.




9


FIRST
FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
 SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





Note
3 – Plan of Reorganization





On
November 15, 2006, and as subsequently amended on April 18, 2007, July 18, 2007,
and July 31, 2007, the Board of Directors of First Financial Holdings, MHC
approved a plan of conversion and reorganization pursuant to which First
Financial Holdings, MHC would convert from a mutual holding company to a stock
holding company. The conversion to a stock holding company was approved by the
depositors and borrowers of First Savings Bank, the Office of Thrift Supervision
(OTS) and the Washington State Department of Financial Institutions and included
the filing of a registration statement with the Securities and Exchange
Commission. Upon the completion of the conversion and reorganization on October
9, 2007, First Financial Holdings, MHC and First Financial of Renton, Inc.
ceased to exist as separate legal entities and First Financial Northwest, Inc.
became the holding company for First Savings Bank. At the time of the
conversion, First Savings Bank of Renton changed its name to First Savings Bank
Northwest. First Savings Bank along with First Financial Diversified
Corporation. became wholly owned subsidiaries of First Financial Northwest, Inc.
On October 9, 2007, the Company also issued and sold shares of capital stock to
eligible depositors and borrowers of First Savings Bank.





As part
of the conversion and reorganization, First Savings Bank elected to be treated
as a savings association rather than as a bank for holding company purposes.
First Financial Northwest, Inc. is subject to regulation by the OTS. First
Savings Bank is also regulated by the Federal Deposit Insurance Corporation
(“FDIC”) and the Washington State Department of Financial
Institutions.




Additionally,
in accordance with OTS regulations, at the time of the conversion from a mutual
holding company to a stock holding company, First Savings Bank substantially
restricted its retained earnings by establishing a liquidation account. The
liquidation account is maintained for the benefit of eligible account holders
and supplemental eligible account holders who continue to maintain their
accounts at First Savings Bank subsequent to the conversion. The liquidation
account is reduced annually to the extent that eligible account holders and
supplemental eligible account holders have reduced their qualifying deposits.
Subsequent increases will not restore an eligible account holder’s or
supplemental eligible account holder’s interest in the liquidation account. In
the event of a complete liquidation of First Savings Bank, and only in such
event, each account holder will be entitled to receive a distribution from the
liquidation account in an amount proportionate to the adjusted qualifying
account balances then held. First Savings Bank may not pay dividends if those
dividends would reduce equity capital below the required liquidation account
amount.




The Board
of Directors also approved the establishment of a charitable foundation which
was funded with authorized but unissued shares equal to 8% of the common stock
outstanding after the offering and the establishment of an ESOP.




Note
4 – Newly Issued But Not Yet Effective Accounting Standards
  In
April 2009, the Financial Accounting Standards Board (“FASB”) issued the
following three FASB Staff Positions (“FSP”) intended to provide additional
application guidance and enhance disclosures regarding fair value measurements
and impairments of securities:
  FSP
Statement of Financial Accounting Standards (“SFAS”) 157-4, “Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly,” provides
additional guidance for estimating fair value in accordance with SFAS
No. 157 when the volume and level of activity for the asset or liability
have decreased significantly.  FSP SFAS 157-4 also provides guidance on
identifying circumstances that indicate a transaction is not orderly.  The
provisions of FSP SFAS 157-4 are effective for the interim period ending on
June 30, 2009.  Management is currently evaluating
the





10




FIRST
FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
 SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


effect
that the provisions of FSP SFAS 157-4 may have on our consolidated balance
sheets and statements of income.




FSP SFAS
107-1 and Accounting Principals Board (“APB”) 28-1, “Interim Disclosures about Fair
Value of Financial Instruments,” requires disclosures about fair value of
financial instruments in interim reporting periods of publicly traded companies
that were previously only required to be disclosed in annual financial
statements.  The provisions of FSP SFAS 107-1 and APB 28-1 are effective
for the interim period ending on June 30, 2009.  As FSP SFAS 107-1 and
APB 28-1 amends only the disclosure requirements about fair value of financial
instruments in interim periods, the adoption of FSP SFAS 107-1 and APB 28-1 is
not expected to affect our consolidated balance sheets and statements of
income.




FSP SFAS
115-2 and SFAS 124-2, “Recognition and Presentation of
Other-Than-Temporary Impairments,” amends current other-than-temporary
impairment guidance in GAAP for debt securities to make the guidance more
operational and to improve the presentation and disclosure of
other-than-temporary impairments on debt and equity securities in the financial
statements.  This FSP does not amend existing recognition and measurement
guidance related to other-than-temporary impairments of equity securities. 
The provisions of FSP SFAS 115-2 and SFAS 124-2 are effective for the interim
period ending on June 30, 2009.  Management is currently evaluating
the effect that the provisions of FSP SFAS 115-2 and SFAS 124-2 may have on our
consolidated balance sheets and statements of income.


Note
5 – Investment Securities Available for Sale




Investment
securities available for sale are summarized as follows:


March 31,
    2009Gross
                        
                        GrossAmortized
                        
                        Unrealized
                        
                        UnrealizedCost
                        
                        Gains
                        
                        Losses
                        
                        Fair
  Value(In
    thousands)Mortgage-backed
      andrelated
      investments:Fannie Mae
                        
                        $
                        58,587
                        $
                        1,233
                        $
                        (9)
                        $
                        59,811Freddie Mac
                        
                        
                        55,812
                        
                        1,266
                        
                        (2)
                        
                        57,076Ginnie Mae
                        
                        
                        7,256
                        
                        35
                        
                        (17)
                        
                        7,274Tax exempt municipal
      bonds
                        
                        4,206
                        
                        24
                        
                        (454)
                        
                        3,776Taxable municipal
      bonds
                        
                        652
                        
                        —
                        
                        (44)
                        
                        608U.S. Government
      agencies
                        
                        7,367
                        
                        298
                        
                        —
                        
                        7,665Mutual fund
    (1)
                        
                        
                        
                        4,611
                        
                        —
                        
                        (177)
                        
                        4,434$
                        138,491
                        $
                        2,856
                        $
                        (703)
                        $
                        140,644


11





FIRST
FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
 SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


December 31,
      2008Gross
                      
                      GrossAmortized
                      
                      Unrealized
                      
                      UnrealizedCost
                      
                      Gains
                      
                      Losses
                      
                      Fair
  Value(In
    thousands)Mortgage-backed
      andrelated
      investments:Fannie Mae
                      
                      $
                      65,991
                      $
                      799
                      $
                      (47)
                      $
                      66,743Freddie Mac
                      
                      
                      59,296
                      
                      844
                      
                      (28)
                      
                      60,112Ginnie Mae
                      
                      
                      7,858
                      
                      11
                      
                      (177)
                      
                      7,692Tax exempt municipal
      bonds
                      
                      4,206
                      
                      16
                      
                      (523)
                      
                      3,699Taxable municipal
      bonds
                      
                      652
                      
                      —
                      
                      (41)
                      
                      611U.S. Government
      agencies
                      
                      5,344
                      
                      511
                      
                      —
                      
                      5,855Mutual fund
    (1)
                      
                      
                      
                      4,611
                      
                      —
                      
                      —
                      
                      4,611$
                      147,958
                      $
                      2,181
                      $
                      (816)
                      $
                      149,323





(1) The
majority of the fund value is invested in U.S. Government or agency securities
with additional holdings of private label securities backed by or representing
interest in mortgages or domestic residential housing or manufactured
housing.







In May 2008, the Board of Trustees of
the AMF Ultra Short Mortgage Fund (“Fund”) (a mutual fund) decided to activate
the Fund’s redemption-in-kind provision because of the uncertainty in the
mortgage-backed securities market.  The activation of this provision
has limited the options available to the shareholders of the Fund with respect
to liquidating their investments.  Only the Fund may repurchase the
shares in accordance with the terms of the Fund.  The Fund is
currently closed to new investors, which means that no new investors may buy
shares in the Fund.  Existing participants are allowed to redeem and
receive up to $250,000 in cash per quarter or may receive 100% of their
investment in “like kind” securities equal to their proportional ownership in
the Fund (i.e. ownership percentage in the Fund times the market value of each
of the approximately 120 securities).  Based on the quality of the
collateral, its performance and the approximate one-year duration of the
underlying assets of the Fund as well as the Fund’s performance for the three
months ended March 31, 2009, we have classified the decrease in the value of the
Fund as temporary.  This decrease is included in our other
comprehensive income for the first quarter of 2009.




On a quarterly basis, management makes
an assessment to determine whether there have been any events or economic
circumstances to indicate that a security on which there is an unrealized loss
is impaired on an other-than-temporary basis.  We consider many
factors including the severity and duration of the impairment, our intent and
ability to hold the security for a period of time sufficient for a recovery in
value, recent events specific to the issuer or industry, and for debt
securities, external credit ratings and recent downgrades.  Securities
on which there is an unrealized loss that is deemed to be other-than-temporary
are written down to fair value with the write-down recorded as a realized loss
in ”other-than-temporary loss on investments” on the income
statement.  Gross unrealized losses of $703,000 during the three
months ended March 31, 2009, were primarily due to interest rate changes, there
has not been significant deterioration in the financial condition of the issuer
and we have the intent and ability to hold the investment for a sufficient time
to recover the carrying value.  We have reviewed these securities in
accordance with our accounting policy for other-than-temporary impairment and
concluded that the $177,000 pre-tax decline in the market value of the AMF Ultra
Short Mortgage Fund, during the quarter ended March 31, 2009, was considered
temporary due to the current uncertainty in the marketplace.  We do
not consider any securities to be other-than-temporarily impaired.


During
April 2009, additional guidance from the FASB was issued regarding
other-than-temporary impairment which we will adopt in the second quarter of
2009.  The impact on our consolidated balance sheets and statements of
income has not been determined at this time.




12




FIRST
FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
 SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


The
amortized cost and estimated fair value of investments available for sale at
March 31, 2009, by contractual maturity, are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment
penalties.





March 31,
    2009Amortized
    Cost
                      
                      Fair
  Value(In
    thousands)Due within one
      year
                      $
                      6,606
                      $
                      6,457Due after one year through five
      years
                      
                      5,784
                      
                      5,875Due after five years through ten
      years
                      
                      39,555
                      
                      40,471Due after ten
      years
                      
                      86,546
                      
                      87,841$
                      138,491
                      $
                      140,644





Gross
proceeds from the sales of investments available for sale during the three
months ended March 31, 2009 were $6.9 million with gross gains of
$76,000.  In January 2008, the Company elected to transfer its entire
investments held to maturity portfolio to its investments available for sale
portfolio. Subsequently, a portion of the tax-exempt municipal bond portfolio
was sold.  Gross proceeds from the sales were $62.6 million with gross
gains of $1.4 million and gross losses of $56,000.




Note
6 - Loans Receivable, Net




Loans
receivable consist of the following:





March 31,
                    
                    December
  31,2009
                    
                    2008(In
    thousands)One-to-four family residential
      (1)
                    $
                    504,663
                    $
                    512,446Multifamily
      residential
                    
                    103,886
                    
                    100,940Commercial real
      estate
                    
                    259,925
                    
                    260,727Construction/land
      development
                    
                    240,813
                    
                    250,512Home equity
                    
                    
                    
                    12,698
                    
                    12,566Savings
    account
                    
                    
                    159
                    
                    205Other
                    
                    
                    
                    
                    
                    
                    216
                    
                    156$
                    1,122,360
                    $
                    1,137,552Less:Loans in
      process
                    
                    74,175
                    
                    82,541Deferred loan
      fees
                    
                    2,705
                    
                    2,848Allowance for loan
      losses
                    
                    14,294
                    
                    16,982$
                    1,031,186
                    $
                    1,035,181(1) Includes $216.4 million of
      non-owner occupied loans.




At March 31, 2009 and December 31, 2008
there were no loans classified as held for sale.





13





FIRST
FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES


SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)


A summary of changes in the allowance
for loan losses for the three months ended March 31, 2009 and 2008 is as
follows:





Three Months Ended March
      31,2009
                            
                            
                            2008(In
    thousands)Balance at beginning of
      period
                            
                            $
                            16,982
                            
                            
                            $
                            7,971Provision for loan
      losses
                            
                            
                            1,544
                            
                            
                            
                            —Charge-offs
                            
                            
                            (4,232
                            )
                            
                            
                            —Balance at end of
      period
                            
                            $
                            14,294
                            
                            
                            $
                            7,971





Nonaccrual, impaired and troubled debt
restructured loans are as follows:





March 31,
                      
                      
                      December
31,2009
                      
                      
                      2008(In
    thousands)Impaired loans with a valuation
      allowance
                      
                      $
                      46,941
                      
                      
                      $
                      52,533Valuation allowance related to
      impaired loans
                      
                      
                      (5,187
                      )
                      
                      
                      (8,537
                      )Net impaired
      loans
                      
                      
                      41,754
                      
                      
                      
                      43,996Nonaccrual loans not considered
      impaired
                      
                      
                      20,614
                      
                      
                      
                      4,005Total nonaccrual loans, net of
      valuation allowance for impaired loans
                      
                      $
                      62,368
                      
                      
                      $
                      48,001





March 31,
                  
                  
                  December
31,2009
                  
                  
                  2008(In
    thousands)Total loans past due 90-days or
      more and still accruing interest
                  
                  $
                  12,657
                  
                  
                  $
                  2,104Average investment of impaired
      loans
                  
                  $
                  43,450
                  
                  
                  $
                  35,967Interest income recognized on
      impaired loans
                  
                  $
                  —
                  
                  
                  $
                  —Performing troubled debt
      restructured loans
                  
                  $
                  5,776
                  
                  
                  $
                  2,226




At
March 31, 2009, the amounts committed to be advanced in connection with the
troubled debt restructured and impaired loans totaled $13.1
million.




Forgone interest on nonaccrual loans for the three months ended March 31, 2009
and 2008 was $1.1 million and $0, respectively.




Note
7 – Earnings Per Share (EPS)
  Basic earnings per share is computed by
dividing net income by the weighted-average number of common shares outstanding
during the period. ESOP shares not committed to be released are not considered
outstanding. The basic EPS calculation excludes the dilutive effect of all
common stock equivalents. Diluted earnings per share reflects the potential
dilution that could occur if securities or other commitments to issue common
stock were exercised or converted into common stock.  At March 31,
2009, all outstanding stock equivalents were determined to be antidilutive and
accordingly were not included in the EPS calculation.  There were no
outstanding stock equivalents at March 31, 2008.




14




FIRST
FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
 SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




The following
table presents a reconciliation of the components used to compute basic and
diluted earnings per share.





Three Months
      EndedMarch 31,
    2009
                            
                            March 31,
    2008(Dollars in thousands, except
      share data)Net income
                            
                            $
                            1,196
                            
                            
                            $
                            4,473Weighted-average common shares
      outstanding
                            
                            
                            19,315,048
                            
                            
                            
                            21,197,927Basic earnings per
      share
                            
                            $
                            0.06
                            
                            
                            $
                            0.21Diluted earnings per
      share
                            
                            $
                            0.06
                            
                            
                            $
                            0.21





Note
8 - Stock-Based Compensation





In June
2008, our shareholders approved the First Financial Northwest, Inc. 2008 Equity
Incentive Plan (“Plan”).  The Plan provides for the grant of stock
options, awards of restricted stock and stock appreciation rights.





Total
compensation cost that has been charged against income for the Plan and the
related income tax benefit was $515,000 and $180,000, respectively for the three
months ended March 31, 2009.  There were no similar costs for the
three months ended March 31, 2008.





Stock
Options





The Plan
authorized the grant of stock options amounting to 2,285,280 shares to its
directors, advisory directors, officers and employees.  Option awards
are granted with an exercise price equal to the market price of our common stock
at the date of grant.  These option awards have a vesting period of
five years, with 20% vesting on the anniversary date of each grant date and a
contractual life of ten years.  Any unexercised stock options will
expire ten years after the grant date or 90 days after employment or service
ends.  We have a policy of issuing new shares upon
exercise.  At March 31, 2009, remaining options for 811,756 shares of
common stock were available for grant under the Plan.





The fair
value of each option award is estimated on the date of grant using a
Black-Scholes model that uses the assumptions noted in the table
below.  The dividend yield is based on the current quarterly dividend
in effect at the time of the grant.  We use historical data to
estimate the forfeiture rate.  The expected volatility is generally
based on the historical volatility of our stock price over a specified period of
time.  Since we became a publicly held company in October 2007, the
amount of historical stock price information is limited.  As a result,
we elected to use a weighted-average of our peers’ historical stock prices as
well as our own historical stock prices to estimate volatility.  We
base the risk-free interest rate on the U.S. Treasury Constant Maturity Indices
in effect on the date of the grant.  We elected to use the Staff
Accounting Bulletin 107, “Share-Based Payments” permitted by the Securities and
Exchange Commission, to calculate the expected term due to the lack of
historical exercise data.  This method uses the vesting term of an
option along with the contractual term, setting the expected life at a midpoint
in between.





15


FIRST
FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
 SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





The fair
value of options granted during the first quarter of 2009 was determined using
the following assumptions as of the grant date.




Annual dividend
      yield
              4.07%Expected
      volatility
              38.82%Risk-free interest
      rate
              1.89%Expected
    term
              6.5
yearsWeighted-average grant date
      fairvalue per
      option
              $2.15





A summary
of our stock option plan awards for the quarter ended March 31, 2009
follows:









Shares
            
            
            Weighted-Average
              Exercise
      Price
            
            Weighted-Average
              Remaining
      Contractual
                Term
      in Years
            
            
            Aggregate
              Intrinsic
                ValueOutstanding
      at January 1, 2009
            1,423,524
            
            $
            9.78
            
            9.26
            
            $
            -Granted
            50,000
            
            
            8.35
            
            9.81Exercised
            -
            
            
            -Forfeited or
      expired
            -
            
            
            -Outstanding at March 31,
      2009
            1,473,524
            
            $
            9.73
            
            9.28
            
            $
            -Expected to vest assuming a 3%
      forfeiturerate over the vesting
      term
            1,429,304
            
            
            9.73
            
            9.28
            
            $
            -






As of
March 31, 2009, there was $2.4 million of total unrecognized compensation cost
related to nonvested stock options granted under the Plan.  The cost
is expected to be recognized over the remaining weighted-average vesting period
of 4.28 years.  No shares were exercisable at March 31,
2009.





Restricted Stock
Awards





The Plan
authorized the grant of restricted stock awards amounting to 914,112 shares to
directors, advisory directors, officers and employees.  Compensation
expense is recognized over the vesting period of the awards based on the fair
value of the stock at the date of grant.  The restricted stock awards’
fair value is equal to the value on the date of grant.  Shares awarded
as restricted stock vest ratably over a five-year period beginning at the grant
date with 20% vesting on the anniversary date of each grant date.  At
March 31, 2009, remaining restricted awards for 133,878 shares were available to
be used.  The 914,112 shares have been repurchased and are held in
trust until they are issued in connection with the agreement.





16




FIRST
FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
 SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


A summary
of changes in our nonvested restricted stock awards for the period ended March
31, 2009 follows:





Weighted-AverageGrant-DateNonvested
      Shares
                          Shares
                          
                          Fair
      ValueNonvested at January 1,
      2009
                          748,234
                          
                          $
                          10.34Granted
                          
                          32,000
                          
                          
                          8.35Vested
                          
                          -
                          
                          
                          -Forfeited
                          
                          -
                          
                          
                          -Nonvested at March 31,
      2009
                          780,234
                          
                          $
                          10.26Expected to vest assuming a 3%
      forfeiturerate over the vesting
      term
                          756,824





As of
March 31, 2009, there was $6.9 million of total unrecognized compensation costs
related to nonvested shares granted as restricted stock awards.  The
cost is expected to be recognized over the remaining weighted-average vesting
period of 4.44 years.





Note
9 – Segment Information





Our activities are considered to be a
single industry segment for financial reporting purposes.  We are
engaged in the business of attracting deposits from the general public and
originating loans for our portfolio in our primary market
area.  Substantially all income is derived from a diverse base of
commercial and residential real estate loans, consumer lending activities and
investments.





Note
10 – Fair Values of Assets and Liabilities





SFAS No. 157 defines fair value,
establishes a consistent framework of measuring fair value under GAAP, and
expands disclosure requirements about fair value measurements.  SFAS
No. 157 among other things requires us to maximize the use of observable inputs
and minimize the use of unobservable inputs when measuring fair
value.





In October 2008, the FASB issued FSP
157-3, which clarifies the application of SFAS No. 157 in an inactive
market.  FSP 157-3 addresses application issues such as how
management’s internal assumptions should be considered when measuring fair value
when relevant observable data do not exist, how observable market information in
a market that is not active should be considered when measuring fair value, and
how the use of market quotes should be considered when assessing the relevance
of observable and unobservable data available to measure fair
value.





Valuation techniques are based upon
observable inputs.  Observable inputs reflect market data obtained
from independent sources, while unobservable inputs reflects management's market
assumptions.  These two types of inputs create the following fair
value hierarchy:




·
              Level
      1 – Quoted prices for identical instruments in active
    markets.




17




FIRST
FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
 SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




·
            Level
      2 – Quoted prices for similar instruments in active markets; quoted prices
      for identical or similar    instruments in markets
      that are not active; and model-derived valuations whose inputs
      are    observable.


·
            Level
      3 – Instruments whose significant value drivers are
      unobservable.





The table
below presents the balances of assets measured at fair value on a recurring
basis.





Fair
      Value Measurements at March 31, 2009Quoted
      Prices in
                
                SignificantActive
      Markets
                
                Other
                
                SignificantFair
      Value
                
                for
      Identical
                
                Observable
                
                UnobservableMeasurements
                
                Assets
      (Level 1)
                
                Inputs
      (Level 2)
                
                Inputs
      (Level 3)(In
      thousands)Available
      for sale investments
                
                $
                
                140,644
                $
                4,434
                $
                136,210
                $
                -





The table below presents the balances
of assets measured at fair value on a nonrecurring basis.





Fair Value Measurements at March
      31, 2009Quoted Prices
      in
                            
                            
                            SignificantActive
    Markets
                            
                            
                            Other
                            
                            
                            Significant
                            
                            
                            TotalFair Value
                            
                            
                            for
    Identical
                            
                            
                            Observable
                            
                            
                            Unobservable
                            
                            
                            GainsMeasurements
                            
                            
                            Assets (Level
      1)
                            
                            
                            Inputs (Level
      2)
                            
                            
                            Inputs (Level
      3)
                            
                            
                            (Losses)(In
    thousands)Impaired loans including
      undisbursed but committed fundsof $13.1 million (included in
      loans receivable, net)
                            
                            $
                            54,867
                            
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            54,867
                            
                            
                            $
                            (3,350
                            )Servicing rights (included in
      prepaidexpenses
      and other assets)
                            
                            
                            715
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            715
                            
                            
                            
                            0$
                            55,582
                            
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            55,582
                            
                            
                            $
                            (3,350
                            )





Investments available for sale consist
primarily of mortgage-backed securities, bank qualified tax-exempt bonds, mutual
funds and agency securities. The estimated fair value of Level 1 investments,
which consist of mutual funds, is based on quoted market prices. The estimated
fair value of Level 2 investments is based on quoted prices for similar
investments in active markets, identical or similar investments in markets that
are not active and model-derived valuations whose inputs are
observable.





Servicing rights are recorded as
separate assets through the purchase of the rights or origination of mortgage
loans that are sold with servicing rights retained. Originated servicing rights
are recorded based on quoted market prices, other observable market data, or on
the estimated discounted cash flows if observed market prices are not available.
Servicing rights are amortized in proportion to, and over, the estimated period
the net servicing income will be collected. Key assumptions included in the
model are prepayment and discount rates, estimated costs of servicing, other
income, and other expenses. On a regular basis servicing rights are evaluated
for any changes to the assumptions used in the model. There have been no lower
of cost or market adjustments of servicing rights because of changes in the fair
value during first quarter of 2009.  The change in fair value was due
to amortization expense for the period.





Loans are considered impaired when,
based upon current information and events, it is probable that we will be unable
to collect the scheduled payments of principal and interest when due according
to the contractual terms of the loan agreement. The fair value of impaired loans
is calculated using the collateral value method. Inputs include appraised
values, estimates of certain completion costs and closing and selling costs.
Some of these inputs may not be observable in the marketplace.





18






FIRST
FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
 SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


Note
11 – Capital Improvements





During the second quarter of 2009 we
began a capital improvement project which upon completion will contain our
entire lending operations.  However, it required the demolition of a
building which previously housed the Bank's back-office operations and most
recently was used to support a portion of the loan origination process. At March
31, 2009, the remaining net book value of the building and related fixtures was
approximately $985,000.  The effect of this event will be a charge to
operations in the second quarter of 2009 of approximately $640,000, net of
tax.  The cost of construction of the new building, estimated at $8.5
million, will be captured in a construction-in-progress account until the
building is ready for occupancy estimated to be in the second quarter of
2010.  At that time, the total cost will be transferred to the
appropriate fixed asset accounts and depreciated over the estimated useful lives
of the assets.



















19










Item
2.  Management’s Discussion and Analysis of Financial Condition and
Results of Operations





Forward-Looking
Statements:





Certain
matters discussed in this Form 10-Q may contain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements relate to, among other things, expectations of
the business environment in which we operate, projections of future performance,
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: the credit risks of lending activities, including changes in the
level and trend of loan delinquencies and write-offs that may be impacted by
deterioration in the housing and commercial real estate markets and may lead to
increased losses and nonperforming assets in our loan portfolio, and may result
in our allowance for loan losses not being adequate to cover actual losses, and
require us to materially increase our reserves; changes in general economic
conditions, either nationally or in our market areas; changes in the levels of
general interest rates, and the relative differences between short and long term
interest rates, deposit interest rates, our net interest margin and funding
sources; 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 Office of Thrift Supervision and our bank
subsidiary by the Federal Deposit Insurance Corporation, the Washington State
Department of Financial Institutions, Division of Banks or other regulatory
authorities, including the possibility that any such regulatory authority may,
among other things, require us to increase our reserve for loan losses,
write-down assets, change our regulatory capital position or affect our ability
to borrow funds or maintain or increase deposits, which could adversely affect
our liquidity and earnings; our ability to control operating costs and expenses;
the use of estimates in determining fair value of certain of our assets, which
estimates may prove to be incorrect and result in significant declines in
valuation; 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; computer systems on which we depend could fail or experience
a security breach; our ability to retain key members of our senior management
team; costs and effects of litigation, including settlements and judgments; our
ability to implement our branch expansion strategy; our ability to successfully
integrate any assets, liabilities, customers, systems, and management personnel
we have acquired or may in the future acquire into our operations and our
ability to realize related revenue synergies and cost savings within expected
time frames and any goodwill charges related thereto; our ability to manage loan
delinquency rates; costs and effects of litigation, including settlements and
judgments; increased competitive pressures among financial services companies;
changes in consumer spending, borrowing and savings habits; legislative or
regulatory changes that adversely affect our business including changes in
regulatory polices and principles, including the interpretation of regulatory
capital or other rules; the availability of resources to address changes in
laws, rules, or regulations or to respond to regulatory actions; adverse changes
in the securities markets; inability of key third-party providers to perform
their obligations to us; changes in accounting policies and practices, as may be
adopted by the financial institution regulatory agencies or the Financial
Accounting Standards Board, including additional guidance and interpretation on
accounting issues and details of the implementation of new accounting methods;
the economic impact of war or any terrorist activities; other economic,
competitive, governmental, regulatory, and technological factors affecting our
operations; pricing, products and services; and other risks detailed in our
reports filed with the Securities and Exchange Commission, including
our  Annual Report on  Form 10-K for the year ended December
31, 2008. Any of the forward-looking statements that we make in this Form 10-Q
and in the other public 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.






20







Overview





First Savings Bank is a community-based
savings bank primarily serving King and to a lesser extent, Pierce, Snohomish
and Kitsap counties, Washington through our full-service banking office located
in Renton, Washington.  Our business strategy has included an emphasis
on one-to-four family residential mortgage and commercial real estate
lending.  First Savings Bank’s business consists of attracting
deposits from the public and utilizing these funds to originate one-to-four
family, multifamily, construction/land development, commercial real estate and
consumer loans.





During the quarter ended March 31,
2009, our total gross loan portfolio decreased $15.2 million or 1.3% from
December 31, 2008. Our one-to-four family residential loans decreased $7.8
million or 1.5% from December 31, 2008; multifamily loans increased $2.9 million
or 2.9% while commercial real estate decreased $802,000 or 0.3% from December
31, 2008. Consumer loans increased $146,000 or 1.1% during the same
period.  Construction/land development loans decreased $9.7 million or
3.9% from December 31, 2008.























21





Our loan
policy limits the maximum amount of loans we can make to one borrower to 20% of
First Savings Bank’s risk-based capital.  As of March 31, 2009, the
maximum amount which we could lend to any one borrower was $40.1 million based
on our policy.  Exceptions may be made to this policy with the prior
approval of the Board of Directors if the borrower exhibits financial strength
or compensating factors to sufficiently offset any weaknesses based on the
loan-to-value ratio, borrower’s financial condition, net worth, credit history,
earnings capacity, installment obligations and current payment
habits.  The five largest borrowing relationships, as of March 31,
2009 and December 31, 2008, in descending order were:







March 31,
    2009
                              
                              
                              December 31,
      2008Aggregate
      Amount
                              Number
                              
                              Aggregate
      Amount
                              NumberBorrower
                              of Loans (1)
      (2)
                              of Loans
                              
                              of Loans (1)
      (2)
                              of LoansReal estate
      builder
                              $
                              48.3
                              million
                              134
                              
                              $
                              47.3
                              million
                              131Real estate
      builder
                              
                              38.5
                              million
                              136
                              
                              
                              37.2
                              million
                              132Real estate
      builder
                              
                              29.2
                              million
                              112
                              
                              
                              29.0
                              million
                              103Real estate
      builder
                              
                              20.3
                              million
      (3)
                              84
                              
                              
                              25.2
                              million
      (5)
                              88Real estate
      builder
                              
                              19.5
                              million
      (4)
                              100
                              
                              
                              19.1
                              million
      (4)
                              100Total
                              $
                              155.8
                              million
                              
                              
                              $
                              157.8
                              million______________(1)   Net of
      undisbursed funds(2)   The
      collateral for the above loans consists of residential properties and
      developed land.(3)   Of this
      amount, $15.9 million is considered impaired loans.(4)   Of this
      amount, $7.7 million is considered impaired loans.(5)   Of this
      amount, $20.8 million is considered impaired loans.


All of the loans to these five builders
have personal guarantees in place as an additional source of repayment,
including those made to partnerships and corporations and the Bank is in the
first lien position.  All of the properties securing these loans were
in our geographic market area.





The
following table details the breakdown of the types of loans to our top five
builder relationships at March 31, 2009:





Permanent
                                                    
                                                    Permanent
                                                    
                                                    PermanentOne-to-Four
      Family
                                                    
                                                    Multifamily
                                                    
                                                    CommercialResidential
      Loans
                                                    
                                                    Loans
                                                    
                                                    Loans
                                                    
                                                    Construction/
                                                    
                                                    Aggregate
      AmountBorrower
                                                    (Rental
      Properties)
                                                    
                                                    (Rental
      Properties)
                                                    
                                                    (Rental
      Properties)
                                                    
                                                    Land
      Development (1)
                                                    
                                                    of
      Loans (1)Real
      estate builder
                                                    $
                                                    16.4
                                                    million
                                                    
                                                    $
                                                    0.0
                                                    million
                                                    
                                                    $
                                                    0.3
                                                    million
                                                    
                                                    $
                                                    31.6
                                                    million
                                                    
                                                    $
                                                    48.3
                                                    millionReal
      estate builder
                                                    
                                                    21.0
                                                    million
                                                    
                                                    
                                                    0.0
                                                    million
                                                    
                                                    
                                                    0.9
                                                    million
                                                    
                                                    
                                                    16.6
                                                    million
                                                    
                                                    
                                                    38.5
                                                    millionReal
      estate builder
                                                    
                                                    17.9
                                                    million
                                                    
                                                    
                                                    1.1
                                                    million
                                                    
                                                    
                                                    0.1
                                                    million
                                                    
                                                    
                                                    10.1
                                                    million
                                                    
                                                    
                                                    29.2
                                                    millionReal
      estate builder
                                                    
                                                    12.6
                                                    million
                                                    
                                                    
                                                    0.0
                                                    million
                                                    
                                                    
                                                    0.0
                                                    million
                                                    
                                                    
                                                    7.7
                                                    million
                                                    
                                                    
                                                    20.3
                                                    millionReal
      estate builder
                                                    
                                                    6.8
                                                    million
                                                    
                                                    
                                                    0.0
                                                    million
                                                    
                                                    
                                                    0.0
                                                    million
                                                    
                                                    
                                                    12.7
                                                    million
                                                    
                                                    
                                                    19.5
                                                    millionTotal
                                                    $
                                                    74.7
                                                    million
                                                    
                                                    $
                                                    1.1
                                                    million
                                                    
                                                    $
                                                    1.3
                                                    million
                                                    
                                                    $
                                                    78.7
                                                    million
                                                    
                                                    $
                                                    155.8
                                                    million______________(1)   Net
      of undisbursed funds.





The builders listed in the above
tables, as part of their business strategy, retain a certain percentage of their
finished homes in their own inventory of permanent investment properties, (i.e.
one-to-four family rental properties).  These properties are used to
enhance the builders’ liquidity through rental income and improve their equity
through the appreciation in market value of the property.  As part of
our underwriting process we review the borrowers’ business strategy to determine
the feasibility of the project.  Although this has been included in
these builders’ business strategy prior to the current economic crises that we
are experiencing, these builders have taken more rental properties into their
portfolio in the last year than originally planned as a result of the sluggish
housing market.  In the aggregate, these five builders’ one-to-four
family residential rental property portfolios have increased $1.1 million as
compared to December 31, 2008.





22





The
following table includes construction/land development loans, net of undisbursed
funds, by the five counties that contain our largest loan concentrations at
March 31, 2009.





County
                              
                              
                              Loan
      Balance (1)
                              % of Loan Balance(Dollars in
      thousands)King
                              
                              $
                              78,040
                              
                              42.6
                              %Pierce
                              
                              
                              43,965
                              
                              24.0Kitsap
                              
                              
                              19,265
                              
                              10.5Snohomish
                              
                              
                              12,940
                              
                              7.1Whatcom
                              
                              
                              11,648
                              
                              6.3All other
      counties
                              
                              17,384
                              
                              9.5Total
                              
                              $
                              183,242
                              
                              100.0
                              %_____________________(1) Net of undisbursed
      funds.





Our primary source of pre-tax income is
net interest income. Net interest income is the difference between interest
income, which is the income that we earn on our loans and investments, and
interest expense, which is the interest that we pay on our deposits and
borrowings.  Changes in levels of interest rates affect our net
interest income.  To offset the impact of the interest rate
environment, we continue to seek means of increasing interest income while
controlling expenses.  Consistent with this strategy, we are
continuing to manage the growth in our loan portfolio to achieve our investment
and credit quality objectives.  During the first quarter of 2009,
collateral-dependent loans of $4.2 million were charged-off.  Specific
reserves had been established for these loans in prior quarters, therefore the
charge-offs had no impact on earnings for the quarter.  An additional
provision of $1.7 million was established for the quarter ended March 31,
2009.





Our operating expenses consist
primarily of salaries and employee benefits, occupancy and equipment, data
processing, marketing, postage and supplies, professional services and deposit
insurance premiums. Salaries and employee benefits consist primarily of the
salaries and wages paid to our employees, payroll taxes, expenses for retirement
benefits, the equity incentive plan and other employee benefits. Occupancy and
equipment expenses, consist primarily of real estate taxes, depreciation
charges, maintenance and costs of utilities.





Critical
Accounting Policies





Critical accounting policies are those
that involve significant judgments and assumptions by management and that have,
or could have, a material impact on our income or the carrying value of our
assets. The following are our critical accounting policies.




Allowance for Loan Losses.  Management recognizes that loan
losses may occur over the life of a loan and that the allowance for loan losses
must be maintained at a level necessary to absorb specific losses on impaired
loans and probable losses inherent in the loan portfolio. Our methodology for
analyzing the allowance for loan losses consists of two components: formula and
specific allowances. The formula allowance is determined by applying factors to
our various groups of loans. Management considers factors such as charge-off
history, the prevailing economy, borrower’s ability to repay, the regulatory
environment, competition, geographic and loan type concentrations, policy and
underwriting standards, nature and volume of the loan portfolio, management’s
experience level, our loan review and grading system, the value of underlying
collateral, the level of problem loans, business conditions and credit
concentrations in assessing the allowance for loan losses. The specific
allowance component is created when management believes that the collectibility
of a specific loan, such as a construction/land development, multifamily or
commercial real estate loan, has been impaired and a loss is probable. The
specific reserves are computed using current appraisals, listed sales prices and
other available information less costs to complete (if any) and costs to sell
the property. This evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available or as future events differ from predictions.






23







Our
Board of Directors approves the provision for loan losses on a quarterly basis.
The allowance is increased by the provision for loan losses, which is charged
against current period earnings and decreased by the amount of actual loan
charge-offs, net of recoveries.




We
believe that the accounting estimate related to the allowance for loan losses is
a critical accounting estimate because it is highly susceptible to change from
period-to-period requiring management to make assumptions about probable losses
inherent in the loan portfolio; and the impact of a sudden large loss could
deplete the allowance and potentially require increased provisions to replenish
the allowance, which would negatively affect earnings. For additional
information see the section titled “We may be required to make further increases
in our provision for loan losses and to charge-off additional loans in the
future, which could adversely affect our results of operations,” within the
section titled “Item 1A. Risk Factors” in this Form
10-Q.




Goodwill.  Goodwill represents the cost in
excess of net assets acquired arising from the purchase of Executive House, Inc.
in December 2005. Goodwill is not amortized, but is reviewed for impairment and
written down and charged to expense during the periods in which the recorded
value is more than its fair value. We evaluate any potential impairment of
goodwill on an annual basis, or more frequently if events or changes in
circumstances indicate that goodwill might be impaired at the First Financial
Northwest level. If First Financial Northwest's market capitalization (total
common shares outstanding multiplied by the current stock price) exceeds the
common book value, absent other indicators of impairments, goodwill is not
considered impaired and no additional analysis is necessary. Despite negative
values in the above tests goodwill might not be considered impaired due to
current market volatility and control purchase premiums in the banking industry.
However, an impairment may be recorded in the future if market capitalization
continues to decrease. Any potential non-cash goodwill impairment expense would
not affect our regulatory capital ratios since goodwill is not included in the
calculation.  Management does not believe there have been any events
in the three months ended March 31, 2009, such as a significant decrease in the
fair value of the Company or its underlying assets and liabilities, a
significant adverse change in the business climate, or any other indication of
impairment, that would trigger a remeasurement of, or result in an impairment to
goodwill as of March 31, 2009.




Deferred Taxes.  Deferred tax assets arise from a
variety of sources, the most significant being: a) expenses, such as our
charitable contribution to the First Financial Northwest Foundation, that can be
carried forward to be utilized against profits in future years; b) expenses
recognized in our books but disallowed in our tax return until the associated
cash flow occurs; and c) writedowns in the value of assets for book purposes
that are not deductible for tax until the asset is sold or deemed
worthless.




We
record a valuation allowance to reduce our deferred tax assets to the amount
which can be recognized in line with the relevant accounting standards. The
level of deferred tax asset recognition is influenced by management’s assessment
of our historic and future profitability profile. At each balance sheet date,
existing assessments are reviewed and, if necessary, revised to reflect changed
circumstances. In a situation where income is less than projected or recent
losses have been incurred, the relevant accounting standards require convincing
evidence that there will be sufficient future tax capacity.


Other-Than-Temporary Impairments In the Market Value of
Investments.  Declines in the fair value of any
available for sale or held to maturity investment below their cost that is
deemed to be other-than-temporary results in a reduction in the carrying amount
of the investment to that of fair value. A charge to earnings and an
establishment of a new cost basis for the investment is made. Unrealized
investment losses are evaluated at least quarterly to determine whether such
declines should be considered other-than-temporary and therefore be subject to
immediate loss recognition in income. Although these evaluations involve
significant judgment, an unrealized loss in the fair value of a debt security is
generally deemed to be temporary when the fair value of the investment security
is below the carrying value primarily due to changes in interest rates, there
has not been significant deterioration in the financial condition of the issuer,
and we have the intent and ability to hold the investment for a sufficient time
to recover the carrying value. An unrealized loss in the value of an equity
security is generally










24




considered temporary when the fair
value of the security is below the carrying value primarily due to current
market conditions and not deterioration in the financial condition of the
issuer. Other factors that may be considered in determining whether a decline in
the value of either a debt or an equity security is other-than-temporary include
ratings by recognized rating agencies; the extent and duration of an unrealized
loss position; actions of commercial banks or other lenders relative to the
continued extension of credit facilities to the issuer of the security; the
financial condition, capital strength and near-term prospects of the issuer and
recommendations of investment advisors or market analysts. Therefore continued
deterioration of market conditions could result in additional impairment losses
recognized within the investment portfolio.




Comparison
of Financial Condition at March 31, 2009 and December 31, 2008


General.  Our
total assets increased $17.3 million, or 1.4%, to $1.3 billion at March 31, 2009
from December 31, 2008. The asset growth resulted primarily from an increase in
interest-bearing deposits and federal funds sold of $32.5 million primarily as a
result of funds received related to the sales of investments and the increase in
deposits during the quarter ended March 31, 2009.  Total liabilities
increased $24.1 million to $978.4 million at March 31, 2009 from $954.3 million
at December 31, 2008 primarily as a result of increases in deposits of $29.7
million. Stockholders’ equity decreased $6.7 million, primarily due to the cost
for the repurchase of our stock of $7.5 million and cash dividends paid during
the quarter of $1.7 million.  These decreases were partially offset by
net income for the quarter of $1.2 million and an increase in accumulated other
comprehensive income of $511,000.





Assets.  Total
assets increased $17.3 million or 1.4% at March 31, 2009, as compared to
December 31, 2008. The following table details the changes in the composition of
our assets at March 31, 2009 from December 31, 2008.




Increase/(Decrease)Balance at
                          
                          
                          from
                          
                          
                          PercentageMarch 31,
    2009
                          
                          
                          December 31,
      2008
                          
                          
                          Increase/(Decrease)(Dollars in
      thousands)Cash on hand and in
      banks
                          
                          $
                          2,532
                          
                          
                          $
                          (834
                          )
                          
                          
                          (24.78
                          )
      %Interest-bearing
      deposits
                          
                          
                          31,776
                          
                          
                          
                          31,176
                          
                          
                          
                          5,196.00Federal Funds
      sold
                          
                          
                          3,105
                          
                          
                          
                          1,315
                          
                          
                          
                          73.46Investments available for
      sale
                          
                          
                          140,644
                          
                          
                          
                          (8,679
                          )
                          
                          
                          (5.81
                          )Loans receivable,
      net
                          
                          
                          1,031,186
                          
                          
                          
                          (3,995
                          )
                          
                          
                          (0.39
                          )Premises and equipment,
      net
                          
                          
                          13,182
                          
                          
                          
                          156
                          
                          
                          
                          1.20Federal Home Loan
      Bankstock, at
      cost
                          
                          
                          7,413
                          
                          
                          
                          -
                          
                          
                          
                          -Accrued interest
      receivable
                          
                          
                          5,794
                          
                          
                          
                          262
                          
                          
                          
                          4.74Deferred tax assets,
      net
                          
                          
                          8,577
                          
                          
                          
                          (689
                          )
                          
                          
                          (7.44
                          )Goodwill
                          
                          
                          14,206
                          
                          
                          
                          -
                          
                          
                          
                          -Prepaid expenses and other
      assets
                          
                          
                          3,367
                          
                          
                          
                          (1,370
                          )
                          
                          
                          (28.92
                          )Total
      assets
                          
                          $
                          1,261,782
                          
                          
                          $
                          17,342
                          
                          
                          
                          1.39
                          %
 
 Cash and cash equivalents increased
$31.7 million from December 31, 2008.  This increase was primarily due
to the net growth in deposits of $29.7 million, proceeds from investment sales
of $6.9 million, partially offset by $8.0 million in net repayments on FHLB
advances during the quarter.
 
 Net loans receivable decreased $4.0
million to $1.0 billion at March 31, 2009 from December 31, 2008. The decrease
was primarily due to repayments during the quarter of $37.4 million exceeding
total originations of $22.2 million plus an increase of $11.2 million in
deferred fees and undisbursed funds during the quarter ended March 31,
2009.  We originated $12.6 million in one-to-four-family mortgage
loans, $800,000 and $3.4 million in commercial real estate and multifamily
loans, respectively, $4.3 million in construction/land development
loans





25


and $1.1
million in consumer loans during the quarter ended March 31, 2009. The
originations of construction/land development loans related to our merchant
builders so they could continue to complete their projects and utilize their
existing land inventory.  We are concentrating on working with our
existing builders and have not expanded our customer base for this type of
lending.  Loan originations were significantly less than the
production for the fourth quarter of 2008 primarily due to the lower interest
rate environment in the first quarter of 2009 and management’s intention to
maintain higher yielding assets in the loan portfolio.





Investments available for sale
decreased $8.7 million or 5.8%, to $140.6 million at March 31, 2009 from $149.3
million at December 31, 2008.  The decrease was primarily due to
investment sales during the quarter of $6.9 million with gross gains of
$76,000.





Deposits. During the three
months ended March 31, 2009, deposits increased $29.7 million to $821.2 million.
The increase in deposits was as a result of our practice of competitively
pricing our deposit products and our enhanced marketing efforts. While all
deposit categories increased from December 31, 2008, the increases in the money
market accounts of $19.5 million and certificate accounts of $8.2 million
comprised the majority of the increase.  In an effort to increase our
core deposits, we have both competitively priced our deposit products and
instituted a new marketing campaign to attract new customers to the
Bank.  We do not have any brokered deposits.





Advances. Total advances at
March 31, 2009 were $148.2 million, a decrease of $8.0 million or 5.1% from
December 31, 2008.  Based on our lower loan origination volume for the
quarter, excess funds were used to pay down short-term FHLB
advances.  In this current low interest rate environment, we are
focusing on investing in higher yielding assets or reducing our cost of funds to
increase our interest rate spread.




Equity. Total equity decreased
$6.7 million, or 2.3%, to $283.4 million at March 31, 2009 from $290.1 million
at December 31, 2008.  The decrease was primarily the result of the
cost for the repurchase of our stock of $7.5 million and cash dividends paid
during the quarter of $1.7 million.  These decreases were partially
offset by net income for the quarter of $1.2 million and an increase in
accumulated other comprehensive income of $511,000.
 
 Comparison
of Operating Results for the Three Months Ended March 31, 2009 and March 31,
2008
 
 General. Our net income for
the three months ended March 31, 2009 was $1.2 million, a decrease of $3.3
million from the comparable quarter in the prior year. The decrease in net
income was the result of increases in the provision for loan losses of $1.7
million and noninterest expense of $2.1 million, and a decrease in noninterest
income of $1.2 million, offset by a decrease in the provision for federal income
taxes of $1.7 million during the quarter ended March 31, 2009.
 
 Net Interest
Income.  Our net interest income for the quarter ended March
31, 2009, remained relatively unchanged at $8.2 million, as compared to the same
quarter in the prior year. Average total interest-earning assets increased $65.6
million for the three months ended March 31, 2009 from $1.1 billion for the same
quarter in 2008, while average total interest-bearing liabilities increased
$91.0 million from the three months ended March 31, 2008. During the same period
our yield on interest-earning assets decreased 51 basis points while our cost of
interest-bearing liabilities decreased 64 basis points, increasing our interest
rate spread for the quarter ended March 31, 2009 by 13 basis points to 1.96%
from 1.83% during the same quarter in 2008.




26




Interest
Income.  Total interest income for the first quarter of 2009
decreased $519,000, or 3.0%, to $16.8 million from $17.3 million for the quarter
ended March 31, 2008.  The following table compares detailed average
interest-earning asset balances, associated yields and resulting changes in
interest income for the three months ended March 31, 2009 and 2008:





Three Months Ended March
      31,2009
                                      
                                      
                                      2008
                                      
                                      
                                      Increase/(Decrease)
    inInterest
  andAverage
                                      
                                      
                                      
                                      
                                      Average
                                      
                                      
                                      
                                      
                                      DividendBalance
                                      
                                      Yield
                                      
                                      
                                      Balance
                                      
                                      Yield
                                      
                                      
                                      Income(Dollars in
      thousands)Loans receivable,
      net
                                      $
                                      1,033,521
                                      
                                      5.85
                                      %
                                      
                                      $
                                      900,245
                                      
                                      6.70
                                      %
                                      
                                      $
                                      54Investments available for
      sale
                                      
                                      143,539
                                      
                                      4.53
                                      
                                      
                                      
                                      152,294
                                      
                                      4.34
                                      
                                      
                                      
                                      (28)Federal funds sold and
      interest-bearingdeposits
                                      
                                      9,492
                                      
                                      0.08
                                      
                                      
                                      
                                      70,965
                                      
                                      3.02
                                      
                                      
                                      
                                      (534)Federal Home Loan Bank
      stock
                                      
                                      7,413
                                      
                                      -
                                      
                                      
                                      
                                      4,834
                                      
                                      0.91
                                      
                                      
                                      
                                      (11)Total interest-earning
      assets
                                      $
                                      1,193,965
                                      
                                      5.61
                                      %
                                      
                                      $
                                      1,128,338
                                      
                                      6.12
                                      %
                                      
                                      $
                                      (519)







The decline in interest income was
primarily the result of foregone interest on nonperforming loans during the
first quarter of 2009 of $1.1 million and to a lesser extent the general decline
in market interest rates.  These two factors combined held interest
income from loans to an increase of only $54,000 as compared to the first
quarter of 2008.  Our foregone interest for the three months ended
March 31, 2008 was immaterial.  Interest earned on federal funds sold
and interest-bearing deposits totaled $2,000 for the quarter ended March 31,
2009, a decrease of $534,000 from the same quarter in 2008.  Cash,
federal funds sold and interest-bearing deposits decreased to $37.4 million at
March 31, 2009 from $85.2 million at March 31, 2008.  During the first
quarter of 2008, we sold a portion of our tax-exempt investment portfolio and
the $62.6 million in proceeds were included in our interest-bearing deposits at
March 31, 2008.  These proceeds were subsequently invested in
higher-yielding assets later in 2008.  Our average interest-earning
assets at March 31, 2009 increased $65.6 million compared to March 31,
2008.  Our average net loan balance increased $133.3 million and the
average balance of federal funds sold and interest-bearing deposits decreased
$61.5 million as compared to the first quarter of last year.  The
yield on our average assets declined to 5.61% during the quarter ended March 31,
2009 from 6.12% for the same quarter in 2008.  The yield on net loans
receivable declined to 5.85% from 6.70% or 85 basis points, 43 basis points of
which related to foregone interest in the loan portfolio with the balance of the
decrease due to the general decline in interest rates.  The yield on
federal funds sold and interest-bearing deposits dropped to 0.08% from 3.02%
reflecting the decline in interest rates over the last year.





Interest Expense.Total
interest expense for the quarter ended March 31, 2009 decreased $533,000 or
5.9%, to $8.6 million from $9.1 million compared to the first quarter of
2008.  The following table details average balances, cost of funds and
the resulting decrease in interest expense for the three months ended March 31,
2009 and 2008:





Three Months Ended March
      31,2009
                                      
                                      
                                      2008
                                      
                                      
                                      Increase
  /(Decrease)
    inAverage
                                      
                                      
                                      
                                      
                                      Average
                                      
                                      
                                      
                                      
                                      
                                      InterestBalance
                                      
                                      Cost
                                      
                                      
                                      Balance
                                      
                                      Cost
                                      
                                      
                                      
                                      Expense(Dollars in
      thousands)NOW
accounts
                                      $
                                      9,981
                                      
                                      0.68
                                      %
                                      
                                      $
                                      11,723
                                      
                                      0.68
                                      %
                                      
                                      $
                                      (3)Statement savings
      accounts
                                      
                                      12,824
                                      
                                      1.72
                                      
                                      
                                      
                                      11,248
                                      
                                      1.74
                                      
                                      
                                      
                                      6Money market
      accounts
                                      
                                      121,445
                                      
                                      1.98
                                      
                                      
                                      
                                      145,620
                                      
                                      2.29
                                      
                                      
                                      
                                      (232)Certificates of
      deposit
                                      
                                      651,902
                                      
                                      4.08
                                      
                                      
                                      
                                      571,980
                                      
                                      5.02
                                      
                                      
                                      
                                      (521)Advances from the Federal Home
      Loan Bank
                                      
                                      144,328
                                      
                                      3.45
                                      
                                      
                                      
                                      108,923
                                      
                                      3.78
                                      
                                      
                                      
                                      217Total interest-bearing
      liabilities
                                      $
                                      940,480
                                      
                                      3.65
                                      %
                                      
                                      $
                                      849,494
                                      
                                      4.29
                                      %
                                      
                                      $
                                      (533)











27






Total average interest-bearing
liabilities increased $91.0 million during the first quarter of 2009 as compared
to the same quarter in 2008.  Average deposits increased $55.6 million
while the average cost of funds for deposits decreased to 3.68% from 4.36% or 68
basis points for the first quarter of 2009 as a result of the general decline in
interest rates.  At the same time, the average balance of advances
from the FHLB increased $35.4 million.  The related average cost of
those funds declined 33 basis points to 3.45%.  While total average
interest-bearing liabilities increased $91.0 million, the favorable drop in
interest rates allowed us to lower our average cost of funds to 3.65% from 4.29%
for the three months ended March 31, 2009 as compared to the same quarter last
year.  The decline in interest rates contributed to an increase in our
interest rate spread to 1.96% for the first quarter of 2009 from 1.83% for the
same quarter in 2008.  Our net interest margin for the quarter was
negatively affected primarily by foregone interest on our nonperforming loans,
resulting in a net interest margin of 2.74% for the first quarter of 2009 as
compared to 2.89% for the same period in 2008.


Provision for Loan
Losses.  We establish provisions for loan losses, which are
charged to operations, at a level necessary to absorb known and inherent losses
that are both probable and reasonably estimable at the date of the financial
statements.  Our methodology in assessing the allowance for loan
losses places greater emphasis on factors such as charge-off history, the
economy, the regulatory environment, competition, geographic and loan type
concentrations, policy and underwriting standards, nature and volume of the loan
portfolio, management experience levels, our loan review and grading system and
the value of underlying collateral.  This evaluation is inherently
subjective, as it requires estimates that are susceptible to significant
revision as more information becomes available or as future events differ from
predictions.





The
allowance for loan losses was $14.3 million or 1.36% of total loans outstanding
at March 31, 2009 as compared to $8.0 million or 0.85% of total loans
outstanding at March 31, 2008. The level of the allowance is based on estimates
and the ultimate losses may vary from these estimates.





Our
provision for loan losses was $1.7 million for the three months ended March 31,
2009.  There was no provision for loan losses for the three months
ended March 31, 2008.  As of March 31, 2009 nonperforming loans
totaled $80.2 million as compared to $58.6 million at December 31,
2008.  As of March 31, 2009, restructured loans, within the meaning of
SFAS No. 15, “Accounting by Debtors and Creditors for Troubled Debt
Restructurings”, totaled $22.3 million, down from $23.0 million at December 31,
2008.  At March 31, 2009 $16.5 million of these restructured loans
were classified as nonaccrual.  We did not have any real estate owned
at March 31, 2009.  The following table presents a breakdown of our
nonperforming assets:





At
      March 31,
                            At December
    31,2009
                            
                            2008(Dollars in
      thousands)Loans accounted for on a
      nonaccrual basis:Real
estate:One-to-four
      family residential
                            $
                            12,013
                            
                            $
                            9,630Commercial
                            
                            5,171
                            
                            
                            2,865Construction/land
      development
                            
                            50,371
                            
                            
                            44,043Total loans accounted for on a
      nonaccrual basis
                            $
                            67,555
                            
                            $
                            56,538Accruing loans which are
      contractually past due90 days or
      more:One-to-four
      family residential
                            $
                            4,620
                            
                            $
                            1,207Commercial
      real estate
                            
                            4,212
                            
                            
                            897Construction/land
      development
                            
                            3,775
                            
                            
                            -Consumer
                            
                            50
                            
                            
                            -Total accrual loans which are
      contractually past due90 days or
      more
                            $
                            12,657
                            
                            $
                            2,104Total real estate
      owned
                            $
                            -
                            
                            $
                            -Total
      nonperforming assets
                            $
                            80,212
                            
                            $
                            58,642





28





Of our
nonperforming, nonaccrual loans, $50.4 million relate to the construction/land
development loan portfolio, primarily located in King County, $12.0 million
relate to one-to-four family residential loans and $5.2 million relate to the
commercial real estate loan portfolio.  The $50.4 million of
construction/land development loans are comprised of 132 loans, of which, 103
loans are related to three merchant builder customers.  Sales for
these merchant builders have been affected by the current credit
tightening.  The $12.0 million of nonperforming, nonaccrual
one-to-four family residential loans are comprised of 33 loans with two
borrowers accounting for 29 of those loans.  The majority of these
loans are rental investment properties held by the merchant
builders.  The $5.2 million of commercial real estate loans are
comprised of 10 loans with one borrower accounting for seven of those
loans.





Included
in our nonperforming assets were $12.7 million of loans that are 90 days or more
past due and still accruing.  Loans 90 days or more delinquent and
still accruing are loans that are well collateralized, in the process of
collection and management believes all principal and interest will be
received.  There are 15 loans in the one-to-four family residential
category totaling $4.6 million.  Each of these borrowers is facing the
effects of poor economic conditions such as unemployment and diminished cash
flows.  The commercial real estate category is comprised of five loans
totaling $4.2 million.  In this group there is a single loan for $3.0
million on land zoned for residential use.  In the construction/land
development category there are four loans totaling $3.8 million.  They
are all single-family construction loans in various stages of
development.  In addition, there is one loan in the consumer category
totaling $50,000 which is a home equity line of credit on a residence with
substantial equity.  With the housing markets continuing to
deteriorate and showing limited signs of stabilizing in the near future, we
continue to aggressively monitor our real estate loan portfolio, including our
construction/land development loan portfolio.





Also,
included in the provision was a $186,000 reserve for unfunded commitments which
is included in other liabilities on the Consolidated Balance
Sheets.  During the first quarter of 2009, collateral-dependent loans
of $4.2 million were charged-off.  Specific reserves had been
established for these loans in prior quarters, therefore the charge-offs had no
impact on the earnings for the quarter.  At March 31, 2009, the
allowance for loan losses was $14.3 million compared to $17.0 million at
December 31, 2008.  The decline in the allowance for loan losses was
primarily due to the $4.2 million charge-off recorded in the first quarter of
2009.





Although we believe that we used the
best information available to establish the allowance for loan losses, future
additions to the allowance may be necessary based on estimates that are
susceptible to change as a result of changes in economic conditions and other
factors.  During the first quarter of 2009, the state unemployment
level was at its highest level since 1985.  It was the second
consecutive month unemployment in the state of Washington exceeded the national
level.  In the four counties we serve, unemployment ranges between
7.8% and 9.9%.  Even though housing has performed better, as of
February 2009 year-over-year home values were down between 7.7% and
11.9%.  Pending home sales, however, increased 4.7% in February
compared to January 2009.





We
believe that the allowance for loan losses as of March 31, 2009 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 not be proven incorrect in
the future, or that the actual amount of future provisions will not exceed the
amount of past provisions or that any increased provisions that may be required
will not adversely impact our financial condition and results of
operations.  Future additions to the allowance may become necessary based
upon changing economic conditions, increased loan balances, or changes in the
underlying collateral of the loan portfolio. In addition, the determination of
the amount of our allowance for loan losses is subject to review by bank
regulators as part of the routine examination process, which may result in the
establishment of additional reserves or charge-offs, based upon their judgment
of information available to them at the time of their examination.





29





At or For the Three
      MonthsEnded March
    31,2009
                      
                      2008(Dollars in
      thousands)Provision for loan
      losses
                      $
                      1,544
                      
                      
                      $
                      -Net
    charge-offs
                      $
                      4,232
                      
                      
                      $
                      -Allowances for loan
      losses
                      $
                      14,294
                      
                      
                      $
                      7,971Allowance for losses as a percent
      of total loans outstandingat the end of
      the period net of undisbursed funds
                      
                      1.36
                      %
                      
                      
                      0.85
                      %Allowance for loan losses as a
      percent of nonperformingloans at the end
      of the period net of undisbursed funds
                      
                      17.82
                      %
                      
                      
                      32.14
                      %Total nonaccrual and 90 days or
      more past due loans netof undisbursed
      funds
                      $
                      80,212
                      
                      
                      $
                      24,799Nonaccrual and 90 days or more
      past due loans as a percentof total loans
      net of undisbursed funds
                      
                      7.65
                      %
                      
                      
                      2.65
                      %Total loans receivable net of
      undisbursed funds
                      $
                      1,048,185
                      
                      
                      $
                      934,503Total loans
      originated
                      $
                      22,236
                      
                      
                      $
                      66,061





Noninterest Income.
Noninterest income decreased $1.2 million to $130,000 for the three months ended
March 31, 2009 from the comparable quarter in 2008. The following table provides
a detailed analysis of the changes in the components of noninterest
income:





Three
Months
                                  
                                  Increase/(Decrease)Ended
                                  from
                                  
                                  PercentageMarch 31,
    2009
                                  March 31,
    2008
                                  
                                  Increase/(Decrease)(Dollars in
      thousands)Service fees on deposit
      accounts
                                  
                                  $
                                  17
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  
                                  -
                                  %Loan service
      fees
                                  
                                  
                                  75
                                  
                                  
                                  
                                  73
                                  
                                  
                                  
                                  3,650.00Gain on sale of
      investments
                                  
                                  
                                  76
                                  
                                  
                                  
                                  (1,297
                                  )
                                  
                                  
                                  (94.46
                                  )Servicing rights,
      net
                                  
                                  
                                  (54
                                  )
                                  
                                  
                                  4
                                  
                                  
                                  
                                  6.90Other
                                  
                                  
                                  16
                                  
                                  
                                  
                                  (13
                                  )
                                  
                                  
                                  (44.83
                                  )Total noninterest
      income
                                  
                                  $
                                  130
                                  
                                  
                                  $
                                  (1,233
                                  )
                                  
                                  
                                  (90.46
                                  )%





The decrease was primarily attributable
to the $1.4 million gain on sale of investments that was realized in the first
quarter of 2008.  These sales were the result of our taking advantage
of favorable market conditions to sell the majority of our tax-exempt investment
portfolio.  Investment sales in the first quarter of 2009 generated
$76,000 in net gains.







30





Noninterest
Expense.  Noninterest expense increased $2.1 million during the
three months ended March 31, 2009 to $5.0 million, compared to $2.9 million for
the quarter ended March 31, 2008. The following table provides the detail of the
changes in noninterest expense:





Three
Months
                                              
                                              Increase/(Decrease)Ended
                                              
                                              from
                                              
                                              PercentageMarch 31,
    2009
                                              
                                              March 31,
    2008
                                              
                                              Increase/(Decrease)(Dollars in
      thousands)Compensation and
      benefits
                                              $
                                              3,039
                                              
                                              
                                              $
                                              1,278
                                              
                                              
                                              
                                              72.57
                                              %Occupancy and
      equipment
                                              
                                              350
                                              
                                              
                                              
                                              56
                                              
                                              
                                              
                                              19.05Data
    processing
                                              
                                              144
                                              
                                              
                                              
                                              31
                                              
                                              
                                              
                                              27.43Professional
      fees
                                              
                                              307
                                              
                                              
                                              
                                              12
                                              
                                              
                                              
                                              4.07Marketing
                                              
                                              52
                                              
                                              
                                              
                                              6
                                              
                                              
                                              
                                              13.04Office supplies and
      postage
                                              
                                              71
                                              
                                              
                                              
                                              38
                                              
                                              
                                              
                                              115.15Regulatory fees and
      depositinsurance
      premiums
                                              
                                              693
                                              
                                              
                                              
                                              654
                                              
                                              
                                              
                                              1,676.92Bank and ATM
      charges
                                              
                                              36
                                              
                                              
                                              
                                              (9)
                                              
                                              
                                              
                                              (20.00)Other
                                              
                                              452
                                              
                                              
                                              
                                              192
                                              
                                              
                                              
                                              73.85Total noninterest
      expense
                                              $
                                              5,144
                                              
                                              
                                              $
                                              2,258
                                              
                                              
                                              
                                              78.24
                                              %





Compensation and benefits expense
increased $1.3 million, or 72.6% during the first quarter of 2009 compared to
the same quarter in 2008.  This increase was primarily the result of
additional staff and related employee benefits expense incurred as a result of
building our infrastructure throughout 2008 to accommodate growth and operate
more effectively as a publicly-traded Company.  Direct compensation
and related payroll taxes totaled $1.9 million for the first three months of
2009 as compared to $1.4 million, or a $468,000 increase for the same quarter
last year.  At March 31, 2009, our total number of employees had
increased to 103 employees from 80, one year ago.  Included in
benefits expense was $515,000 of expenses related to the equity incentive plan
which was implemented in the third quarter of 2008, consequently, these expenses
did not exist in the first quarter of 2008.  In addition, our
regulatory fees and deposit insurance premiums increased $654,000 for the three
months ended March 31, 2009 compared to the same period in 2008.  The
increase was primarily due to increased FDIC insurance premiums as a result of
the increasing number of failing financial institutions and the need to
replenish the Deposit Insurance Fund.





Federal Income Tax Expense.
Federal income tax expense decreased $1.7 million for the three months ended
March 31, 2009 to $421,000 from $2.2 million for the three months ended March
31, 2008. The effective federal income tax rate for the three months ended March
31, 2009 was 26.04% as compared to 32.63% for the three months ended March 31,
2008. The decrease in the effective tax rate is a result of a decrease in
taxable earnings for the period coupled with our permanent differences resulting
from GAAP basis accounting and tax basis accounting.





Liquidity





We are required to have enough cash
flow in order to maintain sufficient liquidity to ensure a safe and sound
operation. Historically, we have maintained cash flow above the minimum level
believed to be adequate to meet the requirements of normal operations, including
potential deposit outflows. On a weekly basis, we review and update cash flow
projections to ensure that adequate liquidity is maintained.  See the
“Consolidated Statements of Cash Flows” contained in Item 1 – Financial
Statements, included herein.




Our primary sources of funds are from
customer deposits, loan repayments, maturing investment securities and advances
from the FHLB. These funds, together with equity, are used to make loans,
acquire investment securities and other assets, and fund continuing operations.
While maturities and the scheduled amortization of




31


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. At March 31, 2009, certificates of deposit scheduled to mature in
one year or less totaled $385.3 million. Historically, we have been able to
retain a significant amount of the deposits as they mature. We believe that our
current liquidity position and our forecasted operating results are sufficient
to fund all of our existing commitments.





While our primary source of funds is
our deposits, when deposits are not available to provide the funds to support
our assets, 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. At March 31, 2009, we maintained
credit facilities with the FHLB for $431.1 million, based on eligible
collateral, with an outstanding balance of $148.2 million. In addition, we have
two lines of credit totaling $15.0 million with other financial institutions
which could be used for liquidity purposes.





Commitments
and Off-Balance Sheet Arrangements





We are a party to financial instruments
with off-balance sheet risk in the normal course of business to meet the
financing needs of our customers. These financial instruments include
commitments to extend credit and the unused portions of lines of credit. These
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the consolidated statements of
financial condition. Commitments to extend credit and lines of credit are not
recorded as an asset or liability by us until the instrument is exercised. At
March 31, 2009, we had no commitments to originate loans for sale.





Commitments to extend credit are
agreements to lend to a customer as long as there is no violation of any
condition established in the loan agreement. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
Since many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements. We evaluate each customer’s creditworthiness on a case-by-case
basis. The amount of the collateral obtained, if deemed necessary, varies, but
may include real estate and income-producing commercial properties. At March 31,
2009, commitments to originate loans, commitments under unused lines of credit
and undisbursed portions of construction loans, for which we were obligated,
were $24.3 million, $7.3 million and $74.2 million, respectively.





We are from time to time involved in
various claims and legal actions arising in the ordinary course of business.
There are currently no matters that in the opinion of management would have a
material adverse effect on our financial position, results of operation, or
liquidity.





Among our contingent liabilities are
exposures to limited recourse arrangements with respect to sales of whole loans
and participation interests.





We anticipate that we will continue to
have sufficient funds and alternative funding sources to meet our current
commitments.





32





The following table summarizes our
outstanding commitments to originate loans and to advance additional amounts
related to lines of credit and construction loans at March 31,
2009.





Amount of Commitment Expiration -
      Per PeriodAfter
                                
                                AfterOne
                                
                                ThreeTotal
                                
                                
                                
                                
                                Through
                                
                                Through
                                
                                AfterAmounts
                                
                                Through
                                
                                Three
                                
                                Five
                                
                                FiveCommitted
                                
                                One Year
                                
                                Years
                                
                                Years
                                
                                Years(In
    thousands)Commitments to originate
      loans
                                $
                                24,304
                                
                                $
                                24,304
                                
                                $
                                -
                                
                                $
                                -
                                
                                $
                                -Unused portion of lines of
      credit
                                
                                7,334
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                7,334Undisbursed portion of
      constructionloans
                                
                                74,175
                                
                                
                                56,680
                                
                                
                                7,518
                                
                                
                                9,702
                                
                                
                                275Total
      commitments
                                $
                                105,813
                                
                                $
                                80,984
                                
                                $
                                7,518
                                
                                $
                                9,702
                                
                                $
                                7,609





Capital





Consistent with our goal to operate a
sound and profitable financial organization, we actively manage our capital
levels in order to be considered “well capitalized” in accordance with
regulatory standards. As of March 31, 2009, we exceeded all regulatory capital
requirements.  Regulatory capital ratios for the Bank were as follows
as of March 31, 2009:  Tier 1 capital 15.65%; Tier 1 (core) risk-based
capital 23.14%; and total risk based capital 24.40%. The regulatory capital
requirements to be considered well capitalized are 5%, 6% and 10%,
respectively.





At March
31, 2009, shareholders' equity totaled $283.4 million, or 22.5% of total
assets. Our book value per share of common stock was $13.92 as of March 31,
2009, as compared to $13.62 as of December 31, 2008.





On
February 9, 2009, we completed the repurchase of approximately 10% of our
outstanding stock, or 2,285,280 shares, pursuant to our stock repurchase plan
announced on November 5, 2008.  The shares were repurchased at an
average cost of $8.52 per share of which 725,848 shares were purchased during
the first quarter of 2009.





On
February 18, 2009, the Board of Directors approved a second stock repurchase
plan for the purchase of up to 2,056,752 shares, or approximately 10% of our
outstanding shares of common stock.  During the first quarter of 2009,
we repurchased 204,400 shares of our common stock at an average cost per share
of $7.44.





We have started our capital
improvement project.  We estimate completing the project during the
second quarter of 2010, at which time, we will have all of our lending staff
located in one building connected to our headquarters.  The estimated
cost of the project is $8.5 million.





Item
3. Quantitative and Qualitative Disclosures about Market Risk





Market
risk is defined as the sensitivity of income and capital to changes in interest
rates and other relevant market rates or prices.  Our profitability is
largely dependent on our net interest income.  Consequently, our
primary exposure to market risk arises from the interest rate risk inherent in
our lending, deposit, and borrowing activities.  Interest rate risk is
the risk to earnings and capital resulting from adverse movements in interest
rates.  To that end, we actively monitor and manage our exposure to
interest rate risk.




A number
of measures are utilized to monitor and manage interest rate risk, including net
interest income and economic value of equity simulation models.  We
prepare these models on a quarterly basis for review by our Asset Liability
Committee (ALCO), senior management, and Board of Directors.  The use
of these models requires




33






us to
formulate and apply assumptions to various balance sheet
items.  Assumptions regarding interest rate risk are inherent in all
financial institutions, and may include, but are not limited to, prepayment
speeds on loans and mortgage-backed securities, cash flows and maturities of
financial instruments held for purposes other than trading, changes in market
conditions, loan volumes and pricing, deposit sensitivities, consumer
preferences, and management’s capital plans.  We believe that the data
and assumptions used for our models are reasonable representations of our
portfolio and possible outcomes under the various interest rate
scenarios.  Nonetheless, these assumptions are inherently uncertain;
therefore, the models cannot precisely estimate net interest income or predict
the impact of higher or lower interest rates on net interest
income.  Actual results may differ significantly from simulated
results due to timing, magnitude, and frequency of interest rate changes, and
changes in market conditions and specific strategies, among other
factors.





Asset/Liability
Management





Our
primary objective in managing interest rate risk is to minimize the adverse
impact of changes in interest rates on our net interest income and capital,
while structuring the asset and liability components to maximize net interest
margin, utilize capital effectively, and provide adequate
liquidity.  We rely primarily on our asset/liability structure to
control interest rate risk.





Asset/liability
management is the responsibility of the Asset/Liability Committee, which acts
within policy directives established by the Board of Directors.  This
committee meets monthly to monitor the composition of the balance sheet, to
assess projected earnings trends, and to formulate strategies consistent with
the objectives for liquidity, interest rate risk, and capital
adequacy.  The objectives of asset/liability management are to
maximize long-term shareholder returns by optimizing net interest income within
the constraints of credit quality, interest rate risk policies, levels of
capital leverage, and adequate liquidity.  Assets and liabilities are
managed by matching maturities and repricing characteristics in a systematic
manner.





Net
Interest Income





Our
primary source of income is net interest income, which is the difference between
interest earned on loans and investments and the interest paid on deposits and
borrowings.  Like other financial institutions, we are subject to
interest rate risk and expect periodic imbalances in the interest rate
sensitivities of our assets and liabilities.  Over any defined period
of time, our interest-earning assets may be more sensitive to changes in market
interest rates than our interest-bearing liabilities, or vice
versa.  We principally manage interest rate risk by managing our
volume and mix of our interest earning assets and interest-bearing
liabilities.





Our
income simulation model, based on information as of March 31, 2009, indicated
that our net interest income over the subsequent twelve months was projected to
increase from its “base case” level in the rate change scenarios discussed
below.  Our income simulation examines changes in interest income in
which interest rates were assumed to gradually increase by 100, 200 and 300
basis points over a twelve-month period, and decline assuming a gradual 100 bps
reduction in rates.  Reductions of 200 and 300 basis points were not
reported due to the very low rate environment and the unlikely nature of rates
declining that much further.  The changes suggest, that in the
indicated rate environments, net interest income will be positive.  In
a declining rate environment we are able to increase net interest income as
higher priced term liabilities reprice into lower priced term liabilities while
many rate sensitive assets remain at newly enacted floors leaving interest
income steady.  In a rising rate environment we will be able to
achieve a benefit from floating rate assets that will reprice faster than some
floating rate liabilities which are currently at floors and will not see an
increase in interest expense until rates rise above the floors.





34





March 31,
    2009Net Interest Income
      ChangeBasis Point
                  Change in
    Rates
                % Change+300
                
                8.26
                %+200
                
                8.33+100
                
                8.52Base
                
                8.47(100)
                
                7.70(1)
                (200)
                
                N/A(1)
                (300)
                
                N/A(1)
                The current federal funds rate is
      0.25%,making a 200 and 300 basis point
      dropunlikely.





The
changes indicated by the simulation model represent variances from a “base case”
scenario, which is a projection of net interest income assuming interest rates
remain unchanged from their current levels over the life of the forecast, and
that the size of the balance sheet remains stable over the forecast timeframe,
with no growth or contraction regardless of interest rate
movements.  The base model will, however, illustrate the future
effects of rate changes that have already occurred but have not yet flowed
through to all of the assets and liabilities on our balance
sheet.  These changes can either increase or decrease net interest
income, depending on the timing and magnitudes of those
changes.  Additionally, the tendencies for loan and investment
prepayments to accelerate in falling interest rate scenarios and slow when
interest rates rise have been incorporated into the model
assumptions.  Implicit in these assumptions are additional assumptions
for increased investment purchases and loan originations at lower interest rate
levels to offset accelerated prepayments, and conversely, reduced investment
purchases and loan production when rates increase and prepayments
slow.





The
rising and falling interest rate scenarios indicate that, if the slope of the
yield curve remains the same and customer loan and deposit preferences do not
change in response to further movements of the yield curve, a parallel 300 basis
point increase or a 100 basis point decrease in rates will moderately change net
interest income from what is presently expected in the “base
case.”





Economic
Value of Equity (EVE) Simulation Model Results





The
following table illustrates the change in the net portfolio value at March 31,
2009 that would occur in the event of an immediate change in interest rates
equally across all maturities.  This modeling is performed quarterly
and is predicated upon a stable balance sheet, with no growth or change in asset
or liability mix.  Additionally, no consideration is given to any
steps that we might take to counter the effect of that interest
movement.  Although the net portfolio value measurement provides an
indication of our interest rate risk exposure at a particular point in time,
such measurement is not intended to and does not provide, a precise
forecast.





The EVE
analysis goes beyond simulating net interest income for a specified period to
estimating the present value of all financial instruments in our portfolio and
analyzing how the economic value of the portfolio would be affected by various
alternative interest rate scenarios.  The portfolio’s economic value
is calculated by generating principal and interest cash flows for the entire
life of all assets and liabilities and discounting these cash flows back to
their present values.  The assumed discount rate used for each
projected cash flow is based on a current market rate, such as a FHLB or
Treasury curve, and from alternative instruments of comparable risk and
duration.





35





March 31,
    2009Net Portfolio as %
      ofBasis Point
                
                Net Portfolio Value
      (2)
                
                Portfolio Value of
      Assets
                
                
                Market
  ValueChange in Rates
      (1)
                
                Amount
                
                $ Change
(3)
                
                % Change
                
                
                NPV Ratio
    (4)
                
                % Change
(5)
                
                of Assets
    (6)(Dollars in
      thousands)+300
                
                $
                188,422
                
                $
                (84,042)
                
                (30.85)
                %
                
                16.43
                %
                
                (6.62)
                %
                
                $
                1,147,101+200
                
                
                216,369
                
                
                (56,095)
                
                (20.59)
                
                
                18.25
                
                
                (4.42)
                
                
                
                1,185,643+100
                
                
                244,198
                
                
                (28,266)
                
                (10.37)
                
                
                19.90
                
                
                (2.23)
                
                
                
                1,227,0280
                
                
                272,464
                
                
                -
                
                -
                
                
                21.46
                
                
                -
                
                
                
                1,269,780(100)
                
                
                290,380
                
                
                17,916
                
                6.58
                
                
                22.30
                
                
                1.41
                
                
                
                1,302,404(200)
                
                
                N/A
                
                
                N/A
                
                N/A
                
                
                N/A
                
                
                N/A
                
                
                
                N/A(300)
                
                
                N/A
                
                
                N/A
                
                N/A
                
                
                N/A
                
                
                N/A
                
                
                
                N/A





(1)
            The
      current federal funds rate is 0.25%, making a 200 or 300 basis point drop
      unlikely.(2)
            The
      net portfolio value is calculated based upon the present value of the
      discontinued cash flows from assets and liabilities.  The
      difference between the present value of assets and liabilities is the net
      portfolio value and represents the market value of equity for the given
      interest rate scenario.  Net portfolio value is useful for
      determining, on a market value basis, how much equity changes in response
      to various interest rate scenarios.  Large changes in net
      portfolio value reflect increased interest rate sensitivity and generally
      more volatile earnings streams.(3)
            Represents
      the increase (decrease) in the estimated net portfolio value at the
      indicated change in interest rates compared to the net portfolio
      value.(4)
            Calculated
      as the net portfolio value divided by the market value of assets (“net
      portfolio value ratio”).(5)
            Calculated
      as the increase (decrease) in the net portfolio value ratio assuming the
      indicated change in interest rates over the estimated portfolio value of
      assets.(6)
            Calculated
      based on the present value of the discounted cash flows from
      assets.  The market value of assets represents the value of
      assets under the various interest rate scenarios and reflects the
      sensitivity of those assets to interest rate
  changes.





In the
simulated upward rate shift of the yield curve, the discount rates used to
calculate the present values of assets and liabilities will increase, causing
the present values of both assets and liabilities to fall, with more prominent
effects on longer-term, fixed-rate instruments.  Our EVE simulation
model results as of March 31, 2009 indicated that when comparing 100 basis point
rate shifts our assets would be expected to exhibit a greater level of
sensitivity to rising rates than liabilities, with the economic value of
liabilities declining by 0.45%, compared to a decline of 2.75% for our
assets.  Given the greater sensitivity of assets, the reduction in the
economic value of assets exceeded the impact on
liabilities.  Consequently, the economic value of our equity was
negatively impacted in this scenario, declining 10.37% at a 100 basis point rate
increase.





The
opposite occurs when rates decline, as the discount rates used to calculate the
present values of assets and liabilities will decrease, causing the present
values of both assets and liabilities to rise.  In this case, the
economic values of both assets and liabilities were positively impacted when
rates were assumed to fall by 100 basis points, assets increased by 3.22% and
liabilities declined by 3.43%.  As a result, with the value of
liabilities rising more than asset values, our economic value of equity was
positively impacted in this scenario, increasing 6.58%.





The net
interest income and net portfolio value tables presented above are predicated
upon a stable balance sheet with no growth or change in asset or liability mix.
In addition, the net portfolio value is based upon the present value of
discounted cash flows using a third party service provider’s market analysis and
our estimates of current replacement rates to discount the cash flows. The
effects of changes in interest rates in the net interest income table are based
upon a cash flow simulation of our existing assets and liabilities and for
purposes of simplifying the analysis, assumes that delinquency rates would not
change as a result of changes in interest rates, although there can be no
assurances that this will be the case. Delinquency rates may change when
interest rates change; as a result of changes in the loan portfolio mix,
underwriting conditions, loan terms, or changes in economic conditions that have
a delayed effect on the portfolio. The model we use does not change the
delinquency






36









At March 31, 2009, we had no derivative
financial instruments.  In addition, we did not maintain a trading
account for any class of financial instruments, nor have we engaged in hedging
activities or purchased off-balance sheet derivative
instruments.  Interest rate risk continues to be the primary market
risk as other types of market risk, such as foreign currency exchange risk and
commodity price risk, do not arise in the normal course of our business
activities and operations.





Item
4.  Controls and Procedures





The management of First Financial
Northwest, Inc. is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term in defined in Rule
13a-15(f) of the Securities Exchange Act of 1934 (Exchange Act).  A
control procedure, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that its objectives are
met.  Also, because of the inherent limitations in all control
procedures, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within the Company have been
detected.  As a result of these inherent limitations, internal control
over financial reporting may not prevent or detect
misstatements.  Further, projections of any evaluation of
effectiveness to future periods are subject to risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.





(a)
            Evaluation of Disclosure
      Controls and Procedures:An evaluation of our disclosure
      controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act)
      was carried out under the supervision and with the participation of our
      Chief Executive Officer, Chief Financial Officer and several other members
      of our senior management as of the end of the period covered by this
      report.  Our Chief Executive Officer and Chief Financial Officer
      concluded that, as of March 31, 2009, our disclosure controls and
      procedures were effective in ensuring that the information required to be
      disclosed by us in the reports we file or submit under the Exchange Act is
      (i) accumulated and communicated to our management (including the Chief
      Executive Officer and Chief Financial Officer) in a timely manner, and
      (ii) recorded, processed, summarized and reported within the time periods
      specified in the SEC’s rules and forms.(b)
            Changes in Internal
      Controls:In the quarter ended March 31, 2009, there was
      no change in our internal control over financial reporting that has
      materially affected, or is reasonably likely to materially affect, our
      internal control over financial
reporting.





37





PART
II





Item 1.  Legal
Proceedings





From time
to time, we are engaged in legal proceedings in the ordinary course of business,
none of which are currently considered to have a material impact on our
financial position or results of operations.




Item
1A.  Risk Factors




There
have been no material changes in the risk factors previously disclosed in Part
1, Item 1A of our Annual Report on Form 10-K for the year ended December 31,
2008, except that the following risk factors are added to those previously
contained in the Form 10-K:




Our
Loan Center remodel will increase our non-earning assets.




We
have started our capital improvement project.  We estimate completing
the project during the second quarter of 2010, at which time, we will have all
of our lending staff located in one building connected to our
headquarters.  The estimated cost of the project is $8.5
million.




We
may be required to make further increases in our provisions for loan losses and
to charge-off additional loans in the future, which could adversely affect our
results of operations.




For
the quarter ended March 31, 2009, we recorded a provision for loan losses of
$1.5 million.  There was no provision for loan losses for the three
months ended March 31, 2008.  Loan charge-offs for the quarter ended
March 31, 2009 and 2008 were $4.2 million and $0, respectively.  We
are experiencing increasing loan delinquencies.  Generally, our
nonperforming assets reflect operating difficulties of individual borrowers
resulting from weakness in the economy.  In addition, slowing sales
have been a contributing factor to the increase in nonperforming loans as well
as the increase in delinquencies.  At March 31, 2009, our total
nonperforming loans, net of undisbursed funds, had increased to $80.2 million
compared $58.6 million at December 31, 2008.  In that regard, our
portfolio includes construction/land development loans, commercial real estate
loans, one-to-four family residential and consumer loans, of which
construction/land development and commercial loans have a higher risk of loss
than residential mortgage and consumer loans.  While loans related to
the construction/land development portfolio represented 21.5% of our gross loan
portfolio at March 31, 2009 they represented 67.5% of our nonperforming assets
at that date.  If current trends in the housing and real estate
markets continue, we expect that we will continue to experience increased
delinquencies and credit losses.  Moreover, if the recession worsens
we expect that it would further negatively impact economic conditions in our
market areas and that we could experience significantly higher delinquencies and
credit losses.  An increase in our credit losses or our provision for
loan losses would adversely affect our financial condition and results of
operations.




Item
2.   Unregistered Sales of Equity Securities and Use of
Proceeds




Not
applicable.




Item
3.  Defaults Upon Senior Securities




Not
applicable.




Item
4.  Submission of Matters to a Vote of Security
Holders




Not
applicable.







38




Item
5.  Other Information




Not
applicable.






Item
6.  Exhibits





3.1
            Articles
      of Incorporation of First Financial Northwest (1)3.2
            Bylaws
      of First Financial Northwest (1)4
            Form
      of stock certificate of First Financial Northwest(1)10.1
            Form
      of Employment Agreement for President and Chief Executive Officer
      (1)10.2
            Form
      of Change in Control Severance Agreement for Executive Officers
      (1)10.3
            Form
      of First Savings Bank Employee Severance Compensation Plan
    (1)10.4
            Form
      of Supplemental Executive Retirement Agreement entered into by First
      Savings Bank with Victor Karpiak, Harry A. Blencoe and Robert H. Gagnier
      (1)10.5
            Form
      of Financial Institutions Retirement Fund (1)10.6
            Form
      of 401(k) Retirement Plan (2)10.7
            2008
      Equity Incentive Plan (3)10.8
            Forms
      of incentive and non-qualified stock option award agreements
      (4)10.9
            Form
      of restricted stock award agreement (4)14
            Code
      of Business Conduct and Ethics (5)21
            Subsidiaries
      of the Registrant31.1
            Certification
      of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
      Act31.2
            Certification
      of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
      Act32.1
            Certification
      of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley
      Act32.2
            Certification
      of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley
      Act


________________________________________


(1)
            Filed
      as an exhibit to First Financial Northwest’s Registration Statement on
      Form S-1 (333-143549).(2)
            Filed
      as an exhibit to First Financial Northwest’s Quarterly Report on Form 10-Q
      for the quarter ended June 30, 2007 and incorporated herein by
      reference.(3)
            Filed
      as Appendix A to First Financial Northwest’s definitive proxy statement
      dated April 15, 2008.(4)
            Filed
      as an exhibit to First Financial Northwest’s Current Report on Form 8-K
      dated July 1, 2008.(5)
            Filed
      as an exhibit to First Financial Northwest’s Annual Report on Form 10-K
      for the year ended December 31, 2008 and incorporated herein by
      reference.









39











SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.








First
      Financial Northwest, Inc.Date:  May
      8, 2009
            
            /s/Victor KarpiakVictor
      KarpiakPresident,Chief
      Executive OfficerDate:  May
      8, 2009
            
            /s/Kari StenslieKari
      StenslieChief
      Financial OfficerPrincipal
      Financial and Accounting Officer








40