EDGAR 10-K Filing

Company CIK: 1163370
Filing Year: 2021
Filename: 1163370_10-K_2021_0001163370-21-000012.json

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ITEM 1. BUSINESS
ITEM 1. BUSINESS
In this document, please note that references to "we", "our", "us", or the "Company" mean Northrim BanCorp, Inc. and its subsidiaries, unless the context suggests otherwise.
General
We are a publicly traded bank holding company headquartered in Anchorage, Alaska. The Company’s common stock trades on the Nasdaq Global Select Stock Market (“NASDAQ”) under the symbol, “NRIM.” The Company is regulated by the Board of Governors of the Federal Reserve System. We began banking operations in Anchorage in December 1990, and formed the Company as an Alaska corporation in connection with our reorganization into a holding company structure; that reorganization was completed effective December 31, 2001. The Company has grown to be the third largest commercial bank in Alaska and in Anchorage in terms of deposits, with $1.8 billion in total deposits and $2.1 billion in total assets at December 31, 2020. Through our sixteen banking branches and twelve mortgage origination offices, we are accessible to approximately 90% of the Alaskan population.
The Company has three direct wholly-owned subsidiaries:
•Northrim Bank (the “Bank”), a state chartered, full-service commercial bank headquartered in Anchorage, Alaska. The Bank is regulated by the Federal Deposit Insurance Corporation (the "FDIC") and the State of Alaska Department of Commerce, Community and Economic Development, Division of Banking, Securities
and Corporations. The Bank has sixteen branch locations in Alaska; eight in Anchorage, one in Wasilla, two in Juneau, one in Fairbanks, one in Ketchikan, one in Sitka, one in Eagle River, and one in Soldotna. Additionally, we have a loan production office in Kodiak. We operate in Washington State through Northrim Funding Services (“NFS”), a factoring business that the Bank started in 2004. We offer a wide array of commercial and consumer loan and deposit products, investment products, and electronic banking services over the Internet;
•Northrim Investment Services Company (“NISC”) was formed in November 2002. In the first quarter of 2006, through NISC, we purchased an equity interest in Pacific Wealth Advisors, LLC (“PWA”), an investment advisory, trust, and wealth management business located in Seattle, Washington, in which we hold 24% of PWA's total outstanding equity interests. PWA is a holding company that owns Pacific Portfolio Consulting, LLC and Pacific Portfolio Trust Company;
•Northrim Statutory Trust 2 (“NST2”), an entity that we formed in December of 2005 to facilitate a trust preferred securities offering by the Company.
The Bank has three direct wholly-owned subsidiaries:
•Northrim Capital Investments Co. (“NCIC”) is a wholly-owned subsidiary of the Bank, which holds a 100% interest in a residential mortgage holding company, Residential Mortgage Holding Company, LLC (“RML”). The predecessor of RML, Residential Mortgage, LLC, was formed in 1998 and has twelve offices throughout Alaska. RML became a wholly-owned subsidiary of NCIC on December 1, 2014. Prior to that, the Company held a 23.5% interest in RML. RML holds a 30% investment in Homestate Mortgage, LLC. In March and December of 2005, NCIC purchased ownership interests totaling 50.1% in Northrim Benefits Group, LLC (“NBG”), an insurance brokerage company that focused on the sale and servicing of employee benefit plans. In August 2017, the Company sold all of its interest in the assets of NBG.
•Northrim Building, LLC (“NBL”) is a wholly-owned subsidiary of the Bank that owns and operates the Company’s main office facility at 3111 C Street in Anchorage.
•Northrim Building LO, LLC is a wholly-owned subsidiary of the Bank that owns and operates the Company’s community branch facility at 2270 E. 37th Avenue in Anchorage.
Segments
The Company operates in two primary segments: Community Banking and Home Mortgage Lending. Measures of the revenues, profit or loss, and total assets for each of the Company's segments are included in this report, Part II. Item 8. "Financial Statements and Supplementary Data", which is incorporated herein by reference.
Business Strategy
The Company’s primary objective is to become Alaska's most trusted financial institution by adding value for our customers, communities, and shareholders. We aspire to be Alaska's premier bank and employer of choice as a leader in financial expertise, products, and services. We value our state, and we are proud to be Alaskan. We embody Alaska's frontier spirit and values, and we support our communities. We have a sincere appreciation for our customers, and we strive to deliver superior customer first service that is reliable, ethical, and secure. We look for growth opportunities for our customers, our institution, and our employees.
Our strategy is one of value-added growth. Management believes that calculated, sustainable organic and inorganic market share growth coupled with good asset quality, an appropriate core deposit and capital base, operational efficiency, diversified sources of other operating income, and improved profitability is the most appropriate means of increasing shareholder value.
Our business strategy emphasizes commercial lending products and services through relationship banking with businesses and professional individuals. Additionally, we are a land development and residential construction lender and an active lender in the commercial real estate market in Alaska. Because of our relatively small size, our experienced senior management team can be more involved with serving customers and making credit decisions, all of which are made in Alaska, allowing us to compete more favorably with larger competitors for business lending relationships. Our business strategy also emphasizes the origination of a variety of home mortgage loan products, which we sell to the secondary market. We retain servicing for home mortgages that we originate and sell to the Alaska Housing Finance Corporation. We believe that there is
opportunity to increase the Company’s loan portfolio, particularly in the commercial portion of the portfolio, in the Company’s current market areas through existing and new customers.
Management believes that our real estate construction and term real estate loan departments have developed a strong level of expertise and will continue to compete favorably in our markets. We have also targeted the acquisition of new customers in professional fields including physicians, dentists, accountants, and attorneys. In addition to lending products, in many cases commercial customers also require multiple deposit and affiliated services that add franchise value to the Company. While we expect that opportunities for growth in 2021 will be modest mainly due to the impacts of the COVID-19 pandemic and the lower oil prices compared to pre-2020 levels, which has led to a slower economy in Alaska, we believe that these strategies will continue to benefit the Company, and we intend to continue to grow our balance sheet through increasing our market share. The Company benefits from solid capital and liquidity positions, and management believes that this provides a competitive advantage in the current business environment. (See “Liquidity and Capital Resources” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.)
The Company’s business strategy also stresses the importance of customer deposit relationships to support its lending activities. Our guiding principle is to serve our market areas by operating with a “Superior Customer First Service” philosophy, affording our customers the highest priority in all aspects of our operations. We believe that our adherence to this philosophy has created a strong core deposit franchise that provides a stable, low cost funding source for expanded growth in all of our lending areas. We have devoted significant resources to future deposit product development, expansion of electronic services for both personal and business customers, and enhancement of information security related to these services.
In addition to market share growth, a significant aspect of the Company’s business strategy is focused on managing the credit quality of our loan portfolio. Over the last several years, the Company has allocated more resources to the credit management function of the Bank to provide enhanced financial analysis of our largest, most complex loan relationships to further develop our processes for analyzing and managing various concentrations of credit within the overall loan portfolio, and to develop strategies to improve or collect our existing loans. Continued success in maintaining or further improving the credit quality of our loan portfolio and managing our level of other real estate owned is a significant aspect of the Company’s strategy for attaining sustainable, long-term market growth to produce increased shareholder value.
Human Capital Resources
We believe that we provide a high level of customer service. To achieve our objective of providing “Superior Customer First Service”, in managing its human capital resources, management emphasizes the hiring and retention of competent and highly motivated employees at all levels of the organization. Management believes that a well-trained and highly motivated core of employees allows maximum personal contact with customers in order to understand and fulfill customer needs and preferences. This “Superior Customer First Service” philosophy is combined with our emphasis on personalized, local decision making. The Company continues to enhance our company-wide employee training program which focuses on Northrim culture, Superior Customer First Service, general sales skills, and various technical areas. The Company complies with all applicable state and local laws governing nondiscrimination in employment in every location in which the Company operates. All applicants and employees are treated with the same high level of respect regardless of their gender, ethnicity, religion, national origin, age, marital status, political affiliation, sexual orientation, gender identity, disability or protected veteran status.
Employee Profile and Diversity
We consider our relations with our employees to be highly satisfactory. We had 438 full-time equivalent employees at December 31, 2020. None of our employees are covered by a collective bargaining agreement. Of the 438 full-time equivalent employees, 312 were Community Banking employees and 126 were Home Mortgage Lending employees.
Among the Company's full-time equivalent employees as of December 31, 2020, 72% identify as women and 28% as men. Approximately 35% of the workforce identify as a member of a racial minority, 5% identify as individuals with a disability, and 2% identify as veterans. In executive and senior management positions, 52% identify as women and 48% as men as of December 31, 2020. Approximately 4% of those in executive and senior management positions identify as a member of a racial minority, 4% identify as individuals with a disability, and 4% identify as veterans.
We work every day to create an open and respectful environment where everyone can actively contribute, have equal access to opportunities and resources, be themselves, and realize their potential. As an Equal Opportunity Employer, we emphasize inclusion through hiring and compensation practices and consider a pool of diverse candidates for open positions and internal advancement opportunities. To address issues related to pay discrimination, we do not ask potential candidates
about their current or previous compensation during the hiring process, and we incorporate equal and fair pay reviews into every employment compensation decision. To reinforce our corporate culture of respect, diversity, and inclusion, each of our employees completes anti-harassment training annually.
Support of Human Capital in Response to COVID-19
In response to COVID-19 related state and local government orders to stay at home, since April of 2020 a portion of the Company's employees have worked remotely directly due to the pandemic. As of December 31, 2020, approximately 45% of the Company's employees are working remotely either on a full- or part-time basis directly due to COVID-19. These employees primarily hold non-customer facing positions within the Company. Prior to the pandemic, less than 8% of the Company's employees worked remotely. The increase in the number of employees that work remotely has had no material impact on the Company's operations.
In addition to remote work arrangements, the Company has expanded other flexible work options including variable work hours, condensed work weeks, and part-time hours to assist employees with managing personal matters during the pandemic caused by COVID-19. Lastly, the Company expanded tele-health and employee assistance program benefits to help employees manage their physical and emotional health during the pandemic.
Products and Services
Community Banking
Lending Services: We have an emphasis on commercial and real estate lending. We also believe we have a significant niche in construction and land development lending in Anchorage, Fairbanks, the Matanuska-Susitna Valley, the Kenai Peninsula, and Southeast Alaska. (See “Loans” in Part II. Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.)
Purchase of accounts receivable: We provide short-term working capital to customers primarily in our Alaska markets as well as Washington, Oregon and some other states by purchasing their accounts receivable through NFS. In 2021, we expect NFS to continue to penetrate these markets and to continue to contribute to the Company’s profitability.
Deposit Services: Our deposit services include business and personal noninterest-bearing checking accounts and interest-bearing time deposits, checking accounts, savings accounts, and individual retirement accounts. Our interest-bearing accounts generally earn interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits.
Several of our deposit services and products are:
•A specialized business checking account customized to account activity;
•A money market deposit account;
•A “Jump-Up” certificate of deposit (“CD”) that allows additional deposits with the opportunity to increase the rate to the current market rate for a similar term CD;
• A savings account that is priced like a money market account that allows additional deposits, quarterly withdrawals without penalty, and tailored maturity dates;
•Insured cash sweep and business sweep;
•Consumer online banking, mobile app, and mobile deposit;
•Business online banking, business mobile app, and business mobile deposit; and
•Instantly issued debit cards for business and consumer accounts at account opening.
Other Services: In addition to our traditional deposit and lending services, we offer our customers several convenience services: Mobile Web and Text Banking, consumer online account opening, Personal Finance, Online Documents, Consumer Debit Cards, Business Debit Cards, My Rewards for consumer debit cards, retail lockbox services, card controls, Consumer Credit Cards, Business Credit Cards, Business Employee Purchase Cards, home equity advantage access cards, telebanking, and
automated teller services. Other services include personalized checks at account opening, overdraft protection from a savings account, extended banking hours and commercial drive-up banking at many locations, automatic transfers and payments, People Pay (a peer-to-peer payment functionality), external transfers, Bill Pay, wire transfers, direct payroll deposit, electronic tax payments, Automated Clearing House origination and receipt, remote deposit capture, account reconciliation and positive pay, merchant services, cash management programs and sweep options to meet the needs of business customers, annuity products, and long term investment portfolios.
Other Services Provided Through Affiliates and Former Affiliates Whom We Continue To Work With: Prior to August of 2017, the Company sold and serviced employee benefit plans for small and medium sized businesses in Alaska through NBG, an insurance brokerage company. In August 2017, we sold our interest in the assets of NBG, but we have continued our relationship with Acrisure, LLC, who purchased the assets of NBG, through an ongoing referral agreement. Our affiliate PWA provides investment advisory, trust, and wealth management services for customers who are primarily located in the Pacific Northwest and Alaska. We plan to continue to leverage these affiliate relationships to strengthen our existing customer base and bring new customers into the Bank.
Significant Business Concentrations: No individual or single group of related accounts is considered material in relation to our total assets or total revenues, or to the total assets, deposits or revenues of the Bank, or in relation to our overall business. Based on classification by North American Industry Classification System ("NAICS"), there are no segments that exceed 10% of portfolio loans, except for real estate (see Note 5, Loans and Credit Quality, of the Notes to Consolidated Financial Statements included in Part II. Item 8 of this report for a breakout of real estate loans). In addition to its review of NAICS codes, the Company has also identified concentrations in various industries that may be adversely impacted by the COVID-19 pandemic and the decline in oil prices. We estimate that as of December 31, 2020 the Company had $78.9 million, or 5% of portfolio loans, in the tourism sector, $56.1 million, or 4% of portfolio loans, in the aviation (non-tourism) sector, $96.9 million, or 7% of total loans, in the healthcare sector, $65.1 million, or 4%, in the oil and gas sector, $17.4 million, or 1%, in retail loans and $31.0 million, or 2% in the restaurant sector, and $37.2 million, or 3% in the accommodations sector. At December 31, 2020, the Company had $78.9 million, or 7% of portfolio loans excluding PPP loans, in the tourism sector, $56.1 million, or 5% of portfolio loans excluding PPP loans, in the aviation (non-tourism) sector, $96.9 million, or 8% of total loans excluding PPP loans, in the healthcare sector, $65.1 million, or 6% of total loans excluding PPP loans, in the oil and gas sector, $17.4 million, or 2% of total loans excluding PPP loans, in retail loans and $31.0 million, or 3% of total loans excluding PPP loans in the restaurant sector, and $37.2 million, or 3% of total loans excluding PPP loans in the accommodations sector. Additionally, approximately 43% of our loan portfolio at December 31, 2020 is attributable to 35 large borrowing relationships. Moreover, our business activities are currently focused primarily in the state of Alaska. Consequently, our results of operations and financial condition are dependent upon the general trends in the Alaska economy and, in particular, the residential and commercial real estate markets in Anchorage, Juneau, Fairbanks, the Matanuska-Susitna Valley, Ketchikan, Sitka, and to a lesser extent, the Kenai Peninsula.
Home Mortgage Lending
Lending Services: The Company originates 1-4 family residential mortgages throughout Alaska which we sell to the secondary market. Residential mortgage choices include several products from the Alaska Housing Finance Corporation including first-time homebuyer, veteran's and rural community programs; Federal Housing Authority, or "FHA" loans; Veterans Affairs, or "VA" loans; Jumbo loans; and various conventional mortgages. The Company retains servicing rights on loans sold to the Alaska Housing Finance Corporation since implementing a new loan servicing program in July 2015.
Alaska Economy
Our growth and operations are impacted by the economic conditions of Alaska and the specific markets we serve. Significant changes in the Alaska economy and the markets we serve eventually could have a positive or negative impact on the Company. Alaska is strategically located on the Pacific Rim, within nine hours by air from 95% of the northern hemisphere, and Anchorage has become a worldwide air cargo and transportation link between the United States and international business in Asia and Europe. The economy of Alaska is dependent upon natural resource industries. Key sectors of the Alaska economy are the oil industry, government and military spending, and the fishing, mining, tourism, air cargo, transportation, and construction industries, as well as health services.
Recent Economic Developments
After three consecutive years of a mild recession, the Alaska economy began to show a positive change in the fourth quarter of 2018, with improvements continuing throughout 2019 and the first part of 2020 until the COVID-19 pandemic caused a significant and sudden negative impact on the economy in Alaska. The State Department of Labor reported a year-over-year loss of 24,100 jobs, or 7.7% in December 2020 compared to December of 2019 following moderate growth of 1,900 jobs, or 0.6%, in December of 2019 compared to December of 2018. The Alaska Department of Labor predicts a recovery of 8,600 jobs, or an approximately 2.8% increase in total employment in 2021. The Company anticipates this relatively slow growth rate will have an impact on our ability to grow organically in the next few years.
Alaska’s annualized and seasonally adjusted gross state product (“GSP”) was $50.4 billion in the third quarter of 2020, compared to $54.5 billion in the third quarter of 2019, according to the Federal Bureau of Economic Analysis ("BEA") in a report released on December 23, 2020. Alaska’s real GSP increased by 0.7% in 2018 and 0.6% in 2019. 2020 has been very erratic primarily due to the impact of COVID-19. According to the BEA, Alaska’s GSP declined 6% at a seasonally adjusted annualized rate in the first quarter of 2020 and declined 33.8% in second quarter. However, in the third quarter of 2020 the GSP in Alaska improved 32.2% at an annualized rate. This is very similar to the nationwide averages for the U.S. which, according to the BEA, saw a decline of 5% in the first quarter of 2020, a loss of 31.4% in the second quarter and a positive improvement of 33.4% in the third quarter. In the third quarter of 2020 in Alaska, the largest improvements came from Transportation and Warehousing, Government, Health Care and Accommodation and Food Services.
Alaska’s seasonally adjusted personal income for the third quarter of 2020 was $48.6 billion compared to $46 billion in the third quarter of 2019, according to a report released by the BEA on December 17, 2020. In a typical year, the majority of personal income is derived from wage earnings. Additionally, some people receive government transfer payments, such as social security, Medicare and Medicaid. Personal income is further supported by earnings from dividends, interest and rents.
In the second quarter of 2020, Alaska’s personal income rose by $2.6 billion compared to the prior year as government transfer payments rose by $4.9 billion, according to the BEA, mainly from COVID-19 stimulus payments. This was somewhat offset by a $2.2 billion reduction in wage income and a $139 million decrease in investment and rental income. In the third quarter of 2020, these two major segments of income reversed. Wage earnings improved by $2.6 billion and government transfer payments decreased by $3.5 billion compared to the prior quarter. Investment and rental income was relatively unchanged, down $55 million. The net effect of all this movement is that personal income is $2.6 billion or 5.6% higher in the third quarter of 2020 in Alaska than where it was in the third quarter of 2019, according to the BEA.
Alaska’s home mortgage delinquency and foreclosure levels continue to be better than most of the nation. According to the Mortgage Bankers Association, Alaska’s foreclosure rate was 0.49% at the end of the third quarter of 2020. The comparable national average rate was 0.59% for the same time period 2020. The national rate continues to improve, while the Alaska rate remains relatively lower. The survey also reported that the percentage of delinquent mortgage loans in Alaska was 6.78% for the third quarter of 2020. The comparable delinquency rate for the entire country was higher at 7.60% for the same time period in 2020.
A material portion of our loans at December 31, 2020, were secured by real estate located in greater Anchorage, Matanuska-Susitna Valley, Fairbanks, and Southeast Alaska. In 2020, 45% of our revenue was derived from the residential housing market in the form of loan fees and interest on residential construction and land development loans and income from RML as compared to 31% and 29% in 2019 and 2018, respectively. Real estate values generally are affected by economic and other conditions in the area where the real estate is located, fluctuations in interest rates, changes in tax and other laws, and other matters outside of our control. A decline in real estate values in the greater Anchorage, Matanuska-Susitna Valley, Fairbanks, and Southeast Alaska areas could significantly reduce the value of the real estate collateral securing our real estate loans and could increase the likelihood of defaults under these loans. At December 31, 2020, $780.1 million, or 54%, of our loan portfolio was represented by commercial loans in Alaska.
Long Term Economic Factors
We believe the long-term growth of the Alaska economy will most likely be determined by large scale natural resource development projects. Several multi-billion dollar projects can potentially advance in the moderate-term. Some of these projects include copper, gold and molybdenum production at the proposed Donlin mine and continued exploration in the National Petroleum Reserve Alaska. Because of their size, we believe each of these projects faces tremendous challenges. We believe various political decisions need to be made by government regulators, issues need to be resolved in the court system, and multi-billion dollar financial commitments need to be made by the private sector if these large natural resource projects are to advance. If none of these projects moves forward in the next ten years, we believe state revenues will continue to decline with falling oil production from older fields on the North Slope of Alaska. We anticipate the decline in state revenues will likely have a negative effect on Alaska’s economy.
The oil industry plays a significant role in the economy of Alaska, but revenues for the State of Alaska are less dependent on the oil industry than they have been historically due to the implementation of a percent of market value ("POMV") concept that has balanced and created more certainty in state revenue streams. Part of the POMV concept creates an allocation of a portion of investment earnings to unrestricted revenue instead of restricted revenue. According to the State of Alaska Department of Revenue, approximately 20% of total state revenues of $8.7 billion in the fiscal year ending June 30, 2020 were generated through various taxes and royalties on the oil industry. Investment earnings were 21% of the total, and federal dollars were 48%. In the fiscal year ending June 30, 2019, 23% of total state revenues were generated through taxes and royalties on the oil industry while investment earnings and federal dollars accounted for 36% and 30%, respectively. However, in 2020 investment earnings represented 66% of unrestricted revenues as compared to 52% in 2019 for the fiscal year ending June 30. As of December 31, 2019, Alaska's Constitutional Budget Reserve was $1.1 billion and the Alaska Permanent Fund had a balance of $72 billion. Investment revenue generated by the Alaska Permanent Fund is also used to pay an annual dividend to every eligible Alaskan citizen.
Even though we believe that the implementation of the POMV concept is a positive for the state of Alaska's financial well-being, we anticipate that if oil prices remain at their current relatively low levels in the longer term it will be a concern for Alaska's long-term economic growth. However, we believe Alaska's economy is less sensitive to oil price volatility in the short-term than Alaska's state government budget. While state government revenue from oil royalties is immediately and directly impacted by a drop in oil prices, we believe that the large scale and nature of oil wells in Alaska are such that project commitments that currently exist will most likely not be disrupted by short-term price volatility. We continue to be encouraged by announcements from several oil exploration companies announcing new oil fields on the North Slope resulting from increased exploration activity that began in 2018 that could lead to future increases in oil production over time.
We believe our exposure to the tourism industry diversifies the Company's customer base in the long-term. We believe this helps mitigate the effect that the decline in natural resource industries, specifically the oil industry, in Alaska has had on the Company's operations. Southeast Alaska is the primary destination for cruise ships that visit Alaska. Based on the latest information from Rain Coast Data, approximately one million cruise ship tourists have visited Southeast Alaska annually in recent years and in 2019, this increased 7% to 1.2 million. However, in 2020, there was essentially no cruise ship activity due to the COVID-19 pandemic and we are uncertain if, or when, cruise ship activity will return to historical levels.
Alaska’s residents are not subject to any state income or state sales taxes. For over 30 years, Alaska residents have received annual distributions payable in October of each year from the Alaska Permanent Fund Corporation, which is supported by royalties from oil production. The distribution was $992 per eligible resident in 2020 for an aggregate distribution of approximately $640 million. The Anchorage Economic Development Corporation estimates that, for most Anchorage households, distributions from the Alaska Permanent Fund Corporation exceed other Alaska taxes to which those households are subject (primarily real estate taxes).
Competition
We operate in a highly competitive and concentrated banking environment. We compete not only with other commercial banks, but also with many other financial competitors, including credit unions (including Alaska USA Federal Credit Union, one of the nation’s largest credit unions), finance companies, mortgage banks and brokers, securities firms, insurance companies, private lenders, and other financial intermediaries, many of which have a state-wide or regional presence, and in some cases, a national presence. Many of our competitors have substantially greater resources and capital than we do and offer products and services that are not offered by us. Our non-bank competitors also generally operate under fewer regulatory constraints, and in the case of credit unions, are not subject to income taxes. We estimate that credit unions in Alaska have a 44% share of total deposits held in banks and credit unions in the state as of June 30, 2020. Changes in credit union operating practices have effectively eliminated the “common bond” of membership requirement and liberalized their lending authority to include business and real estate loans on par with commercial banks. The differences in resources and regulation may make it harder for us to compete profitably, to reduce the rates that we can earn on loans and investments, to increase the rates we must offer on deposits and other funds, and adversely affect our financial condition and earnings.
As our industry becomes increasingly dependent on and oriented toward technology-driven delivery systems, permitting transactions to be conducted electronically, non-bank institutions are able to attract funds and provide lending and other financial services even without offices located in our primary service area. Some insurance companies and brokerage firms compete for deposits by offering rates that are higher than may be appropriate for the Company in relation to its asset and liability management objectives. However, we offer a wide array of deposit products and services and believe we can compete effectively through relationship based pricing and effective delivery of “Superior Customer First Service”. We also compete with full service investment firms for non-bank financial products and services offered by PWA and through retail investment advisory services and annuity investment products that we offer through a third-party vendor.
Currently, there are seven commercial banks operating in Alaska. At June 30, 2020, the date of the most recently available information, Northrim Bank had approximately a 12% share of the Alaska bank deposits, 17% in the Anchorage area, 18% in Juneau, 15% in Matanuska-Susitna, 13% in Sitka, 10% in Fairbanks, 6% in Ketchikan, and 1% in the Kenai Peninsula.
The following table sets forth market share data for the banks and credit unions having a presence in Alaska as of June 30, 2020, the most recent date for which comparative deposit information is available.
Financial institution Number of branches Total deposits (in thousands) Market share of total financial institution deposits Market share of total bank deposits
Northrim Bank(1)
16 $1,752,109 7 % 12.3 %
Wells Fargo Bank Alaska(1)
43 7,152,819 28 % 50.3 %
First National Bank Alaska(1)
27 2,912,046 12 % 20.4 %
Key Bank(1)
13 1,082,449 4 % 7.6 %
First Bank(1)
9 590,622 2 % 4.2 %
Mt. McKinley Bank(1)
5 424,901 2 % 3.0 %
Denali State Bank(1)
5 312,196 1 % 2.2 %
Total bank branches 118 $14,227,142 56 % 100 %
Credit unions(2)
79 $10,968,880 44 % NA
Total financial institution branches 197 $25,196,022 100 % 100 %
(1) FDIC Summary of Deposits as of June 30, 2020.
(2) SNL Financial Deposit Market Share Summary as of June 30, 2020.
Supervision and Regulation
The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956 (the “BHC Act”) registered with and subject to examination by the Board of Governors of the Federal Reserve System (the “FRB”). The Company’s bank subsidiary is an Alaska-state chartered commercial bank and is subject to examination, supervision, and regulation by the Alaska Department of Commerce, Community and Economic Development, Division of Banking, Securities and Corporations (the “Division”). The FDIC insures the Bank’s deposits and also examines, supervises, and regulates the Bank. The Company’s affiliated investment advisory and wealth management company, Pacific Portfolio Consulting, LLC, is subject to and regulated under the Investment Advisors Act of 1940 and applicable state investment advisor rules and regulations. The Company’s affiliated trust company, Pacific Portfolio Trust Company, is regulated as a non-depository trust company under the trust company laws of the State of Washington and is subject to supervision and examination by the Department of Financial Institutions of Washington State.
The Company’s earnings and activities are affected, among other things, by legislation, by actions of the FRB, the Division, the FDIC and other regulators, by local legislative and administrative bodies, and decisions of courts. These include limitations on the ability of the Bank to pay dividends to the Company, numerous federal and state consumer protection laws imposing requirements on the making, enforcement, and collection of consumer loans, and restrictions on and regulation of the sale of mutual funds and other uninsured investment products to customers.
Regulation of banks and the financial services industry has been undergoing major changes in recent years, including the enactment in 2010 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) and several provisions were significantly changed by enactment of the Economic Growth Regulatory Relief and Consumer Protection Act in May 2018. The Dodd-Frank Act significantly modifies and expands legal and regulatory requirements imposed on banks and other financial institutions.
The Dodd-Frank Act has significantly affected the Bank and its business and operations. The Dodd-Frank Act permanently increased the maximum amount of deposit insurance coverage to $250,000 per depositor and deposit insurance assessments paid by the Bank are now based on the Bank’s total assets. Other Dodd-Frank Act changes include: (i) tightened capital requirements for the Bank and the Company; (ii) new requirements on parties engaged in residential mortgage origination, brokerage, lending and securitization; (iii) expanded restrictions on affiliate and insider transactions; (iv) enhanced restrictions on management compensation and related governance procedures; (v) creation of a federal Consumer Financial Protection Bureau (the "CFPB") with broad authority to regulate consumer financial products and services; and (vi) restrictions and prohibitions on the ability of banking entities to engage in proprietary trading and to invest in or have certain relationships with hedge funds and private equity funds.
The Trump Administration and various members of Congress previously expressed a desire to modify or repeal parts of the Dodd-Frank Act. We cannot predict whether the Biden administration will support any modification or repeal of any portion of the Dodd-Frank Act or whether any modification or repeal will be enacted or, if so, any effect they would have on our business, operation or financial condition or on the financial services industry in general.
In December 2013, the Federal Reserve, the Office of the Comptroller of the Currency, the FDIC, the Securities and Exchange Commission (“SEC”), and the Commodities Futures Trading Commission issued final rules to implement certain provisions of the Dodd-Frank Act commonly known as the “Volcker Rule.” The Volcker Rule, as amended on August 20, 2019, generally prohibits U.S. banks from engaging in proprietary trading and restricts those banking entities from sponsoring, investing in, or having certain relationships with hedge funds and private equity funds. The prohibitions under the Volcker Rule are subject to a number of statutory exemptions, restrictions, and definitions. The Volcker Rule has not had a material impact on the Company’s Consolidated Financial Statements, but we continue to evaluate its application to our current and future operations.
The Gramm-Leach-Bliley Act (the “GLB Act”), which was enacted in 1999, allows bank holding companies to elect to become financial holding companies, subject to certain regulatory requirements. In addition to the activities previously permitted bank holding companies, financial holding companies may engage in non-banking activities that are financial in nature, such as securities, insurance, and merchant banking activities, subject to certain limitations. The Company could utilize this structure to accommodate an expansion of its products and services in the future.
Bank holding companies, such as the Company, are subject to a variety of restrictions on the activities in which they can engage and the acquisitions they can make. The activities or acquisitions of bank holding companies, such as the Company, that are not financial holding companies, are limited to those which constitute banking, managing or controlling banks or which are closely related activities. A bank holding company is required to obtain the prior approval of the FRB for
the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Nonbank acquisitions and activities of a bank holding company are also generally limited to the acquisition of up to 5% of the outstanding shares of any class of voting securities of a company unless the FRB has previously determined that the nonbank activities are closely related to banking, or prior approval is obtained from the FRB.
The GLB Act also included extensive consumer privacy provisions. These provisions, among other things, limit the ability of banks and other financial institutions to disclose nonpublic consumer information to non-affiliated third parties. The regulations require disclosure of privacy policies and allow consumers to prevent certain personal information from being shared with non-affiliated third parties. The Fair and Accurate Credit Transaction Act (“FACT Act”) requires financial institutions to develop and implement an identity theft prevention program to detect, prevent and mitigate identity theft “red flags” to reduce the risk that customer information will be misused to conduct fraudulent financial transactions. As a result of the Dodd-Frank Act, the rule-making authority for the privacy provisions of the GLB Act has been transferred to the CFPB. In addition, the states are permitted to adopt more extensive privacy protections through legislation or regulation.
There are various legal restrictions on the extent to which a bank holding company and certain of its nonbank subsidiaries can borrow or otherwise obtain credit from their banking subsidiaries or engage in certain other transactions with or involving those banking subsidiaries. With certain exceptions, federal law imposes limitations on, and requires collateral for, extensions of credit by insured depository institutions, such as the Bank, to their non-bank affiliates, such as the Company. In addition, new capital rules may affect the Company's ability to pay dividends.
Subject to certain limitations and restrictions, a bank holding company, with prior approval of the FRB, may acquire an out-of-state bank. Banks in states that do not prohibit out-of-state mergers may merge with the approval of the appropriate federal banking agency. A state bank may establish a de novo branch out of state if such branching is permitted by the other state for state banks chartered by such other state.
Among other things, applicable federal and state statutes and regulations which govern a bank’s activities relate to minimum capital requirements, required reserves against deposits, investments, loans, legal lending limits, mergers and consolidations, borrowings, issuance of securities, payment of dividends, establishment of branches and other aspects of its operations. The Division and the FDIC also have authority to prohibit banks under their supervision from engaging in what they consider to be unsafe or unsound practices.
There also are certain limitations on the ability of the Company to pay dividends to its shareholders. It is the policy of the FRB that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if the prospective rate of earnings retention is consistent with the organization’s current and expected future capital needs, asset quality and overall financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines a bank holding company’s ability to serve as a source of strength to its banking subsidiaries. Additionally, the Alaska Corporations Code generally prohibits the Company from making any distributions to the Company's shareholders unless the amount of the retained earnings of the Company immediately before the distribution equals or exceeds the amount of the proposed distribution. The Alaska Corporations Code also prohibits the Company from making any distribution to the Company's shareholders if the Company or a subsidiary of the Company making the distribution is, or as a result of the distribution would be, likely to be unable to meet its liabilities as they mature. Under Alaska law, the Bank is not permitted to pay or declare a dividend in an amount greater than its undivided profits.
Various federal and state statutory provisions also limit the amount of dividends that subsidiary banks can pay to their holding companies without regulatory approval. The FDIC or the Division could take the position that paying a dividend would constitute an unsafe or unsound banking practice. In addition, new capital rules may affect the Bank's ability to pay dividends.
Under longstanding FRB policy and under the Dodd-Frank Act, a bank holding company is required to act as a source of financial strength for its subsidiary banks. The Company could be required to commit resources to its subsidiary bank in circumstances where it might not do so, absent such requirement.
Both the Company and the Bank are required to maintain minimum levels of regulatory capital. In July 2013, federal banking regulators (including the FDIC and the FRB) adopted new capital requirement rules (the “Rules”). The Rules apply to both depository institutions (such as the Bank) and their holding companies (such as the Company). The Rules reflect, in part, certain standards initially adopted by the Basel Committee on Banking Supervision in December 2010 (which standards are commonly referred to as “Basel III”) as well as requirements contemplated by the Dodd-Frank Act. The Rules have applied to both the Company and the Bank since the beginning of 2015.
The Rules recognize three types, or tiers, of capital: common equity Tier 1 capital, additional Tier 1 capital and Tier 2 capital. Common equity Tier 1 capital generally consists of retained earnings and common stock instruments (subject to certain adjustments), as well as accumulated other comprehensive income ("AOCI"), except to the extent that the Company and the Bank exercise a one-time irrevocable option to exclude certain components of AOCI. Additional Tier 1 capital generally includes noncumulative perpetual preferred stock and related surplus subject to certain adjustments and limitations. Tier 2 capital generally includes certain capital instruments (such as subordinated debt) and portions of the amounts of the allowance for loan and lease losses, subject to certain requirements and deductions. The term "Tier 1 capital" means common equity Tier 1 capital plus additional Tier 1 capital, and the term "total capital" means Tier 1 capital plus Tier 2 capital.
The Rules generally measure an institution's capital using four capital measures or ratios. The common equity Tier 1 capital ratio is the ratio of the institution's common equity Tier 1 capital to its total risk-weighted assets. The Tier 1 capital ratio is the ratio of the institution's total Tier 1 capital to its total risk-weighted assets. The total capital ratio is the ratio of the institution's total capital to its total risk-weighted assets. The leverage ratio is the ratio of the institution's Tier 1 capital to its average total consolidated assets. To determine risk-weighted assets, assets of an institution are generally placed into a risk category and given a percentage weight based on the relative risk of that category. The percentage weights range from 0% to 1,250%. An asset's risk-weighted value will generally be its percentage weight multiplied by the asset's value as determined under generally accepted accounting principles. In addition, certain off-balance-sheet items are converted to balance-sheet credit equivalent amounts, and each amount is then assigned to one of the risk categories. An institution's federal regulator may require the institution to hold more capital than would otherwise be required under the Rules if the regulator determines that the institution's capital requirements under the Rules are not commensurate with the institution's credit, market, operational or other risks.
Both the Company and the Bank are required to have a common equity Tier 1 capital ratio of 4.5% as well as a Tier 1 leverage ratio of 4.0%, a Tier 1 risk-based ratio of 6.0% and a total risk-based ratio of 8.0%. In addition to the preceding requirements, both the Company and the Bank are required to have a “conservation buffer,” consisting of common equity Tier 1 capital, which is at least 2.5% above each of the preceding common equity Tier 1 capital ratio, the Tier 1 risk-based ratio and the total risk-based ratio. An institution that does not meet the conservation buffer will be subject to restrictions on certain activities including payment of dividends, stock repurchases and discretionary bonuses to executive officers.
The Rules set forth the manner in which certain capital elements are determined, including but not limited to, requiring certain deductions related to mortgage servicing rights and deferred tax assets. When the federal banking regulators initially proposed new capital rules in 2012, the rules would have phased out trust preferred securities as a component of Tier 1 capital. As finally adopted, however, the Rules permit holding companies with less than $15 billion in total assets as of December 31, 2009 (which includes the Company) to continue to include trust preferred securities issued prior to May 19, 2010 in Tier 1 capital, generally up to 25% of other Tier 1 capital.
The Rules made changes in the methods of calculating certain risk-based assets, which in turn affects the calculation of risk- based ratios. Higher or more sensitive risk weights are assigned to various categories of assets, among which are commercial real estate, credit facilities that finance the acquisition, development or construction of real property, certain exposures or credits that are 90 days past due or are nonaccrual, foreign exposures, certain corporate exposures, securitization exposures, equity exposures and in certain cases mortgage servicing rights and deferred tax assets.
Both the Company and the Bank were required to begin compliance with the Rules on January 1, 2015. The conservation buffer took full effect on January 1, 2019. Certain calculations under the Rules will also have phase-in periods. We believe that the current capital levels of the Company and the Bank are in compliance with the standards under the Rules including the conservation buffer.
Following the enactment of certain federal legislation in 2018, the federal banking regulators (including the FDIC and FRB) proposed a rule intended to simplify capital rules for certain community banks and their holding companies, the Community Bank Leverage Ratio ("CBLR"). Qualifying community banking organizations can elect to opt-into the CBLR and be under a new capital requirement rather than the current capital framework. To be eligible to make this election, the community banking organization would have to have less than $10 billion in assets, have a community bank leverage ratio of at least 9.00% and meet certain other criteria (including limits on off-balance sheet exposures and trading assets and liabilities). The CBLR would generally be the ratio of the organization's total bank equity capital to average assets, subject to certain adjustments. The intent of the CBLR is to simplify but not weaken capital requirements for qualifying community banks. Management has not elected to opt in to these new capital rules. However, the guidelines allow the Company to opt in to the simplification in the future should our assessment change.
In addition to the minimum capital standards, the federal banking agencies have issued regulations to implement a system of "prompt corrective action." These regulations apply to the Bank but not the Company. The regulations establish five capital categories; under the Rules, a bank generally is:
“well capitalized” if it has a total risk-based capital ratio of 10.0% or more, a Tier 1 risk-based capital ratio of 8.0% or more, a common equity Tier 1 risk-based ratio of 6.5% or more, and a leverage capital ratio of 5.0% or more, and is not subject to any written agreement, order or capital directive to meet and maintain a specific capital level for any capital measure;
“adequately capitalized” if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 6.0% or more, a common equity Tier 1 risk-based ratio of 4.5% or more, and a leverage capital ratio of 4.0% or more;
“undercapitalized” if it has a total risk-based capital ratio less than 8.0%, a Tier 1 risk-based capital ratio less than 6.0%, a common equity risk-based ratio less than 4.5% or a leverage capital ratio less than 4.0%;
“significantly undercapitalized” if it has a total risk-based capital ratio less than 6.0%, a Tier 1 risk-based capital ratio less than 4.0%, a common equity risk-based ratio less than 3.0% or a leverage capital ratio less than 3.0%; and
“critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%.
A bank that, based upon its capital levels, is classified as “well capitalized,” “adequately capitalized” or “undercapitalized” may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for a hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment.
At each successive lower capital category, a bank is subject to increasing supervisory restrictions. For example, being “adequately capitalized” rather than “well-capitalized” affects a bank’s ability to accept brokered deposits without the prior approval of the FDIC, and may cause greater difficulty obtaining retail deposits. Banks in the “adequately capitalized” classification may have to pay higher interest rates to continue to attract those deposits, and higher deposit insurance rates for those deposits. This status also affects a bank’s eligibility for a streamlined review process for acquisition proposals.
Management intends to maintain capital ratios for the Bank in 2021 that exceed the FDIC’s requirements for the “well-capitalized” capital requirement classification. The dividends that the Bank pays to the Company will be limited to the extent necessary for the Bank to meet the regulatory requirements of a “well-capitalized” bank.
The capital ratios for the Company exceed those for the Bank primarily because the trust preferred securities offerings that the Company completed in the second quarter of 2003 and in the fourth quarter of 2005 are included in the Company’s capital for regulatory purposes, although they are accounted for as a liability in its consolidated financial statements. The trust preferred securities are not accounted for on the Bank’s financial statements nor are they included in its capital (although the Company did contribute to the Bank a portion of the cash proceeds from the sale of those securities). The Company redeemed $8 million in trust preferred securities in August 2017. As a result, the Company has $10 million more in regulatory capital than the Bank at December 31, 2020 and 2019, respectively, which explains most of the difference in the capital ratios for the two entities.
The Bank is required to file periodic reports with the FDIC and the Division and is subject to periodic examinations and evaluations by those regulatory authorities. These examinations must be conducted every 12 months, except that certain “well-capitalized” banks may be examined every 18 months. The FDIC and the Division may each accept the results of an examination by the other in lieu of conducting an independent examination.
In the liquidation or other resolution of a failed insured depository institution, claims for administrative expenses (including certain employee compensation claims) and deposits are afforded a priority over other general unsecured claims, including non-deposit claims, and claims of a parent company such as the Company. Such priority creditors would include the FDIC, which succeeds to the position of insured depositors to the extent it has made payments to such depositors.
The Company is also subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Securities Exchange Act of 1934, as amended (the “Securities Exchange Act of 1934”), including certain requirements under the Sarbanes-Oxley Act of 2002.
The Bank is subject to the Community Reinvestment Act of 1977 (“CRA”). The CRA requires that the Bank help meet the credit needs of the communities it serves, including low and moderate income neighborhoods, consistent with the safe and sound operation of the institution. The FDIC assigns one of four possible ratings to the Bank’s CRA performance and makes the rating and the examination reports publicly available. The four possible ratings are outstanding, satisfactory, needs to improve and substantial noncompliance. A financial institution’s CRA rating can affect an institution’s future business. For example, a federal banking agency will take CRA performance into consideration when acting on an institution’s application to establish or move a branch, to merge or to acquire assets or assume liabilities of another institution. In its most recent CRA examination, the Bank received a “Satisfactory” rating from the FDIC.
The Company is also subject to the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”) and the Anti-Money Laundering Act of 2020 (the “AMLA”). Among other things, the USA PATRIOT Act and AMLA require the Company and the Bank to adopt and implement specific policies and procedures designed to prevent and defeat money laundering. Management believes the Company is in compliance with the USA PATRIOT Act as in effect on December 31, 2020. The AMLA was passed on January 1, 2021 and regulatory agencies are in the process of finalizing rules and regulations required by the passage of the AMLA.
On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act into law. The CARES Act established several new temporary U.S. Small Business Administration (“SBA”) loan programs to assist U.S. small businesses through the COVID-19 pandemic. One of the new loan programs is the PPP, an expansion of the SBA’s 7(a) loan program and the Economic Injury Disaster Loan Program.
The PPP provides loans to small businesses who were affected by economic conditions as a result of COVID-19 to provide cash-flow assistance to employers who maintain their payroll (including healthcare and certain related expenses), mortgage interest, rent, leases, utilities and interest on existing debt during this emergency. Eligible borrowers need to make a good faith certification that the uncertainty of current economic conditions make requesting assistance necessary to support ongoing operations. Pursuant to the provisions of Section 1106 of the CARES Act, borrowers may apply to the Bank for loan forgiveness of all or a portion of the loan, subject to certain eligibility requirements and conditions.
The Bank is an SBA lender and began accepting applications under the CARES Act via its online application process on April 3, 2020. As of December 31, 2020, the Bank had 2,498 PPP loans totaling $310.5 million outstanding.
A number of other federal and state consumer protection laws extensively govern the Bank’s relationship with its customers. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, Telephone Consumer Protection Act, the Service Members Civil Relief Act and these laws’ respective state-law counterparts, as well as state and territorial usury laws and laws regarding unfair and deceptive acts and practices. These and other laws subject the Bank to substantial regulatory oversight and, among other things, require disclosures of the cost of credit and terms of deposit accounts, provide substantive consumer rights, prohibit discrimination in credit transactions, regulate the use of credit report information, provide financial privacy protections, prohibit unfair, deceptive and abusive practices, and restrict the Bank’s ability to raise interest rates.
Available Information
The Company’s annual report on Form 10-K and quarterly reports on Form 10-Q, as well as its current reports on Form 8-K and proxy statement filings (and all amendments thereto), which are filed with the SEC, are accessible free of charge at our website at http://www.northrim.com as soon as reasonably practicable after filing with the SEC. By making this reference to our website, the Company does not intend to incorporate into this report any information contained in the website. The website should not be considered part of this report.
The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC.

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ITEM 1A. RISK FACTORS
ITEM 1A. RISK FACTORS
The material risks and uncertainties that management believes affect the Company are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report. The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations. This report is qualified in its entirety by these risk factors. If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the Company’s common stock could decline significantly, and you could lose all or part of your investment.
Risk Factors Summary
An investment in the Company's common stock is subject to risks inherent to the Company's business. Such risks, including those set forth in the summary of material risks in this Part I. Item 1A. should be carefully considered before purchasing our securities.
COVID-19 Pandemic Risk Factors
•The COVID-19 pandemic has materially impacted our business and financial results, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions that have been taken, and may in the future be imposed, by governmental authorities in response to the pandemic.
Operational, Strategic and Business Risk Factors
•Current economic conditions in the State of Alaska pose challenges for us and could adversely affect our financial condition and results of operations.
•Our concentration of operations in the Anchorage, Matanuska-Susitna Valley, Fairbanks and Southeast areas of Alaska makes us more sensitive to downturns in those areas.
•Our information systems or those of our third-party vendors may be subject to an interruption or breach in security, including as a result of cyber-attacks.
•A failure in or breach of the Company's operational systems, information systems, or infrastructure, or those of the Company's third-party vendors and other service providers, may result in financial losses, or loss of customers.
•Our business is highly reliant on third party vendors.
•We continually encounter technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements.
•Residential mortgage lending is a market sector that experiences significant volatility and is influenced by many factors beyond our control.
•If we do not comply with the agreements governing servicing of loans, if these agreements change materially, or if others allege non-compliance, our business and results of operations may be harmed.
•Certain hedging strategies that we use to manage interest rate risk may be ineffective to offset any adverse changes in the fair value of these assets due to changes in interest rates and market liquidity.
•Our loan loss allowance may not be adequate to cover future loan losses, which may adversely affect our earnings.
•We have a significant concentration in real estate lending. A downturn in real estate within our markets would have a negative impact on our results of operations.
•Real estate values may decrease leading to additional and greater than anticipated loan charge-offs and valuation writedowns on our other real estate owned (“OREO”) properties.
•We conduct substantially all of our operations through Northrim Bank, our banking subsidiary; our ability to pay dividends, repurchase our shares, or to repay our indebtedness depends upon liquid assets held by the holding company and the results of operations of our subsidiaries and their ability to pay dividends.
•There can be no assurance that the Company will continue to declare cash dividends or repurchase stock.
•We may be unable to attract and retain key employees and personnel.
•Liquidity risk could impair our ability to fund operations and jeopardize our financial conditions.
•A failure of a significant number of our borrowers, guarantors and related parties to perform in accordance with the terms of their loans would have an adverse impact on our results of operations.
Regulatory, Legislative and Legal Risk Factors
•We operate in a highly regulated environment and changes of or increases in banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us.
•We are subject to more stringent capital and liquidity requirements which may adversely affect our net income and future growth.
•Changes in the FRB’s monetary or fiscal policies could adversely affect our results of operations and financial condition.
•Changes in market interest rates could adversely impact the Company.
•Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, Anti-Money Laundering Act of 2020, Real Estate Settlement Procedures Act, Truth-in-Lending Act or other laws and regulations could result in fines, sanctions or other adverse consequences.
Accounting, Tax and Financial Risk Factors
•Changes in income tax laws and interpretations, or in accounting standards, could materially affect our financial condition or results of operations.
•Uncertainty about the continuing availability of the London Inter-Bank Offered Rate ("LIBOR") may adversely affect our business.
General Economic and Market Risk Factors
•Natural disasters and adverse weather could negatively affect real estate property values and Bank operations.
•The soundness of other financial institutions could adversely affect us.
•The financial services business is intensely competitive and our success will depend on our ability to compete effectively.
•We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so could materially adversely affect our performance.
•Social, political, and economic instability, unrest, and other circumstances beyond our control could adversely affect our business operations.
•Climate change, severe weather, natural disasters, and other external events could significantly impact our business.
We attempt to mitigate the foregoing risks. However, if we are unable to effectively manage the impact of these and other risks, our financial condition, results of operations, our ability to make distributions to our shareholders, or the market price of our common stock could be materially impacted.
COVID-19 Pandemic Risks
The COVID-19 pandemic has materially impacted our business and financial results, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions that have been taken, and may in the future be imposed, by governmental authorities in response to the pandemic.
In December 2019, a novel coronavirus (COVID-19) was reported in China, and, in March 2020, the World Health Organization declared it a pandemic. On March 12, 2020, the President of the United States declared the COVID-19 outbreak in the United States a national emergency. The COVID-19 pandemic has caused significant economic dislocation in the United
States as many state and local governments have ordered non-essential businesses to close and residents to shelter in place at home. This has resulted in an unprecedented slow-down in economic activity and a related increase in unemployment. The national unemployment rate peaked in April 2020 at 14.8%, before declining to a still-elevated level at 6.7% in December 2020, according to the National Bureau of Economic Research. In addition, stock markets have experienced significant volatility in value and, in particular, bank stocks have declined in value. Governments, businesses, and the public are taking unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief. While the scope, duration, and full effects of COVID-19 are rapidly evolving and not fully known, the pandemic and related efforts to contain it have resulted in material decreases in oil and gas prices, disrupted global economic activity, adversely affected the functioning of financial markets, impacted interest rates, increased economic and market uncertainty, and disrupted trade and supply chains. In addition, the timing, availability and efficacy of the COVID-19 vaccines remains uncertain. These developments as a consequence of the COVID-19 pandemic are materially impacting our business and the businesses of our customers and are expected to have a material adverse effect on our financial results for 2021. If these effects continue for a prolonged period or result in sustained economic stress or recession, such effects could have a material adverse impact on us in a number of ways related to credit, collateral, customer demand, loan funding, operations, interest rate risk, and human capital, as described in more detail below.
• Credit Risk
Our risks of timely loan repayment and the value of collateral supporting the loans are affected by the strength of our borrower’s business. Concern about the spread of COVID-19 has caused and is likely to continue to cause volatility in oil and gas prices, business shutdowns, limitations on commercial activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and commercial property vacancy rates, reduced profitability and ability for property owners to make mortgage payments, and overall economic and financial market instability, all of which may cause our customers to be unable to make scheduled loan payments. In addition, the responses of the government that have been, and may in the future be imposed in response to the pandemic, including stimulus programs could adversely impact lending demand. If the effects of COVID-19 result in widespread and sustained repayment shortfalls on loans in our portfolio, we could incur significant delinquencies, foreclosures and credit losses, particularly if the available collateral is insufficient to cover our exposure. The future effects of COVID-19 on economic activity could negatively affect the collateral values associated with our existing loans, the ability to liquidate the real estate collateral securing our residential and commercial real estate loans, our ability to maintain loan origination volume and to obtain additional financing, the future demand for or profitability of our lending and services, and the financial condition and credit risk of our customers. Further, in the event of delinquencies, regulatory changes and policies designed to protect borrowers may slow or prevent us from making our business decisions or may result in a delay in our taking certain remediation actions, such as foreclosure. In addition, we have unfunded commitments to extend credit to customers. During the current challenging economic environment, our customers are more dependent on our credit commitments and increased borrowings under these commitments could adversely impact our liquidity. Furthermore, in an effort to support our communities during the pandemic, we are participating in the PPP program under the CARES Act whereby loans to small businesses are made and those loans are subject to the regulatory requirements that would require forbearance of loan payments for a specified time or that would limit our ability to pursue all available remedies in the event of a loan default. If the borrower under the PPP loan fails to qualify for loan forgiveness, we are at the heightened risk of holding these loans at lower interest rates as compared to the loans to customers that we would have otherwise extended credit.
• Strategic Risk
Our success may be affected by a variety of external factors that may affect the price or marketability of our products and services, changes in interest rates that may increase our funding costs, reduced demand for our financial products due to economic conditions and the various responses of governmental and nongovernmental authorities. In recent months, the COVID-19 pandemic has significantly increased economic and demand uncertainty and has led to disruption and volatility in the global capital markets. Furthermore, many of the governmental actions have been directed toward curtailing household and business activity to contain COVID-19. For example, in our markets, state and local governments previously acted to temporarily close or restrict the operations of most businesses. The future effects of COVID-19 on economic activity could negatively affect the future banking products we provide, including a decline in loan originations.
• Operational Risk
Current and future restrictions on our customers' and employees’ access to our branches and other facilities could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations. We rely on business processes and branch activity that largely depend on people and technology, including access to information technology
systems as well as information, applications, payment systems and other services provided by third parties. In response to COVID-19, we have modified our business practices with a portion of our employees working remotely from their homes to have our operations uninterrupted as much as possible. Further, technology in employees’ homes may not be as robust as in our offices and could cause the connectivity, information systems, applications, and other tools available to employees to be more limited or less reliable than in our offices. The continuation of these work-from-home measures also introduces additional operational risk, and scammers attempting to capitalize on the pandemic have amplified cyber threats including increased phishing, malware, and other cybersecurity attacks. Future consequences from the pandemic could impair our ability to perform critical functions, including wiring funds, all of which could expose us to risks of data or financial loss, litigation and liability and could seriously disrupt our operations and the operations of any impacted customers. Moreover, we rely on many third parties in our business operations, including appraisers of the real property collateral, providers of financial information, systems and analytical tools and providers of electronic payment and settlement systems, and local and federal government agencies, offices, and courthouses. In light of the developing measures responding to the pandemic, many of these entities may limit the availability and access of their services. For example, loan origination could be delayed due to the limited availability of real estate appraisers for the collateral. Loan closings could be delayed related to reductions in available staff in recording offices or the closing of courthouses in certain counties, which slows the process for title work, mortgage and UCC filings in those counties. If the third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.
• Liquidity Risk
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings and other sources could have a substantial negative effect on our liquidity and severely constrain our financial flexibility. Our primary source of funding is deposits gathered through our network of branch offices. Our access to funding sources in amounts adequate to finance our activities on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or the economy in general. During the COVID-19 outbreak, our deposits have increased significantly, primarily due to the Company’s PPP efforts during the second and third quarter of 2020. As customers withdraw funds from deposit accounts that were obtained from the Company via PPP loans, the Company may need to borrow funds to meet an immediate liquidity need. Our ability to borrow could be impaired by factors that are not specific to us or our region, such as a disruption in the financial markets, including those caused by COVID-19, or negative views and expectations about the prospects for the financial services industry and unstable credit markets.
• Interest Rate Risk
Our net interest income, lending activities, deposits and profitability could be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19. In response to the COVID-19 outbreak, the Federal Reserve reduced the benchmark fed funds rate to a target range of 0% to 0.25%, and on January 27, 2021, the Federal Reserve maintained the benchmark fed funds rate to the same target range. The yields on 10 and 30-year treasury notes have declined to historic lows. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income and a decrease in current fair market values of our assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition.
Because there have been no comparable recent global pandemics that resulted in similar global impact, we do not yet know the full extent of COVID-19’s effects on our business, operations, or the global economy as a whole. Any future development, including the timing, availability and efficacy of the COVID-19 vaccines, will be highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the effectiveness of our work from home arrangements, third party providers’ ability to support our operation, and any actions taken by governmental authorities and other third parties in response to the pandemic. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of the virus’s global economic impact, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future. In addition, the effects could have a material impact on our results of operations and heighten many of our known risks described in this Part I, Section 1A “Risk Factors”.
Operational, Strategic and Business Risks
Current economic conditions in the State of Alaska pose challenges for us and could adversely affect our financial condition and results of operations.
We are operating in an uncertain economic environment. The decrease in the price of oil which began in 2014 has led to a significant deficit in the budget for the State of Alaska, which was partially alleviated by legislative action in 2018 that now allows for the use of a portion of State's investment income from the Alaska Permanent Fund to help fund the state budget. However, we believe that this has solved only part of Alaska's structural finance problem. In the longer term, relatively low oil prices are expected to negatively impact the overall economy in Alaska on a larger scale as we estimate that one third of the Alaskan economy is related to oil. Financial institutions continue to be affected by changing conditions in the real estate and financial markets, along with an arduous regulatory climate. Dramatic declines in the United States housing market from 2008 through 2012, with falling home prices and increasing foreclosures and unemployment, resulted in significant writedowns of asset values by financial institutions. While conditions have improved nationally, a return to a recessionary economy could result in financial stress on our borrowers that would adversely affect our financial condition and results of operations. Deteriorating conditions in the regional economies of Anchorage, Matanuska-Susitna Valley, Fairbanks, and the Southeast areas of Alaska served by the Company could drive losses beyond that which is provided for in our allowance for loan losses. We may also face the following risks in connection with events:
▪ Ineffective monetary policy could cause rapid changes in interest rates and asset values that would have a materially adverse impact on our profitability and overall financial condition.
▪ Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, resulting in increased delinquencies and default rates on loans and other credit facilities.
▪ Regulatory scrutiny of the industry could increase, leading to harsh regulation of our industry that could lead to a higher cost of compliance, limit our ability to pursue business opportunities and increase our exposure to the judicial system and the plaintiff’s bar.
▪ Erosion in the fiscal condition of the U.S. Treasury could lead to new taxes that would limit the ability of the Company to pursue growth and return profits to shareholders.
If these conditions or similar ones develop, we could experience adverse effects on our financial condition and results of operations.
Our concentration of operations in the Anchorage, Matanuska-Susitna Valley, Fairbanks and Southeast areas of Alaska makes us more sensitive to downturns in those areas.
Substantially all of our business is derived from the Anchorage, Matanuska-Susitna Valley, Fairbanks, and Southeast areas of Alaska. The majority of our lending has been with Alaska businesses and individuals. At December 31, 2020, approximately 21% of the Bank's loans are PPP loans which are 100% guaranteed by the SBA. Of the remaining loan portfolio, excluding PPP loans, approximately 73% of loans are secured by real estate and 2% are unsecured. Approximately 25% are for general commercial uses, including professional, retail, and small businesses, and are secured by non-real estate assets. Repayment is expected from the borrowers’ cash flow or, secondarily, the collateral. Our exposure to credit loss, if any, is the outstanding amount of the loan if the collateral is proved to be of no value. These areas rely primarily upon the natural resources industries, particularly oil production, as well as tourism and government and U.S. military spending for their economic success. In particular, the oil industry plays a significant role in the Alaskan economy. We estimate that one third of Alaska's gross state product is currently derived from the oil industry.
Our business is and will remain sensitive to economic factors that relate to these industries and local and regional business conditions. As a result, local or regional economic downturns, or downturns that disproportionately affect one or more of the key industries in regions served by the Company, may have a more pronounced effect upon our business than they might on an institution that is less geographically concentrated. The extent of the future impact of these events on economic and business conditions cannot be predicted; however, prolonged or acute fluctuations could have a material and adverse impact upon our financial condition and results of operation.
Our information systems or those of our third-party vendors may be subject to an interruption or breach in security, including as a result of cyber attacks.
The Company’s technologies, systems, networks and software, and those of other financial institutions have been, and are likely to continue to be, the target of cybersecurity threats and attacks, which may range from uncoordinated individual
attempts to sophisticated and targeted measures directed at us. These cybersecurity threats and attacks may include, but are not limited to, breaches, unauthorized access, misuse, malicious code, computer viruses and denial of service attacks that could result in unauthorized access, misuse, loss or destruction of data (including confidential customer information), account takeovers, unavailability of service or other events. These types of threats may result from human error, fraud or malice on the part of external or internal parties, or from accidental technological failure. Further, to access our products and services our customers may use computers and mobile devices that are beyond our security control systems. The risk of a security breach or disruption, particularly through cyber-attack or cyber intrusion, including by computer hackers, has increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased.
Our business requires the collection and retention of large volumes of customer data, including payment card numbers and other personally identifiable information in various information systems that we maintain and in those maintained by third parties with whom we contract to provide data services. We also maintain important internal company data such as personally identifiable information about our employees and information relating to our operations. The integrity and protection of that customer and company data is important to us. As customer, public, legislative and regulatory expectations and requirements regarding operational and information security have increased, our operations systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions and breakdowns.
Our customers and employees have been, and will continue to be, targeted by parties using fraudulent e-mails and other communications in attempts to misappropriate passwords, payment card numbers, bank account information or other personal information or to introduce viruses or other malware through “trojan horse” programs to our customers’ computers. These communications may appear to be legitimate messages sent by the Bank or other businesses, but direct recipients to fake websites operated by the sender of the e-mail or request that the recipient send a password or other confidential information via e-mail or download a program. Despite our efforts to mitigate these threats through product improvements, use of encryption and authentication technology to secure online transmission of confidential consumer information, and customer and employee education, such attempted frauds against us or our merchants and our third-party service providers remain a serious issue. The pervasiveness of cyber security incidents in general and the risks of cyber-crime are complex and continue to evolve. In addition, due to COVID-19, we have modified our business practices with a portion of our employees working remotely from their homes. The continuation of these work-from-home measures also introduces additional operational risk, including increased cybersecurity risk. In light of several recent high-profile data breaches at other companies involving customer personal and financial information, we believe the potential impact of a cyber security incident involving the Company, any exposure to consumer losses and the cost of technology investments to improve security could cause customer and/or Bank losses, damage to our brand, and increase our costs.
Although we make significant efforts to maintain the security and integrity of our information systems and have implemented various measures to manage the risk of a security breach or disruption, there can be no assurance that our security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. Even the most well-protected information, networks, systems and facilities remain potentially vulnerable because attempted security breaches, particularly cyber-attacks and intrusions, or disruptions will occur in the future, and because the techniques used in such attempts are constantly evolving and generally are not recognized until launched against a target, and in some cases are designed not to be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures, and thus it is virtually impossible for us to entirely mitigate this risk. A security breach or other significant disruption could: disrupt the proper functioning of our networks and systems and therefore our operations and/or those of certain of our customers; result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of confidential, sensitive or otherwise valuable information of ours or our customers, including account numbers and other financial information; result in a violation of applicable privacy, data breach and other laws, subjecting the Bank to additional regulatory scrutiny and exposing the Bank to civil litigation, governmental fines and possible financial liability; require significant management attention and resources to remedy the damages that result; or harm our reputation or cause a decrease in the number of customers that choose to do business with us or reduce the level of business that our customers do with us. The occurrence of any such failures, disruptions or security breaches could have a negative impact on our financial condition and results of operations.
A failure in or breach of the Company's operational systems, information systems, or infrastructure, or those of the Company's third party vendors and other service providers, may result in financial losses, or loss of customers.
The Company relies heavily on communications and information systems to conduct our business. In addition, we rely on third parties to provide key components of our infrastructure, including the processing of sensitive consumer and business customer data, internet connections, and network access. These types of information and related systems are critical to the operation of our business and essential to our ability to perform day-to-day operations, and, in some cases, are critical to the operations of many of our customers. These third parties with which the Company does business or that facilitate our business
activities, including exchanges, financial intermediaries or vendors that provide services or security solutions for our operations, could also be sources of operational and information security risk to us, including breakdowns or failures of their own systems or capacity constraints. Although the Company has implemented safeguards and business continuity plans, our business operations may be adversely affected by significant and widespread disruption to our physical infrastructure or operating systems that support our business and our customers, resulting in financial losses or loss of customers.
Our business is highly reliant on third party vendors.
We rely on third parties to provide services that are integral to our operations. These vendors provide services that support our operations, including the storage and processing of sensitive consumer and business customer data. The loss of these vendor relationships, or a failure of these vendors' systems, could disrupt the services we provide to our customers and cause us to incur significant expense in connection with replacing these services.
We continually encounter technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our clients by using technology to provide products and services that will satisfy client demands for convenience, as well as to create additional efficiencies in our operations. Many national vendors provide turn-key services to community banks, such as Internet banking and remote deposit capture that allow smaller banks to compete with institutions that have substantially greater resources to invest in technological improvements. We may not be able, however, to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
Residential mortgage lending is a market sector that experiences significant volatility and is influenced by many factors beyond our control.
The Company earns revenue from the residential mortgage lending activities primarily in the form of gains on the sale of mortgage loans that we originate and sell to the secondary market. Residential mortgage lending in general has experienced substantial volatility in recent periods primarily due to changes in interest rates and other market forces beyond our control. Interest rate changes, such as rate increases implemented by the FRB, may result in lower rate locks and closed loan volume, which may adversely impact the earnings and results of operations of RML. In addition, an increase in interest rates may materially and adversely affect our future loan origination volume and margins.
If we do not comply with the agreements governing servicing of loans, if these agreements change materially, or if others allege non-compliance, our business and results of operations may be harmed.
We have contractual obligations under the servicing agreements pursuant to which we service mortgage loans. Many of our servicing agreements require adherence to general servicing standards, and certain contractual provisions delegate judgment over various servicing matters to us. If the terms of these servicing agreements change, we may sustain higher costs. Our servicing practices, and the judgments that we make in our servicing of loans, could also be questioned by parties to these agreements. We could also become subject to litigation claims seeking damages or other remedies arising from alleged breaches of our servicing agreements.
Additionally, under our loan servicing program we retain servicing rights on mortgage loans originated by RML and sold to the Alaska Housing Finance Corporation. If we breach any of the representations and warranties in our servicing agreements with the Alaska Housing Finance Corporation, we may be required to repurchase any loan sold under this program and record a loss upon repurchase and/or bear any subsequent loss on the loan. We may not have any remedies available to us against third parties for such losses, or the remedies might not be as broad as the remedies available to the Alaska Housing Finance Corporation against us.
Certain hedging strategies that we use to manage interest rate risk may be ineffective to offset any adverse changes in the fair value of these assets due to changes in interest rates and market liquidity.
We use derivative instruments to economically hedge the interest rate risk in our residential mortgage loan commitments. Our hedging strategies are susceptible to prepayment risk, basis risk, market volatility and changes in the shape of the yield curve, among other factors. In addition, hedging strategies rely on assumptions and projections regarding assets and general market factors. If these assumptions and projections prove to be incorrect or our hedging strategies do not adequately
mitigate the impact of changes in interest rates, we may incur losses that would adversely impact our financial condition and results of operations.
Our loan loss allowance may not be adequate to cover future loan losses, which may adversely affect our earnings.
We have established a reserve for probable losses we expect to incur in connection with loans in our credit portfolio. This allowance reflects our estimate of the collectability of certain identified loans, as well as an overall risk assessment of total loans outstanding. Our determination of the amount of loan loss allowance is highly subjective; although management personnel apply criteria such as risk ratings and historical loss rates; these factors may not be adequate predictors of future loan performance. Accordingly, we cannot offer assurances that these estimates ultimately will prove correct or that the loan loss allowance will be sufficient to protect against losses that ultimately may occur. If our loan loss allowance proves to be inadequate, we may suffer unexpected charges to income, which would adversely impact our results of operations and financial condition. Moreover, bank regulators frequently monitor banks' loan loss allowances, and if regulators were to determine that the allowance is inadequate, they may require us to increase the allowance, which also would adversely impact our financial condition and results of operations.
We have a significant concentration in real estate lending. A downturn in real estate within our markets would have a negative impact on our results of operations.
Approximately 73% of the Bank’s loan portfolio, excluding PPP loans, at December 31, 2020 consisted of loans secured by commercial and residential real estate located in Alaska. Additionally, all of the Company's loans held for sale are secured by residential real estate. A slowdown in the residential sales cycle in our major markets and a constriction in the availability of mortgage financing, such as what occurred during the financial crisis in the United States housing market from 2008 through 2012, would negatively impact residential real estate sales, which would result in customers’ inability to repay loans. This would result in an increase in our non-performing assets if more borrowers fail to perform according to loan terms and if we take possession of real estate properties. Additionally, if real estate values decline, the value of real estate collateral securing our loans could be significantly reduced. If any of these effects continue or become more pronounced, loan losses will increase more than we expect and our financial condition and results of operations would be adversely impacted.
Further, approximately 36% of the Bank’s loan portfolio at December 31, 2020 consisted of commercial real estate loans. While our investments in these types of loans have not been as adversely impacted as residential construction and land development loans, there can be no assurance that the credit quality in these portfolios will remain stable. Commercial construction and commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers. Consequently, an adverse development with respect to one commercial loan or one credit relationship exposes us to significantly greater risk of loss compared to an adverse development with respect to a consumer loan. The credit quality of these loans may deteriorate more than expected which may result in losses that exceed the estimates that are currently included in our loan loss allowance, which could adversely affect our financial condition and results of operations.
Real estate values may decrease leading to additional and greater than anticipated loan charge-offs and valuation writedowns on our other real estate owned (“OREO”) properties.
Real estate owned by the Bank and not used in the ordinary course of its operations is referred to as “other real estate owned” or “OREO” property. We foreclose on and take title to the real estate serving as collateral for defaulted loans as part of our business. At December 31, 2020, the Bank held $7.3 million of OREO properties, most of which relate to a commercial real estate loan. Increased OREO balances lead to greater expenses as we incur costs to manage and dispose of the properties. Our ability to sell OREO properties is affected by public perception that banks are inclined to accept large discounts from market value in order to quickly liquidate properties. Any decrease in market prices may lead to OREO writedowns, with a corresponding expense in our income statement. We evaluate OREO property values periodically and writedown the carrying value of the properties if the results of our evaluations require it. Further writedowns on OREO or an inability to sell OREO properties could have a material adverse effect on our results of operations and financial condition.
We conduct substantially all of our operations through Northrim Bank, our banking subsidiary; our ability to pay dividends, repurchase our shares, or to repay our indebtedness depends upon liquid assets held by the holding company and the results of operations of our subsidiaries and their ability to pay dividends.
The Company is a separate legal entity from our subsidiaries. It receives substantially all of its revenue from dividends paid from the Bank. There are legal limitations on the extent to which the Bank may extend credit, pay dividends or otherwise supply funds to, or engage in transactions with us. Our inability to receive dividends from the Bank could adversely affect our business, financial condition, results of operations and prospects.
Our net income depends primarily upon the Bank’s net interest income, which is the income that remains after deducting from total income generated by earning assets the expense attributable to the acquisition of the funds required to support earning assets (primarily interest paid on deposits and borrowings). The amount of interest income is dependent on many factors including the volume of earning assets, the general level of interest rates, the dynamics of changes in interest rates and the levels of nonperforming loans. All of those factors affect the Bank’s ability to pay dividends to the Company. On January 1, 2019, a requirement to have a capital conservation buffer went into full effect and could adversely affect the Bank's ability to pay dividends.
Various statutory provisions restrict the amount of dividends the Bank can pay to us without regulatory approval. Under Alaska law, a bank may not declare or pay a dividend in an amount greater than its net undivided profits then on hand. In addition, the Bank may not pay cash dividends if that payment could reduce the amount of its capital below that necessary to meet the “adequately capitalized” level in accordance with regulatory capital requirements. It is also possible that, depending upon the financial condition of the Bank and other factors, regulatory authorities could conclude that payment of dividends or other payments, including payments to us, is an unsafe or unsound practice and impose restrictions or prohibit such payments. It is the policy of the FRB that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if the prospective rate of earnings retention is consistent with the organization’s current and expected future capital needs, asset quality and overall financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines a bank holding company’s ability to serve as a source of strength to its banking subsidiaries.
There can be no assurance that the Company will continue to declare cash dividends or repurchase stock.
During 2020, the Company repurchased 327,000 shares of common stock at an average price of $30.51 per share under its previously announced share repurchase program. On February 1, 2021, the Company announced that its Board of Directors had authorized the repurchase of up to an additional 313,000 shares of common stock. The Company also paid cash dividends of $1.38 per diluted share in 2020. On February 25, 2021, the Board of Directors approved payment of a $0.37 per share dividend on the Company’s outstanding shares.
Whether we continue, and the amount and timing of, such dividends and/or stock repurchases is subject to capital availability and periodic determinations by our Board. The Company continues to evaluate the potential impact that regulatory proposals may have on our liquidity and capital management strategies, including Basel III and those required under the Dodd-Frank Act. The actual amount and timing of future dividends and share repurchases, if any, will depend on market and economic conditions, applicable SEC rules, federal and state regulatory restrictions, and various other factors. In addition, the amount we spend and the number of shares we are able to repurchase under our stock repurchase program may further be affected by a number of other factors, including the stock price and blackout periods in which we are restricted from repurchasing shares. Our dividend payments and/or stock repurchases may change from time to time, and we cannot provide assurance that we will continue to declare dividends and/or repurchase stock in any particular amounts or at all. A reduction in or elimination of our dividend payments and/or stock repurchases could have a negative effect on our stock price.
We may be unable to attract and retain key employees and personnel.
We will be dependent for the foreseeable future on the services of Joseph M. Schierhorn, our Chairman of the Board, President, Chief Executive Officer, and Chief Operating Officer of the Company; Michael Martin, our Executive Vice President, General Counsel and Corporate Secretary; and Jed W. Ballard, our Executive Vice President and Chief Financial Officer. While we maintain keyman life insurance on the lives of Messrs. Schierhorn, Martin, and Ballard in the amounts of $2.4 million, $2 million, and $2 million, respectively, we may not be able to timely replace Mr. Schierhorn, Mr. Martin, or Mr. Ballard with a person of comparable ability and experience should the need to do so arise, causing losses in excess of the insurance proceeds. The unexpected loss of key employees could have a material adverse effect on our business and possibly result in reduced revenues and earnings.
Liquidity risk could impair our ability to fund operations and jeopardize our financial conditions.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings and other sources could have a substantial negative effect on our liquidity and severely constrain our financial flexibility. Our primary source of funding is deposits gathered through our network of branch offices. Our access to funding sources in amounts adequate to finance our activities on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or the economy in general. Factors that could negatively impact our access to liquidity sources include:
•a decrease in the level of our business activity as a result of an economic downturn in the markets in which our loans are concentrated;
•adverse regulatory actions against us; or
•our inability to attract and retain deposits.
Our ability to borrow could be impaired by factors that are not specific to us or our region, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry and unstable credit markets.
A failure of a significant number of our borrowers, guarantors and related parties to perform in accordance with the terms of their loans would have an adverse impact on our results of operations.
A source of risk arises from the possibility that losses will be sustained if a significant number of our borrowers, guarantors and related parties fail to perform in accordance with the terms of their loans. We have adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of our allowance for loan losses, which we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance, and diversifying our credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could materially affect our financial condition and results of operations.
Regulatory, Legislative and Legal Risks
We operate in a highly regulated environment and changes of or increases in banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us.
We are subject to extensive regulation, supervision and examination by federal and state banking authorities. In addition, as a publicly-traded company, we are subject to regulation by the SEC and NASDAQ. Any change in applicable regulations or federal or state legislation or in policies or interpretations or regulatory approaches to compliance and enforcement, income tax laws and accounting principles could have a substantial impact on us and our operations. Changes in laws and regulations may also increase our expenses by imposing additional fees or taxes or restrictions on our operations. Additional legislation and regulations that could significantly affect our authority and operations may be enacted or adopted in the future, which could have a material adverse effect on our financial condition and results of operations. Failure to appropriately comply with any such laws, regulations or principles could result in sanctions by regulatory agencies or damage to our reputation, all of which could adversely affect our business, financial condition or results of operations.
In that regard, the Dodd-Frank Act was enacted in July 2010. Among other provisions, the Dodd-Frank Act created the CFPB with broad powers to regulate consumer financial products such as credit cards and mortgages, created a Financial Stability Oversight Council comprised of the heads of other regulatory agencies, has resulted in new capital requirements from federal banking agencies, placed new limits on electronic debit card interchange fees, and requires banking regulators, the SEC and national stock exchanges to adopt significant new corporate governance and executive compensation reforms.
Certain provisions of these new rules have phase-in periods, including a 2.5% conservation buffer, which began to be phased-in in 2016 and took full effect on January 1, 2019. Further, regulators have significant discretion and authority to prevent or remedy practices that they deem to be unsafe or unsound, or violations of laws or regulations by financial institutions and holding companies in the performance of their supervisory and enforcement duties. These powers have been utilized more frequently in recent years due to the serious national economic conditions that faced the financial system in late 2008 and early 2009. The exercise of regulatory authority may have a negative impact on our financial condition and results of operations. Additionally, our business is affected significantly by the fiscal and monetary policies of the U.S. federal government and its agencies, including the FRB.
We cannot accurately predict the full effects of recent or future legislation or the various other governmental, regulatory, monetary and fiscal initiatives which have been and may be enacted on the financial markets and on the Company. The terms and costs of these activities could materially and adversely affect our business, financial condition, results of operations and the trading price of our common stock.
We are subject to more stringent capital and liquidity requirements which may adversely affect our net income and future growth.
In July 2013, the FRB and the FDIC announced the new capital rules, which apply to both depository institutions and (subject to certain exceptions not applicable to the Company) their holding companies. As described in further detail above in “Part I. Item 1 Business - Supervision and Regulation” these rules created increased capital requirements for United States depository institutions and their holding companies. These rules include risk-based and leverage capital ratio requirements, which became effective on January 1, 2015. These rules also revise the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels do not meet certain thresholds. These revisions also became effective January 1, 2015.
Our failure to comply with the minimum capital requirements could result in our regulators taking formal or informal actions against us which could restrict our future growth or operations.
Changes in the FRB’s monetary or fiscal policies could adversely affect our results of operations and financial condition.
Our earnings will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The FRB has, and is likely to continue to have, an important impact on the operating results of depository institutions through its power to implement national monetary policy, among other things, in order to curb inflation or combat a recession. The FRB affects the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. Since December 2015, the FRB has increased short-term interest rates nine times. However, the FRB reduced interest rates in 2019 and 2020 and announced its target to keep federal funds rate near zero percent in January 2021. While we expect the FRB to hold short-term interest rates stable in 2021, we cannot predict the nature or impact of future changes in monetary and fiscal policies.
Changes in market interest rates could adversely impact the Company.
Our earnings are impacted by changing interest rates. Changes in interest rates affect the demand for new loans, the credit profile of existing loans, the rates received on loans and securities, and rates paid on deposits and borrowings. These impacts may negatively impact our ability to attract deposits, make loans, and achieve satisfactory interest rate spreads, which could adversely affect our financial condition or results of operations. In particular, increases in interest rates will likely reduce RML’s revenues by reducing the market for refinancings, as well as the demand for RML’s other residential loan products. Additionally, increases in interest rates may impact our borrowers' ability to make loan payments, particularly in our commercial loan portfolio.
Interest rates may be affected by many factors beyond our control, including general and economic conditions and the monetary and fiscal policies of various governmental and regulatory authorities. Since December 2015, the FRB has increased short-term interest rates nine times. However, the FRB reduced interest rates in 2019 and 2020 and announced its target to keep the federal funds rate near zero percent in January 2021. While we expect the FRB to hold short-term interest rates stable in 2021, market volatility in interest rates can be difficult to predict, as unexpected interest rate changes may result in a sudden impact while anticipated changes in interest rates generally impact the mortgage rate market prior to the actual rate change. Exposure to interest rate risk is managed by monitoring the repricing frequency of our rate-sensitive assets and rate-sensitive liabilities over any given period. Although we believe the current level of interest rate sensitivity is reasonable, significant fluctuations in interest rates could potentially have an adverse effect on our business, financial condition and results of operations.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, Anti-Money Laundering Act of 2020, Real Estate Settlement Procedures Act, Truth-in-Lending Act or other laws and regulations could result in fines, sanctions or other adverse consequences.
Financial institutions are required under the USA PATRIOT Act and Bank Secrecy Act to develop programs to prevent financial institutions from being used for money-laundering and terrorist activities. Financial institutions are also obligated to file suspicious activity reports with the United States Treasury Department’s Office of Financial Crimes Enforcement Network if such activities are detected. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure or the inability to comply with these regulations could result in fines or penalties, intervention or sanctions by regulators, and costly litigation or expensive additional controls and systems. In recent years, several banking institutions have received large fines for non-compliance with these laws and regulations. In addition, the federal government has in place laws and regulations relating to residential and consumer lending, as well as other activities with customers, that create significant compliance burdens and financial risks. We have developed policies and continue to augment procedures and systems designed to assist in compliance with these laws and regulations; however, it is possible for such safeguards to fail or prove deficient during the implementation phase to avoid non-compliance with such laws.
Accounting, Tax and Financial Risks
Changes in income tax laws and interpretations, or in accounting standards, could materially affect our financial condition or results of operations.
Further changes in income tax laws could be enacted, or interpretations of existing income tax laws could change, causing an adverse effect on our financial condition or results of operations. Similarly, our accounting policies and methods are fundamental to how we report our financial condition and results of operations. Some of these policies require the use of estimates and assumptions that may affect the value of our assets, liabilities, and financial results. Periodically, new accounting standards are issued or existing standards are revised, changing the methods for preparing our financial statements. These changes are not within our control and may significantly impact our financial condition and results of operations.
Uncertainty about the continuing availability of the London Inter-Bank Offered Rate ("LIBOR") may adversely affect our business.
On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates the LIBOR announced that after December 31, 2021 it would no longer compel banks to submit the rates required to calculate LIBOR. With this announcement there is uncertainty about the continued availability of LIBOR after 2021. If LIBOR ceases to be available or the methods of calculating LIBOR change from the current methods, financial products with interest rates tied to LIBOR may be adversely affected. Even if LIBOR remains available it is uncertain whether it will continue to be viewed as an acceptable market benchmark, what rate or rates may become accepted alternatives to LIBOR or what the effect of any such changes in views or alternatives may be on the markets for LIBOR-indexed financial instruments. We have loans, derivative contracts, and other financial instruments, including debentures related to our trust preferred securities, with rates that are either directly or indirectly tied to LIBOR. If any of the foregoing were to occur, the interest rates on these instruments, as well as the revenue and expenses associated with the same, may be adversely affected. Furthermore, failure to adequately manage this transition process with our customers could adversely impact our reputation.
General Economic and Market Risks
Natural disasters and adverse weather could negatively affect real estate property values and Bank operations.
Real estate and real estate property values play an important role for the Bank in several ways. The Bank owns or leases many real estate properties in connection with its operations, located in Anchorage, Juneau, Fairbanks, the Matanuska-Susitna Valley, Kodiak, Ketchikan, Sitka, and the Kenai Peninsula. Real estate is also utilized as collateral for many of our loans. A natural disaster could cause property values to fall, which could require the Bank to record an impairment on its financial statements. A natural disaster could also impact collateral values, which would increase our exposure to loan defaults. Our business operations could also suffer to the extent the Bank cannot utilize its branch network due to a natural disaster or other weather-related damage.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure. There can be no assurance that any such losses would not materially and adversely affect our results of operations.
The financial services business is intensely competitive and our success will depend on our ability to compete effectively.
The financial services business in our market areas is highly competitive. It is becoming increasingly competitive due to changes in regulation, technological advances, and the accelerating pace of consolidation among financial services providers. We face competition both in attracting deposits and in originating loans. We compete for loans principally through the pricing of interest rates and loan fees and the efficiency and quality of services. Increasing levels of competition in the banking and financial services industries may reduce our market share or cause the prices charged for our services to fall. Improvements in technology, communications, and the internet have intensified competition. As a result, our competitive position could be weakened, which could adversely affect our financial condition and results of operations.
We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so could materially adversely affect our performance.
We are a community bank, and our reputation is one of the most valuable components of our business. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected, by the actions of our employees or otherwise, our business and, therefore, our operating results could be materially adversely affected.
Social, political, and economic instability, unrest, and other circumstances beyond our control could adversely affect our business operations.
Our business may be adversely affected by social, political, and economic instability, unrest, or disruption in a geographic region in which we operate, regardless of cause, including legal, regulatory, and policy changes by a new presidential administration in the U.S., protests, demonstrations, strikes, riots, civil disturbance, disobedience, insurrection, or social and other political unrest.
Such events may result in restrictions, curfews, or other actions and give rise to significant changes in regional and global economic conditions and cycles, which may adversely affect our financial condition and operations. In 2020, there were protests in cities throughout the U.S. as well as globally, including in Hong Kong, in connection with civil rights, liberties, and social and governmental reform. Looting, vandalism, and fires have occurred in cities such as Seattle, Portland, Los Angeles, Washington, D.C., New York City, and Minneapolis that have led to the imposition of mandatory curfews and, in some locations, deployment of the U.S. National Guard. Government actions in an effort to protect people and property, including curfews and restrictions on business operations, may disrupt operations, harm perceptions of personal well-being, and increase the need for additional expenditures on security resources. In addition, action resulting from such social or political unrest may pose significant risks to our personnel, facilities, and operations. The effect and duration of demonstrations, protests, or other factors is uncertain, and we cannot ensure there will not be further political or social unrest in the future or that there will not be other events that could lead to social, political, and economic disruptions. If such events or disruptions persist for a prolonged period of time, our overall business and results of operations may be adversely affected.
In addition, a new U.S. President, Joseph R. Biden, was elected in November 2020. The aftermath of the November 2020 presidential election, including the January 6, 2021, violent disruption at the Capitol, has left the U.S. in what many consider to be an extremely heightened state of political and social tension, and it is unclear whether this tension will dissipate or intensify in coming months and what resulting impacts may occur to adversely affect our business operations or the safety of our employees, our customers, and the communities in which we operate.
Changes in federal policy, including tax policies, and at regulatory agencies occur over time through policy and personnel changes following elections, which lead to changes involving the level of oversight and focus on certain industries and corporate entities. The nature, timing, and economic and political effects of potential changes to the current legal and regulatory frameworks affecting the financial services industry remain highly uncertain.
Climate change, severe weather, natural disasters, and other external events could significantly impact our business.
Severe weather events of increasing strength and frequency due to climate change cannot be predicted and may be exacerbated by global climate change, natural disasters, including volcanic eruptions and earthquakes, and other adverse external events could have a significant impact on our ability to conduct business or upon third parties who perform operational services for us. In addition, there is continuing uncertainty over demand for oil and gas in part due to regulatory changes from climate change related policies. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in lost revenue, or cause us to incur additional expenses. Although management has established disaster recovery policies and procedures, there can be no assurance of the effectiveness of such policies and procedures, and the occurrence of any such event could have a material adverse effect on our business, financial condition and results of operations.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.

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ITEM 2. PROPERTIES
ITEM 2. PROPERTIES
The following sets forth information about our Community Banking branch locations:
Locations Type Leased/Owned
Midtown Financial Center: Northrim Headquarters
3111 C Street, Anchorage, AK
Traditional Land partially leased, partially owned, building owned
SouthSide Financial Center
8730 Old Seward Highway, Anchorage, AK Traditional Land leased, building owned
Lake Otis Community Branch
2270 East 37th Avenue, Anchorage, AK Traditional Land leased, building owned
Huffman Branch
1501 East Huffman Road, Anchorage, AK In-store Leased
Jewel Lake Branch
9170 Jewel Lake Road Suite 101, Anchorage, AK Traditional Leased
Seventh Avenue Branch
517 West Seventh Avenue, Suite 300, Anchorage, AK Traditional Leased
Eastside Community Branch
7905 Creekside Center Drive, Suite 100, Anchorage, AK Traditional Leased
West Anchorage Branch
2709 Spenard Road, Anchorage, AK Traditional Owned
Eagle River Branch
12812 Old Glenn Highway, Suite C03, Eagle River, AK Traditional Leased
Fairbanks Financial Center
360 Merhar Avenue, Fairbanks, AK Traditional Owned
Wasilla Financial Center
850 E. USA Circle, Suite A, Wasilla, AK Traditional Owned
Soldotna Financial Center
44384 Sterling Highway, Suite 101, Soldotna, AK Traditional Leased
Juneau Financial Center
2094 Jordan Avenue, Juneau, AK Traditional Leased
Juneau Downtown Branch
301 North Franklin Street, Juneau, AK Traditional Leased
Sitka Financial Center
315 Lincoln Street, Suite 206, Sitka, AK Traditional Leased
Ketchikan Financial Center
2491 Tongass Avenue, Ketchikan, AK Traditional Owned
Kodiak Loan Production Office
2011 Mill Bay Road, #101, Kodiak, AK Loan Production Leased
The following sets forth information about our Home Mortgage Lending branch locations, operated by RML:
Locations Leased/Owned
Main Office at Calais
100 Calais Drive, Anchorage, AK Leased
ReMax/Dynamic Office
3350 Midtown Place, Suite 101, Anchorage, AK Leased
Midtown Office
101 W. Benson Boulevard, #201, Anchorage, AK Leased
Eagle River Office
12812 Old Glenn Highway, Suite C03, Eagle River, AK Leased
Fairbanks Office
324 Old Steese Highway, Suite 7, Fairbanks, AK Leased
Fairbanks Northrim Office
360 Merhar Avenue, Fairbanks, AK Leased
Fairbanks Office
711 Gaffney Road, Suite 202, Fairbanks, AK Leased
Juneau Office
8800 Glacier Highway, #232, Juneau, AK Leased
Kodiak Office
2011 Mill Bay Road, #101, Kodiak, AK Leased
Soldotna Office
44384 Sterling Highway, Suite 101, Soldotna, AK Leased
Wasilla Remax Dynamic Branch
892 E USA Circle, Suite 105, Wasilla, AK Leased
Wasilla Northrim Branch
850 E USA Circle, Suite B, Wasilla, AK Leased

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ITEM 3. LEGAL PROCEEDINGS
ITEM 3. LEGAL PROCEEDINGS
The Company from time to time may be involved with disputes, claims and litigation related to the conduct of its banking business. Management does not expect that the resolution of these matters will have a material effect on the Company’s business, financial position, results of operations or cash flows.

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ITEM 4. MINE SAFETY DISCLOSURE
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the NASDAQ Global Select Stock Market under the symbol, “NRIM.” At March 5, 2021, the number of shareholders of record of our common stock was 228. As many of our shares of common stock are held of record in "street name" by brokers and other institutions on behalf of shareholders, we are unable to estimate the total number of beneficial holders of our common stock represented by these record holders.
The following are high and low closing prices as reported by NASDAQ. Prices do not include retail markups, markdowns or commissions.
First Second Third Fourth
Quarter Quarter Quarter Quarter
High $40.40 $28.75 $29.07 $34.67
Low $20.16 $19.63 $20.90 $25.48
High $39.60 $36.71 $41.82 $39.79
Low $32.36 $33.22 $34.72 $36.46
In 2020, we paid cash dividends of $0.34 per share in the first and second quarters and $0.35 per share in the third and fourth quarters. In 2019, we paid cash dividends of $0.30 per share in the first and second quarters and $0.33 per share in the third and fourth quarters. Cash dividends totaled $8.9 million, $8.5 million, and $7.1 million in 2020, 2019, and 2018, respectively. On February 25, 2021, the Board of Directors approved payment of a $0.37 subject to restrictions on the payment of dividends pursuant to applicable federal and state banking regulations and Alaska corporate law. The dividends that the Bank pays to the Company are limited to the extent necessary for the Bank to meet the regulatory requirements of a “well-capitalized” bank. Given the fact that the Bank believes it will remain “well-capitalized” and exceed the capital conservation buffer; the Company expects to receive dividends from the Bank in 2021.
Repurchase of Securities
At December 31, 2020, there were no shares available under the stock repurchase program. The Company repurchased 327,000 shares in 2020 and 347,676 shares in 2019. On February 1, 2021, the Company announced that its Board of Directors had authorized the repurchase of up to an additional 313,000 shares of common stock. The Company intends to continue to repurchase its stock from time to time depending upon market conditions, but we can make no assurances that we will continue this program.
Equity Compensation Plan Information
The following table sets forth information regarding securities authorized for issuance under the Company’s equity plans as of December 31, 2020. Additional information regarding the Company’s equity plans is presented in Note 23 of the Notes to Consolidated Financial Statements included in Item 8 of this report.
Plan Category Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights (a) (2)
Weighted-Average Exercise Price of Outstanding Options,
Warrants and Rights Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a))
Equity compensation plans approved by security holders1
247,677 $22.12 236,700
Total 247,677 $22.12 236,700
1Consists of the Company's 2020 Stock Incentive Plan, which replaced the 2017 Stock Incentive Plan (the "2017 Plan")
2 Includes 204,795 options awarded under the 2017 Plan and other previous stock option plans.
We do not have any equity compensation plans that have not been approved by our shareholders.
Stock Performance Graph
The graph shown below depicts the total return to shareholders during the period beginning after December 31, 2015, and ending December 31, 2020. The definition of total return includes appreciation in market value of the stock, as well as the actual cash and stock dividends paid to shareholders. The comparable indices utilized are the Russell 3000 Index, representing approximately 98% of the U.S. equity market, and the SNL Financial Bank Stock Index, comprised of publicly traded banks with assets of $1 billion to $5 billion, which are located in the United States. The graph assumes that the value of the investment in the Company’s common stock and each of the two indices was $100 on December 31, 2015, and that all dividends were reinvested.
Period Ending
Index 12/31/15 12/31/16 12/31/17 12/31/18 12/31/19 12/31/20
Northrim BanCorp, Inc. 100.00 122.45 134.83 134.45 162.17 150.84
Russell 3000 100.00 112.74 136.56 129.40 169.54 204.95
SNL Bank $1B-$5B 100.00 143.87 153.37 134.37 163.35 138.81

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ITEM 6. SELECTED FINANCIAL DATA
ITEM 6. SELECTED FINANCIAL DATA (1)
Years Ended December 31,
(In thousands, except per share data and shares outstanding amounts)
2020 2019 2018 2017 2016 2015 Five Year Compound Growth Rate
(Unaudited)
Net interest income $70,665 $64,442 $61,208 $57,678 $56,357 $56,909 4 %
Provision (benefit) for loan losses 2,432 (1,175) (500) 3,200 2,298 1,754 NM
Other operating income 63,328 37,346 32,167 40,474 43,263 44,608 7 %
Compensation expense, RML acquisition payments - 468 - 130 4,775 4,094 NM
Other operating expense 89,114 76,370 69,800 71,023 71,505 68,551 5 %
Income before provision for income taxes $42,447 $26,125 $24,075 $23,799 $21,042 $27,118 9 %
Provision for income taxes 9,559 5,434 4,071 10,321 6,052 8,784 2 %
Net Income 32,888 20,691 20,004 13,478 14,990 18,334 12 %
Less: Net income attributable to
noncontrolling interest - - - 327 579 551 NM
Net income attributable to Northrim Bancorp, Inc. $32,888 $20,691 $20,004 $13,151 $14,411 $17,783 13 %
Year End Balance Sheet
Assets $2,121,798 $1,643,996 $1,502,988 $1,518,596 $1,525,851 $1,498,691 7 %
Portfolio loans 1,444,050 1,043,371 984,346 954,953 974,074 979,682 8 %
Deposits 1,824,981 1,372,351 1,228,088 1,258,283 1,267,653 1,240,792 8 %
Securities sold under repurchase agreements - - 34,278 27,746 27,607 31,420 (100) %
Borrowings 14,817 8,891 7,241 7,362 4,338 2,120 48 %
Junior subordinated debentures 10,310 10,310 10,310 10,310 18,558 18,558 (11) %
Shareholders' equity 221,575 207,117 205,947 192,802 186,712 177,214 5 %
Common shares outstanding 6,251,004 6,558,809 6,883,216 6,871,963 6,897,890 6,877,140 (2) %
Average Balance Sheet
Assets $1,936,047 $1,555,707 $1,493,385 $1,511,052 $1,506,522 $1,480,913 6 %
Earning assets 1,758,839 1,386,557 1,346,449 1,367,203 1,361,913 1,334,102 6 %
Portfolio loans 1,339,908 1,010,098 971,548 981,001 976,613 968,752 7 %
Deposits 1,638,216 1,276,407 1,227,272 1,248,333 1,250,243 1,219,445 6 %
Securities sold under repurchase agreements - 15,167 29,940 29,690 27,322 24,447 (100) %
Borrowings 25,608 8,071 7,309 5,767 4,215 14,552 12 %
Junior subordinated debentures 10,310 10,310 10,310 15,066 18,558 18,558 (11) %
Shareholders' equity 211,721 208,602 201,022 193,129 181,628 169,802 5 %
Basic common shares outstanding 6,354,687 6,708,622 6,877,573 6,889,621 6,883,663 6,859,209 (2) %
Diluted common shares outstanding 6,431,367 6,808,209 6,981,557 6,977,910 6,974,864 6,948,474 (2) %
Per Common Share Data
Basic earnings $5.18 $3.08 $2.91 $1.91 $2.09 $2.59 15 %
Diluted earnings $5.11 $3.04 $2.86 $1.88 $2.06 $2.56 15 %
Book value per share $35.45 $31.58 $29.92 $28.06 $27.07 $25.77 7 %
Tangible book value per share(2)
$32.88 $29.12 $27.57 $25.70 $24.70 $22.31 8 %
Cash dividends per share $1.38 $1.26 $1.02 $0.86 $0.78 $0.74 13 %
Years Ended December 31,
2020 2019 2018 2017 2016 2015 Five Year Compound Growth Rate
(Unaudited)
Performance Ratios
Return on average assets 1.70 % 1.33 % 1.34 % 0.87 % 0.96 % 1.20 % 7 %
Return on average equity 15.53 % 9.92 % 9.95 % 6.81 % 7.93 % 10.47 % 8 %
Equity/assets 10.44 % 12.60 % 13.70 % 12.70 % 12.24 % 11.82 % (2) %
Tangible common equity/tangible assets(3)
9.76 % 11.73 % 12.76 % 11.75 % 11.29 % 10.40 % (1) %
Net interest margin 4.02 % 4.65 % 4.55 % 4.22 % 4.14 % 4.27 % (1) %
Net interest margin (tax equivalent)(4)
4.05 % 4.70 % 4.60 % 4.28 % 4.20 % 4.32 % (1) %
Non-interest income/total revenue 47.26 % 36.69 % 34.45 % 41.24 % 43.43 % 43.94 % 1 %
Efficiency ratio (5)
66.47 % 75.43 % 74.68 % 72.39 % 76.44 % 71.31 % (1) %
Dividend payout ratio 26.66 % 40.79 % 35.08 % 45.44 % 37.59 % 28.81 % (2) %
Asset Quality
Nonperforming loans, net of government guarantees $10,048 $13,951 $14,694 $21,411 $12,936 $2,125 36 %
Nonperforming assets, net of government guarantees 16,289 19,946 22,619 28,729 19,315 5,178 26 %
Nonperforming loans, net of government guarantees/portfolio loans 0.70 % 1.34 % 1.49 % 2.24 % 1.33 % 0.22 % 26 %
Net charge-offs (recoveries)/average loans 0.03 % (0.07) % 0.15 % 0.15 % 0.08 % 0.03 % NM
Allowance for loan losses/portfolio loans 1.46 % 1.83 % 1.98 % 2.25 % 2.02 % 1.85 % (5) %
Nonperforming assets, net of government guarantees/assets 0.77 % 1.21 % 1.50 % 1.89 % 1.27 % 0.35 % 17 %
Other Data
Effective tax rate (6)
23 % 21 % 17 % 43 % 29 % 32 % (6) %
Number of banking offices(7)
17 16 16 14 14 14 4 %
Number of employees (FTE) (8)
438 431 430 429 451 441 - %
1 These unaudited schedules provide selected financial information concerning the Company that should be read in conjunction with Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report.
2Tangible book value per share is a non-GAAP ratio defined as shareholders’ equity, less intangible assets, divided by common shares outstanding. Management believes that tangible book value is a useful measurement of the value of the Company’s equity because it excludes the effect of intangible assets on the Company’s equity. See reconciliation to book value per share, the most comparable GAAP measurement below.
3Tangible common equity to tangible assets is a non-GAAP ratio that represents total equity less goodwill and intangible assets divided by total assets less goodwill and intangible assets. Management believes this ratio is important as it has received more attention over the past several years from stock analysts and regulators. The most comparable GAAP measure of shareholders' equity to total assets is calculated by dividing total shareholders' equity by total assets. See reconciliation to shareholders' equity to total assets below.
4Tax-equivalent net interest margin is a non-GAAP performance measurement in which interest income on non-taxable investments and loans is presented on a tax-equivalent basis using a combined federal and state statutory rate of 28.43% in 2018 through 2020 and 41.11% in all other years presented. Management believes that tax-equivalent net interest margin is a useful financial measure because it enables investors to evaluate net interest margin excluding tax expense in order to monitor our effectiveness in growing higher interest yielding assets and
managing our costs of interest bearing liabilities over time on a fully tax equivalent basis. See reconciliation to net interest margin, the comparable GAAP measurement below.
5In managing our business, we review the efficiency ratio exclusive of intangible asset amortization, which is a non-GAAP performance measurement. Management believes that this is a useful financial measurement because we believe this presentation provides investors with a more accurate picture of our operating efficiency. The efficiency ratio is calculated by dividing other operating expense, exclusive of intangible asset amortization, by the sum of net interest income and other operating income. Other companies may define or calculate this data differently. For additional information see the "Other Operating Expense" section in Part II. Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report. See reconciliation to comparable GAAP measurement below.
6The Company’s 2017 results included the impact of the enactment of the Tax Cuts and Jobs Act, which was signed into law on December 22, 2017. The law includes significant changes to the U.S. corporate tax system, including a Federal corporate rate reduction from 35% to 21%. In 2017, the Company applied the newly enacted corporate federal income tax rate of 21%, reducing the value of the Company's net deferred tax asset, resulting in approximately a $2.7 million increase in tax expense. In 2018, the Company finalized changes related to the reduction in the federal tax rate which resulted in a $470,000 reduction in tax expense.
7Number of banking offices does not include RML locations. 2020 number of banking offices includes 16 full service branches and 1 loan production office. 2018 number of banking offices includes 15 full service branches and 1 loan production office.
8FTE includes 312, 311, 320, 314, 321, and 317 Community Banking employees in 2020, 2019, 2018, 2017, 2016 and 2015, respectively. FTE includes 126, 120, 110, 115, 130, and 124 Home Mortgage Lending employees in 2020, 2019, 2018, 2017, 2016 and 2015, respectively.
Reconciliation of Selected Non-GAAP Financial Data to GAAP Financial Measures
These unaudited schedules provide selected financial information concerning the Company that should be read in conjunction with "Part II. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report.
Reconciliation of total shareholders' equity to tangible common shareholders’ equity (Non-GAAP) and total assets to tangible assets:
(In Thousands) 2020 2019 2018 2017 2016 2015
Total shareholders' equity $221,575 $207,117 $205,947 $192,802 $186,712 $177,214
Total assets 2,121,798 1,643,996 1,502,988 1,518,596 1,525,851 1,498,691
Total shareholders' equity to total assets ratio 10.44 % 12.60 % 13.70 % 12.70 % 12.24 % 11.82 %
(In Thousands) 2020 2019 2018 2017 2016 2015
Total shareholders' equity $221,575 $207,117 $205,947 $192,802 $186,712 $177,214
Less: goodwill and other intangible assets, net 16,046 16,094 16,154 16,224 16,324 23,776
Tangible common shareholders' equity $205,529 $191,023 $189,793 $176,578 $170,388 $153,438
Total assets $2,121,798 $1,643,996 $1,502,988 $1,518,596 $1,525,851 $1,498,691
Less: goodwill and other intangible assets, net 16,046 16,094 16,154 16,224 16,324 23,776
Tangible assets $2,105,752 $1,627,902 $1,486,834 $1,502,372 $1,509,527 $1,474,915
Tangible common equity to tangible assets ratio 9.76 % 11.73 % 12.76 % 11.75 % 11.29 % 10.40 %
Reconciliation of tangible book value per share (Non-GAAP) to book value per share
(In thousands, except per share data) 2020 2019 2018 2017 2016 2015
Total shareholders' equity $221,575 $207,117 $205,947 $192,802 $186,712 $177,214
Divided by common shares outstanding 6,251,004 6,558,809 6,883,216 6,871,963 6,897,890 6,877,140
Book value per share $35.45 $31.58 $29.92 $28.06 $27.07 $25.77
(In thousands, except per share data) 2020 2019 2018 2017 2016 2015
Total shareholders' equity $221,575 $207,117 $205,947 $192,802 $186,712 $164,441
Less: goodwill and intangible assets, net 16,046 16,094 16,154 16,224 16,324 23,776
$205,529 $191,023 $189,793 $176,578 $170,388 $140,665
Divided by common shares outstanding 6,251,004 6,558,809 6,883,216 6,871,963 6,897,890 6,877,140
Tangible book value per share $32.88 $29.12 $27.57 $25.70 $24.70 $20.45
Reconciliation of tax-equivalent net interest margin (Non-GAAP) to net interest margin
(In Thousands) 2020 2019 2018 2017 2016 2015
Net interest income(9)
$70,665 $64,442 $61,208 $57,678 $56,357 $56,909
Divided by average interest-bearing assets 1,758,839 1,386,557 1,346,449 1,367,203 1,361,913 1,334,102
Net interest margin 4.02 % 4.65 % 4.55 % 4.22 % 4.14 % 4.27 %
(In Thousands) 2020 2019 2018 2017 2016 2015
Net interest income(9)
$70,665 $64,442 $61,208 $57,678 $56,357 $56,909
Plus: reduction in tax expense related to
tax-exempt interest income 613 722 726 872 808 722
$71,278 $65,164 $61,934 $58,550 $57,165 $57,631
Divided by average interest-bearing assets 1,758,839 1,386,557 1,346,449 1,367,203 1,361,913 1,334,102
Tax-equivalent net interest margin 4.05 % 4.70 % 4.60 % 4.28 % 4.20 % 4.32 %
Calculation of efficiency ratio
(In Thousands) 2020 2019 2018 2017 2016 2015
Net interest income(9)
$70,665 $64,442 $61,208 $57,678 $56,357 $56,909
Other operating income 63,328 37,346 32,167 40,474 43,263 44,608
Total revenue 133,993 101,788 93,375 98,152 99,620 101,517
Other operating expense 89,114 76,838 69,800 71,153 76,280 72,645
Less intangible asset amortization 48 60 70 100 135 258
Adjusted other operating expense $89,066 $76,778 $69,730 $71,053 $76,145 $72,387
Efficiency ratio 66.47 % 75.43 % 74.68 % 72.39 % 76.44 % 71.31 %
9Amount represents net interest income before provision for loan losses.
Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although we believe these non-GAAP financial measures are frequently used by stakeholders in the evaluation of the Company, they have limitations as analytical tools and should not be considered in isolation or as a substitute for analysis of results as reported under GAAP.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion highlights key information as determined by management but may not contain all of the information that is important to you. For a more complete understanding, the following should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto as of December 31, 2020, 2019 and 2018 included in Part II. Item 8 of this report. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for fiscal year ended December 31, 2019.
This annual report contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those indicated in forward-looking statements. See “Cautionary Note Regarding Forward-Looking Statements.”
Executive Overview
Net income attributable to the Company increased 59% to $32.9 million or $5.11 per diluted share for the year ended December 31, 2020, from $20.7 million, or $3.04 per diluted share, for the year ended December 31, 2019. Significant items contributing to the increase in 2020 compared to 2019 were:
•an increase in mortgage banking income due to increased mortgage production and refinance activity; and
•an increase in net interest income resulting from higher average net interest-earning asset balances.
Highlights for the year ended December 31, 2020 are as follows:
•Total revenues, which include net interest income plus other operating income, increased 32% to $134.0 million in 2020 from $101.8 million in 2019. This increase mainly reflects increases in net interest income and mortgage banking income. These increases were partially offset by a decreases in purchased receivable income and unrealized gains on marketable equity securities.
•The net interest margin decreased to 4.02% in 2020 from 4.65% in 2019 mostly due to a decrease in average yields on interest earning assets to 4.36% in 2020 compared to 5.05% in 2019 as a result of lower interest rates. Additionally, the mix of earning assets, specifically the addition of lower yielding PPP loans, also contributed to the decrease in the net interest margin in 2020 as compared to the prior year.
•The provision for loan losses increased in 2020 to a provision of $2.4 million from a benefit of $1.2 million in 2019 primarily due to management's assessment of risks associated with the COVID-19 pandemic, which were only partially offset by improvement in the overall credit quality of the loan portfolio. Our nonperforming loans, net of government guarantees, decreased to $10.0 million at the end of 2020 compared to $14.0 million at the end of 2019, while total adversely classified loans, net of government guarantees at December 31, 2020 decreased to $12.8 million from $22.3 million at December 31, 2019. The allowance for loan losses (“Allowance”) totaled 1.46% of total portfolio loans at December 31, 2020, compared to 1.83% at December 31, 2019. The Allowance compared to nonperforming loans, net of government guarantees, was 210% at December 31, 2020 compared to 137% at the end of 2019.
•Return on average assets was 1.70% in 2020 compared to 1.33% in 2019.
•The Company continued to maintain strong capital ratios with Tier 1 Capital to Risk Adjusted Assets of 14.20% at December 31, 2020 as compared to 14.38% at December 31, 2019.
•The aggregate cash dividends paid by the Company in 2020 rose 4% to $8.8 million from $8.5 million paid in 2019.
•The Company repurchased 327,000 shares of its common stock in 2020 at an average price of $30.51 per share.
COVID-19 Issues:
•Industry Exposure: Northrim has identified various industries that may be adversely impacted by the COVID-19 pandemic and the decline in oil prices that occurred in 2020. Though the industries affected may change through the progression of the pandemic, the following sectors for which the Company has exposure, as a percent of the total loan portfolio as of December 31, 2020 are being impacted: Tourism (5%), Oil and Gas (4%), Aviation (non-tourism) (4%), Healthcare (7%), Accommodations (3%), Retail (1%) and Restaurants (2%). The Company's exposure as a percent of the total loan portfolio excluding PPP loans as of December 31, 2020 are: Tourism (7%), Oil and Gas (6%), Aviation (non-tourism) (5%), Healthcare (8%), Accommodations (3%), Retail (2%) and Restaurants (3%).
•Customer Accommodations: The Company has implemented several forms of assistance to help customers experiencing financial challenges as a result of COVID-19 in addition to our participation in PPP lending. The provisions of the CARES Act included an election to not apply the guidance on accounting for certain troubled debt restructurings related to COVID-19 and allow certain accommodations to borrowers. These accommodations include interest only and deferral options on loan payments, as well as the waiver of various fees related to loans, deposits and other services. The Company has elected to adopt these provisions of the CARES Act. The outstanding principal balance of loan modifications due to the economic impacts of COVID-19 for the periods below were as follows:
Loan Modifications due to COVID-19 as of December 31, 2020
(Dollars in thousands) Interest Only Full Payment Deferral Total
Portfolio loans $43,379 $22,165 $65,544
Number of modifications 23 11 34
Loan Modifications due to COVID-19 as of September 30, 2020
(Dollars in thousands) Interest Only Full Payment Deferral Total
Portfolio loans $46,056 $74,337 $120,393
Number of modifications 16 59 75
Loan Modifications due to COVID-19 as of June 30, 2020
(Dollars in thousands) Interest Only Full Payment Deferral Total
Portfolio loans $64,298 $293,224 $357,522
Number of modifications 76 403 479
Consumer loans represent less than 1% of total loan modifications identified above. Of the $65.5 million and 34 loan modifications as of December 31, 2020, approximately $53.9 million and 31 loans have entered into a second modification.
•Loan Loss Reserve: The Company booked a loan loss provision of $2.4 million in 2020 compared to a benefit for loan loss provisions of $1.2 million in 2019.
•Credit Quality: Net adversely classified loans were $12.8 million at December 31, 2020, compared to $22.3 million at December 31, 2019.
•Branch Operations: All branches are fully operational, while a number of customer and employee safety measure continue to be implemented.
•Growth and Paycheck Protection Program:
•Northrim funded 2,888 PPP loans totaling $375.6 million to both existing and new customers in 2020.
•According to the SBA, the Company originated more PPP loans in the State of Alaska than any other financial institution, funding 23% of the number and 28% of the value of all Alaska PPP loans for the period ending September 30, 2020.
•As of December 31, 2020, Northrim customers had received forgiveness through the SBA on 537 PPP loans totaling $65.1 million.
•The Company initially utilized the Federal Reserve Bank's Paycheck Protection Program Liquidity Facility (the "PPPLF") to fund PPP loans, but paid those funds back in full during the second quarter and has since funded the PPP loans through core deposits and maturity of long-term investments.
•Capital Management: At December 31, 2020, the capital of Northrim Bank (the "Bank") was well in excess of all regulatory requirements.
Critical Accounting Policies
The SEC defines "critical accounting policies" as those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Our significant accounting policies are described in Note 1 in the Notes to Consolidated Financial Statements in Item 8 of this report. Not all of these significant accounting policies require management to make difficult, subjective or complex judgments or estimates. Management believes that the following accounting policies would be considered critical under the SEC's definition.
Allowance for loan losses: The Company maintains an Allowance to reflect inherent losses in its loan portfolio as of the balance sheet date. The Company performs regular credit reviews of the loan portfolio to determine the credit quality and adherence to underwriting standards. When loans are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the credit review process. The Company's risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. These risk ratings are then consolidated into five classes, which include pass, special mention, substandard, doubtful and loss. These classes are a primary factor in determining an appropriate amount for the allowance for loan losses. Each class is assessed an inherent credit loss factor that determines an amount of allowance for loan losses provided for that group of loans. This allowance is then adjusted for qualitative factors, by segment and class. Qualitative factors are based on management’s assessment of current trends that may cause losses inherent in the current loan portfolio to differ significantly from historical losses. Some factors that management considers in determining the qualitative adjustment to the general reserve include loan quality trends in our own portfolio, the degree of concentrations of large borrowers in our loan portfolio, national and local economic trends, business conditions, underwriting policies and standards, trends in local real estate markets, effects of various political activities, peer group data, and internal factors such as underwriting policies and expertise of the Company’s employees.
Regular credit reviews of the portfolio also identify loans that are considered potentially impaired. A loan is considered impaired when based on current information and events, we determine that we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. The analysis of collateral dependent loans includes appraisals on loans secured by real property, management’s assessment of the current market, recent payment history and an evaluation of other sources of repayment. The Company obtains appraisals on real and personal property that secure its loans during the loan origination process in accordance with regulatory guidance and its loan policy. The Company obtains updated appraisals on loans secured by real or personal property based upon its assessment of changes in the current market or particular projects or properties, information from other current appraisals and other sources of information. The Company uses the information provided in these updated appraisals along with its evaluation of all other information available on a particular property as it assesses the collateral coverage on its performing and nonperforming loans and the impact that may have on the adequacy of its Allowance.
If we determine that the value of the impaired loan is less than the recorded investment in the loan, we either recognize an impairment reserve as a specific component to be provided for in the Allowance or charge-off the impaired balance on collateral dependent loans if it is determined that such amount represents a confirmed loss. The combination of the risk rating-based allowance component and the impairment reserve allowance component lead to an allocated allowance for loan losses.
Finally, the Company assesses the overall adequacy of the Allowance based on several factors including the level of the Allowance as compared to total loans and nonperforming loans in light of current economic conditions. This portion of the Allowance is deemed “unallocated” because it is not allocated to any segment or class of the loan portfolio. This portion of the Allowance provides for coverage of credit losses inherent in the loan portfolio but not captured in the credit loss factors that are utilized in the risk rating-based component or in the specific impairment component of the Allowance and acknowledges the inherent imprecision of all loss prediction models.
The unallocated portion of the Allowance is based upon management’s evaluation of various factors that are not directly measured in the determination of the allocated portions of the Allowance. Such factors include uncertainties in identifying triggering events that directly correlate to subsequent loss rates, uncertainties in economic conditions, risk factors that have not yet manifested themselves in loss allocation factors, and historical loss experience data that may not precisely correspond to the current portfolio. In addition, the unallocated reserve may fluctuate based upon the direction of various risk indicators. Examples of such factors include the risk as to current economic conditions, the level and trend of charge offs or
recoveries, and the risk of heightened imprecision or inconsistency of appraisals used in estimating real estate values. Although this allocation process may not accurately predict credit losses by loan type or in aggregate, the total allowance for credit losses is available to absorb losses that may arise from any loan type or category. Due to the subjectivity involved in the determination of the unallocated portion of the Allowance, the relationship of the unallocated component to the total Allowance may fluctuate from period to period.
Based on our methodology and its components, management believes the resulting Allowance is adequate and appropriate for the risk identified in the Company's loan portfolio. Given current processes employed by the Company, management believes the segments, classes, and estimated loss rates currently assigned are appropriate. It is possible that others, given the same information, may at any point in time reach different reasonable conclusions that could be material to the Company's financial statements. In addition, current loan classes and fair value estimates of collateral are subject to change as we continue to review loans within our portfolio and as our borrowers are impacted by economic trends within their market areas. Although we have established an Allowance that we consider adequate, there can be no assurance that the established Allowance will be sufficient to offset losses on loans in the future. In addition, a substantial percentage of our loan portfolio is secured by real estate; as a result, a significant decline in real estate market values may require an increase in the Allowance.
Valuation of goodwill and other intangibles: Goodwill and other intangible assets with indefinite lives are not amortized but instead are periodically tested for impairment. Management performs an impairment analysis for the intangible assets with indefinite lives on an annual basis as of December 31. Additionally, goodwill and other intangible assets with indefinite lives are evaluated on an interim basis when events or circumstances indicate impairment potentially exists. The impairment analysis requires management to make subjective judgments. Events and factors that may significantly affect the estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures, technology, changes in discount rates and specific industry and market conditions. There can be no assurance that changes in circumstances, estimates or assumptions may result in additional impairment of all, or some portion of, goodwill or other intangible assets. The Company performed its annual goodwill impairment testing at December 31, 2020 and 2019 in accordance with the policy described in Note 1 to the financial statements included with this report. At December 31, 2020, the Company performed its annual impairment test by performing a quantitative assessment. The Company estimated the fair value of the Company using two valuation methodologies including a control premium approach and a discounted cash flow approach. We then compared the estimated fair value of each segment to the carrying value and concluded that no potential impairment existed at of December 31, 2020
Valuation of OREO: OREO represents properties acquired through foreclosure or its equivalent. Prior to foreclosure, the carrying value is adjusted to the fair value, less cost to sell, of the real estate to be acquired by an adjustment to the allowance for loan loss. The amount by which the fair value less cost to sell is greater than the carrying amount of the loan plus amounts previously charged off is recognized in earnings. Any subsequent reduction in the carrying value is charged against earnings. Management's evaluation of fair value is based on appraisals or discounted cash flows of anticipated sales. The amounts ultimately recovered from the sale of OREO may differ from the carrying value of the assets because of market factors beyond the Company's control or due to changes in the Company's strategies for recovering the investment.
Servicing rights: The Company measures mortgage servicing rights ("MSRs") and commercial servicing rights ("CSRs") at fair value on a recurring basis with changes in fair value going through earnings in the period in which the change occurs. Changes in the fair value of MSRs are recorded in mortgage banking income, and changes in the fair value of CSRs are recorded in commercial servicing revenue. Fair value adjustments encompass market-driven valuation changes and the decrease in value that occurs from the passage of time, which are separately reported. Retained servicing rights are measured at fair value as of the date of sale. Initial and subsequent fair value measurements are determined using a discounted cash flow model. In order to determine the fair value of servicing rights, the present value of expected net future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, escrow calculations, delinquency rates and ancillary fee income net of servicing costs. The model assumptions for MSRs are also compared to publicly filed information from several large MSR holders, as available.
Fair Value: A hierarchical disclosure framework associated with the level of pricing observability is utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no pricing observability and a higher degree of judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction.
Impact of accounting pronouncements to be implemented in future periods
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (“ASU 2016-13” or "CECL"). ASU 2016-13 is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates, but will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. ASU 2016-13 is effective for the Company for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2019, and must be applied prospectively. However, on October 16, 2019 the FASB voted to delay ASU 2016-13 for Smaller Reporting Companies. The Company has elected Small Reporting Company status, which changes the effective date for ASU 2016-13 for the Company to fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2022. Early application was permitted for specified periods. The Company early adopted ASU 2016-13 on January 1, 2021 after finalizing data and model validation and our internal governance framework. The guidance was applied on a modified retrospective basis with the cumulative effect of initially applying the amendments recognized in retained earnings at January 1, 2021. However, certain provisions of the guidance are only required to be applied on a prospective basis.
Adoption of CECL as of January 1, 2021 resulted in an allowance for loan losses of $16.6 million, which is a $4.5 million decrease in the allowance under the incurred loss model as of December 31, 2020. This decrease will increase the Company's total shareholder's equity by $3.2 million. The reduction reflects a decrease for all loan segments given their short contractual maturities. The Company does not hold a material amount of residential mortgage loans with long or indeterminate maturities as of December 31, 2020. In most instances the Company believes that the ACL for residential mortgage loans with long or indeterminate maturities would lead to an increase in the ACL.
Adoption of CECL as of January 1, 2021 resulted in a reserve for unfunded commitments of $1.4 million, which is a $1.2 million increase in the reserve under the incurred loss model as of December 31, 2020. This increase will decrease the Company's total shareholder's equity by $880,000.
See the “Accounting pronouncements to be implemented in future periods” section in Note 1 of the Notes to Consolidated Financial Statements included in Part II. Item 8 of this report for further discussion of the Company's implementation of CECL.
RESULTS OF OPERATIONS
Income Statement
Net Income
Our results of operations are dependent to a large degree on our net interest income. We also generate other income primarily through mortgage banking income, purchased receivables products, service charges and fees, and bankcard fees. Our operating expenses consist in large part of salaries and other personnel costs, occupancy, data processing, marketing, and professional services expenses. Interest income and cost of funds, or interest expense, are affected significantly by general economic conditions, particularly changes in market interest rates, by government policies and the actions of regulatory authorities, and by competition in our markets.
We earned net income of $32.9 million in 2020, compared to net income of $20.7 million in 2019. During these periods, net income per diluted share was $5.11 and $3.04, respectively. The increase in net income in 2020 compared to 2019 was primarily due to increases in other operating income, specifically mortgage banking income, as well as improved net interest income.
Net Interest Income / Net Interest Margin
Net interest income is the difference between interest income from loan and investment securities portfolios and interest expense on customer deposits and borrowings. Changes in net interest income result from changes in volume and spread, which in turn affect our margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Changes in net interest income are influenced by yields and the level and relative mix of interest-earning assets and interest-bearing liabilities.
Net interest income in 2020 was $70.7 million, compared to $64.4 million in 2019. The increase in 2020 as compared to 2019 was the result of higher net average interest-earning asset balances which was only partially offset by a decrease in net interest income as a result of decreased interest rates. Additionally, the Company recognized $5.6 million in loan fee income from PPP loans in 2020. During 2020 and 2019, net interest margins were 4.02% and 4.65%, respectively. The decrease in net interest margin in 2020 as compared to 2019 is the result of decreases in the spread between the average yield on interest-earning assets and the average cost of interest-bearing liabilities which was impacted by a decrease in interest rates.
The following table sets forth for the periods indicated information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities. Average yields or costs, net interest income, and net interest margin are also presented:
Years ended December 31, 2020 2019 2018
Average outstanding balance Interest income / expense Average Yield / Cost Average outstanding balance Interest income / expense Average Yield / Cost Average outstanding balance Interest income / expense Average Yield / Cost
(In Thousands)
Loans (1),(2)
$1,339,908 $67,876 5.07 % $1,010,098 $59,919 5.93 % $971,548 $55,526 5.72 %
Loans held for sale 105,287 3,215 3.05 % 56,344 2,231 3.96 % 46,089 2,016 4.37 %
Long-term Investments(3)
247,384 5,316 2.15 % 273,711 7,011 2.56 % 286,426 5,829 2.04 %
Short-term investments(4)
66,260 309 0.47 % 46,404 922 1.99 % 42,386 806 1.90 %
Total interest-earning assets $1,758,839 $76,716 4.36 % $1,386,557 $70,083 5.05 % $1,346,449 $64,177 4.77 %
Noninterest-earning assets 177,208 169,150 146,936
Total $1,936,047 $1,555,707 $1,493,385
Interest-bearing deposits $1,040,606 $5,279 0.51 % $850,202 $4,961 0.58 % $809,808 $2,307 0.28 %
Borrowings 35,918 772 2.15 % 33,730 680 1.37 % 47,570 662 1.39 %
Total interest-bearing liabilities $1,076,524 $6,051 0.56 % $883,932 $5,641 0.64 % $857,378 $2,969 0.35 %
Noninterest-bearing demand deposits 597,610 426,205 417,464
Other liabilities 50,192 36,968 17,521
Equity 211,721 208,602 201,022
Total $1,936,047 $1,555,707 $1,493,385
Net interest income $70,665 $64,442 $61,208
Net interest margin 4.02 % 4.65 % 4.55 %
Average portfolio loans to average-earnings assets 76.18 % 72.85 % 72.16 %
Average portfolio loans to average total deposits 81.79 % 79.14 % 79.16 %
Average non-interest deposits to average total deposits 36.48 % 33.39 % 34.02 %
Average interest-earning assets to average interest-bearing liabilities 163.38 % 156.86 % 157.04 %
1Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled $8.9 million, $3.3 million and $3.0 million for 2020, 2019 and 2018, respectively.
2Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loans were $13.8 million, $16.9 million, and $17.5 million in 2020, 2019 and 2018, respectively.
3Consists of investment securities available for sale, investment securities held to maturity, marketable equity securities, and investment in Federal Home Loan Bank stock.
4Consists of interest bearing deposits in other banks and domestic CDs.
The following table sets forth the changes in consolidated net interest income attributable to changes in volume and to changes in interest rates. Changes attributable to the combined effect of volume and interest rate have been allocated proportionately to the changes due to volume and the changes due to interest rate:
2020 compared to 2019 2019 compared to 2018
Increase (decrease) due to Increase (decrease) due to
(In Thousands) Volume Rate Total Volume Rate Total
Interest Income:
Loans $17,590 ($9,633) $7,957 $2,246 $2,147 $4,393
Loans held for sale 1,336 (352) 984 374 (159) 215
Long-term investments (634) (1,061) (1,695) (245) 1,427 1,182
Short term investments 779 (1,392) (613) 79 37 116
Total interest income $19,071 ($12,438) $6,633 $2,454 $3,452 $5,906
Interest Expense:
Interest-bearing deposits $763 ($445) $318 $120 $2,534 $2,654
Borrowings 9 83 92 (29) 47 18
Total interest expense $772 ($362) $410 $91 $2,581 $2,672
Provision for Loan Losses
We recorded a provision for loan losses in 2020 of $2.4 million, compared to a benefit for loan losses of $1.2 million in 2019. The loan loss provision increased in 2020 compared to 2019 primarily due to an increase in the loan portfolio, excluding loans that are guaranteed by the government, and management's assessment about increased risks in the loan portfolio association with the economic impacts of COVID-19. See the “Allowance for Loan Losses” section under “Financial Condition” and Note 6 of the Notes to Consolidated Financial Statements included in Part II. Item 8 of this report for further discussion of these decreases and changes in the Company’s Allowance.
Other Operating Income
The following table details the major components of other operating income for the years ended December 31:
(In Thousands) 2020 $ Change % Change 2019 $ Change % Change 2018
Other Operating Income
Mortgage banking income $52,635 $28,434 117 % $24,201 $3,357 16 % $20,844
Bankcard fees 2,837 (139) (5) % 2,976 165 6 % 2,811
Purchased receivable income 2,650 (621) (19) % 3,271 16 - % 3,255
Service charges on deposit accounts 1,102 (455) (29) % 1,557 49 3 % 1,508
Interest rate swap income 949 (15) (2) % 964 880 1,048 % 84
Commercial servicing revenue 527 (97) (16) % 624 (798) (56) % 1,422
Rental income 278 (219) (44) % 497 (195) (28) % 692
Gain (loss) on sale of securities 98 75 326 % 23 23 100 % -
Gain (loss) on marketable equity securities 61 (850) (93) % 911 1,536 246 % (625)
Other income 2,191 (131) (6) % 2,322 146 7 % 2,176
Total other operating income $63,328 $25,982 70 % $37,346 $5,179 16 % $32,167
2020 Compared to 2019
The most significant change in other operating income in 2020 was an increase in mortgage banking income which was only partially offset by decreases in gains on marketable equity securities, as well as decreases in purchased receivable income and service charges on deposit accounts. Mortgage banking income consists of gross income from the origination and sale of mortgages as well as mortgage loan servicing fees and is the largest component of other operating income at 83% of total other operating income in 2020. Mortgage banking income increased in 2020 compared to 2019 mainly due to an increase in mortgage loans originated and sold as this volume increased to $1.30 billion in 2020 from $684 million in 2019. The overall increase in mortgage originations in 2020 as compared to the prior year is primarily the result of the decrease in interest rates during the year that led to increased refinance activity. The Company recognized $61,000 in unrealized gains on marketable equity securities in 2020, an $850,000 decrease as compared to 2019, due to market volatility. Purchased receivable income and service charges on deposit accounts saw significant decreases as compared to 2019. Purchased receivable income decreased as customers reportedly used PPP loans to fund liquidity needs, resulting in decreased outstanding purchased receivable balances. Service charges on deposit accounts decreased due to customer accommodations made by the Company for customers impacted by COVID-19.
Other Operating Expense
The following table details the major components of other operating expense for the years ended December 31:
(In Thousands) 2020 $ Change % Change 2019 $ Change % Change 2018
Other Operating Expense
Salaries and other personnel expense $61,137 $9,820 19 % $51,317 $6,667 15 % $44,650
Data processing expense 7,668 540 8 % 7,128 1,093 18 % 6,035
Occupancy expense 6,624 17 - % 6,607 471 8 % 6,136
Professional and outside services 3,157 626 25 % 2,531 78 3 % 2,453
Marketing expense 2,320 (53) (2) % 2,373 55 2 % 2,318
Insurance expense 1,228 671 120 % 557 (305) (35) % 862
Compensation expense - RML acquisition payments - (468) (100) % 468 468 100 % -
Intangible asset amortization 48 (12) (20) % 60 (10) (14) % 70
OREO (income) expense, net rental income and gains on sale:
OREO operating expense 658 (35) (5) % 693 (109) (14) % 802
Rental income on OREO (509) (3) (1) % (506) 35 6 % (541)
Gains on sale of OREO (391) (11) (3) % (380) (377) NM (3)
Subtotal (242) (49) (25) % (193) (451) (175) % 258
Other expenses 7,174 1,184 20 % 5,990 (1,028) (15) % 7,018
Total other operating expense $89,114 $12,276 16 % $76,838 $7,038 10 % $69,800
2020 Compared to 2019
Other operating expense increased by $12.3 million to $89.1 million in 2020 as compared to $76.8 million in the prior year primarily due to increases in salaries and other personnel expense, as well as smaller increases in insurance expense, professional and outside services, and data processing expense. These increases were only partially offset by a decrease in compensation expense related to RML acquisition payments. The fourth quarter of 2019 marked the end of the five-year period following the acquisition of RML during which the Company was required to make additional payments to the former owners of RML when profitability hit certain targets. Per the terms of the purchase agreement, no further payments are required, and therefore no additional expense for RML acquisition payments will be recorded in the future. The $9.8 million increase in salaries and other personnel expense in 2020 as compared to 2019 is the result of the following items. Originator commission expenses increased $5.2 million, or approximately 82% in 2020 compared to 2019 due to increased mortgage production in the home mortgage lending segment. Additionally, overtime expense increased $1 million, or 309% in 2020 compared to 2019 due to increased mortgage production. Salaries increased $1.6 million, or 5%, in 2020 as compared to 2019 due to salary increases and an increase in full-time equivalent employees. Smaller increases also occurred in bonus payments and profit share expense due to the increased mortgage production in the Home Mortgage Lending segment and increased net income for the Community Banking segment. These increases were only partially offset by a $1.6 million increase in salary deferral related to loan production costs and a $696,000 decrease in group medical insurance expense due to lower medical claims associated with the Company's self-insured employee health benefit plan. Insurance expense increased $671,000 primarily as a result of increased FDIC insurance costs associated with asset growth. Professional and outside services increased $626,000 due to costs associated with increased mortgage production volume. Lastly, data processing expense increased $540,000 in 2020 as compared to 2019 due to costs for improved functionality for digital products and services and the addition of various software applications related to our lending activities.
Income Taxes
The provision for income taxes increased $4.1 million or 76%, to $9.6 million in 2020 as compared to 2019. The increase in 2020 is primarily due to higher pretax income. The Company's effective tax rates were 23% and 21% in 2020 and 2019, respectively. The changes in the Company's effective tax rates for 2020 and 2019 are primarily due to lower tax-exempt income and fewer low income housing tax credits as a percentage of pre-tax income as compared to 2019.
FINANCIAL CONDITION
Investment Securities
The composition of our investment securities portfolio, which includes securities available for sale and marketable equity securities, reflects management’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of interest income. The investment securities portfolio also mitigates interest rate and credit risk inherent in the loan portfolio, while providing a vehicle for the investment of available funds, a source of liquidity (by pledging as collateral or through repurchase agreements), and collateral for certain public funds deposits. Investment securities designated as available for sale comprised 93% of the portfolio as of December 31, 2020 and are available to meet liquidity requirements.
Our investment portfolio consists primarily of government sponsored entity securities, corporate securities, collateralized loan obligations, and municipal securities. Investment securities at December 31, 2020 decreased $17.4 million, or 6%, to $266.7 million from $284.1 million at December 31, 2019. The decrease at December 31, 2020 as compared to December 31, 2019 is primarily due to proceeds from sales, maturities, and security calls being used for loan fundings. The average maturity of the investment portfolio was approximately three years at December 31, 2020.
Investment securities may be pledged as collateral to secure public deposits or borrowings. At December 31, 2020 and 2019, $77.9 million and $30.6 million in securities were pledged for deposits and borrowings, respectively. Pledged securities increased at December 31, 2020 as compared to December 31, 2019 primarily due to increased pledges to the FHLB to increase the Company's immediate borrowing capacity at December 31, 2020.
The following tables set forth the composition of our investment portfolio at December 31 for the years indicated:
(In Thousands) Amortized Cost Fair Value
Securities Available for Sale:
2020:
U.S. Treasury and government sponsored entities $173,318 $174,601
Municipal Securities 820 856
Corporate Bonds 29,951 30,492
Collateralized Loan Obligations 41,782 41,684
Total $245,871 $247,633
2019:
U.S. Treasury and government sponsored entities $210,756 $211,852
Municipal Securities 3,288 3,297
Corporate Bonds 34,764 35,066
Collateralized Loan Obligations 25,980 25,923
Total $274,788 $276,138
2018:
U.S. Treasury and government sponsored entities $209,908 $208,860
Municipal Securities 9,089 9,084
Corporate Bonds 40,139 39,780
Collateralized Loan Obligations 13,990 13,886
Total $273,126 $271,610
Marketable Equity Securities:
2020:
Preferred Stock $8,395 $9,052
Total $8,395 $9,052
2019:
Preferred Stock $7,349 $7,945
Total $7,349 $7,945
2018:
Preferred Stock $7,580 $7,265
Total $7,580 $7,265
Securities Held to Maturity:
2020:
Corporate Bonds $10,000 $10,000
Total $10,000 $10,000
2019:
Corporate Bonds $- $-
Total $- $-
2018:
Corporate Bonds $- $-
Total $- $-
The following table sets forth the market value, maturities, and weighted average pretax yields of our investment portfolio as of December 31, 2020:
Maturity
Within Over
(In Thousands) 1 Year 1-5 Years 5-10 Years 10 Years Total
Securities Available for Sale:
U.S. Treasury and government sponsored entities
Balance $44,601 $130,000 $- $- $174,601
Weighted average yield 2.06 % 0.82 % - % - % 1.14 %
Municipal securities
Balance $- $856 $- $- $856
Weighted average yield - % 2.14 % - % - % 2.14 %
Corporate bonds
Balance $2,257 $28,235 $- $- $30,492
Weighted average yield 1.23 % 1.36 % - % - % 1.35 %
Collateralized loan obligations
Balance $- $- $8,720 $32,964 $41,684
Weighted average yield - % - % 1.70 % 1.60 % 1.62 %
Total
Balance $46,858 $159,091 $8,720 $32,964 $247,633
Weighted average yield 2.02 % 0.92 % 1.70 % 1.60 % 1.25 %
Security Held to Maturity
Corporate bonds
Balance $- $- $10,000 $- $10,000
Weighted average yield - % - % 5.00 % - % 5.00 %
Marketable Equity Securities
Preferred Stock
Balance $- $- $- $9,052 $9,052
Weighted average yield - % - % - % 5.08 % 5.08 %
The Company’s investment in marketable equity securities does not have a maturity date but it has been included in the over 10 years column above. At December 31, 2020, we held no securities of any single issuer (other than government sponsored entities) that exceeded 10% of our shareholders’ equity.
Loans
Our loan products include short and medium-term commercial loans, commercial credit lines, construction and real estate loans, and consumer loans. To a lesser extent, through our wholly-owned subsidiary RML, we also originate mortgage loans which we sell to the secondary market. We retain servicing rights on mortgage loans originated by RML and sold to the Alaska Housing Finance Corporation ("AHFC"). We emphasize providing financial services to small and medium-sized businesses and to individuals. From our inception, we have emphasized commercial, land development and home construction, and commercial real estate lending. These types of lending have provided us with needed market opportunities and generally provide higher net interest margins compared to other types of lending such as consumer lending. However, they also involve greater risks, including greater exposure to changes in local economic conditions. Additionally in 2020, we originated a significant amount of PPP loans and we expect to originate additional PPP loans in 2021.
All of our loans and credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness and commitments to us, including the indebtedness of any guarantor. Generally, we are permitted to make loans to one borrower of up to 15% of the unimpaired capital and surplus of the Bank. The loan-to-one-borrower limitation for the Bank was $29.9 million at December 31, 2020. At December 31, 2020, the Company had three relationships whose total direct and indirect commitments exceeded $29.9 million; however, no individual direct relationship exceeded the loans-to-one borrower limitation. See “Management’s Discussion and Analysis of Financial Condition and
Results of Operations - Provision for Loan Losses” for further discussion of the Company's concentration of loans to large borrowers.
Our lending operations are guided by loan policies, which outline the basic policies and procedures by which lending operations are conducted. Generally, the policies address our desired loan types, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations, and compliance with laws and regulations. The policies are reviewed and approved annually by the board of directors of the Bank. Our Quality Assurance Department provides a detailed financial analysis of our largest, most complex loans. In addition, the Quality Assurance Department, along with the Chief Credit Officer of the Bank, have developed processes to analyze and manage various concentrations of credit within the overall loan portfolio. The Credit Administration Department monitors the procedures and processes for both the analysis and reporting of problem loans, and also develops strategies to resolve problem loans based on the facts and circumstances for each loan. Finally, our Internal Audit Department also performs an independent review of each loan portfolio for compliance with loan policy as well as a review of credit quality. The Internal Audit review follows the FDIC sampling guidelines, and a review of each portfolio is performed on an annual basis.
The following table sets forth the composition of our loan portfolio by loan segment:
December 31, 2020 December 31, 2019 December 31, 2018 December 31, 2017 December 31, 2016
Dollar Amount Percent of Total Dollar Amount Percent of Total Dollar Amount Percent of Total Dollar Amount Percent of Total Dollar Amount Percent of Total
(In Thousands)
Commercial $780,058 54.0 % $412,690 39.5 % $342,420 34.8 % $313,514 32.8 % $277,802 28.5 %
Real estate construction one-to-four family 38,467 2.7 % 38,818 3.7 % 37,111 3.8 % 31,201 3.3 % 26,061 2.7 %
Real estate construction other 80,315 5.6 % 61,808 5.9 % 72,256 7.3 % 80,093 8.4 % 72,159 7.4 %
Real estate term owner occupied 163,597 11.3 % 138,891 13.3 % 126,414 12.8 % 132,042 13.8 % 152,112 15.6 %
Real estate term non-owner occupied 309,074 21.4 % 312,960 30.0 % 325,720 33.1 % 319,313 33.4 % 356,411 36.6 %
Real estate term other 46,620 3.2 % 42,506 4.1 % 42,039 4.3 % 40,411 4.2 % 45,402 4.7 %
Consumer secured by 1st deeds of trust 15,585 1.1 % 16,198 1.6 % 19,228 2.0 % 22,616 2.4 % 23,280 2.4 %
Consumer other 22,069 1.5 % 24,585 2.4 % 23,645 2.4 % 19,919 2.1 % 25,281 2.6 %
Subtotal $1,455,785 $1,048,456 $988,833 $959,109 $978,508
Less: Unearned origination fee,
net of origination costs (11,735) (0.8) % (5,085) (0.5) % (4,487) (0.5) % (4,156) (0.4) % (4,434) (0.5) %
Total portfolio loans $1,444,050 $1,043,371 $984,346 $954,953 $974,074
Commercial Loans: Our commercial loan portfolio includes both secured and unsecured loans for working capital and expansion. Short-term working capital loans generally are secured by accounts receivable, inventory, or equipment. We also make longer-term commercial loans secured by equipment and real estate. We also make commercial loans that are guaranteed in large part by the SBA or the Bureau of Indian Affairs and to a lesser extent guaranteed by the United States Department of Agriculture, as well as commercial real estate loans that are purchased by the Alaska Industrial Development and Export Authority (“AIDEA”). Commercial loans increased to $780.1 million at December 31, 2020 from $412.7 million at December 31, 2019 and represented approximately 54% and 40% of our total loans outstanding as of December 31, 2020 and December 31, 2019, respectively. The increase in commercial loans at the end of 2020 is primarily due to $310.5 million in PPP loans. The Company originated $375.6 million PPP loans in 2020. As of December 31, 2020, $65.1 million in PPP loans had been forgiven by the SBA. Commercial loans reprice more frequently than other types of loans, such as real estate loans. More frequent repricing means that interest cash flows from commercial loans are more sensitive to changes in interest rates. In a rising interest rate environment, our philosophy is to emphasize the pricing of loans on a floating rate basis, which allows these loans to reprice more frequently and to contribute positively to our net interest margin.
Commercial Real Estate: We are an active lender in the commercial real estate market. At December 31, 2020, commercial real estate loans increased to $519.3 million from $494.4 million at December 31, 2019, and represented approximately 36% and 47% of our loan portfolio as of December 31, 2020 and December 31, 2019, respectively. These loans are typically secured by office buildings, apartment complexes or warehouses. Loan amortization periods range from 10 to 25 years and generally have a maximum maturity of 10 years.
We may sell all or a portion of a commercial real estate loan to two State of Alaska entities, AIDEA and AHFC, which were both established to provide long-term financing in the State of Alaska. The loans that AIDEA purchases typically feature a maturity twice that of the loans retained by us and bear a lower interest rate. The blend of our and AIDEA’s loan terms allows
us to provide competitive long-term financing to our customers, while reducing the risk inherent in this type of lending. We also originate and sell to AHFC loans secured by multifamily residential units. Typically, 100% of these loans are sold to AHFC and we provide ongoing servicing of the loans for a fee. AIDEA and AHFC make it possible for us to originate these commercial real estate loans and enhance fee income while reducing our exposure to interest rate risk.
Construction Loans: We provide construction lending for commercial real estate projects. Such loans generally are made only when the Company has also committed to finance the completed project with a commercial real estate loan, or if there is a firm take-out commitment upon completion of the project by a third party lender. Additionally, we provide land development and residential subdivision construction loans. We also originate one-to-four-family residential and condominium construction loans to builders for construction of homes. The Company’s construction loans increased in 2020 to $118.8 million, up from $100.6 million in 2019, and represented approximately 8% and 10% of our loan portfolio in December 31, 2020 and December 31, 2019, respectively. As of December 31, 2020, approximately $6.0 million or 5%, of the Company's construction loans were for low income housing tax credit projects as compared to $24.0 million or 24% as of December 31, 2019.
Consumer Loans: We provide personal loans for automobiles, recreational vehicles, boats, and other larger consumer purchases. We provide both secured and unsecured consumer credit lines to accommodate the needs of our individual customers, with home equity lines of credit serving as the major product in this area.
Loans Directly Exposed to the Oil and Gas Industry: The Company defines "direct exposure" to the oil and gas industry as companies that it has identified as significantly reliant upon activity related to the oil and gas industry, such as oil producers or drilling and exploration companies, and companies who provide oilfield services, lodging, equipment rental, transportation, and other logistic services specific to the industry. The Company estimates that $65.1 million, or approximately 4% of loans as of December 31, 2020 have direct exposure to the oil and gas industry as compared to $79.2 million, or approximately 8% of loans as of December 31, 2019. The Company's exposure as a percent of the total loan portfolio excluding PPP loans as of December 31, 2020 was 6%. The Company has no loans to oil producers or drilling and exploration companies as of the end of 2020 or 2019, but the $65.1 million outstanding as of December 31, 2020 noted above does include $3.0 million related to the construction of an oil drilling rig. The Company's unfunded commitments to borrowers that have direct exposure to the oil and gas industry were $63.5 million and $31.1 million at December 31, 2020 and 2019, respectively. The portion of the Company's allowance for loan losses that related to the loans with direct exposure to the oil and gas industry was estimated at $1.2 million and $1.6 million as of December 31, 2020 and 2019, respectively.
The following table details loan balances by loan segment asset quality rating ("AQR") and class of financing receivable for loans with direct oil and gas exposure as of the dates indicated:
(In Thousands) Commercial Real estate construction one-to-four family Real estate construction other Real estate term owner occupied Real estate term non-owner occupied Real estate term other Consumer secured by 1st deeds of trust Consumer other Total
December 31, 2020
AQR Pass $46,943 $- $- $4,023 $- $- $- $- $50,966
AQR Special Mention 4,597 - - 1,541 6,606 - - - 12,744
AQR Substandard 1,412 - - - - - - - 1,412
Total loans $52,952 $- $- $5,564 $6,606 $- $- $- $65,122
December 31, 2019
AQR Pass $62,345 $- $- $4,153 $- $- $- $361 $66,859
AQR Special Mention 450 - - 1,900 6,916 - - - 9,266
AQR Substandard 3,070 - - - - - - - 3,070
Total loans $65,865 $- $- $6,053 $6,916 $- $- $361 $79,195
Supplemental information about significant COVID-19 exposure on directly impacted industries: In addition, at December 31, 2020, the Company had $78.9 million, or 5% of portfolio loans, in the tourism sector, $56.1 million, or 4% of portfolio loans, in the aviation (non-tourism) sector, $96.9 million, or 7% of total loans, in the healthcare sector, $17.4 million, or 1%, in retail loans and $31.0 million, or 2% in the restaurant sector, and $37.2 million, or 3% in the accommodations sector. At December 31, 2020, the Company had $78.9 million, or 7% of portfolio loans excluding PPP loans, in the tourism sector, $56.1 million, or 5% of portfolio loans excluding PPP loans, in the aviation (non-tourism) sector, $96.9 million, or 8% of total loans excluding PPP loans, in the healthcare sector, $17.4 million, or 2% of total loans excluding PPP loans, in retail loans and $31.0 million, or 3% of total loans excluding PPP loans in the restaurant sector, and $37.2 million, or 3% of total loans excluding PPP loans in the accommodations sector.The portion of the Company's Allowance that related to the loans with exposure to these industries is estimated at the following amounts as of December 31, 2020:
(In Thousands) Tourism Aviation (non-tourism) Healthcare Retail Restaurant Accommodations Total
Allowance $1,481 $1,049 $1,758 $309 $581 $695 $5,873
Maturities and Sensitivities of Loans to Change in Interest Rates: The following table presents the aggregate maturity data of our loan portfolio, excluding loans held for sale, at December 31, 2020:
Maturity
(In Thousands) Within 1 Year 1-5 Years Over 5 Years Total
Commercial $133,528 $418,031 $228,499 $780,058
Real estate construction one-to-four family 36,673 1,794 - 38,467
Real estate construction other 40,665 5,439 34,211 80,315
Real estate term owner occupied 7,344 30,579 125,674 163,597
Real estate term non-owner occupied 10,073 78,453 220,548 309,074
Real estate term other 9,283 10,322 27,015 46,620
Consumer secured by 1st deeds of trust 208 834 14,543 15,585
Consumer other 1,196 4,330 16,543 22,069
Total $238,970 $549,782 $667,033 $1,455,785
Fixed interest rate $92,040 $391,531 $175,677 $659,248
Floating interest rate 146,930 158,251 491,356 796,537
Total $238,970 $549,782 $667,033 $1,455,785
At December 31, 2020, 59% of the portfolio was scheduled to mature or reprice in 2021 with 36% scheduled to mature or reprice between 2022 and 2025.
As of December 31, 2020, approximately 44% of commercial loans are variable rate loans, of which 57% reprice within one year. Approximately 38% of variable rate commercial loans reprice to an index based upon the prime rate of interest, 30% reprice based the respective Federal Home Loan Bank of Boston (the "Boston FHLB") rate, and 29% reprice based on one-month LIBOR. The Company also uses floors in its commercial loan pricing as loans are originated or renewed during the year.
At December 31, 2020, the interest rates for approximately 85% of commercial real estate loans are variable, of which 41% reset within one year. Approximately 38% of commercial real estate variable rate loans reprice in greater than one year but within three years. The indices for these loans include the prime rate of interest or the respective Treasury or FHLB-Boston rate. The Company also uses floors in its commercial real estate loan pricing as loans are originated or renewed during the year.
Loans Held for Sale and Mortgage Servicing Rights ("MSRs"): The Company originates residential mortgage loans and sells them in the secondary market through our wholly-owned subsidiary, RML. All residential mortgage loans originated and sold in 2020 and 2019 were newly originated loans that did not affect nonperforming loans. The Company also has a mortgage servicing portfolio which is comprised of 1-4 family loans serviced for Freddie Mac Home Loan Corporation ("FHLMC") and AHFC. The Company retains servicing rights on all mortgage loans originated by RML and sold to AHFC. Mortgages originated by RML and sold to AHFC represented approximately 16% and 23% of the mortgages originated by RML in 2020 and 2019, respectively. MSRs are adjusted to fair value quarterly with the change recorded in mortgage banking income. The
value of MSRs at December 31, 2020 and 2019 were $11.2 million and $11.9 million, respectively. The value of MSRs is impacted by market rates for mortgage loans primarily due to how changes in interest rates affect prepayments of mortgage loans. To the extent loans are prepaid sooner than estimated at the time servicing assets are originally recorded, it is possible that certain residential MSR assets may decrease in value. Generally, the fair value of our residential MSRs is expected to increase as market rates for mortgage loans rise and decrease if market rates fall.
Credit Quality and Nonperforming Assets
Nonperforming assets consist of nonaccrual loans, accruing loans that are 90 days or more past due, repossessed assets and OREO. The following table sets forth information regarding our nonperforming loans and total nonperforming assets:
(In Thousands) 2020 2019 2018 2017 2016
Nonperforming loans
Nonaccrual loans $11,120 $15,356 $15,210 $21,626 $13,893
Loans 90 days past due and accruing 449 - - 252 456
Government guarantees on nonperforming loans (1,521) (1,405) (516) (467) (1,413)
Net nonperforming loans $10,048 $13,951 $14,694 $21,411 $12,936
Other real estate owned 7,289 7,043 7,962 8,651 6,574
Repossessed assets 231 231 1,242 - -
Other real estate owned guaranteed by government (1,279) (1,279) (1,279) (1,333) (195)
Net nonperforming assets $16,289 $19,946 $22,619 $28,729 $19,315
Nonperforming loans, net of government guarantees
to portfolio loans 0.70 % 1.34 % 1.49 % 2.24 % 1.33 %
Nonperforming assets, net of government guarantees to total assets 0.77 % 1.21 % 1.50 % 1.89 % 1.27 %
Performing restructured loans, net of government guarantees $832 $1,448 $3,413 $7,668 $6,131
Nonperforming loans plus performing restructured loans, net of government guarantees $10,880 $15,399 $18,107 $29,079 $19,067
Nonperforming loans plus performing restructured loans, net of government guarantees to portfolio loans 0.75 % 1.48 % 1.84 % 3.05 % 1.96 %
Nonperforming assets plus performing restructured loans, net of government guarantees to total assets 0.81 % 1.30 % 1.73 % 2.40 % 1.67 %
Adversely classified loans, net of government guarantees $12,768 $22,330 $27,217 $33,845 $35,634
Loans 30-89 days past due and accruing, net of government guarantees to portfolio loans 0.05 % 0.15 % 0.36 % 0.22 % 0.22 %
Allowance for loan losses to portfolio loans 1.46 % 1.83 % 1.98 % 2.25 % 2.02 %
Allowance for loan losses to nonperforming loans, net of government guarantees 210 % 137 % 133 % 100 % 152 %
The Company’s nonperforming loans, net of government guarantees decreased in 2020 to $10.0 million as compared to $14.0 million in 2019. This decrease was mostly due to a large nonaccrual loan payoff, as well as principal paydowns and charge-offs on nonaccrual loans in 2020. There was interest income of $924,000 and $301,000 recognized in net income for 2020 and 2019, respectively, related to interest collected on nonaccrual loans whose principal has been paid down to zero. The Company had four relationships that each represented more than 10% of nonaccrual loans as of December 31, 2020.
The Company had $832,000 and $1.4 million in loans classified as troubled debt restructuring loans ("TDRs"), net of government guarantees that were performing as of December 31, 2020 and 2019, respectively. Additionally, there were $4.5 million and $8.7 million in TDRs included in nonaccrual loans at December 31, 2020 and 2019 for total TDRs, net of government guarantees of $5.3 million and $10.1 million at December 31, 2020 and 2019, respectively. The decrease in TDRs at December 31, 2020 as compared to 2019 was primarily due to payoffs and paydowns on loans classified as TDRs that were only partially offset by additions to TDRs in 2020. See Note 5 of the Notes to Consolidated Financial Statements included in Part II. Item 8 of this report for further discussion of TDRs.
At December 31, 2020, management had identified potential problem loans of $6.1 million as compared to potential problem loans of $9.0 million at December 31, 2019. Potential problem loans are loans which are currently performing that have developed negative indications that the borrower may not be able to comply with present payment terms and which may later be included in nonaccrual, past due, or impaired loans. The $2.9 million decrease in potential problem loans at December 31, 2020 from December 31, 2019 was primarily due to paydowns and additional government guarantees that were partially offset by the addition of new potential problem loans in 2020.
The Company acquired other assets consisting of aircraft totaling $1.2 million in the fourth quarter of 2018 through foreclosure proceedings related to one lending relationship. These assets were sold in the third quarter of 2019. The Company acquired a vessel totaling $231,000 in the third quarter of 2019 through foreclosure proceedings related to one lending relationship that is still held as of the end of 2020.
The following summarizes OREO activity for the periods indicated:
(In Thousands) 2020 2019 2018
Balance, beginning of the year $7,043 $7,962 $8,651
Transfers from loans 652 - 686
Investment in other real estate owned - - 144
Proceeds from the sale of other real estate owned (797) (1,299) (1,522)
Gain on sale of other real estate owned, net 391 380 3
Impairment on other real estate owned - - -
Balance, end of year 7,289 7,043 7,962
Government guarantees (1,279) (1,279) (1,279)
Balance, end of year, net of government guarantees $6,010 $5,764 $6,683
At December 31, 2020 and 2019 the Company held $6.0 million and $5.8 million, respectively, of OREO assets, net of government guarantees. At December 31, 2020, OREO consists of $1.2 million in residential lots in various stages of development, a $5.6 million commercial building, and $490,000 of undeveloped land. All OREO property is located in Alaska. The Bank initiates foreclosure proceedings to recover and sell collateral pledged by a debtor to secure a loan based on various events of default and circumstances related to loans that are secured by either commercial or residential real property. These events and circumstances include delinquencies, the Company’s relationship with the borrower, and the borrower’s ability to repay the loan via a source other than the collateral. If the loan has not yet matured, the debtors may cure the events of default up to the time of sale to retain their interest in the collateral. Failure to cure the defaults will result in the debtor losing ownership interest in the property, which is taken by the creditor, or high bidder at a foreclosure sale.
During 2020, the Company transferred two loans to OREO totaling $652,000. During 2020, the Company received approximately $797,000 in proceeds from the sale of OREO. The Company recognized $391,000 and $380,000 in gains and no losses on the sale of OREO properties in 2020 and 2019, respectively. The Company had remaining accumulated deferred gains on the sale of OREO properties of $123,000 and $231,000 at December 31, 2020 and 2019, respectively.
The Company did not make any loans to facilitate the sale of OREO in 2020 or 2019. Our underwriting policies and procedures for loans to facilitate the sale of OREO are no different than our standard loan policies and procedures.
The Company recognized impairments of zero in both 2020 and 2019 due to adjustments to the Company’s estimate of the fair value of certain properties based on changes in estimated costs to complete the projects, decrease in expected sales prices, and changes in the Anchorage and the Southeastern Alaska real estate markets.
Allowance for Loan Losses
The Company maintains an Allowance to reflect management's assessment of probable, estimable losses inherent in the loan portfolio. The Allowance is increased by provisions for loan losses and loan recoveries and decreased by loan charge-offs. The size of the Allowance is determined through quarterly assessments of probable estimated losses in the loan portfolio. Our methodology for making such assessments and determining the adequacy of the Allowance includes the following key elements:
•A specific allocation for impaired loans. Management determines the fair value of the majority of these loans based on the underlying collateral values. This analysis is based upon a specific analysis for each impaired loan, including external appraisals on loans secured by real property, management’s assessment of the current market, recent payment history, and an evaluation of other sources of repayment. In-house evaluations of fair value are used in the impairment analysis in some situations. Inputs to the in-house evaluation process include information about sales of comparable properties in the appropriate markets and changes in tax assessed values. The Company obtains appraisals on real and personal property that secure its loans during the loan origination process in accordance with regulatory guidance and its loan policy. The Company obtains updated appraisals on loans secured by real or personal property based upon its assessment of changes in the current market or particular projects or properties, information from other current appraisals, and other sources of information. Appraisals may be adjusted downward by the Company based on its evaluation of the facts and circumstances on a case by case basis. External appraisals may be discounted when management believes that the absorption period used in the appraisal is unrealistic, when expected liquidation costs exceed those included in the appraisal, or when management’s evaluation of deteriorating market conditions warrants an adjustment. Additionally, the Company may also adjust appraisals in the above circumstances between appraisal dates. The Company uses the information provided in these updated appraisals along with its evaluation of all other information available on a particular property as it assesses the collateral coverage on its performing and nonperforming loans and the impact that may have on the adequacy of its Allowance. The specific allowance for impaired loans, as well as the overall Allowance, may increase based on the Company’s assessment of updated appraisals. See Note 26 of the Notes to Consolidated Financial Statements included in Part II. Item 8 of this report for further discussion of the Company’s estimation of impaired loans measured at fair value.
When the Company determines that a loss has occurred on an impaired loan, a charge-off equal to the difference between carrying value and fair value is recorded. If a specific allowance is deemed necessary for a loan, and then that loan is partially charged off, the loan remains classified as a nonperforming loan after the charge-off is recognized.
•A general allocation - The Company has identified segments and classes of loans not considered impaired for purposes of establishing the general allocation allowance. The Company disaggregates the loan portfolio into segments and classes based on its assessment of how different pools of loans with like characteristics in the portfolio behave over time. This determination is based on historical experience and management’s assessment of how current facts and circumstances are expected to affect the loan portfolio.
The Company first disaggregates the loan portfolio into the following eight segments: commercial, real estate construction one-to-four family, real estate construction other, real estate term owner occupied, real estate term non-owner occupied, real estate term other, consumer secured by first deeds of trust, and other consumer loans.
After division of the loan portfolio into segments, the Company then further disaggregates each of the segments into classes. The Company has a total of five classes, which are based off of the Company's loan risk grading system known as the Asset Quality Rating (“AQR”) system. The risk ratings are discussed in Note 5 to the Consolidated Financial Statements included in Part II. Item 8 of this report. There are five loan classes: pass (pass AQR grades, which are grades 1 - 6), special mention, substandard, doubtful, and loss. There have been no changes to these loan classes in 2020.
After the portfolio has been disaggregated into segments and classes, the Company calculates a general reserve for each segment and class based on the average loss history for each segment and class. The Company utilizes a look-back period of five years in the calculation of average historical loss rates.
After the Company calculates a general allocation using our loss history, the general reserve is then adjusted for qualitative factors by segment and class. Qualitative factors are based on management’s assessment of current trends that may cause losses inherent in the current loan portfolio to differ significantly from historical losses. Some factors that management considers in determining the qualitative adjustment to the general reserve include our concentration of large borrowers; national and local economic trends; general business conditions; trends in local real estate markets; economic, political, and industry specific factors that affect resource development in Alaska; effects of various political activities; peer group data; and internal factors such as underwriting policies and expertise of the Company’s employees.
•An unallocated reserve - The unallocated portion of the Allowance provides for other credit losses inherent in our loan portfolio that may not have been contemplated in the specific and general components of the Allowance, and
it acknowledges the inherent imprecision of all loss prediction models. The unallocated component is reviewed periodically based on trends in credit losses and overall economic conditions. At December 31, 2020 and 2019, the unallocated allowance as a percentage of the total Allowance was 10% and 11%, respectively.
The following table shows the allocation of the Allowance for the years indicated:
2020 2019 2018 2017 2016
% of Loans(1)
% of Loans(1)
% of Loans(1)
% of Loans(1)
% of Loans(1)
(In Thousands) Amount Amount Amount Amount Amount
Commercial $7,973 39 % $6,604 39 % $5,660 35 % $6,172 34 % $5,535 28 %
Real estate construction one-to-four family 679 3 % 643 4 % 675 4 % 629 3 % 550 3 %
Real estate construction other 1,179 6 % 1,017 6 % 1,275 7 % 1,566 8 % 1,465 7 %
Real estate term owner occupied 2,625 11 % 2,188 13 % 2,027 13 % 2,194 14 % 2,358 16 %
Real estate term non-owner occupied 5,133 21 % 5,180 30 % 5,799 33 % 6,043 33 % 6,853 37 %
Real estate term other 779 3 % 671 4 % 716 4 % 725 4 % 819 5 %
Consumer secured by 1st deeds of trust 261 1 % 270 2 % 306 2 % 315 2 % 313 2 %
Consumer other 400 2 % 436 2 % 426 2 % 307 2 % 408 2 %
Unallocated 2,107 - % 2,079 - % 2,635 - % 3,510 - % 1,396 - %
Total $21,136 100 % $19,088 100 % $19,519 100 % $21,461 100 % $19,697 100 %
1Represents percentage of this category of loans to total portfolio loans.
The following table sets forth information regarding changes in our Allowance for the years indicated:
(In Thousands) 2020 2019 2018 2017 2016
Balance at beginning of year $19,088 $19,519 $21,461 $19,697 $18,153
Charge-offs:
Commercial (1,021) (195) (1,716) (1,611) (903)
Real estate construction one-to-four family - - - - (535)
Real estate term owner occupied (85) - - - -
Real estate term other - - (28) (5) -
Consumer secured by 1st deeds of trust - (4) (143) (85) (36)
Consumer other (15) (18) (39) (43) (8)
Total charge-offs (1,121) (217) (1,926) (1,744) (1,482)
Recoveries:
Commercial 710 908 442 293 699
Real estate term other 2 28 3 2 -
Consumer secured by 1st deeds of trust - - 12 2 -
Consumer other 25 25 27 11 29
Total recoveries 737 961 484 308 728
Net, (charge-offs) recoveries (384) 744 (1,442) (1,436) (754)
Provision (benefit) for loan losses 2,432 (1,175) (500) 3,200 2,298
Balance at end of year $21,136 $19,088 $19,519 $21,461 $19,697
Ratio of net charge-offs (recoveries) to average loans
outstanding during the period 0.03 % (0.07) % 0.15 % 0.15 % 0.08 %
In accordance with GAAP, loans acquired in connection with our acquisition of Alaska Pacific on April 1, 2014 were recorded at their fair value at the acquisition date. Credit discounts were included in the determination of fair value; therefore, an allowance for loan losses was not recorded at the acquisition date. Purchased credit impaired loans were evaluated on a loan by loan basis and the valuation allowance for these loans was netted against the carrying value. Loans acquired from Alaska Pacific have been classified as impaired loans and evaluated for specific impairment using the same methodology as all other
loans since April 1, 2014. A general allowance for loans acquired from Alaska Pacific was established if there was deterioration in credit quality of the acquired loans subsequent to acquisition from April 1, 2014 through December 31, 2017. As of December 31, 2020, 2019 and 2018, loans acquired from Alaska Pacific are included in the Company's general allowance using the same methodology as all other loans as described above due to the amount of time that has passed since the loans were purchased. There was no specific impairment on acquired loans at December 31, 2020 or 2019. The purchase discount related to acquired credit impaired loans was $328,000 and $345,000 as of December 31, 2020 and 2019, respectively.
The provision for loan losses in 2020 as compared to 2019 increased $3.6 million to provision for loan losses of $$2.4 million compared to a benefit of $1.2 million in 2019. This increase is primarily due to management's assessment of risk associated with the economic impacts of the COVID-19 pandemic, the reduction in oil prices and a slowing Alaska economy, as well as growth in the unguaranteed portion of the loan portfolio. The Company determined that an Allowance of $21.1 million, or 1.46% of portfolio loans, is appropriate as of December 31, 2020 based on our analysis of the current credit quality of the portfolio and current economic conditions. The provision for loan losses in 2019 as compared to 2018 decreased $675,000 to a benefit of $1.2 million compared to a benefit of $500,000 in 2018. This decrease is primarily due to net recoveries on loans and a decrease in qualitative factors mostly due to strengthening in the Alaska economy in 2019. The provision for loan losses in 2018 as compared to 2017 decreased $3.7 million to a benefit of $500,000 compared to a provision of $3.2 million in 2017. This decrease is primarily due to a decrease in nonperforming loans and the portion of the Allowance specific to impaired loans. The provision for loan losses in 2017 as compared to 2016 increased $902,000 to $3.2 million compared to $2.3 million in 2016. This increase was primarily due to an increase in nonperforming loans and the portion of the Allowance specific to impaired loans.
While management believes that it uses the best information available to determine the Allowance, unforeseen market conditions and other events could result in an adjustment to the Allowance, and net income could be significantly affected if circumstances differed substantially from the assumptions used in making the final determination of the Allowance.
Purchased Receivables
We purchase accounts receivable from our business customers and provide them with short-term working capital. We provide this service to our customers in Alaska, Washington, Oregon, and some other states through NFS.
Our purchased receivable activity is guided by policies that outline risk management, documentation, and approval limits. The policies are reviewed and approved annually by the Company's Board of Directors. Purchased receivables are recorded on the balance sheet net of a reserve for purchased receivable losses.
Purchased receivable balances decreased at December 31, 2020 to $13.9 million from $24.4 million at December 31, 2019, and year-to-date average purchased receivable balances were $14.5 million and $18.8 million in 2020 and 2019, respectively. Purchased receivable income was $2.7 million and $3.3 million in 2020 and 2019, respectively. Purchased receivable income in 2020 decreased from 2019 due to decreased average balances due to customers reportedly using PPP loans to fund liquidity needs instead of selling receivables.
The following table sets forth information regarding changes in the purchased receivable reserve for the years indicated:
(In Thousands) 2020 2019 2018
Balance at beginning of year $94 $190 $200
Charge-offs - - -
Recoveries - - -
Net recoveries (charge-offs) - - -
Reserve for (recovery from) purchased receivables (21) (96) (10)
Balance at end of year $73 $94 $190
Ratio of net charge-offs (recoveries) to average purchased receivables during the period - % - % - %
Deposits
Deposits are our primary source of funds. Total deposits increased 33% to $1.825 billion at December 31, 2020 from $1.372 billion at December 31, 2019. This increase is primarily due to funding PPP loans, but is also due to new client relationships as a result of the Company's significant PPP efforts during 2020. Our deposits generally are expected to fluctuate according to the level of our market share, economic conditions, and normal seasonal trends.
The following table sets forth the average balances outstanding and average interest rates for each major category of our deposits, for the periods indicated:
2020 2019 2018
Average balance Average rate paid Average balance Average rate paid Average balance Average rate paid
(In Thousands)
Interest-bearing demand accounts $387,416 0.16 % $272,895 0.17 % $243,000 0.07 %
Money market accounts 219,025 0.32 % 209,245 0.55 % 225,014 0.31 %
Savings accounts 257,292 0.28 % 233,057 0.46 % 241,807 0.31 %
Certificates of deposit 176,873 1.83 % 135,005 1.67 % 99,987 0.70 %
Total interest-bearing accounts 1,040,606 0.51 % 850,202 0.58 % 809,808 0.28 %
Noninterest-bearing demand accounts 597,610 426,205 417,464
Total average deposits $1,638,216 $1,276,407 $1,227,272
Certificates of Deposit: The only deposit category with stated maturity dates is certificates of deposit. At December 31, 2020, we had $175.6 million in certificates of deposit, of which $129.0 million, or 73%, are scheduled to mature in 2021. The Company’s certificates of deposit increased to $175.6 million during 2020 as compared to $164.5 million at December 31, 2019. The aggregate amount of certificates of deposit in amounts of $100,000 or more at December 31, 2020 and 2019, was $133.3 million and $118.9 million, respectively. The following table sets forth the amount outstanding of certificates of deposits in amounts of $100,000 or more by time remaining until maturity and percentage of total deposits as of December 31, 2020:
Time Certificates of Deposits
of $100,000 or More
Percent of Total Deposits
(In Thousands) Amount
Amounts maturing in:
Three months or less $26,748 20 %
Over 3 through 6 months 20,893 16 %
Over 6 through 12 months 52,528 39 %
Over 12 months 33,113 25 %
Total $133,282 100 %
The Company offers the Certificate of Deposit Account Registry Service® (CDARS®) as a member of Promontory Interfinancial Network, LLCSM (Network). When a Network member places a deposit using CDARS, that certificate of deposit is divided into amounts under the standard FDIC insurance maximum ($250,000) and is allocated among member banks, making the large deposit eligible for FDIC insurance. The Company had $9.4 million CDARS certificates of deposits at December 31, 2020 and $1.2 million CDARS certificates of deposits at December 31, 2019.
Borrowings
FHLB: The Bank is a member of the Federal Home Loan Bank of Des Moines (the "FHLB"). As a member, the Bank is eligible to obtain advances from the FHLB. FHLB advances are dependent on the availability of acceptable collateral such as marketable securities or real estate loans, although all FHLB advances are secured by a blanket pledge of the Company’s assets. At December 31, 2020, our maximum borrowing line from the FHLB was $946.2 million, approximately 45% of the Bank’s assets, subject to the FHLB’s collateral requirements. The Company has outstanding advances of $14.8 million as of December 31, 2020 which were originated to match fund low income housing projects that qualify for long term fixed interest rates. These advances have original terms of either 18 or 20 years with 30 year amortization periods and fixed interest rates ranging from 1.23% to 3.25%.
Federal Reserve Bank: The Federal Reserve Bank of San Francisco (the "Federal Reserve Bank") is holding $79.5 million of loans as collateral to secure advances made through the discount window as of December 31, 2020. There were no discount window advances outstanding at December 31, 2020 or 2019. The Company $2,000 in interest in 2020 and paid less than $1,000 in interest in 2019 on this agreement. The Company utilized the Federal Reserve Bank's PPPLF to fund SBA PPP loans during the second quarter of 2020, but has repaid those funds in full as of June 30, 2020. This advance had an interest rate of 0.35%.
Other Short-term Borrowings: Securities sold under agreements to repurchase were zero as of December 31, 2020 and 2019, respectively. The average balance outstanding of securities sold under agreements to repurchase during 2020 and 2019 was zero and $15.2 million, respectively, and the maximum outstanding at any month-end was zero and $36.6 million, respectively, during the same time periods. The securities sold under agreements to repurchase were held by the FHLB under the Company’s control.
The Company is subject to provisions under Alaska state law which generally limit the amount of outstanding debt to 35% of total assets or $736.0 million at December 31, 2020 and 15% of total assets or $244.7 million at December 31, 2019. As of April 7, 2020, the State of Alaska increased this limit to 35% of total assets.
Long-term Borrowings: The Company had no long-term borrowings outstanding other than the FHLB advances noted above as of December 31, 2020 or 2019.
Contractual Obligations
The following table references contractual obligations of the Company for the periods indicated. This table does not include interest payments:
Payments Due by Period
Within 1 Year 1-3 Years 3-5 Years Over 5 Years
(In Thousands) Total
December 31, 2020:
Certificates of deposit $128,970 $44,237 $630 $1,794 $175,631
Long-term borrowings 312 833 872 12,800 14,817
Junior subordinated debentures - - - 10,310 10,310
Operating lease obligations 2,619 4,140 3,527 4,875 15,161
Other long-term liabilities(1)
9,482 1,654 778 4,291 16,205
Capital commitments 71 - - - 71
Total $141,454 $50,864 $5,807 $34,070 $232,195
December 31, 2019:
Certificates of deposit $90,554 $70,734 $1,390 $1,794 $164,472
Long-term borrowings 187 444 471 7,789 8,891
Junior subordinated debentures - - - 10,310 10,310
Operating lease obligations 2,665 4,718 3,592 6,453 17,428
Other long-term liabilities 2,937 9,484 1,341 4,001 17,763
Capital commitments 1,389 - - - 1,389
Total $97,732 $85,380 $6,794 $30,347 $220,253
(1) Includes principal payments related to employee benefit plans. If a benefit payment schedule is established, payments are recorded in the corresponding dates listed in the table above. Unscheduled payments for all remaining benefits are recorded "Over 5 Years". Additional information about employee benefit plans is provided in Note 19 of the Notes to the Consolidated Financial Statements in Part II. Item 8 below.
Short and long-term borrowings included in the table above are described in the "Borrowings" section above. Junior subordinated debentures include $10.3 million that was originated on December 16, 2005, matures on March 15, 2036, and bears interest at a rate of 90-day LIBOR plus 1.37%, adjusted quarterly. The Company entered into an interest rate swap in the
third quarter of 2017 to hedge the variability in cash flows arising out of its junior subordinated debentures, by swapping the cash flows with an interest rate swap which receives floating and pays fixed. The Company has designated this interest rate swap as a hedging instrument. The interest rate swap effectively fixes the Company's interest payments on the $10 million of junior subordinated debentures held under Northrim Statutory Trust 2 ("NST2") at 3.72% through its maturity date. Operating lease obligations are more fully described in Note 12 of the Company’s Consolidated Financial Statements included in Item 8 of this report. Other long-term liabilities consist of amounts that the Company owes for its investments in Delaware limited partnerships that develop low-income housing projects throughout the United States. Additional information about these partnerships is included at Note 8 of the Company’s Consolidated Financial Statements included in Part II. Item 8 of this report. The Company purchased a $10.7 million interest in R4 Frontier Housing Partners L.P., Coronado Park Senior Village L.P. ("R4-Coronado") in March 2013. The investment in R4-Coronado was 99% funded at the end of 2020 and is expected to be fully funded in 2029. The Company purchased an $8.5 million interest in R4 Frontier Housing Partners L.P., Mountain View Village V L.P. ("R4-MVV") in May 2014. The investment in R4-MVV was 98% funded at the end of 2020 and is expected to be fully funded in 2030. The Company purchased a $6.8 million interest in R4 Frontier Housing Partners L.P., PJ33 L.P. ("R4-PJ33") in June 2016. The investment in R4-PJ33 was 95% funded at the end of 2020 and is expected to be fully funded in 2032. The Company purchased a $7.3 million interest in R4 Frontier Housing Partners L.P., Parkscape L.P. ("R4-Coronado II") in June 2019. The investment in R4-Coronado II was 23% funded at the end of 2020 and is expected to be fully funded in 2035. The Company also purchased a $4.0 million interest in R4 Frontier Housing Partners L.P., Duke Apartments L.P. ("R4-Duke") in November 2019. The investment in R4-Duke was 9% funded at the end of 2020 and is expected to be fully funded in 2035.
Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance sheet risk. Among the off-balance sheet items entered into in the ordinary course of business are commitments to extend credit, commitments to originate loans held for sale and the issuance of letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized on the balance sheet. Certain commitments are collateralized. We apply the same credit standards to these commitments as in all of our lending activities and include these commitments in our lending risk evaluations.
As of December 31, 2020, we had commitments to extend credit of $375.1 million, which were not reflected on our balance sheet, compared to $301.9 million as of December 31, 2019. Commitments to extend credit are agreements to lend to customers. These commitments have specified interest rates and generally have fixed expiration dates but may be terminated by the Company if certain conditions of the contract are violated. Collateral held relating to these commitments varies, but generally includes real estate, inventory, accounts receivable, and equipment. Our exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. Since many of the commitments are expected to expire without being drawn upon, these total commitment amounts do not necessarily represent future cash requirements.
As of December 31, 2020, we had commitments to originate loans held for sale of $150.3 million, which were not reflected in the balance sheet compared to $48.8 million as of December 31, 2019. Mortgage loans sold to investors may be sold with servicing rights released, for which the Company makes only standard legal representations and warranties as to meeting certain underwriting and collateral documentation standards. In the past two years, the Company has had to repurchase one loan due to deficiencies in underwriting or loan documentation and has not realized significant losses related to this repurchase. Management currently believes that any liabilities that may result from such recourse provisions are not significant.
As of December 31, 2020, we had standby letters of credit of $2.3 million, which were not reflected on our balance sheet compared to $2.0 million as of December 31, 2019. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Credit risk arises in these transactions from the possibility that a customer may not be able to repay the Company upon default of performance. Collateral held for standby letters of credit is based on an individual evaluation of each customer’s creditworthiness.
Our total unfunded lending commitments at December 31, 2020, which includes commitments to extend credit, commitments to originate loans held for sale and standby letters of credit, were $527.7 million, compared to $352.7 million as of December 31, 2019. We do not expect that all of these commitments are likely to be fully drawn upon at any one time. The Company has established reserves of $187,000 and $152,000 at December 31, 2020 and 2019, respectively, for estimated losses related to these commitments that are recorded in other liabilities on the consolidated balance sheet.
Additional information regarding Off-Balance Sheet Arrangements is included in Notes 20 and 21 of the Notes to the Company’s Consolidated Financial Statements included in Part II. Item 8 of this report.
Liquidity and Capital Resources
Our shareholders’ equity at December 31, 2020, was $221.6 million, as compared to $207.1 million at December 31, 2019. The Company earned net income of $32.9 million, issued 19,195 shares of common stock through the vesting of restricted stock units and repurchased 327,000 shares during 2020. At December 31, 2020, the Company had approximately 6.3 million shares of its common stock outstanding.
The Company is a single bank holding company and its primary ongoing source of liquidity is from dividends received from the Bank. Such dividends arise from the cash flow and earnings of the Bank. Banking regulations and regulatory authorities may limit the amount of, or require the Bank to obtain certain approvals before paying, dividends to the Company. Given that the Bank currently meets and the Bank anticipates that it will continue to meet, all applicable capital adequacy requirements for a “well-capitalized” institution by regulatory standards, including the conservation buffer that is now in full effect, the Company expects to continue to receive dividends from the Bank during 2021.
The Bank manages its liquidity through its Asset and Liability Committee. Our primary sources of funds are customer deposits and advances from the FHLB. These funds, together with loan repayments, loan sales, other borrowed funds, retained earnings, and equity are used to make loans, to acquire securities and other assets, and to fund deposit flows and continuing operations. The primary sources of demands on our liquidity are customer demands for withdrawal of deposits and borrowers’ demands that we advance funds against unfunded lending commitments. Our total unfunded commitments to fund loans, loans held for sale, and letters of credit at December 31, 2020, were $527.7 million. We do not expect that all of these loans are likely to be fully drawn upon at any one time. Additionally, as noted above, our total deposits at December 31, 2020, were $1.8 billion.
As shown in the Consolidated Statements of Cash Flows, net cash used by operating activities was $36.5 million in 2020 and net cash used by operating activities was $821,000 in 2019. The primary source of cash provided by operating activities for all periods presented was positive net income; however, in 2020 and 2019 the origination of loans held for sale exceeded proceeds from the sale of loans held for sale which is the primary reason that operating cash flow is negative in both years. Net cash used by investing activities was $382.8 million in 2020 primarily due to increases in loans, in particular PPP loans. Net cash used by investing activities was $71.9 million in 2019 primarily due to the fact that purchases of investment securities and net investments in loans and purchased receivables exceeded proceeds from sales and maturities of securities available for sale. Financing activities provided cash of $439.8 million in 2020 and $90.6 million in 2019. Financing activities provided cash in 2020 due to an increase in deposits largely due to funding PPP loans that was done via deposit into customer accounts. This increase was only partially offset by the repurchase of 327,000 shares of the Company's common stock for $10.0 million and the payment of dividends to shareholders. Financing activities provided cash in 2019 due to an increase in deposits that was only partially offset by a decrease in securities sold under repurchase agreements, repurchase of 347,676 shares of the Company's common stock for $12.6 million, and the payment of cash dividends to shareholders.
The sources by which we meet the liquidity needs of our customers are current assets and borrowings available through our correspondent banking relationships and our credit lines with the Federal Reserve Bank and the FHLB. At December 31, 2020, our current assets were $423.8 million and our funds available for borrowing under our existing lines of credit were $1.01 billion. Additionally, the Company can obtain additional nonrecourse borrowings under the Federal Reserve Bank's newly created PPPLF as a source of additional liquidity in order to meet liquidity needs created by the origination of PPP loans without excessive usage of the Company's other existing liquidity sources. The Company had $216.0 million in PPP loans eligible to be pledged for the PPPLF program as of December 31, 2020. the Company has not obtained any other new borrowing lines or other new sources of liquidity other than the PPPLF program resulting from anticipated liquidity challenges from COVID-19. Given these sources of liquidity and our expectations for customer demands for cash and for our operating cash needs, we believe our sources of liquidity to be sufficient in the foreseeable future.
During 2020, the Company's Board of Directors approved a quarterly cash dividend of $0.34 per common share for the first and second quarters and $0.35 per common share for the third and fourth quarters. These dividends were made pursuant to our existing dividend policy and in consideration of, among other things, earnings, regulatory capital levels, liquidity, asset quality, and the overall payout ratio. We expect that dividend payments will be reassessed on a quarterly basis by the Board of Directors in accordance with the dividend policy. The payment of cash dividends is subject to regulatory limitations as described under the Supervision and Regulation section of Part I. Item 1 of this report. There is no assurance that future cash dividends on common shares will be declared or increased.
On February 25, 2021, the Board of Directors approved payment of a $0.37 per share dividend on March 19, 2021, to shareholders of record on March 11, 2021. This dividend is $0.02, or 6%, higher than the Company’s dividend of $0.35 that was paid in the fourth quarter of 2020.
In September 2002, our Board of Directors approved a plan whereby we would periodically repurchase for cash up to approximately 5% of our shares of common stock in the open market. We purchased an aggregate of 688,442 shares of our common stock under this program through December 31, 2009 at a total cost of $14.2 million at an average price of $20.65 per share, which left a balance of 227,242 shares available under the stock repurchase program. The Company did not repurchase any of its shares in 2010 through 2016. In 2017, we purchased an aggregate of 58,341 shares at an average price of $27.56 per share. In 2018, we purchased an aggregate of 15,468 shares at an average price of $31.90 per share. In April 2019, the Company’s Board of Directors approved a plan whereby it would periodically repurchase for cash up to approximately 5% of its shares of common stock in the open market where 340,000 shares were available for repurchase. In 2019 we purchased an aggregate of 347,676 shares at an average price of $36.15 per share. On January 27, 2020, the Board authorized the repurchase of up to an additional 327,000 shares of common stock. In 2020, the Company repurchased 327,000 shares at an average price of $30.51. At December, 31, 2020, there were zero shares available under the stock repurchase program. On February 1, 2021, the Company announced that its Board of Directors had authorized the repurchase of up to an additional 313,000 shares of common stock. We intend to continue to repurchase our stock from time-to-time depending upon market conditions, but we can make no assurances that we will continue this program or that we will authorize additional shares for repurchase. The table below shows this effect on diluted earnings per share.
Years Ending: Diluted
EPS as
Reported Diluted EPS without Stock Repurchase
2020 $5.11 $4.22
2019 $3.04 $2.59
2018 $2.86 $2.56
2017 $1.88 $1.69
2016 $2.06 $1.87
On December 16, 2005, the Company’s subsidiary, NST2, issued trust preferred securities in the principal amount of $10 million. These securities carry an interest rate of 90-day LIBOR plus 1.37% per annum that was initially set at 5.86% adjusted quarterly. The securities have a maturity date of March 15, 2036, and are callable by the Company on or after March 15, 2011. These securities are treated as Tier 1 capital by the Company’s regulators for capital adequacy calculations. The interest cost to the Company of these securities was $219,000 in 2020. At December 31, 2020, the securities had an interest rate of 1.59%. The Company entered into an interest rate swap in the third quarter of 2017 to hedge the variability in cash flows arising out of its junior subordinated debentures, by swapping the cash flows with an interest rate swap which receives floating and pays fixed. The Company has designated this interest rate swap as a hedging instrument. The interest rate swap effectively fixes the Company's interest payments on the $10 million of junior subordinated debentures held under NST2 at 3.72% through its maturity date. Net of the impact of the interest rate swap, interest expense on these securities was $385,000 in 2020 and $389,000 in 2019.
We are subject to minimum capital requirements. Federal banking agencies have adopted regulations establishing minimum requirements for the capital adequacy of banks and bank holding companies. The requirements address both risk-based capital and leverage capital. We believe as of December 31, 2020, that the Company and the Bank met all applicable capital adequacy requirements for a “well-capitalized” institution by regulatory standards.
The table below illustrates the capital requirements in effect in 2020 for the Company and the Bank and the actual capital ratios for each entity that exceed these requirements. Management intends to maintain capital ratios for the Bank in 2021, exceeding the FDIC’s new requirements for the “well-capitalized” classification. The capital ratios for the Company exceed those for the Bank primarily because the $10 million trust preferred securities offering that the Company completed in the fourth quarter of 2005 is included in the Company’s capital for regulatory purposes, although they are accounted for as a long-term debt in our consolidated financial statements. The trust preferred securities are not accounted for on the Bank’s financial statements nor are they included in its capital. As a result, the Company has $10 million more in regulatory capital than the Bank at December 31, 2020 and 2019, respectively, which explains most of the difference in the capital ratios for the two entities.
Minimum Required Capital Well-Capitalized Actual Ratio Company Actual Ratio Bank
December 31, 2020
Total risk-based capital 8.00% 10.00% 15.46% 13.13%
Tier 1 risk-based capital 6.00% 8.00% 14.20% 11.88%
Common equity tier 1 capital 4.50% 6.50% 13.57% 11.89%
Leverage ratio 4.00% 5.00% 10.25% 8.55%
See Note 24 of the Consolidated Financial Statements included in Part II. Item 8 of this report for a detailed discussion of the capital ratios. The requirements for "well-capitalized" come from the Prompt Correction Action rules. See Part I. Item 1 Supervision and Regulation. These rules apply to the Bank but not to the Company. Under the rules of the Federal Reserve Bank, a bank holding company such as the Company is generally defined to be "well capitalized" if its Tier 1 risk-based capital ratio is 8.0% or more and its total risk-based capital ratio is 10.0% or more.
Effects of Inflation and Changing Prices: The primary impact of inflation on our operations is increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates, which could affect the degree and timing of the repricing of our assets and liabilities. In addition, inflation has an impact on our customers’ ability to repay their loans. See additional discussion below in Part II. Item 7A of this report regarding how various market risks affect the Company.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is defined as the sensitivity of income, expense, fair value measurements, and capital to changes in interest rates, foreign currency rates, commodity prices, and other relevant market rates or prices. The primary market risks that we are exposed to are interest rate and price risks, in addition to risk in the Alaska economy due to our community banking focus. Price risk is the risk to current or future earnings or capital arising from changes in the value of either assets or liabilities that are entered into as part of distributing or managing risk. Interest rate risk is the risk to current or future earnings or capital arising from changes in interest rates. Generally, there are four sources of interest rate risk as described below:
•Re-pricing Risk: Generally, re-pricing risk is the risk of adverse consequences from a change in interest rates that arises because of differences in the timing of when those interest rate changes affect an institution’s assets and liabilities.
•Basis Risk: Basis risk is the risk of adverse consequences resulting from unequal changes in the spread between two or more rates for different instruments with the same maturity.
•Yield Curve Risk: Also called yield curve twist risk, yield curve risk is the risk of adverse consequences resulting from unequal changes in the spread between two or more rates for different maturities for the same instrument.
•Option Risk: In banking, option risks are known as borrower options to prepay loans and depositor options to make deposits, withdrawals, and early redemptions. Option risk arises whenever bank products give customers the right, but not the obligation, to alter the quantity of the timing of cash flows.
The Company is exposed to price and interest rate risks in the financial instruments and positions we hold. This includes investment securities, loans, loans held for sale, mortgage servicing rights, deposits, borrowings, and derivative
financial instruments. Market risks such as foreign currency exchange risk and commodity price risk do not arise in the normal course of the Company's business.
The Company's price and interest rate risks are managed by the Asset and Liability Committee, a management committee that identifies and manages the sensitivity of earnings and capital to changing interest rates to achieve our overall financial objectives. Based on economic conditions, asset quality and various other considerations, the Asset and Liability Committee establishes overall balance sheet management policies as well as tolerance ranges for interest rate sensitivity and manages within these ranges.
A number of measures are used to monitor and manage interest rate risk, including interest sensitivity (gap) analysis and income simulations. An income simulation model is the primary tool used to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Key assumptions in the model include loan and deposit volumes and pricing, prepayment speeds on fixed rate assets, and cash flows and maturities of investment securities. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes, changes in market conditions and management strategies, among other factors.
Although analysis of interest rate gap (the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time) is one standard tool for the measurement of exposure to interest rate risk, we believe that because interest rate gap analysis does not address all factors that can affect earnings performance it should not be used as the primary indicator of exposure to interest rate risk and the related volatility of net interest income in a changing interest rate environment. Interest rate gap analysis is primarily a measure of liquidity based upon the amount of change in principal amounts of assets and liabilities outstanding, as opposed to a measure of changes in the overall net interest margin.
The Company uses derivatives in the Home Mortgage Lending segment, including commitments to originate residential mortgage loans at fixed prices, and it enters into forward delivery contracts to sell mortgage-backed securities to broker/dealers at specific prices and dates in order to hedge the interest rate risk in its residential mortgage loan commitments. The Company does not use derivatives outside of these activities in the Home Mortgage Lending segment to manage our interest rate risk exposures. However, the Company does enter into commercial loan interest rate swap agreements in its Community Banking segment in order to provide commercial loan customers the ability to convert from variable to fixed interest rates. Commercial loan interest rate swap agreements are offset with corresponding swap agreements with a third party swap dealer in order to offset the Company's exposure on the fixed component of the customer’s interest rate swap. Additional information regarding the Company’s customer interest rate swap program is presented in Note 21 of the Notes to Consolidated Financial Statements included in Part II. Item 8 of this report.
The following table sets forth the estimated maturity or repricing, and the resulting interest rate gap, of our interest-earning assets (which exclude nonaccrual loans) and interest-bearing liabilities at December 31, 2020. The amounts shown below could be significantly affected by external factors such as changes in prepayment assumptions, early withdrawals of deposits, and competition.
Estimated maturity or repricing at December 31, 2020
(In Thousands) Within 1 year 1-5 years >5 years Total
Interest -Earning Assets:
Interest bearing deposits in other banks $92,661 $- $- $92,661
Portfolio investments and FHLB Stock 242,121 27,115 - 269,236
Portfolio loans 854,010 526,679 63,976 1,444,665
Loans held for sale 146,178 - - 146,178
Total interest-earning assets $1,334,970 $553,794 $63,976 $1,952,740
Percent of total interest-earning assets 68.36 % 28.36 % 3.28 % 100.00 %
Interest-Bearing Liabilities:
Interest-bearing demand accounts $459,095 $- $- $459,095
Money market accounts 237,705 - - 237,705
Savings accounts 308,725 - - 308,725
Certificates of deposit 130,968 43,345 1,318 175,631
Securities sold under repurchase agreements - - - -
Borrowings 764 3,334 10,719 14,817
Junior subordinated debentures - - 10,310 10,310
Total interest-bearing liabilities $1,137,257 $46,679 $22,347 $1,206,283
Percent of total interest-bearing liabilities 94.28 % 3.87 % 1.85 % 100.00 %
Interest sensitivity gap $197,713 $507,115 $41,629 $746,457
Cumulative interest sensitivity gap $197,713 $704,828 $746,457
Cumulative interest sensitivity gap as a percentage
of total interest-earning assets 10.1 % 36.1 % 38.2 %
As stated previously, certain shortcomings, including those described below, are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market interest rates. Additionally, certain assets have features that restrict changes in their interest rates, both on a short-term basis and over the lives of the assets. Further, in the event of a change in market interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables as can the relationship of rates between different loan and deposit categories. Moreover, the ability of many borrowers to service their adjustable-rate debt may decrease in the event of an increase in market interest rates.
While the analysis above sets forth the estimated maturity or repricing and the resulting interest rate gap of our interest-earning assets and interest-bearing liabilities, the following tables show the estimated impact on net interest income and net income at one and two year time horizons with instantaneous parallel rate shocks of up 400 basis points, up 300 basis points, up 200 basis points, up 100 basis points, and up 50 basis points. The Company did not perform analyses for rate shock scenarios where interest rates instantaneously drop as of December 31, 2020 because those scenarios do not produce meaningful results in the current low interest rate environment. Due to the various assumptions used for this modeling and potential balance sheet strategies management may implement to mitigate interest rate risk, no assurance can be given that projections will reflect actual results.
The following table shows the estimated impact on net interest income under the stated interest rate scenarios:
1st Year Change in net interest income from base scenario Percentage change 2nd Year Change in net interest income from base scenario Percentage change
(In Thousands)
Scenario:
Up 400 basis points $8,214 11.66 % $24,825 18.16 %
Up 300 basis points $6,790 9.64 % $20,029 14.65 %
Up 200 basis points $4,420 6.28 % $13,252 9.69 %
Up 100 basis points $2,248 3.19 % $6,826 4.99 %
Up 50 basis points $2,332 3.96 % $3,808 6.80 %
Down 50 basis points NM NM NM NM
Down 100 basis points NM NM NM NM
The following table shows the estimated impact on net income under the stated interest rate scenarios. The trends in the estimated impact on net income under the stated interest rate scenarios differ from the table above primarily due to the inclusion of the estimated impact of changes in other operating income and expense related to mortgage banking activities:
1st Year Change in net income from base scenario Percentage change 2nd Year Change in net income from base scenario Percentage change
(In Thousands)
Scenario:
Up 400 basis points ($663) (4.02) % $6,337 23.85 %
Up 300 basis points $1,434 8.69 % $8,998 33.86 %
Up 200 basis points $854 5.17 % $6,216 23.39 %
Up 100 basis points $429 2.60 % $3,711 13.97 %
Up 50 basis points $951 5.77 % $3,014 29.91 %
Down 50 basis points NM NM NM NM
Down 100 basis points NM NM NM NM

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following report, audited consolidated financial statements and the notes thereto are set forth in this Annual Report on Form 10-K on the pages indicated:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2020 and 2019
For the Years Ended December 2020, 2019 and 2018:
Consolidated Statements of Income
Consolidated Statements of Comprehensive Income
Consolidated Statements of Changes in Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of
Northrim BanCorp, Inc. and Subsidiaries
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Northrim BanCorp, Inc. and subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2020 and 2019, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Loan Losses
As described in Notes 1 and 6 to the consolidated financial statements, the Company’s allowance for loan losses balance was $21.1 million at December 31, 2020. The allowance for loan losses is management’s best estimate of probable losses inherent in its loan portfolio and is based on historical loss experience by loan segment and class with adjustments for current events and conditions. These factors include, among others, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions, specific credit risks, industry concentrations, and unidentified losses inherent in the current loan portfolio.
We identified management’s asset quality ratings of loans, determination of qualitative factors, including the estimation of the unallocated general valuation allowance component of the allowance for loan losses, which is based on general economic conditions and other qualitative risk factors both internal and external to the Company, both of which are used in the allowance for loan losses calculation, as a critical audit matter. The Company uses credit quality indicators, including internally determined asset quality risk ratings, to stratify loans into pools and to estimate inherent loss rates for each of the loan pools, which are used in the calculation of the allowance for loan losses. Determination of the asset quality ratings involves significant management judgement. The unallocated general valuation allowance portion of the allowance for loan losses is used to estimate losses and is based on management’s evaluation of various factors that are not captured in the historical credit loss factors utilized in the asset quality risk rating-based component or on the specific impairment component. Such factors include uncertainties in identifying triggering events that directly correlate to subsequent loss rates, uncertainties in economic conditions, risk factors that have not yet manifested themselves in loss allocation factors, and historical loss experience data that may not precisely correspond to the current portfolio. In addition, the unallocated reserve may fluctuate based upon the direction of various risk indicators, such as the risk as to current economic conditions, the level and trend of charge offs or recoveries, and the risk of heightened imprecision or inconsistency of appraisals used in estimating real estate values. Auditing management’s judgments regarding the determination of asset quality ratings and unallocated general valuation allowance portion of the allowance for loan losses involved a high degree of subjectivity.
The primary procedures we performed to address the critical audit matters included:
•Testing the design, implementation, and operating effectiveness of controls relating to management’s calculation of the allowance for loan losses, including controls over the accuracy of asset quality ratings of loans and the determination of the qualitative factors, including the unallocated general valuation allowance component of the allowance for loan losses.
•Testing a risk-based targeted selection of loans to gain substantive evidence that the Company is appropriately rating these loans in accordance with its policies, and that the asset quality ratings for the loans are reasonable.
•Obtaining management’s analysis and supporting documentation related to the qualitative factors, including the unallocated general valuation allowance, and testing whether the general economic conditions and other qualitative risk factors both internal and external to the Company used in the calculation of the allowance for loan losses are in accordance with the Company’s policies and are supported by the analysis provided by management.
•Testing the appropriateness of the methodology and assumptions used in the calculation of the allowance for loan losses, and testing the calculation itself, including completeness and accuracy of the data used in the calculation, application of the loan asset quality ratings determined by management and used in the calculation, application of the qualitative factors, including the unallocated general valuation allowance determined by management and used in the calculation, and recalculation of the allowance for loan losses balance.
•Performing an independent sensitivity analysis to evaluate the reasonableness of the qualitative factors, including the unallocated general valuation allowance used by management to account for inherent losses that are not captured in the calculation of the allowance for loan losses based on historical loss rates alone.
/s/ Moss Adams LLP
Everett, Washington
March 5, 2021
We have served as the Company’s auditor since 2010.
CONSOLIDATED FINANCIAL STATEMENTS
NORTHRIM BANCORP, INC.
Consolidated Balance Sheets
December 31, 2020 and 2019
December 31,
2020 December 31,
(In Thousands, Except Share Data)
ASSETS
Cash and due from banks $23,304 $20,518
Interest bearing deposits in other banks 92,661 74,906
Investment securities available for sale, at fair value 247,633 276,138
Marketable equity securities 9,052 7,945
Investment securities held to maturity 10,000 -
Total portfolio investments 266,685 284,083
Investment in Federal Home Loan Bank stock 2,551 2,138
Loans held for sale 146,178 67,834
Loans 1,444,050 1,043,371
Allowance for loan losses (21,136) (19,088)
Net loans 1,422,914 1,024,283
Purchased receivables, net 13,922 24,373
Mortgage servicing rights, at fair value 11,218 11,920
Other real estate owned, net 7,289 7,043
Premises and equipment, net 38,102 38,422
Operating lease right-of-use assets 12,440 14,306
Goodwill 15,017 15,017
Other intangible assets, net 1,029 1,077
Other assets 68,488 58,076
Total assets $2,121,798 $1,643,996
LIABILITIES
Deposits:
Demand $643,825 $451,896
Interest-bearing demand 459,095 320,264
Savings 308,725 229,918
Money market 237,705 205,801
Certificates of deposit less than $250,000 92,047 90,702
Certificates of deposit $250,000 and greater 83,584 73,770
Total deposits 1,824,981 1,372,351
Borrowings 14,817 8,891
Junior subordinated debentures 10,310 10,310
Operating lease liabilities 12,378 14,229
Other liabilities 37,737 31,098
Total liabilities 1,900,223 1,436,879
COMMITMENTS AND CONTINGENCIES (NOTE 20)
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value, 2,500,000 shares authorized, none issued or outstanding
- -
Common stock, $1 par value, 10,000,000 shares authorized, 6,251,004 and 6,558,809 shares
issued and outstanding at December 31, 2020 and December 31, 2019, respectively
6,251 6,559
Additional paid-in capital 41,808 50,512
Retained earnings 173,498 149,615
Accumulated other comprehensive income, net of tax 18 431
Total shareholders' equity 221,575 207,117
Total liabilities and shareholders' equity $2,121,798 $1,643,996
See notes to consolidated financial statements
NORTHRIM BANCORP, INC.
Consolidated Statements of Income
Years Ended December 31, 2020, 2019, and 2018
(In Thousands, Except Share and Per Share Data) 2020 2019 2018
Interest and Dividend Income
Interest and fees on loans and loans held for sale $71,091 $62,150 $57,542
Interest on investment securities available for sale 4,832 6,572 5,481
Dividends on marketable equity securities 466 439 348
Interest on investment securities held to maturity 18 - -
Dividends on Federal Home Loan Bank stock 84 76 64
Interest on deposits in other banks 225 846 742
Total Interest Income 76,716 70,083 64,177
Interest Expense
Interest expense on deposits 5,279 4,961 2,307
Interest expense on securities sold under agreements to repurchase - 40 50
Interest expense on borrowings 387 251 223
Interest expense on junior subordinated debentures 385 389 389
Total Interest Expense 6,051 5,641 2,969
Net Interest Income 70,665 64,442 61,208
Provision (benefit) for loan losses 2,432 (1,175) (500)
Net Interest Income After Provision (Benefit) for Loan Losses 68,233 65,617 61,708
Other Operating Income
Mortgage banking income 52,635 24,201 20,844
Bankcard fees 2,837 2,976 2,811
Purchased receivable income 2,650 3,271 3,255
Service charges on deposit accounts 1,102 1,557 1,508
Interest rate swap income 949 964 84
Commercial servicing revenue 527 624 1,422
Gain on sale of marketable equity securities, net 98 - -
Unrealized gain (loss) on marketable equity securities 61 911 (625)
Gain on sale of investment securities available for sale, net - 23 -
Other income 2,469 2,819 2,868
Total Other Operating Income 63,328 37,346 32,167
Other Operating Expense
Salaries and other personnel expense 61,137 51,317 44,650
Data processing expense 7,668 7,128 6,035
Occupancy expense 6,624 6,607 6,136
Professional and outside services 3,157 2,531 2,453
Marketing expense 2,320 2,373 2,318
Insurance expense 1,228 557 862
Intangible asset amortization expense 48 60 70
Compensation expense - RML acquisition payments - 468 -
Impairment of equity method investment - - 804
OREO (income) expense, net of rental income and gains on sale (242) (193) 258
Other operating expense 7,174 5,990 6,214
Total Other Operating Expense 89,114 76,838 69,800
Income Before Provision for Income Taxes 42,447 26,125 24,075
Provision for income taxes 9,559 5,434 4,071
Net Income $32,888 $20,691 $20,004
Earnings Per Share, Basic $5.18 $3.08 $2.91
Earnings Per Share, Diluted $5.11 $3.04 $2.86
Weighted Average Shares Outstanding, Basic 6,354,687 6,708,622 6,877,573
Weighted Average Shares Outstanding, Diluted 6,431,367 6,808,209 6,981,557
See notes to consolidated financial statements
NORTHRIM BANCORP, INC.
Consolidated Statements of Comprehensive Income
Years Ended December 31, 2020, 2019, and 2018
(In Thousands) 2020 2019 2018
Net income $32,888 $20,691 $20,004
Other comprehensive income (loss), net of tax:
Securities available for sale:
Unrealized holding gains (losses) arising during the period $411 $2,866 ($692)
Reclassification of net gains included in net income (net of tax
expense of $-, $7, and $- in 2020, 2019, and 2018,
respectively) - (16) -
Derivatives and hedging activities:
Unrealized holding (losses) gains arising during the period (1,201) (1,142) 423
Income tax benefit (expense) related to unrealized gains and losses 377 (757) 210
Other comprehensive (loss) income, net of tax (413) 951 (59)
Comprehensive income $32,475 $21,642 $19,945
See notes to consolidated financial statements
NORTHRIM BANCORP, INC.
Consolidated Statements of Changes in Shareholders’ Equity
Years Ended December 31, 2020, 2019, and 2018
Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Income (Loss) Total
Number of Shares Par Value
(In Thousands)
Balance at January 1, 2018 6,872 $6,872 $61,793 $124,407 ($270) $192,802
Cash dividend declared - - - (7,088) - (7,088)
Stock-based compensation expense - - 816 - - 816
Exercise of stock options and vesting of restricted stock units, net 27 27 1 - - 28
Repurchase of common stock (16) (16) (478) - - (494)
Other comprehensive loss, net of tax - - - - (59) (59)
Cumulative effect of adoption of accounting principles related to premium amortization of investment securities - - - (62) - (62)
Reclassification for cumulative effect of adoption of accounting principles related to fair value measurement of equity securities - - - 191 (191) -
Net income - - - 20,004 - 20,004
Balance at December 31, 2018 6,883 $6,883 $62,132 $137,452 ($520) $205,947
Cash dividend declared - - - (8,528) - (8,528)
Stock-based compensation expense - - 832 - - 832
Exercise of stock options and vesting of restricted stock units, net 24 24 (231) - - (207)
Repurchase of common stock (348) (348) (12,221) - - (12,569)
Other comprehensive income, net of tax - - - - 951 951
Net income - - - 20,691 - 20,691
Balance at December 31, 2019 6,559 $6,559 $50,512 $149,615 $431 $207,117
Cash dividend declared - - - (8,866) - (8,866)
Stock-based compensation expense - - 943 - - 943
Exercise of stock options and vesting of restricted stock units, net 19 19 (137) - - (118)
Repurchase of common stock (327) (327) (9,649) - - (9,976)
Other comprehensive (loss), net of tax - - - - (413) (413)
Cumulative effect of adoption of accounting principles related to equity compensation expense - - 139 (139) - -
Net income - - - 32,888 - 32,888
Balance at December 31, 2020 6,251 $6,251 $41,808 $173,498 $18 $221,575
See notes to consolidated financial statements
NORTHRIM BANCORP, INC.
Consolidated Statements of Cash Flows
Years Ended December 31, 2020, 2019, and 2018
(In Thousands) 2020 2019 2018
Operating Activities:
Net income $32,888 $20,691 $20,004
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Gain on sale of securities, net (98) (23) -
Loss on sale of premises and equipment 22 - 2
Depreciation and amortization of premises 3,147 2,986 2,283
Amortization of software 1,104 1,019 911
Intangible asset amortization 48 60 70
Amortization of investment security premium, net of discount accretion 19 (15) 199
Unrealized (gain) loss on marketable equity securities (61) (911) 625
Deferred tax expense 555 711 3,014
Stock-based compensation 943 832 816
Deferral of loan fees and amortization, net of costs 6,650 598 331
Provision (benefit) for loan losses 2,432 (1,175) (500)
Benefit for purchased receivables (21) (96) (10)
Additions to home mortgage servicing rights carried at fair value (4,824) (3,707) (3,641)
Change in fair value of home mortgage servicing rights carried at fair value 5,526 2,608 125
Change in fair value of commercial servicing rights carried at fair value 99 (6) (972)
Gain on sale of loans (46,258) (19,813) (14,822)
Proceeds from the sale of loans held for sale 1,263,325 670,986 551,607
Origination of loans held for sale (1,295,411) (684,297) (527,516)
Gain on sale of other real estate owned (391) (380) (3)
Impairment on equity method investment - - 804
Net changes in assets and liabilities:
(Increase) decrease in accrued interest receivable (3,467) 305 (432)
(Increase) decrease in other assets (15,096) 6,395 (2,512)
Increase (decrease) in other liabilities 12,415 2,411 (5,233)
Net Cash (Used) Provided by Operating Activities (36,454) (821) 25,150
Investing Activities:
Investment in securities:
Purchases of investment securities available for sale (160,423) (132,104) (88,139)
Purchases of marketable equity securities (1,552) - (2,992)
Purchases of FHLB stock (5,931) (880) -
Purchases of investment securities held to maturity (10,000) - -
Proceeds from sales/calls/maturities of securities available for sale 189,323 130,482 122,644
Proceeds from sales of marketable equity securities 601 229 783
Proceeds from redemption of FHLB stock 5,518 843 14
Decrease (increase) in purchased receivables, net 10,472 (9,871) 7,835
Increase in loans, net (408,365) (58,879) (31,852)
Proceeds from sale of other real estate owned 797 1,299 1,522
Investment in other real estate owned - - (144)
Purchases of software (416) (721) (517)
Proceeds from sales of premises and equipment - - 3
Purchases of premises and equipment (2,849) (2,318) (3,511)
Net Cash (Used) Provided by Investing Activities (382,825) (71,920) 5,646
Financing Activities:
Increase (decrease) in deposits 452,630 144,263 (30,195)
(Decrease) increase in securities sold under repurchase agreements - (34,278) 6,532
Proceeds from borrowings 110,610 1,817 -
Repayments of borrowings (104,684) (167) (121)
Proceeds from the issuance of common stock 84 73 243
Repurchase of common stock (9,976) (12,569) (494)
Cash dividends paid (8,844) (8,512) (7,064)
Net Cash Provided (Used) by Financing Activities 439,820 90,627 (31,099)
Net Change in Cash and Cash Equivalents 20,541 17,886 (303)
Cash and Cash Equivalents at Beginning of Year 95,424 77,538 77,841
Cash and Cash Equivalents at End of Year $115,965 $95,424 $77,538
Supplemental Information:
Income taxes paid $7,790 $1,658 $1,766
Interest paid $6,009 $5,640 $2,971
Noncash commitments to invest in Low Income Housing Tax Credit Partnerships $- $11,267 $-
Transfer of loans to other real estate owned $652 $- $686
Non-cash lease liability arising from obtaining right of use assets $370 $1,234 $-
Cash dividends declared but not paid $98 $89 $72
See notes to consolidated financial statements
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Summary of Significant Accounting Policies
Nature of Operations: Northrim BanCorp, Inc. (the “Company”), is a publicly traded bank holding company headquartered in Anchorage, Alaska that is primarily engaged in the delivery of business and personal banking services through its wholly-owned banking subsidiary, Northrim Bank ("the Bank"). The Bank also engages in retail mortgage origination services through its wholly-owned subsidiary, Residential Mortgage Holding Company, LLC (“RML”). Additionally, the Bank through its wholly-owned subsidiary, Northrim Funding Services ("NFS"), operates a factoring division in Bellevue, Washington. Related companies include Pacific Wealth Advisors, LLC (“PWA”) and Homestate Mortgage Company, LLC ("Homestate"). The Company has an equity investment in PWA through its wholly owned subsidiary, Northrim Investment Services Company ("NISC"), and the Company has an equity investment in Homestate through RML.
Use of Estimates: The Company prepares its consolidated financial statements in conformity with accounting principles generally accepted in the United States and prevailing practices within the banking industry. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of income, gains, expenses, and losses during the reporting periods. Actual results could differ from those estimates. Significant estimates include the allowance for loan losses (“Allowance”), valuation of goodwill and other intangibles, valuation of other real estate owned (“OREO”), valuation of mortgage servicing rights, and fair value disclosures.
Consolidation: The Company consolidates affiliates in which we have a controlling interest. The accompanying consolidated financial statements include the accounts of the Company, the Bank, RML, and NISC. Significant intercompany balances have been eliminated in consolidation. As of December 31, 2020, the Company had one wholly-owned business trust subsidiary, Northrim Statutory Trust 2 ("Trust 2") that was formed to issue trust preferred securities and related common securities of Trust 2. The Company has not consolidated the accounts of Trust 2 in its consolidated financial statements in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB”) ASC 810, Consolidation (“ASC 810”). As a result, the junior subordinated debentures issued by the Company to Trust 2 are reflected on the Company’s consolidated balance sheet as junior subordinated debentures. The Company has determined that PWA and Homestate are not variable interest entities and therefore, the Company does not consolidate the balance sheets and income statements of PWA or Homestate into its financial statements. The Company's investments in PWA and Homestate are accounted for as equity method investments. Results of PWA and Homestate are included in "Other income" in our Consolidated Statements of Income. Investments in associated companies are presented on a one-line basis in the caption “Other assets” in our Consolidated Balance Sheets.
Operating Segments: In accordance with ASC 280, Segment Reporting, operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker ("CODM"), or decision making group, in deciding how to allocate resources and in assessing performance. The Company uses the "management approach" in determining reportable operating segments. The management approach considers the internal organization and reporting used the by the Company's CODM for making operating decisions and assessing performance as the source for determining the Company's reportable segments. Management, including the CODM, review operating results by the revenue of different services. For the year ended December 31, 2020 and 2019, the Company has two operating business lines; Community Banking and Home Mortgage Lending. Information about the Company's operating segments is included in Note 27 of the Notes to the Company's Consolidated Financial Statements included in Part II. Item 8 of this report.
Reclassifications: Certain reclassifications have been made to prior year amounts to maintain consistency with the current year with no impact on net income or total shareholders’ equity.
Subsequent Events: The Company has evaluated events and transactions subsequent to December 31, 2020 for potential recognition or disclosure.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits with other banks, federal funds sold, and securities with original maturities of less than 90 days at acquisition.
Marketable Securities: Marketable securities are equity investments excluding those accounted for under the equity method of accounting or those that result in consolidation of the investee. Marketable securities are stated at fair value. Changes in fair value are included in "Unrealized gain (loss) on marketable equity securities" in our Consolidated Statements of Income.
Investment Securities: Securities available for sale are stated at fair value with unrealized holding gains and losses, net of tax, excluded from earnings and reported as a separate component of other comprehensive income, unless an unrealized loss is deemed other than temporary. Gains and losses on available for sale securities sold are determined on a specific identification basis.
Held to maturity securities are stated at cost, adjusted for amortization of premium and accretion of discount on a level-yield basis. The Company has the ability and intent to hold these securities to maturity.
The Company amortizes purchase premiums for callable debt securities to the earliest call date.
A decline in the market value of any available for sale or held to maturity security below cost that is deemed other than temporary results in a charge to earnings and the establishment of a new cost basis for the security. Unrealized investment securities losses are evaluated at least quarterly on a specific identification basis to determine whether such declines in value 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 security is below the carrying value primarily due to changes in interest rates and there has not been significant deterioration in the financial condition of the issuer. Other factors that may be considered in determining whether a decline in the value is "other than temporary" include the financial condition, capital strength, and near-term prospects of the issuer; actions of commercial banks or other lenders relative to the continued extension of credit facilities to the issuer of the security; recommendations of investment advisors or market analysts; and ratings by recognized rating agencies.
Federal Home Loan Bank Stock: The Company’s investment in Federal Home Loan Bank of Des Moines (“FHLB”) stock is carried at par value because the shares can only be redeemed with the FHLB at par. The Company is required to maintain a minimum level of investment in FHLB stock based on the Company’s total Bank assets and outstanding advances. FHLB stock is carried at cost and is subject to recoverability testing at least annually.
Loans held for sale: The Company designates loans held for sale as either carried at fair value or the lower of cost or fair value at origination. Loans held for sale include residential mortgage loans that have been originated for sale in the secondary market. Related gains or losses on the sale of these loans are recognized in mortgage banking income.
Loans: Loans are carried at their principal amount outstanding, net of charge-offs, unamortized fees, and direct loan origination costs. Loan origination fees received in excess of direct origination costs are deferred and accreted to interest income using the interest method in accordance with ASC 310 over the life of the loan. Loan balances are charged-off to the Allowance when management believes that collection of principal is unlikely. Interest income on loans is accrued and recognized on the principal amount outstanding except for loans in a nonaccrual status. All classes of loans are placed on nonaccrual when management believes doubt exists as to the collectability of the interest or principal. Cash payments received on nonaccrual loans are directly applied to the principal balance. Generally, a loan may be returned to accrual status when the delinquent principal and interest is brought current in accordance with the terms of the loan agreement and certain ongoing performance criteria have been met. Loans are reported as past due when installment payments, interest payments, or maturity payments are past due based on contractual terms.
The Company considers a loan to be impaired when it is probable that it will be unable to collect all amounts due according to the contractual terms of the loan agreement. Once a loan is determined to be impaired, the impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate, unless the loan is collateral dependent, in which case the impairment is measured by using the fair value of the loan’s collateral. Nonperforming loans greater than $50,000 are individually evaluated for impairment based upon the borrower’s overall financial condition, resources, and payment record, and the prospects for support from any financially responsible guarantors.
The Company uses either in-house evaluations or external appraisals to estimate the fair value of collateral-dependent impaired loans as of each reporting date. The Company’s determination of which method to use is based upon several factors. The Company takes into account compliance with legal and regulatory guidelines, the amount of the loan, the estimated value of the collateral, the location and type of collateral to be valued, and how critical the timing of completion of the analysis is to the assessment of value. Those factors are balanced with the level of internal expertise, internal experience, and market information available, versus external expertise available such as qualified appraisers, brokers, auctioneers, and equipment specialists.
The Company uses external appraisals to estimate fair value for projects that are not fully constructed as of the date of valuation. These projects are generally valued as if complete, with an appropriate allowance for cost of completion, including contingencies developed from external sources such as vendors, engineers, and contractors.
The Company classifies fair value measurements on loans as level 3 valuations in the fair value hierarchy because of their use of unobservable inputs..
When the fair value measurement of the impaired loan is less than the recorded amount of the loan, an impairment is recognized by recording a charge-off to the Allowance or by designating a specific reserve in accordance with GAAP. The Company’s policy is to record cash payments received on impaired loans that are not also nonaccrual loans in the same manner that cash payments are applied to performing loans.
A loan is classified as a troubled debt restructuring ("TDR") when a borrower is experiencing financial difficulties that lead to a restructuring of the loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider. These concessions may include interest rate reductions, principal forgiveness, extension of maturity date and other actions intended to minimize potential losses. Generally, a nonaccrual loan that is restructured remains on nonaccrual status for a period of at least six months to demonstrate that the borrower can meet the restructured terms. If the borrower's performance under the new terms is not reasonably assured, the loan remains classified as a nonaccrual loan. Interest on TDRs will be accrued at the restructured rates when it is anticipated that no loss of original principal will occur, and the interest can be collected, which is generally after a period of six months.
Acquired Loans: Loans are recorded at their fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan losses is not recorded at the acquisition date. Purchased loans are evaluated upon acquisition and classified as either purchased credit impaired or purchased non-credit-impaired. Purchased credit impaired loans reflect credit deterioration since origination such that it is probable at acquisition that the Company will be unable to collect all contractually required payments.
Purchased credit impaired loans were individually evaluated for credit impairment at acquisition using expected future cash flows or the estimated value of underlying collateral. A purchased credit impaired loan will be removed from impaired loans only if the loan is sold, foreclosed, or assets are received in full satisfaction of the loan, and it will be removed from impaired loans at its carrying value. If an individual loan is removed, the difference between its relative carrying amount and its cash, fair value of the collateral, or other assets received will be recognized in other income immediately as a gain and would not affect the effective yield used to recognize the accretable yield on purchased credit impaired loans.
The excess of the undiscounted contractual balances due over the cash flows expected to be collected is considered to be the nonaccretable difference. The nonaccretable difference represents our estimate of the credit losses expected to occur and was considered in determining the fair value of the purchased credit impaired loans as of the acquisition date. Subsequent to the acquisition date, any increases in expected cash flows over those expected at purchase date in excess of fair value are adjusted through an increase to the accretable yield on a prospective basis. The purchased credit impaired loans are and will continue to be subject to the Company’s internal and external credit review and monitoring. If credit deterioration is experienced subsequent to the initial acquisition fair value amount, such deterioration will be measured, and a charge-off will be recorded.
For purchased non-credit-impaired loans, the difference between the fair value and unpaid principal balance of the loan at the acquisition date is amortized or accreted to interest income over the estimated life of the loans.
For the purpose of estimating the Allowance, as of December 31, 2018, the Company evaluated the credit quality of purchased non-credit-impaired loans separately from loans that were originated by the Company and applied different qualitative factors to these loans. For the purpose of estimating the subsequent to December 31, 2018, the Company evaluated the credit quality of purchased non-credit-impaired loans together with loans that were originated by the Company. Purchased non-credit-impaired loans that have been identified as impaired subsequent to the merger are included in the Company's normal process for reporting impaired loans and calculation of a specific valuation allowance.
Allowance for Loan Losses: The Allowance for Loan Losses is management’s best estimate of probable losses inherent in its loan portfolio as of the balance sheet date. The Allowance methodology is based on historical loss experience by loan segment and class with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the Allowance for probable loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including levels of and trends related to past due and nonaccrual loans, net charge-offs or recoveries, and other factors. The Company has identified the following segments: commercial, real estate construction one-to-four family, real estate construction other, real estate term owner occupied, real estate term non-owner occupied, real estate
term other, consumer loans secured by 1st deeds of trust, and other consumer loans. Then the Company further disaggregates each segment into the following classes, which are also known as asset quality ratings: pass (grades 1-6), special mention (grade 7), substandard (grade 8), doubtful (grade 9), and loss (grade 10).
The level of the Allowance reflects management’s continuing evaluation of loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions, specific credit risks, industry concentrations, and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the Allowance is dependent upon a variety of factors beyond the Company’s control including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates, and the view of the regulatory authorities toward loan classification.
The Company’s Allowance consists of three elements: (1) specific valuation allowances based on probable losses on specific loans, (2) general valuation allowances based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted as necessary to reflect the impact of current conditions, and (3) unallocated general valuation allowances based on general economic conditions and other qualitative risk factors both internal and external to the Company.
The specific valuation allowance is an allocated allowance for impaired loans. This analysis is based upon a specific analysis for each impaired loan that is collateral dependent, including appraisals and in-house evaluations on loans secured by real property, management’s assessment of the current market, recent payment history, and an evaluation of other sources of repayment. The Company obtains appraisals on real and personal property that secure its loans during the loan origination process in accordance with regulatory guidance and its loan policy.
The Company then estimates a general allocated allowance for all other loans that were not impaired as of the balance sheet date using a formula-based approach that includes average historical loss factors that are adjusted for quantitative and qualitative factors. After the portfolio has been disaggregated into segments and classes, the Company calculates a general reserve for each segment and class based on the average five year loss history for each segment and class. This general reserve is then adjusted for qualitative factors, by segment and class. Qualitative factors are based on management’s assessment of current trends that may cause losses inherent in the current loan portfolio to differ significantly from historical losses. Some factors that management considers in determining the qualitative adjustment to the general reserve include our concentration of large borrowers; national and local economic trends; general business conditions; economic, political, and industry specific factors that affect resource development in Alaska; underwriting policies and standards; trends in local real estate markets; effects of various political activities; peer group data; and internal factors such as underwriting policies and expertise of the Company’s employees.
The unallocated general valuation portion of the Allowance is based on several factors, including the level of the Allowance as compared to total loans and nonperforming loans in light of current economic conditions. This portion of the Allowance is based upon management’s evaluation of various factors that are not directly measured in the determination of the allocated portions of the Allowance and it is deemed “unallocated” because it is not allocated to any segment or class of the loan portfolio. This portion of the Allowance provides for coverage of credit losses inherent in the loan portfolio but not captured in the credit loss factors that are utilized in the risk rating-based component or in the specific impairment component of the Allowance and acknowledges the inherent imprecision of all loss prediction models. Such factors include uncertainties in identifying triggering events that directly correlate to subsequent loss rates, uncertainties in economic conditions, risk factors that have not yet manifested themselves in loss allocation factors, and historical loss experience data that may not precisely correspond to the current portfolio. In addition, the unallocated reserve may fluctuate based upon the direction of various risk indicators. Examples of such factors include the risk as to current economic conditions, the level and trend of charge offs or recoveries, and the risk of heightened imprecision or inconsistency of appraisals used in estimating real estate values. Although this allocation process may not accurately predict credit losses by loan type or in aggregate, the total allowance for credit losses is available to absorb losses that may arise from any loan type or category.
Based on our methodology and its components, management believes the resulting Allowance is adequate and appropriate for the risk identified in the Company's loan portfolio. While management believes that it uses the best information available to determine the Allowance, unforeseen market conditions and other events could result in adjustment to the Allowance, and net income could be significantly affected if circumstances differed substantially from the assumptions used in making the final determination. Our banking regulators, as an integral part of their examination process, periodically review the Company's Allowance. Our regulators may require the Company to recognize additions to the Allowance based on their judgments related to information available to them at the time of their examinations.
Reserve for Unfunded Loan Commitments and Letters of Credit: The Company maintains a separate reserve for losses related to unfunded loan commitments and letters of credit. The determination of the adequacy of the reserve is based on periodic evaluations of the unfunded credit facilities including assessment of historical losses and current economic conditions. The allowance for unfunded loan commitments and letters of credit is included in other liabilities on the Consolidated Balance Sheets, with changes to the balance charged against other operating expense.
Purchased Receivables: The Bank, through NFS, purchases accounts receivable from its customers. The purchased receivables are carried at their principal amount outstanding, net of a reserve for anticipated losses that have not yet been identified. Fees charged to the customer are earned while the balances of the purchases are outstanding, which is typically less than one year. The Company maintains a separate reserve for losses related to purchased receivable assets. The determination of the adequacy of the reserve is based on periodic evaluations of purchased receivable assets including an assessment of historical losses and current economic conditions. The reserve for purchased receivable assets is included in the balance of these accounts on a net basis on the consolidated balance sheets, with changes to the balance charged against other operating expense.
Other Real Estate Owned: Other real estate owned ("OREO") represents properties acquired through foreclosure or its equivalent. Prior to foreclosure, the carrying value is adjusted to the fair value, less cost to sell, of the real estate to be acquired by an adjustment to the Allowance. Management’s evaluation of fair value is based on appraisals or discounted cash flows of anticipated sales. After foreclosure, any subsequent reduction in the carrying value is charged against earnings. Operating expenses associated with OREO are charged to earnings in the period they are incurred. Operating expenses associated with OREO are recorded net of rental income and gain on sales associated with OREO.
Premises and Equipment: Premises and equipment, including leasehold improvements, are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization expense for financial reporting purposes is computed using the straight-line method based upon the shorter of the lease term or the estimated useful lives of the assets that vary according to the asset type and include; furniture and equipment ranging between 3 and 7 years, leasehold improvements ranging between 2 and 15 years, and buildings at 39 years. Maintenance and repairs are charged to current operations, while renewals and betterments are capitalized. Long-lived assets such as premises and equipment are reviewed for impairment at least annually or whenever events or changes in business circumstances indicate that the remaining useful life may warrant revision, or that the carrying amount of the long-lived asset may not be fully recoverable. If impairment is determined to exist, any related impairment loss is calculated based on fair value. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal.
Goodwill and Other Intangible Assets: Intangible assets are comprised of goodwill and other intangibles acquired in business combinations. Goodwill and intangible assets with indefinite useful lives are not amortized. Intangible assets with definite useful lives are amortized to their estimated residual values over their respective useful lives, and are also reviewed for impairment. Amortization of intangible assets is included in other operating expense in the Consolidated Statements of Income. The Company performs a goodwill impairment analysis at the segment level on an annual basis. Additionally, the Company performs a goodwill impairment evaluation on an interim basis when events or circumstances indicate impairment potentially exists.
Low Income Housing Tax Credit Partnerships: The Company earns a return on its investments in these partnerships in the form of tax credits and deductions that flow through to it as a limited partner. The Company amortizes these investments in tax expense over the period during which tax benefits are received.
Servicing Rights: Mortgage and commercial servicing rights associated with loans originated and sold, where servicing is retained, are measured at fair value and changes in fair value are reported through earnings. Changes in the fair value of servicing rights occur primarily due to the collection/realization of expected cash flows, as well as changes in valuation inputs and assumptions. Under the fair value method, servicing rights are carried on the balance sheet at fair value and the changes in fair value are reported in earnings in other operating income in the period in which the change occurs. Fair value measurements are determined using a discounted cash flow model. In order to determine the fair value of servicing rights, the present value of net expected future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, escrow calculations, delinquency rates, and ancillary fee income net of servicing costs. For mortgage servicing rights ("MSRs"), the model assumptions are also compared to publicly filed information from several large MSR holders, as available.
Other Assets: Other assets include purchased software and prepaid expenses. Purchased software is carried at amortized cost and is amortized using the straight-line method over its estimated useful life or the term of the agreement. Also included in other assets is the net deferred tax asset, bank owned life insurance carried at cash surrender value, net of premium charges, accrued interest receivable, taxes receivable, rate lock derivatives, and the Company’s equity method investments.The
Company performs an impairment analysis on it's equity method investments when events or circumstances indicate impairment potentially exists.
Derivatives: The Company records all derivatives on the Consolidated Balance Sheets at fair value. The accounting for change in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate the derivative in a hedging relationship and apply hedge accounting, and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Interest rate swaps that are designated as a cash flow hedge and satisfy the hedge accounting requirements involve the receipt of variable amounts from a counter-party in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. For derivatives which are designed as cash flow hedges and satisfy hedge accounting requirements, the effective portion of changes in the fair value of the derivative is recorded in accumulated other comprehensive income (loss). The fair value of the Company's derivatives is determined using discounted cash flow analysis using observable market based inputs. The Company considers all free-standing derivatives not designated in a hedging relationship as economic hedges and recognizes these derivatives as either assets or liabilities in the balance sheet. These assets and liabilities are measured at fair value, and changes in fair value are recorded in earnings. By using derivatives, the Company is exposed to counterparty credit risk, which is the risk that counterparties to the derivative contracts do not perform as expected. If a counterparty fails to perform, our counterparty credit risk is equal to the amount reported as a derivative asset on our balance sheet, net of cash collateral received. We minimize counterparty credit risk through credit approvals, limits, monitoring procedures, and obtaining collateral, where appropriate. For derivative instruments executed with the same counterparty under a master netting arrangement, we do not offset fair value amounts of interest rate swaps in liability positions with interest rate swaps in asset positions. For further detail, see Note 21.
Transfers or sales of financial assets: For transfers of entire financial assets or a participating interest in an entire financial asset recorded as sales, we recognize and initially measure at fair value all assets obtained and liabilities incurred. We record a gain or loss in other operating income for the difference between the carrying amount and the fair value of the assets sold. Fair values are based on quoted market prices, quoted market prices for similar assets, or if market prices are not available, then the fair value is estimated using discounted cash flow analysis with assumptions for credit losses, prepayments and discount rates that are corroborated by and verified against market observable data, where possible.
Advertising: Advertising, promotion, and marketing costs are expensed as incurred. The Company reported total expenses in these areas of $2.3 million, $2.4 million, and $2.3 million for each of the years ending December 31, 2020, 2019, and 2018, respectively.
Stock Incentive Plans: The Company has stock-based employee compensation plans as more fully discussed in Note 23, Stock-Based Compensation. Compensation cost is recognized for stock options and restricted stock units issued to employees based on the fair value of these awards at the date of grant. A Black Scholes model is utilized to estimate the fair value of stock options, while the market price for the Company's common stock at the date of grant issued is utilized for restricted stock awards. The Company recognizes compensation expense over the vesting period of each award. The Company's accounting policy changed during the year ended December 31, 2020 and now recognizes forfeitures as they occur.
Income Taxes: The Company uses the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Our policy is to recognize interest and penalties on unrecognized tax benefits in “Other operating expense" in the Consolidated Statements of Income.
Earnings Per Share: Earnings per share is calculated using the weighted average number of shares and dilutive common stock equivalents outstanding during the period. Stock options and restricted stock units, as described in Note 23, are considered to be common stock equivalents. Potentially dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. Anti-dilutive shares outstanding related to options to acquire common stock for the year ended December 31, 2020 totaled 45,062 and for the year ended December 31, 2018 totaled 44,721. There were no anti-dilutive shares outstanding related to options to acquire common stock in 2019.
Information used to calculate earnings per share was as follows:
(In Thousands) 2020 2019 2018
Net income $32,888 $20,691 $20,004
Basic weighted average common shares outstanding 6,355 6,709 6,878
Dilutive effect of potential common shares from awards granted under equity incentive program 76 99 104
Total 6,431 6,808 6,982
Earnings per common share
Basic $5.18 $3.08 $2.91
Diluted $5.11 $3.04 $2.86
Comprehensive Income: Comprehensive income consists of net income, net unrealized gains (losses) on securities available for sale after the tax effect, and net unrealized gains (losses) on derivative and hedging activities.
Concentrations: Substantially all of the Company’s business is derived from the Anchorage, Matanuska-Susitna Valley, Fairbanks, Kenai Peninsula, and Southeast areas of Alaska. As such, the Company’s growth and operations depend upon the economic conditions of Alaska and these specific markets. These areas rely primarily upon the natural resources industries, particularly oil production, as well as tourism, government and U.S. military spending for their economic success. A significant majority of the unrestricted revenues of the Alaska state government are currently funded through various taxes and royalties on the oil industry. The Company’s business is and will remain sensitive to economic factors that relate to these industries and local and regional business conditions. As a result, local or regional economic downturns, or downturns that disproportionately affect one or more of the key industries in regions served by the Company, may have a more pronounced effect upon its business than they might on an institution that is less geographically concentrated. The extent of the future impact of these events on economic and business conditions cannot be predicted; however, prolonged or acute fluctuations could have a material and adverse impact upon the Company’s results of operation and financial condition.
At December 31, 2020 and 2019, the Company had $898.8 million and $513.3 million, respectively, in commercial and construction loans. At December 31, 2020, commercial loans included $310.5 million in Payment Protection Program ("PPP") loans administered by the U.S. Small Business Administration ("SBA"). Additionally, the Company continues to have a concentration in large borrowing relationships. At December 31, 2020, 43% of the Company’s loan portfolio is attributable to 35 large borrowing relationships. The Company has additional unfunded commitments to these borrowers of $137.9 million at December 31, 2020.
Fair Value Measurements: Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. GAAP established a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies. In accordance with GAAP, the Company groups its assets and liabilities measured at fair value into the following three levels:
•Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets. A quoted market price in an active market provides the most reliable evidence of fair value and is used to measure fair value whenever available. A contractually binding sales price also provides reliable evidence of fair value.
•Level 2: Valuation is based upon quoted market prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
•Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market, or inputs that require significant management judgment or estimation, some of which may be internally developed.
Recent Accounting Pronouncements
Accounting pronouncements implemented in 2020
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including allowing entities to elect an accounting policy to account for forfeitures as they occur by reversing compensation expense when the award is forfeited instead of estimating future forfeitures that will occur when recognizing compensation expense related to share-based payment awards. The Company elected to account for forfeitures as they occur in accordance with the guidance in ASU 2016-09 on January 1, 2020, which resulted in a $139,000 decrease in beginning retained earnings through a cumulative-effect adjustment.
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (“ASU 2017-04”). ASU 2017-04 simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. The Company adopted ASU 2017-04 on January 1, 2020. The adoption of ASU 2017-04 did not have a material impact on the Company’s consolidated financial position or results of operations.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) (“ASU 2018-13”). ASU 2018-13 modifies the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, based on the concepts in the Concepts Statement, including the consideration of costs and benefits. The Company adopted ASU 2018-13 on January 1, 2020. The adoption of ASU 2018-13 did not have a material impact on the Company’s consolidated financial position or results of operations.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848) ("ASU 2020-04"). ASU 2020-04 provides optional expedients and exceptions for applying generally accepted accounting principles to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The expedients and exceptions provided by ASU 2020-04 do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. The Company adopted ASU 2020-04 as of March 31, 2020. The adoption of ASU 2020-04 did not have a material impact on the Company’s consolidated financial position or results of operations because no contract modifications have been made to date.
Accounting pronouncements to be implemented in future periods
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (“ASU 2016-13” or "CECL"). ASU 2016-13 is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates but will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. ASU 2016-13 requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization's portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.
ASU 2016-13 is effective for the Company for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2019, and must be applied prospectively. However, on October 16, 2019 the FASB voted to delay ASU 2016-13 for Smaller Reporting Companies. The Company has elected Small Reporting Company status, which changes the effective date for ASU 2016-13 for the Company to fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2022. Early application was permitted for specified periods. The Company early adopted ASU 2016-13 on January 1, 2021 after finalizing data and model validation and our internal governance framework. The guidance was applied on a modified retrospective basis with the cumulative effect of initially applying the amendments recognized in retained earnings at January 1, 2021. However, certain provisions of the guidance are only required to be applied on a prospective basis.
CECL is not prescriptive in the methodology used to determine the expected credit loss estimate. Therefore, management has flexibility in selecting the methodology. The expected credit losses must be estimated over a financial asset's contractual term, adjusted for prepayments utilizing quantitative and qualitative factors. There are also specific considerations
for purchased credit-deteriorated, troubled debt restructured, and collateral dependent loans. CECL also applies to the reserve for unfunded commitments.
The combination of the current expected credit loss, qualitative factors, collateral dependent, troubled debt restructuring, purchased credit deteriorated, and the reserve for unfunded commitments represent the allowance for credit losses ("ACL").
The estimate of expected credit losses is based on relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. Historical loss experience is the starting point for estimating expected credit losses. Adjustments are made to historical loss experience to reflect differences in asset-specific risk characteristics - e.g. underwriting standards, portfolio mix or asset terms, and differences in economic conditions - both current conditions and reasonable and supportable forecasts. When the Company is not able to make or obtain reasonable and supportable forecasts for the entire life of the financial asset, it has estimated expected credit losses for the remaining life using an approach that reverts to historical credit loss information.
The Company utilizes complex models to obtain reasonable and supportable forecasts; most of the models calculate two predictive metrics, the probability of default ("PD") and loss given default ("LGD"). The PD measures the probability that a loan will default within a given time horizon and primarily measures the adequacy of the debtor's cash flow as the primary source of repayment of the loan. The LGD is the expected loss which would be realized presuming a default has occurred and primarily measures the value of the collateral or other secondary source of repayment related to the collateral. The ACL is measured on a collective (pool) basis when similar characteristics exist. The Company has selected models at the portfolio level using a risk-based approach, with larger, more complex portfolios having more complex models.
For ACL calculation purposes, management considered the financial and economic environment at the time of assessment and different economic scenarios that differed in the levels of severity and sensitivity to the ACL results. Management determined the use of a third-party baseline economic forecast was reasonable and supportable as it is from a credible subject matter experts and institution. In this baseline scenario, the probability that the economy will perform better than this consensus is equal to the probability that it will perform worse.
Loss factors from the models, prepayment speeds, and qualitative factors are inputs into the Company's CECL accounting application. Once this information is aggregated, the Company uses two methods to calculate the current expected credit loss: 1) the discounted cash flow ("DCF") method, which is used for approximately 97% of all loans and the reserve for unfunded commitments and 2) a weighted average remaining life method for the remainder of the loan portfolio where loan level data constraints preclude the use of the DCF method. The DCF method utilizes the effective interest rate of individual assets to discount the expected credit losses adjusted for prepayments. The difference in the net present value and the amortized cost of the asset will result in the required allowance. The weighted average remaining life method uses the exposure at default, along with the expected credit losses adjusted for prepayments to calculate the required allowance.
Adoption of CECL as of January 1, 2021 resulted in an allowance for loan losses of $16.6 million, which is a $4.5 million decrease in the allowance under the incurred loss model as of December 31, 2020. This decrease will increase the Company's total shareholder's equity by $3.2 million.
Adoption of CECL as of January 1, 2021 resulted in a reserve for unfunded commitments of $1.4 million, which is a $1.2 million increase in the reserve under the incurred loss model as of December 31, 2020. This increase will decrease the Company's total shareholder's equity by $880,000.
We will recognize an ACL for available-for-sale and held-to-maturity debt securities. The ACL on available-for-sale debt securities will be subject to a limitation based on the fair value of the debt securities. Based on the credit quality of our existing debt securities portfolio, we do not expect the ACL for held-to-maturity and available-for-sale debt securities to be significant. As of December 31, 2020, the Company holds one newly issued debt security that is classified as held-to-maturity.
NOTE 2 - Cash and Due from Banks
The Company is required to maintain cash balances or deposits with the Federal Reserve Bank of San Francisco ("Federal Reserve Bank") sufficient to meet its statutory reserve requirements and for purposes of settling financial transactions and charges for Federal Reserve Bank services. The average reserve requirement for the maintenance period, which included December 31, 2020, was zero.
The Company is required to maintain a $250,000 balance with a correspondent bank for outsourced servicing of ATMs.
The Company is required to maintain a $100,000 and $2.8 million balance with a correspondent bank to collateralize the initial margin and the fair value exposure of one of its interest rate swaps, respectively.
NOTE 3 - Interest Bearing Deposits in Other Banks
All interest bearing deposits in other banks have a maturity of one year or less. Balances at December 31 for the respective years are as follows:
(In Thousands) 2020 2019
Interest bearing deposits at Federal Reserve Bank $54,488 $48,200
Interest bearing deposits at FHLB 133 36
Other interest bearing deposits at other institutions 38,040 26,670
Total $92,661 $74,906
NOTE 4 - Investment Securities
The carrying values and approximate fair values of investment securities at the periods indicated are presented below:
(In Thousands) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value
December 31, 2020
Securities available for sale
U.S. Treasury and government sponsored entities $173,318 $1,330 ($47) $174,601
Municipal securities 820 36 - 856
Corporate bonds 29,951 546 (5) 30,492
Collateralized loan obligations 41,782 44 (142) 41,684
Total securities available for sale $245,871 $1,956 ($194) $247,633
Securities held to maturity
Corporate bonds $10,000 $- $- $10,000
Total securities held to maturity $10,000 $- $- $10,000
December 31, 2019
Securities available for sale
U.S. Treasury and government sponsored entities $210,756 $1,133 ($37) $211,852
Municipal securities 3,288 9 - 3,297
Corporate bonds 34,764 302 - 35,066
Collateralized loan obligations 25,980 - (57) 25,923
Total securities available for sale $274,788 $1,444 ($94) $276,138
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2020 and 2019, were as follows:
Less Than 12 Months More Than 12 Months Total
(In Thousands) Fair
Value Unrealized Losses Fair
Value Unrealized Losses Fair
Value Unrealized Losses
Securities Available for Sale
U.S. Treasury and government sponsored entities $31,270 ($47) $- $- $31,270 ($47)
Corporate bonds 3,198 (5) - - 3,198 (5)
Collateralized loan obligations 23,670 (118) 2,967 (24) 26,637 (142)
Total $58,138 ($170) $2,967 ($24) $61,105 ($194)
Securities Available for Sale
U.S. Treasury and government sponsored entities $39,797 ($33) $2,996 ($4) $42,793 ($37)
Collateralized loan obligations 14,972 (17) 7,951 (40) 22,923 (57)
Total $54,769 ($50) $10,947 ($44) $65,716 ($94)
The unrealized losses on investments in both periods were caused by changes in interest rates. At December 31, 2020 and 2019, there were 12 and 8 available for sale securities in an unrealized loss position, respectively, that have been in a loss position for less than twelve months. There were 1 and 3 securities with unrealized losses at December 31, 2020 and 2019, respectively, that have been at a loss position for more than twelve months. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. The Company does not intend to sell, nor is it more likely than not that it will be required to sell, securities whose market value is less than carrying value. Because it is more likely than not that the Company will hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.
At December 31, 2020 and 2019, $77.9 million and $30.6 million in securities were pledged for deposits and borrowings, respectively.
The amortized cost and fair values of available for sale and held to maturity debt securities at December 31, 2020, are distributed by contractual maturity as shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
(In Thousands) Amortized Cost Fair Value Weighted Average Yield
U.S. Treasury and government sponsored entities
Within 1 year $44,044 $44,601 2.06 %
1-5 years 129,274 130,000 0.82 %
Total $173,318 $174,601 1.14 %
Corporate bonds
Within 1 year $2,241 $2,257 1.23 %
1-5 years 27,710 28,235 1.36 %
5-10 years 10,000 10,000 5.00 %
Total $39,951 $40,492 2.26 %
Collateralized loan obligations
5-10 years $8,783 $8,720 1.70 %
Over 10 years 32,999 32,964 1.60 %
Total $41,782 $41,684 1.62 %
Municipal securities
1-5 years 820 856 2.14 %
Total $820 $856 2.14 %
The proceeds and resulting gains and losses, computed using specific identification, from sales of investment securities for the years ending December 31, 2020, 2019, and 2018, respectively, are as follows:
(In Thousands) Proceeds Gross Gains Gross Losses
Available for sale securities $- $- $-
Available for sale securities $4,219 $23 $-
Available for sale securities $- $- $-
A summary of interest income for the years ending December 31, 2020, 2019, and 2018 on available for sale investment securities is as follows:
(In Thousands) 2020 2019 2018
U.S. Treasury and government sponsored entities $3,396 $4,170 $3,682
Other 1,354 2,282 1,532
Total taxable interest income $4,750 $6,452 $5,214
Municipal securities $82 $120 $267
Total tax-exempt interest income $82 $120 $267
Total $4,832 $6,572 $5,481
NOTE 5 - Loans and Credit Quality
As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends in past due and nonaccrual loans, gross and net charge-offs, and movement in loan balances within the risk classifications. The Company utilizes a loan risk grading system called the Asset Quality Rating (“AQR”) system to assign a risk classification to each of its loans. The risk classification is a dual rating system that contemplates both probability of default and risk of loss given default. Loans are graded on a scale of 1 to 10 and, loans graded 1 - 6 are considered “pass” grade loans. A description of the general characteristics of the AQR risk classifications are as follows:
Pass grade loans - 1 through 6: The borrower demonstrates sufficient cash flow to fund debt service, including acceptable profit margins, cash flows, liquidity and other balance sheet ratios. Historic and projected performance indicates that the borrower is able to meet obligations under most economic circumstances. The company has competent management with an acceptable track record. The category does not include loans with undue or unwarranted credit risks that constitute identifiable weaknesses.
Special Mention - 7: A "special mention" credit has weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of either the repayment prospects for the asset or the Bank's credit position at some future date. Special mention assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Loans are currently protected, but are weak due to negative trends in the balance sheet and income statement. Current cash flow may be insufficient to meet debt service, with prospects that the condition may not be temporary. Profitability and key balance sheet ratios are below peers. There is a lack of effective control over collateral or there are documentation deficiencies as well as a potential risk of payment default. Collateral coverage is minimal in gross dollars or due to quality issues. Financial information may be inadequate to show the recent condition of borrower. The loan would not be approved as a new credit, and new loans would not be granted. Management may not be adequately qualified or may have very limited prior experience with similar activities or markets. The ability of management to cope with current conditions is questionable. Internal conflict and turnover in key positions may be present. Succession is unclear. The borrower's asset quality is below average. The capital base may be insufficient to cover capital losses. Leverage is above average or increasing. The industry outlook is generally negative but there are reasonable expectations of a turnaround within 12-18 months. The firm may be new, resulting in competitive deficiencies in comparison to the older, more established firms in the industry. Over-capacity may be evident in the industry. Collateral and guarantor strength are comparable to Management Attention-6, but agings and certifications of accounts receivable and inventory are required and are not being provided on a regular basis.
Substandard - 8: A "substandard" credit is inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loans have well-defined weaknesses where a payment default and/or a loss are possible, but not yet probable. Cash flow is insufficient to service debt, with prospects that the condition is permanent. Assets classified as substandard are inadequately protected by the current net worth and paying capacity of the borrower, and there is a likelihood that collateral will have to be liquidated and/or the guarantor called upon to repay the debt. Generally, the loan is considered collectible as to both principal and interest, primarily because of collateral coverage. Loan(s) may have been restructured at less than market terms or have been partially charged off. If deficiencies are not corrected quickly, there is a probability of loss and the borrower’s ability to operate as a going concern may be deemed questionable/is questionable. Management has no prior experience with similar activities, demonstrating inability to realistically address problems and meet commitments. The borrower’s asset quality is poor. The capital base is weak and insufficient to absorb continuing losses, and leverage is significantly above peers. Liquidity is poor with significant reliance on short-term borrowing to support trade debt. Key balance sheet ratios are substantially inferior to industry norms. The industry is currently trending downward or demonstrating recovery from an adverse cycle. The outlook is generally negative at this time. Timing of recovery is unclear, but expectations are that market conditions will improve within 18-24 months. The borrower has substantial competitive deficiencies when compared to other firms, such as excess capacity and over-supply, resulting in frequent and significant concessions and discounting. Business failures are prevalent. Collateral coverage is marginal or non-existent. Collateral may be located outside the borrower’s market area. There are no agings or certifications of accounts receivable and inventory being received from the borrower, and collateral has doubtful marketability/convertibility. If guaranteed, the guarantor has limited outside worth and is highly leveraged with a poor credit report, which may reflect liens, collection problems, or lawsuits.
Doubtful - 9: An asset classified "doubtful" has all the weaknesses inherent in one that is classified "substandard-8" with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable and improbable. The loan has substandard characteristics, and available
information suggests that it is unlikely that the loan will be repaid in its entirety. Cash flow is insufficient to service debt. The company has had a series of substantial losses. If the current material adverse trends continue, it is unlikely the borrower will have the ability to meet the terms of the loan agreement. It may be difficult to predict the exact amount of loss, but the probability of some loss is greater than 50%. Loans are to be placed on non-accrual status when any portion is classified as doubtful. Non-accrual loans would not be classified "doubtful" as long as the collateral appears adequate to retire the outstanding balance. Management is clearly unable to address problems and meet commitments, and there is little expectation either of improvement or for sustaining the relationship with current management. The company is highly illiquid with excessive leverage. Key balance sheet ratios are at unacceptable levels, and downturn is severe. Timing of recovery is undeterminable. The company is unable to compete; collateral and guarantees provide limited support.
Loss - 10: An asset classified "loss" is considered uncollectable and of such little value that its continuance on the books is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this basically worthless asset, even though partial recovery may be affected in the future. The loan has doubtful characteristics, but the loan will definitely not be repaid in full. Debt service coverage clearly reflects the company's inability to service debt. The borrower cannot generate sufficient cash flow to cover fixed charges. All near-term and long-term trends concerning cash flow and earnings are negative. The damage to the financial condition of the Company cannot be reversed at this point in time. Collateral and guarantees provide no support.
The composition of the loan portfolio as of the periods indicated is as follows:
(In Thousands) Commercial Real estate construction one-to-four family Real estate construction other Real estate term owner occupied Real estate term non-owner occupied Real estate term other Consumer secured by 1st deeds of trust Consumer other Total
December 31, 2020
AQR Pass $765,952 $37,380 $80,315 $153,607 $291,382 $43,290 $15,441 $21,963 $1,409,330
AQR Special Mention 6,241 385 - 3,028 17,097 2,154 - - 28,905
AQR Substandard 6,378 702 - 6,962 595 1,176 144 106 16,063
AQR Doubtful 1,487 - - - - - - - 1,487
Subtotal $780,058 $38,467 $80,315 $163,597 $309,074 $46,620 $15,585 $22,069 $1,455,785
Less: Unearned origination fees, net of origination costs (11,735)
Total loans $1,444,050
December 31, 2019
AQR Pass $394,107 $34,132 $61,808 $129,959 $295,482 $38,771 $15,860 $24,464 $994,583
AQR Special Mention 2,279 3,337 - 3,828 17,478 2,559 179 - 29,660
AQR Substandard 16,304 1,349 - 5,104 - 1,176 159 121 24,213
Subtotal $412,690 $38,818 $61,808 $138,891 $312,960 $42,506 $16,198 $24,585 $1,048,456
Less: Unearned origination fees, net of origination costs (5,085)
Total loans $1,043,371
The above table includes $310.5 million in PPP loans administered by the SBA within the Commercial loan segment as of December 31, 2020. Additionally, unearned origination fees, net of origination costs includes $5.9 million associated with SBA PPP loans as of December 31, 2020.
At December 31, 2020, approximately 73% of the Company’s loans, excluding PPP loans, are secured by real estate and 2% are unsecured. Approximately 25% are for general commercial uses, including professional, retail, and small businesses. Repayment is expected from the borrowers’ cash flow or, secondarily, the collateral. The Company’s exposure to credit loss, if any, is the outstanding amount of the loan if the collateral is determined to be of no value.
Nonaccrual Loans
Nonaccrual loans net of government guarantees totaled $9.6 million and $14.0 million at December 31, 2020 and December 31, 2019, respectively. Interest income which would have been earned on nonaccrual loans for 2020, 2019, and 2018 amounted to $856,000, $1.3 million, and $1.3 million, respectively. Additionally, the Company recognized interest income of $924,000, $301,000, and $159,000 in 2020, 2019, and 2018, respectively, related to interest collected on nonaccrual loans whose principal has been paid down to zero. Nonaccrual loans at the periods indicated, by segment are presented below:
(In Thousands) 30-59 Days
Past Due 60-89 Days
Past Due Greater Than
90 Days Past Due Current Total
December 31, 2020
Commercial $48 $229 $3,673 $1,626 $5,576
Real estate construction one-to-four family - - 702 - 702
Real estate term owner occupied - - 1,520 1,977 3,497
Real estate term other - - 1,176 - 1,176
Consumer secured by 1st deeds of trust - - - 63 63
Consumer other 20 - - 86 106
Total nonaccrual loans 68 229 7,071 3,752 11,120
Government guarantees on nonaccrual loans (35) (258) - (1,228) (1,521)
Net nonaccrual loans $33 ($29) $7,071 $2,524 $9,599
December 31, 2019
Commercial $270 $385 $2,862 $5,636 $9,153
Real estate construction one-to-four family - - 1,349 - 1,349
Real estate term owner occupied 1,641 - 623 1,225 3,489
Real estate term other - - 1,176 - 1,176
Consumer secured by 1st deeds of trust - - - 68 68
Consumer other 26 89 - 6 121
Total nonaccrual loans 1,937 474 6,010 6,935 15,356
Government guarantees on nonaccrual loans (268) - - (1,137) (1,405)
Net nonaccrual loans $1,669 $474 $6,010 $5,798 $13,951
Past Due Loans
There was one past due loan greater than 90 days and still accruing interest at December 31, 2020 and no past due loans greater than 90 days and still accruing interest at December 31, 2019. Past due loans and nonaccrual loans at the periods indicated are presented below by loan class:
(In Thousands) 30-59 Days
Past Due
Still
Accruing 60-89 Days
Past Due
Still
Accruing Greater Than
90 Days
Still
Accruing Total Past
Due Nonaccrual Current Total
December 31, 2020
Commercial $387 $- $- $387 $5,576 $774,095 $780,058
Real estate construction one-to-four family - - - - 702 37,765 38,467
Real estate construction other - - - - - 80,315 80,315
Real estate term owner occupied - - 449 449 3,497 159,651 163,597
Real estate term non-owner occupied - - - - - 309,074 309,074
Real estate term other - - - - 1,176 45,444 46,620
Consumer secured by 1st deed of trust 483 - - 483 63 15,039 15,585
Consumer other 18 - - 18 106 21,945 22,069
Subtotal $888 $- $449 $1,337 $11,120 $1,443,328 $1,455,785
Less: Unearned origination fees, net of origination costs (11,735)
Total $1,444,050
December 31, 2019
Commercial $270 $- $- $270 $9,153 $403,267 $412,690
Real estate construction one-to-four family - - - - 1,349 37,469 38,818
Real estate construction other - - - - - 61,808 61,808
Real estate term owner occupied 338 - - 338 3,489 135,064 138,891
Real estate term non-owner occupied - - - - - 312,960 312,960
Real estate term other 26 - - 26 1,176 41,304 42,506
Consumer secured by 1st deed of trust 750 - - 750 68 15,380 16,198
Consumer other 150 - - 150 121 24,314 24,585
Subtotal $1,534 $- $- $1,534 $15,356 $1,031,566 $1,048,456
Less: Unearned origination fees, net of origination costs (5,085)
Total $1,043,371
Impaired Loans
At December 31, 2020 and 2019, the recorded investment in loans that are considered to be impaired was $18.0 million and $24.7 million, respectively. The following table presents information about impaired loans by class for the years ended December 31, 2020 and 2019:
(In Thousands) Recorded Investment Unpaid Principal Balance Related Allowance
December 31, 2020
With no related allowance recorded
Commercial - AQR substandard $6,299 $6,979 $-
Commercial - AQR doubtful 1,179 1,308 -
Real estate construction one-to-four family - AQR substandard 702 702 -
Real estate term owner occupied - AQR substandard 6,962 7,047 -
Real estate term non-owner occupied - AQR pass 176 176 -
Real estate term non-owner occupied - AQR substandard 595 595 -
Real estate term other - AQR pass 291 291 -
Real estate term other - AQR substandard 1,176 1,176 -
Consumer secured by 1st deeds of trust - AQR pass 114 114 -
Consumer secured by 1st deeds of trust - AQR substandard 144 144 -
Consumer other - AQR substandard 82 87 -
Subtotal $17,720 $18,619 $-
With an allowance recorded
Commercial - AQR doubtful $308 $308 $13
Subtotal $308 $308 $13
Commercial - AQR substandard $6,299 $6,979 $-
Commercial - AQR doubtful 1,487 1,616 13
Real estate construction one-to-four family - AQR substandard 702 702 -
Real estate term owner-occupied - AQR substandard 6,962 7,047 -
Real estate term non-owner occupied - AQR pass 176 176 -
Real estate term non-owner occupied - AQR substandard 595 595 -
Real estate term other - AQR pass 291 291 -
Real estate term other - AQR substandard 1,176 1,176 -
Consumer secured by 1st deeds of trust - AQR pass 114 114 -
Consumer secured by 1st deeds of trust - AQR substandard 144 144 -
Consumer other - AQR substandard 82 87 -
Total $18,028 $18,927 $13
(In Thousands) Recorded Investment Unpaid Principal Balance Related Allowance
December 31, 2019
With no related allowance recorded
Commercial - AQR substandard $15,517 $15,582 $-
Real estate construction one-to-four family - AQR substandard 1,349 1,349 -
Real estate term owner occupied - AQR substandard 5,104 5,104 -
Real estate term non-owner occupied - AQR pass 178 178 -
Real estate term other - AQR pass 417 417 -
Real estate term other - AQR substandard 1,176 1,176 -
Consumer secured by 1st deeds of trust - AQR pass 122 122 -
Consumer secured by 1st deeds of trust - AQR substandard 159 163 -
Consumer other - AQR substandard 90 94 -
Subtotal $24,112 $24,185 $-
With an allowance recorded
Commercial - AQR substandard $561 $561 $17
Subtotal $561 $561 $17
Commercial - AQR substandard $16,078 $16,143 $17
Real estate construction one-to-four family - AQR substandard 1,349 1,349 -
Real estate term owner-occupied - AQR substandard 5,104 5,104 -
Real estate term non-owner occupied - AQR pass 178 178 -
Real estate term other - AQR pass 417 417 -
Real estate term other - AQR substandard 1,176 1,176 -
Consumer secured by 1st deeds of trust - AQR pass 122 122 -
Consumer secured by 1st deeds of trust - AQR substandard 159 163 -
Consumer other - AQR substandard 90 94 -
Total $24,673 $24,746 $17
The unpaid principal balance included in the table above represents the recorded investment at the dates indicated, plus amounts charged-off for book purposes.
The following table summarizes our average recorded investment and interest income recognized on impaired loans for years ended December 31, 2020 and 2019, respectively:
Year Ended December 31, 2020 2019
(In Thousands) Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized
With no related allowance recorded
Commercial - AQR pass $- $- $532 $35
Commercial - AQR substandard 9,111 139 16,892 405
Commercial - AQR doubtful 433 - - -
Real estate construction one-to-four family - AQR substandard 781 - 1,933 -
Real estate term owner occupied - AQR substandard 6,739 125 5,747 113
Real estate term non-owner occupied - AQR pass 177 10 251 19
Real estate term non-owner occupied - AQR substandard 385 19 230 -
Real estate term other - AQR pass 362 20 448 31
Real estate term other - AQR substandard 1,189 - 1,046 -
Consumer secured by 1st deeds of trust - AQR pass 118 9 126 13
Consumer secured by 1st deeds of trust - AQR substandard 148 3 202 7
Consumer secured by 1st deeds of trust - AQR loss 33 - - -
Consumer other - AQR substandard 86 - 70 -
Subtotal $19,562 $325 $27,477 $623
With an allowance recorded
Commercial - AQR substandard $1,343 $8 $683 $-
Commercial - AQR doubtful 77 - - -
Real estate term other - AQR substandard - - 163 -
Consumer secured by 1st deeds of trust - AQR substandard - - 72 -
Subtotal $1,420 $8 $918 $-
Total
Commercial - AQR pass $- $- $532 $35
Commercial - AQR substandard 10,454 147 17,575 405
Commercial - AQR doubtful 510 - - -
Real estate construction one-to-four family - AQR substandard 781 - 1,933 -
Real estate term owner-occupied - AQR substandard 6,739 125 5,747 113
Real estate term non-owner occupied - AQR pass 177 10 251 19
Real estate term non-owner occupied - AQR substandard 385 19 230 -
Real estate term other - AQR pass 362 20 448 31
Real estate term other - AQR substandard 1,189 - 1,209 -
Consumer secured by 1st deeds of trust - AQR pass 118 9 126 13
Consumer secured by 1st deeds of trust - AQR substandard 148 3 274 7
Consumer secured by 1st deeds of trust - AQR loss 33 - - -
Consumer other - AQR substandard 86 - 70 -
Total Impaired Loans $20,982 $333 $28,395 $623
The average recorded investment was $34.7 million, and interest income recognized on impaired loans was $847,000 for the year ended December 31, 2018.
Troubled Debt Restructurings
Loans classified as TDRs totaled $7.9 million and $10.1 million at December 31, 2020 and 2019, respectively. A TDR is a loan to a borrower that is experiencing financial difficulty that has been modified from its original terms and conditions in such a way that the Company is granting the borrower a concession of some kind. The provisions of the Coronavirus Aid, Relief, and Economic Security ("CARES") Act included an election to not apply the guidance on accounting for TDRs to loan modifications, such as extensions or deferrals, related to COVID-19 made between March 1, 2020 and the earlier of (i) January 1, 2022 or (ii) 60 days after the end of the COVID-19 national emergency. The relief can only be applied to modifications for borrowers that were not more than 30 days past due as of December 31, 2019. The Company has elected to adopt these provisions of the CARES Act. As of December 301 2020, the Company has made the following types of loan modifications related to COVID-19, which are not classified as TDRs with principal balance outstanding of:
(Dollars in thousands) Interest Only Full Payment Deferral Total
Portfolio loans $43,379 $22,165 $65,544
Number of modifications 23 11 34
The Company has granted a variety of concessions to borrowers in the form of loan modifications. The modifications granted can generally be described in the following categories:
Rate Modification: A modification in which the interest rate is changed.
Term Modification: A modification in which the maturity date, timing of payments, or frequency of payments is changed.
Payment Modification: A modification in which the dollar amount of the payment is changed, or in which a loan is converted to interest only payments for a period of time is included in this category.
Combination Modification: Any other type of modification, including the use of multiple categories above.
AQR pass graded loans included above in the impaired loan data are loans classified as TDRs. By definition, TDRs are considered impaired loans. All of the Company’s TDRs are included in impaired loans.
The following table presents the breakout between newly restructured loans that occurred during 2020 and restructured loans that occurred prior to 2020 that are still included in portfolio loans. As discussed above, the CARES Act provided banks an option to elect to not account for certain loan modifications related to COVID-19 as TDRs as long as the borrowers were not more than 30 days past due as of December 31, 2019. The below disclosed restructurings were not related to COVID-19 modifications:
Accrual Status Nonaccrual Status Total Modifications
(In Thousands)
New Troubled Debt Restructurings
Commercial - AQR substandard $1,590 $161 $1,751
Subtotal $1,590 $161 $1,751
Existing Troubled Debt Restructurings 765 5,344 6,109
Total $2,355 $5,505 $7,860
The following tables present newly restructured loans that occurred during 2020 and 2019, by concession (terms modified):
December 31, 2020
(In Thousands) Number of Contracts Rate Modification Term Modification Payment Modification Combination Modification Total Modifications
Pre-Modification Outstanding Recorded Investment:
Commercial - AQR substandard 2 $- $3,249 $164 $- $3,413
Total 2 $- $3,249 $164 $- $3,413
Post-Modification Outstanding Recorded Investment:
Commercial - AQR substandard 2 $- $1,590 $161 $- $1,751
Total 2 $- $1,590 $161 $- $1,751
December 31, 2019
(In Thousands) Number of Contracts Rate Modification Term Modification Payment Modification Combination Modification Total Modifications
Pre-Modification Outstanding Recorded Investment:
Commercial - AQR substandard 7 $- $- $509 $2,585 $3,094
Real estate term owner occupied - AQR substandard 1 - - 192 - 192
Total 7 $- $- $701 $2,585 $3,286
Post-Modification Outstanding Recorded Investment:
Commercial - AQR substandard 7 $- $- $408 $2,561 $2,969
Real estate term owner occupied - AQR substandard 1 - - 182 - 182
Total 7 $- $- $590 $2,561 $3,151
The Company had no commitments to extend additional credit to borrowers owing receivables whose terms have been modified in TDRs at December 31, 2020. There were zero charge-offs in 2020 on loans that were later classified as a TDR and there were $64,000 of charge-offs in 2019 on loans that were later classified as a TDR in 2019.
All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation of the Allowance. There was one TDR with specific impairment at December 31, 2020 and none at December 31, 2019, respectively.
There were no loans that were restructured during 2020 or 2019, that also subsequently defaulted within the first twelve months of restructure in those same periods. The following table presents TDRs that occurred during 2018 that subsequently defaulted during the twelve-months ended December 31, 2018:
December 31, 2018
Number of Contracts Recorded Investment
(In Thousands)
Troubled Debt Restructurings that Subsequently Defaulted:
Commercial - AQR substandard 4 $1,166
Real estate term owner occupied - AQR substandard 2 1,694
Total 6 $2,860
Loans to Related Parties
Certain directors, and companies of which directors are principal owners, have loans and other transactions such as architectural fees with the Company. Such transactions are made on substantially the same terms, including interest rates and collateral required, as those prevailing for similar transactions of unrelated parties. An analysis of the loan transactions for the years indicated follows:
(In Thousands) 2020 2019 2018
Balance, beginning of the year $309 $- $-
Loans made - 309 -
Repayments 92 - -
Balance, end of year $217 $309 $-
The Company had $15,000 of unfunded loan commitments to these directors or their related interests on December 31, 2020 and 2019.
Pledged Loans
At December 31, 2020 and 2019, there were no loans pledged as collateral to secure public deposits.
NOTE 6 - Allowance for Loan Losses
The following table details activity in the Allowance for the periods indicated:
(In Thousands) Commercial Real estate construction one-to-four family Real estate construction other Real estate term owner occupied Real estate term non-owner occupied Real estate term other Consumer secured by 1st deed of trust Consumer other Unallocated Total
Balance, beginning of period $6,604 $643 $1,017 $2,188 $5,180 $671 $270 $436 $2,079 $19,088
Charge-Offs (1,021) - - (85) - - - (15) - (1,121)
Recoveries 710 - - - - 2 - 25 - 737
Provision (benefit) 1,680 36 162 522 (47) 106 (9) (46) 28 2,432
Balance, end of period $7,973 $679 $1,179 $2,625 $5,133 $779 $261 $400 $2,107 $21,136
Balance, end of period:
Individually evaluated
for impairment $13 $- $- $- $- $- $- $- $- $13
Balance, end of period:
Collectively evaluated
for impairment $7,960 $679 $1,179 $2,625 $5,133 $779 $261 $400 $2,107 $21,123
Balance, beginning of period $5,660 $675 $1,275 $2,027 $5,799 $716 $306 $426 $2,635 $19,519
Charge-Offs (195) - - - - - (4) (18) - (217)
Recoveries 908 - - - - 28 - 25 - 961
Provision (benefit) 231 (32) (258) 161 (619) (73) (32) 3 (556) (1,175)
Balance, end of period $6,604 $643 $1,017 $2,188 $5,180 $671 $270 $436 $2,079 $19,088
Balance, end of period:
Individually evaluated
for impairment $17 $- $- $- $- $- $- $- $- $17
Balance, end of period:
Collectively evaluated
for impairment $6,587 $643 $1,017 $2,188 $5,180 $671 $270 $436 $2,079 $19,071
Balance, beginning of period $6,172 $629 $1,566 $2,194 $6,043 $725 $315 $307 $3,510 $21,461
Charge-Offs (1,716) - - - - (28) (143) (39) - (1,926)
Recoveries 442 - - - 3 12 27 - 484
Provision (benefit) 762 46 (291) (167) (244) 16 122 131 (875) (500)
Balance, end of period $5,660 $675 $1,275 $2,027 $5,799 $716 $306 $426 $2,635 $19,519
Balance, end of period:
Individually evaluated
for impairment $14 $- $- $- $- $- $- $- $- $14
Balance, end of period:
Collectively evaluated
for impairment $5,646 $675 $1,275 $2,027 $5,799 $716 $306 $426 $2,635 $19,505
The following is a detail of the recorded investment, including unearned origination fees, net of origination costs, in the loan portfolio, segregated by amounts evaluated individually or collectively in the Allowance at the periods indicated:
(In Thousands) Commercial Real estate construction one-to-four family Real estate construction other Real estate term owner occupied Real estate term non-owner occupied Real estate term other Consumer secured by 1st deed of trust Consumer other Total
December 31, 2020
Balance, end of period $772,468 $38,180 $79,403 $162,724 $307,247 $46,230 $15,548 $22,250 $1,444,050
Balance, end of period:
Individually evaluated
for impairment $7,786 $702 $- $6,962 $770 $1,467 $259 $82 $18,028
Balance, end of period:
Collectively evaluated
for impairment $764,682 $37,478 $79,403 $155,762 $306,477 $44,763 $15,289 $22,168 $1,426,022
December 31, 2019
Balance, end of period $411,327 $38,503 $60,906 $138,181 $311,302 $42,200 $16,191 $24,761 $1,043,371
Balance, end of period:
Individually evaluated
for impairment $16,077 $1,349 $- $5,104 $178 $1,594 $281 $90 $24,673
Balance, end of period:
Collectively evaluated
for impairment $395,250 $37,154 $60,906 $133,077 $311,124 $40,606 $15,910 $24,671 $1,018,698
The following represents the balance of the Allowance for the periods indicated segregated by segment and class:
(In Thousands) Total Commercial Real estate construction 1-4 family Real estate construction other Real estate term owner occupied Real estate term non-owner occupied Real estate term other Consumer secured by 1st deeds of trust Consumer other Unallocated
December 31, 2020
Individually evaluated for impairment
AQR Doubtful $13 $13 $- $- $- $- $- $- $- $-
Collectively evaluated for impairment:
AQR Pass 18,626 7,801 672 1,179 2,573 5,001 742 261 397 -
AQR Special Mention 384 156 7 - 52 132 37 - - -
AQR Substandard 6 3 - - - - - - 3 -
Unallocated 2,107 - - - - - - - - 2,107
$21,136 $7,973 $679 $1,179 $2,625 $5,133 $779 $261 $400 $2,107
December 31, 2019
Individually evaluated for impairment:
AQR Substandard $17 $17 $- $- $- $- $- $- $- $-
Collectively evaluated for impairment:
AQR Pass 16,399 6,514 588 1,017 2,125 4,829 629 266 431 -
AQR Special Mention 579 64 55 - 63 351 42 4 - -
AQR Substandard 14 9 - - - - - - 5 -
Unallocated 2,079 - - - - - - - - 2,079
$19,088 $6,604 $643 $1,017 $2,188 $5,180 $671 $270 $436 $2,079
NOTE 7 - Purchased Receivables
We purchase accounts receivable from our business customers and provide them with short-term working capital. We provide this service to our customers in Alaska and in Washington and the greater west coast through NFS. Our purchased receivable activity is guided by policies that outline risk management, documentation, and approval limits. The policies are reviewed and approved annually by the Board of Directors.
Purchased receivables are carried at their principal amount outstanding, net of a reserve for inherent losses that have not yet been identified, and have a maturity of less than one year. Purchased receivable balances are charged against this reserve when management believes that collection of principal is unlikely. Management evaluates the adequacy of the reserve for purchased receivable losses based on historical loss experience by segment and class of receivable and its assessment of current economic conditions. As of December 31, 2020, the Company has one segment and class of purchased receivables. There are no purchased receivables past due at December 31, 2020 or 2019, and there were no restructured purchased receivables in 2020, 2019, or 2018.
Income on purchased receivables is accrued and recognized on the balance outstanding using an effective interest method, except when management believes doubt exists as to the collectability of the income or principal. As of December 31, 2020, the Company is accruing income on all purchased receivable balances outstanding.
The following table summarizes the components of net purchased receivables at December 31, for the years indicated:
(In Thousands) 2020 2019
Purchased receivables $13,995 $24,467
Reserve for purchased receivable losses (73) (94)
Total $13,922 $24,373
The following table sets forth information regarding changes in the purchased receivable reserve for the periods indicated:
(In Thousands) 2020 2019 2018
Balance at beginning of year $94 $190 $200
Reserve for (recovery from) purchased receivables (21) (96) (10)
Balance at end of year $73 $94 $190
The Company recorded no charge-offs of purchased receivables in 2020, 2019, or 2018.
NOTE 8 - Other Real Estate Owned
At December 31, 2020 and 2019, the Company held $7.3 million and $7.0 million, respectively, as OREO. The following table details net operating (income) expense related to OREO for the years indicated:
Years Ended December 31,
(In Thousands) 2020 2019 2018
OREO (income) expense, net rental income and gains on sale:
OREO operating expense $658 $693 $802
Impairment on OREO - - -
Rental income on OREO (509) (506) (541)
Gains on sale of OREO (391) (380) (3)
Total ($242) ($193) $258
NOTE 9 - Premises and Equipment
The following summarizes the components of premises and equipment at December 31 for the years indicated:
(In Thousands) Useful Life 2020 2019
Land $5,137 $5,137
Furniture and equipment 3-7 years
13,157 11,778
Tenant improvements 2-15 years
9,182 9,161
Buildings 39 years 37,618 36,205
Total Premises and Equipment 65,094 62,281
Accumulated depreciation and amortization (26,992) (23,859)
Total Premises and Equipment, Net $38,102 $38,422
Depreciation expense and amortization of leasehold improvements was $3.1 million, $3.0 million, and $2.3 million for the years ended December 31, 2020, 2019, and 2018, respectively.
Related Party Transactions: The Company made no payments to related parties in 2020 or 2019 and $49,000 in payments to related parties for design consultation for Bank branches for the year ended December 31, 2018.
NOTE 10 - Servicing Rights
Mortgage servicing rights
The following table details the activity in the Company's MSR for the year indicated:
(In Thousands) 2020 2019 2018
Balance, beginning of period $11,920 $10,821 $7,305
Additions for new MSR capitalized 4,824 3,707 3,641
Changes in fair value:
Due to changes in model inputs of assumptions (1)
(2,701) (1,313) 591
Other (2)
(2,825) (1,295) (716)
Carrying value, December 31 $11,218 $11,920 $10,821
(1) Principally reflects changes in discount rates and prepayment speed assumptions, which are primarily affected by changes in interest rates.
(2) Represents changes due to collection/realization of expected cash flows over time.
The following table details information related to our serviced mortgage loan portfolio:
(In Thousands) December 31, 2020 December 31, 2019
Balance of mortgage loans serviced for others $683,117 $659,048
MSR as a percentage of serviced loans 1.64 % 1.81 %
The Company recognized servicing fees of $2.7 million, $2.4 million, and $1.9 million during 2020, 2019, and 2018, respectively, which includes contractually specified servicing fees and ancillary fees are included in "Mortgage banking income" as a component of other noninterest income in the Company's Consolidated Statements of Income.
The following table outlines the key assumptions used in measuring the fair value of mortgage servicing rights as of December 31, 2020 and 2019:
2020 2019
Average constant prepayment rate 13.05 % 10.61 %
Average discount rate 7.75 % 8.52 %
Key economic assumptions and the sensitivity of the current fair value for mortgage servicing rights to immediate adverse changes in those assumptions at December 31, 2020 and 2019 were as follows:
(In Thousands) December 31, 2020 December 31, 2019
Aggregate portfolio principal balance $683,117 $659,048
Weighted average rate of note 3.62 % 3.90 %
December 31, 2020 Base 1.0% Adverse Rate Change 2.0% Adverse Rate Change
Conditional prepayment rate 13.05 % 26.11 % 38.97 %
Discount rate 7.75 % 6.75 % 5.75 %
Fair value MSR $11,218 $7,455 $5,404
Percentage of MSR 1.64 % 1.09 % 0.79 %
December 31, 2019
Conditional prepayment rate 10.61 % 26.25 % 28.39 %
Discount rate 8.52 % 7.52 % 6.52 %
Fair value MSR $11,920 $7,005 $6,625
Percentage of MSR 1.81 % 1.06 % 1.01 %
The above tables show the sensitivity to market rate changes for the par rate coupon for a conventional one-to-four family Alaska Housing Finance Corporation/FNMA/FHLMC serviced home loan. The above tables reference a 100 basis point and 200 basis point decrease in note rates.
These sensitivities are hypothetical and should be used with caution as the tables above demonstrate the Company’s methodology for estimating the fair value of MSR is highly sensitive to changes in key assumptions. For example, actual prepayment experience may differ and any difference may have a material effect on MSR fair value. Changes in fair value resulting from changes in assumptions generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, in these tables, the effects of a variation in a particular assumption on the fair value of the MSR is calculated without changing any other assumption; in reality, changes in one factor may be associated with changes in another (for example, decreases in market interest rates may provide an incentive to refinance; however, this may also indicate a slowing economy and an increase in the unemployment rate, which reduces the number of borrowers who qualify for refinancing), which may magnify or counteract the sensitivities. Thus, any measurement of MSR fair value is limited by the conditions existing and assumptions made at a particular point in time. Those assumptions may not be appropriate if they are applied to a different point in time.
Commercial servicing rights
Commercial servicing right assets ("CSRs") have a carrying value of $1.3 million and $1.2 million at December 31, 2020 and 2019, respectively, and total commercial loans serviced for others were $274.6 million and $252.9 million at December 31, 2020 and 2019, respectively. Key assumptions used in measuring the fair value of CSRs as of December 31, 2020 and 2019 include a conditional prepayment rate of 9.66% and 12.25% and a discount rate of 9.46% and 11.70%, respectively.
NOTE 11 - Goodwill and Intangible Assets
A summary of goodwill and intangible assets at December 31, 2020 and 2019, is as follows:
(In Thousands) 2020 2019
Intangible assets:
Goodwill $15,017 $15,017
Core deposit intangible 79 127
Trade name intangible 950 950
Total $16,046 $16,094
The Company performed goodwill impairment testing at March 31, 2020, December 31, 2020 and December 31, 2019 in accordance with the policy described in Note 1 to the financial statements. The Company's policy dictates that the Company will perform interim impairment testing when a triggering event occurs. The Company performed the interim impairment test as of March 31, 2020 using a discounted cash flow approach. The estimated fair value of each of the Company's segments exceeded its carrying value as of March 31, 2020, and management therefore concluded that no impairment existed at that time.
At December 31, 2020, the Company performed its annual impairment test using a quantitative assessment. The Company estimated the fair value of the Company using two valuation methodologies including a control premium approach and a discounted cash flow approach. We then compared the estimated fair value of each segment to the carrying value at December 31, 2020 and concluded that no impairment existed at that time.
The Company recorded amortization expense of its intangible assets of $48,000, $60,000, and $70,000 for the years ended December 31, 2020, 2019, and 2018, respectively. Accumulated amortization for intangible assets was $6.0 million and $5.9 million at December 31, 2020 and 2019.
The future amortization expense required on these assets is as follows:
(In Thousands)
2021 $37
2022 25
2023 14
2024 3
2025 -
Thereafter -
Total $79
NOTE 12 - Leases
We adopted ASU 2016-02 Leases (Topic 842) ("ASU 2016-02") using the modified retrospective approach with an effective date as of January 1, 2019. Prior year financial statements were not recast under the new standard and, therefore, those amounts are not presented below. We elected the package of transition provisions available for expired or existing contracts, which allowed us to carryforward our historical assessments of (1) whether contracts are or contain leases, (2) lease classification and (3) initial direct costs. The Company also elected the practical expedient on not separating lease components from nonlease components for all operating leases. Additionally, the Company has elected to not apply ASU 2016-02 to short-term leases. Short-term leases are those leases that, at the lease commencement date, have a lease term of 12 months or less and do not include an option to purchase the underlying asset that the Company is reasonably certain to exercise.
The Company has lease agreements for land and office facilities that it occupies to operate several of its retail branch locations, as well as one storage facility, that are classified as operating leases and are recognized on the balance sheet as right-of-use ("ROU") assets and lease liabilities. Most of these leases contain options to extend the duration of the leases at management's discretion. Management has recognized these renewal options as part of its ROU asset and lease liabilities when management is reasonably certain to exercise these options. Whether or not management is reasonably certain to exercise such
an option is determined based on facts and circumstances for each individual lease. However, if a renewal option is offered at below market terms, management considers the exercise of that option to be reasonably certain for the purposes of calculating its ROU assets and lease liabilities. None of the Company's leases include residual value guarantees, and there are no restrictions or covenants imposed by these leases that impose significant additional financial obligations on the Company. The Company uses the rate implicit in each lease as the discount rate to determine the lease liability, which is the present value of lease payments not yet paid at the lease commencement date. If the rate implicit in each lease is not readily determinable, which is often the case, the Company uses its incremental borrowing rate as the discount rate. The incremental borrowing rate is the rate that the Company would have incurred to borrow the funds necessary to purchase the leased asset over a similar term.
As of December 31, 2020, the Company has operating lease ROU assets of $12.4 million and operating lease liabilities of $12.4 million. As of December 31, 2019, the Company has operating lease ROU assets of $14.3 million and operating lease liabilities of $14.2 million. The Company does not have any agreements that are classified as finance leases.
The following table presents additional information about the Company's operating leases:
(In Thousands) 2020 2019
Lease Cost
Operating lease cost(1)
$2,819 $2,704
Short term lease cost(1)
35 35
Total lease cost $2,854 $2,739
Other information
Operating leases - operating cash flows $2,681 $2,684
Weighted average lease term - operating leases, in years 10.72 10.82
Weighted average discount rate - operating leases 3.29 % 3.32 %
(1)Expenses are classified within occupancy expense on the Consolidated Statements of Income.
The table below reconciles the remaining undiscounted cash flows for the next five years for each twelve-month period presented and the total of the subsequent remaining years to the operating lease liabilities recorded on the balance sheet:
(In Thousands) Operating Leases
2021 $2,619
2022 2,215
2023 1,925
2024 1,795
2025 1,732
Thereafter 4,875
Total minimum lease payments $15,161
Less: amount of lease payment representing interest (2,783)
Present value of future minimum lease payments $12,378
NOTE 13 - Other Assets
A summary of other assets as of December 31, 2020 and 2019, is as follows:
(In Thousands) 2020 2019
Other assets:
Investment in Low Income Housing Partnerships $24,142 $27,841
Accrued interest receivable 7,979 4,512
Interest rate swaps not designated as hedging instruments 7,387 2,950
Bank owned life insurance, net 6,520 6,393
Taxes receivable 4,083 1,429
Interest rate lock commitments 4,034 810
Software 3,905 4,590
Equity method investments 2,462 2,232
Prepaid expenses 2,404 1,649
Deferred taxes, net 1,980 2,535
Commercial servicing rights 1,310 1,214
Repossessed assets 231 231
Other assets 2,051 1,690
Total $68,488 $58,076
Equity Method Investments: The Company applies the equity method of accounting for the following related entities:
•The Company owns a 24% interest in PWA, an investment advisory, trust, and wealth management business located in Seattle, Washington.
•The Company owns a 30% interest in Homestate Mortgage Company, LLC, a mortgage origination business located in Anchorage, Alaska.
Low Income Housing Partnerships: The following table shows the Company's commitments to invest in various low income housing tax credit partnerships. The Company earns a return on its investments in the form of tax credits and deductions that flow through to it as a limited partner in these partnerships. The Company recognized amortization expense of $3.5 million, $2.7 million, and $2.7 million in 2020, 2019, and 2018, respectively. The Company expects to fund its remaining $9.9 million in commitments on these investments through 2030.
(In Thousands) Date of original commitment Years over which tax benefits are earned Original commitment amount Less: life to date contributions Remaining commitment amount
USA 57 December 2006 15 3,000 (3,000) -
WNC December 2012 16 2,500 (2,500) -
R4 - Coronado March 2013 17 10,729 (10,616) 113
R4 - MVV May 2014 17 8,528 (8,328) 200
R4 - PJ33 June 2016 17 6,835 (6,512) 323
R4 - Coronado II July 2019 17 7,282 (1,665) 5,617
R4 - Duke Apartments November 2019 17 3,985 (372) 3,613
Total $42,859 ($32,993) $9,866
NOTE 14 - Deposits
Deposits: At December 31, 2020, the scheduled maturities of certificates of deposit are as follows:
(In Thousands)
2021 $128,970
2022 37,347
2023 6,890
2024 495
2025 135
Thereafter 1,794
Total $175,631
The Company offers the Certificate of Deposit Account Registry Service® (CDARS®) and Insured Cash Sweep® (ICS®) service as a member of Promontory Interfinancial Network, LLCSM (Network). When a Network member places a deposit using CDARS, that certificate of deposit is divided into amounts under the standard FDIC insurance maximum ($250,000) and is allocated among member banks, making the large deposit eligible for FDIC insurance. The ICS service allows the Company to place customers’ funds through the Network into demand deposit accounts and/or money market accounts at FDIC-insured banks that are also members of the ICS Network in increments below the standard FDIC insurance maximum ($250,000) so that both principal and interest are eligible for FDIC insurance. In addition to customer deposit placement, the CDARS and ICS service also allows placement of the Bank's own investment dollars. The Company had $9.4 million CDARS certificates of deposits and $86.5 million ICS deposits at December 31, 2020 and $1.2 million CDARS certificates of deposits and $44.5 million ICS deposits at December 31, 2019.
At December 31, 2020 and 2019, the Company held $4.6 million and $1.6 million, in deposits for related parties, including directors, executive officers, and their affiliates.
Interest expense: Interest expense on deposits is presented below:
(In Thousands) 2020 2019 2018
Interest-bearing demand accounts $108 $182 $8
Money market accounts 1,222 1,435 855
Savings accounts 717 1,083 744
Certificates of deposit $250,000 and greater 1,823 1,310 472
Certificates of deposit less than $250,000 1,409 951 228
Total $5,279 $4,961 $2,307
NOTE 15 - Borrowings
The Company has a maximum line of credit with the FHLB approximating 45% of eligible assets. FHLB advances are subject to collateral criteria that require the Company to pledge assets under a blanket pledge arrangement as collateral for its borrowings from the FHLB. Based on assets currently pledged and advances currently outstanding at December 31, 2020, the Company's available borrowing line is $232.7 million, representing approximately 11% of total assets. Additional advances of up to 45% of eligible assets, or $946.2 million, are dependent on the availability of acceptable collateral such as marketable securities or real estate loans, although all FHLB advances are secured by a blanket pledge of the Company’s assets. The Company has outstanding FHLB advances of $14.8 million and $8.9 million as of December 31, 2020 and 2019, respectively, which were originated to match fund low income housing projects that qualify for long-term fixed interest rates. These advances have original terms of either 18 or 20 years with 30 year amortization periods and fixed interest rates ranging from 1.23% to 3.25%.
The Federal Reserve Bank is holding $79.5 million of loans as collateral to secure available borrowing lines through the discount window of $46.4 million at December 31, 2020. There were no discount window advances outstanding at December 31, 2020 and 2019. The Company paid less than $1,000 in interest in 2020 and 2019 on this agreement. The
Company utilized the Federal Reserve Bank's PPPLF to fund SBA PPP loans during the second quarter of 2020, but has repaid those funds in full as of June 30, 2020. This advance had an interest rate of 0.35%.
The Company is subject to provisions under Alaska state law, which generally limit the amount of the Bank's outstanding debt to 35% of total assets or $736.0 million at December 31, 2020 and 15% of total assets $244.7 million at December 31, 2019.
Securities sold under agreements to repurchase were zero for both December 31, 2020 and 2019. The average balance outstanding of securities sold under agreement to repurchase during 2020 and 2019 was zero and $15.2 million, respectively, and the maximum outstanding at any month-end was zero and $36.6 million, respectively, during the same time periods. The securities sold under agreement to repurchase were held by the FHLB under the Company’s control.
The future principal payments that are required on the Company’s borrowings as of December 31, 2020, are as follows:
(In Thousands)
2021 $312
2022 412
2023 421
2024 431
2025 441
Thereafter 12,800
Total $14,817
The Company recognized interest expense of $387,000, $291,000, and $273,000 on borrowings and securities sold under repurchase agreements in 2020, 2019, and 2018, respectively. The average interest rates paid on long-term debt in the same periods was 3.12%, 3.39%, and 3.39%, respectively.
NOTE 16 - Junior Subordinated Debentures
In December of 2005, the Company formed a wholly-owned Connecticut statutory business trust subsidiary, Northrim Statutory Trust 2 (the “Trust 2”), which issued $10 million of guaranteed undivided beneficial interests in the Company’s Junior Subordinated Deferrable Interest Debentures (“Trust Preferred Securities 2”). These debentures qualify as Tier 1 capital under Federal Reserve Board guidelines. All of the common securities of Trust 2 are owned by the Company. The proceeds from the issuance of the common securities and the Trust Preferred Securities 2 were used by Trust 2 to purchase $10.3 million of junior subordinated debentures of the Company. Trust 2 is not consolidated in the Company’s financial statements in accordance with GAAP; therefore, the Company has recorded its investment in Trust 2 as an other asset and the subordinated debentures as a liability. The debentures, which represent the sole asset of Trust 2, accrue and pay distributions quarterly at a variable rate of 90-day LIBOR plus 1.37% per annum, adjusted quarterly, of the stated liquidation value of $1,000 per capital security. The interest rate on these debentures was 1.59% at December 31, 2020. The interest cost to the Company on these debentures was $219,000, $398,000, and $368,000 in 2020, 2019, and 2018, respectively. The Company has entered into contractual arrangements which, taken collectively, fully and unconditionally guarantee payment of: (i) accrued and unpaid distributions required to be paid on the Trust Preferred Securities 2; (ii) the redemption price with respect to any Trust Preferred Securities 2 called for redemption by Trust 2; and (iii) payments due upon a voluntary or involuntary dissolution, winding up or liquidation of Trust 2. The Trust Preferred Securities 2 are mandatorily redeemable upon maturity of the debentures on March 15, 2036, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by Trust 2 in whole or in part, on or after March 15, 2011. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued but unpaid interest.
NOTE 17 - Accumulated Other Comprehensive Income (Loss)
The following table shows changes in accumulated other comprehensive income (loss) by component for the years ended December 31, 2020, 2019, and 2018:
(In Thousands) Unrealized gains (losses) on securities available for sale Unrealized gains (losses) on derivatives and hedging Total
Balance at December 31, 2017 ($454) $184 ($270)
Other comprehensive income (loss), net of tax expense of $210
(482) 423 (59)
Reclassification for cumulative effect of adoption of accounting principles related to fair value measurement of equity securities (191) - (191)
Balance at December 31, 2018 ($1,127) $607 ($520)
Other comprehensive income (loss), net of tax benefit of $(757)
2,092 (1,141) 951
Balance at December 31, 2019 $965 ($534) $431
Other comprehensive income (loss), net of tax expense of $1,600
294 (707) (413)
Balance at December 31, 2020 $1,259 ($1,241) $18
NOTE 18 - Revenue
The Company's revenue is included in net interest income and other operating income on its Consolidated Statements of Income. Topic 606 in the Accounting Standards Codification ("Topic 606") includes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity's contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.
The majority of our ongoing revenue-generating transactions are not subject to Topic 606, including revenue associated with financial instruments and revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with MSRs, purchased receivable income, financial guarantees, and derivatives are also not in scope of the guidance. Topic 606 is applicable to noninterest revenue streams such as deposit related fees, interchange fees, merchant services income, and commissions from the sales of mutual funds and other investments. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s non-interest revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below.
Bankcard fees
Bankcard fees are primarily comprised of debit card income and ATM fees. Debit card income is primarily comprised of interchange fees earned whenever the Company’s debit cards are processed through card payment networks such as Visa or MasterCard. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. The Company’s performance obligation for bankcard fees are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payments are typically received immediately or in the following month.
Service charges on deposit accounts
Service charges on deposit accounts consist of general service fees for monthly account maintenance, activity- or transaction-based fees, and account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), and other deposit account related fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when our performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed. Payments for service
charges on deposit accounts are primarily received immediately or in the following month through a direct charge to customers’ accounts.
Other
Other operating income consists of other recurring revenue streams such as merchant services income, commissions from sales of mutual funds and other investments, safety deposit box rental fees, bank check and other check fees, unrealized gains and losses on marketable securities, and other miscellaneous revenue streams. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. The Company’s performance obligation for merchant services income is largely satisfied, and related revenue recognized, when the transactions have been completed. Payment is typically received immediately or in the following month. The Company earns commissions from the sale of mutual funds as periodic service fees (i.e., trailers) from Elliott Cove Capital Management typically based on a percentage of net asset value. Trailer revenue is recorded over time, quarterly, as net asset value is determined. The Company also earns commission income from the sale of annuity products. The Company acts as an intermediary between the Company's customer and Elliott Cove Investment Advisors for these transactions, and commissions from annuity product sales are recorded when the Company’s performance obligation is satisfied, which is generally upon the issuance of the annuity policy. The Company does not earn trailer fees on annuity sales. Payment for commissions from sales of mutual funds and other investments and annuity sales is typically received in the following quarter. Other service charges include revenue from safety deposit box rental fees, processing wire transfers, bank check and other check fees, and other services. The Company’s performance obligations for these other revenue streams are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payments are typically received immediately or in the following month.
The following presents other operating income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the years ended December 31, 2020, 2019 and 2018:
(In Thousands) December 31,
Other operating income 2020 2019 2018
In-scope of Topic 606:
Bankcard fees $2,837 $2,976 $2,811
Service charges on deposit accounts 1,102 1,557 1,508
Other 1,528 1,664 1,592
Other operating income (in-scope of Topic 606) $5,467 $6,197 $5,911
Other operating income (out-of-scope of Topic 606) 57,861 31,149 26,256
Total other operating income $63,328 $37,346 $32,167
Gains on the sale of OREO are also within the scope of Topic 606 and are recorded within other operating expense on the Company's Consolidated Statements of Income. Gains on the sale of OREO properties were $391,000, $380,000, and $3,000 for the years ended December 31, 2020, 2019, and 2018, respectively.
NOTE 19 - Employee Benefit Plans
Employees of the Company are eligible to participate in the Company's 401(k) plan immediately upon date of hire. Employees may elect to have a portion of their salary contributed to the 401(k) plan in accordance with Section 401(k) of the Internal Revenue Code of 1986. The Company provides for a mandatory $1.00 match for each $1.00 contributed by employees of Northrim Bank up to 5.5% of the employee’s eligible salary. The Company provides for a mandatory $1.00 match for each $1.00 contributed by employees of RML up to 2% of the employee’s eligible salary. Northrim Bank or RML may increase the matching contribution at the discretion of the Board of Directors. The Company expensed $1.7 million, $1.4 million, and $1.4 million, in 2020, 2019, and 2018, respectively, for 401(k) contributions and included this expense in "Salaries and other personal expense" in the Consolidated Statements of Income.
On July 1, 1994, Northrim Bank implemented a Supplemental Executive Retirement Plan for executive officers of Northrim Bank whose retirement benefits under the 401(k) plan have been limited under provisions of the Internal Revenue Code. Contributions to this plan totaled $290,000, $262,000, and $247,000, in 2020, 2019, and 2018, respectively. These expenses are included in "Salaries and other personnel expense" in the Consolidated Statements of Income. At December 31,
2020 and 2019, the balance of the accrued liability for this plan was included in "Other liabilities" and totaled $2.1 million and $2.1 million, respectively.
RML has established a Supplemental Executive Retirement Plan ("SERP"), under which RML has agreed to make payment to certain key executives, based on contributions made by RML to the plan and a variable rate of return. The SERP's assets primarily consist of the cash surrender value of life insurance policies. Contributions and earnings made to the participant accounts to the SERP are vested over ten years. The Company recorded expenses of $997,000, $580,000, and $489,000 in 2020, 2019, and 2018, respectively. RML's recorded obligation under the SERP amounted to $2.6 million and $2.8 million at December 31, 2020 and 2019, respectively, and was included in "Other liabilities".
In February of 2002, Northrim Bank implemented a non-qualified deferred compensation plan in which certain of the executive officers participate. Northrim Bank's net liability under this plan is dependent upon market gains and losses on assets held in the plan. Northrim Bank recognized an increase in its liability of $78,000 in 2020, an increase in its liability of $36,000 in 2019, and an increase in its liability of $52,000 in 2018. These changes are included in "Salaries and other personnel expense" in the Consolidated Statements of Income. At December 31, 2020 and 2019, the balance of the accrued liability for this plan was included in "Other liabilities" and totaled $1.6 million and $1.6 million, respectively.
In November of 2011, Northrim Bank implemented a Profit Sharing Plan. All employees of the Bank employed on the last day of the calendar year are eligible and will participate in the Profit Sharing Plan. The aggregate amount to be paid to employees under the Profit Sharing Plan is determined using Company-wide performance goals that are established by the Compensation Committee of the Board of Directors. If the performance goals are met for the year, profit sharing for the period is calculated based on a formula that is also approved by the Compensation Committee each year. The Compensation Committee has complete discretion to designate an employee as ineligible for profit sharing, or to adjust the amount of profit share payments by individual employee or in aggregate. The Compensation Committee approved management’s recommendation based upon the calculated payout under the Profit Sharing Plan’s methodology resulting in aggregate payouts of $3.7 million, $2.9 million, and $1.3 million for 2020, 2019, and 2018, respectively.
NOTE 20 - Commitments and Contingencies
Employee benefit plans: The Company is self-insured for medical, dental, and vision plan benefits provided to employees. The Company has obtained stop-loss insurance to limit total medical claims in any one year to $175,000 per covered individual. The Company has established a liability for outstanding incurred but unreported claims. While management uses what it believes are pertinent factors in estimating the liability, it is subject to change due to claim experience, type of claims, and rising medical costs.
Legal proceedings: The Company from time to time may be involved with disputes, claims, and litigation related to the conduct of its banking business. In the opinion of management, the resolution of these matters will not have a material effect on the Company’s financial position, results of operations, or cash flows.
Financial Instruments with Off-Balance Sheet Risk: In the ordinary course of business, the Company enters into various types of transactions that involve financial instruments with off-balance sheet risk. These instruments include commitments to extend credit and standby letters of credit and are not reflected in the accompanying balance sheets. These transactions may involve to varying degrees credit and interest rate risk in excess of the amount, if any, recognized in the balance sheets. Certain commitments are collateralized. We apply the same credit standards to these commitments as in all of our lending activities and include these commitments in our lending risk evaluations. Management does not anticipate any loss as a result of these commitments.
The Company’s off-balance sheet credit risk exposure is the contractual amount of commitments to extend credit and standby letters of credit. The Company applies the same credit standards to these contracts as it uses in its lending process.
(In Thousands) 2020 2019
Off-balance sheet commitments:
Commitments to extend credit $375,065 $301,911
Commitments to originate loans held for sale $150,276 $48,796
Standby letters of credit $2,333 $2,006
Commitments to extend credit are agreements to lend to customers. These commitments have specified interest rates and generally have fixed expiration dates but may be terminated by the Company if certain conditions of the contract are violated. Our exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. Although currently subject to draw down, many of the commitments do not necessarily represent future cash requirements. Collateral held relating to these commitments varies, but generally includes real estate, inventory, accounts receivable, and equipment.
Mortgage loans sold to investors may be sold with servicing rights released, for which the Company makes only standard legal representations and warranties as to meeting certain underwriting and collateral documentation standards. In the past two years, the Company has had to repurchase one loan due to deficiencies in underwriting or loan documentation and has not realized significant losses related to this loans. Management believes that any liabilities that may result from such recourse provisions are not significant.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Credit risk arises in these transactions from the possibility that a customer may not be able to repay the Company upon default of performance. Collateral held for standby letters of credit is based on an individual evaluation of each customer’s creditworthiness.
Total unfunded commitments were $527.7 million and $352.7 million at December 31, 2020 and 2019, respectively. The Company does not expect that all of these commitments are likely to be fully drawn upon at any one time. The Company has a reserve for losses related to these commitments and letters of credit that is recorded in "Other liabilities" on the Consolidated Balance Sheets. The reserve was $187,000 and $152,000 as of December 31, 2020 and 2019, respectively.
Capital Expenditures and Commitments: At December 31, 2020, the Company has capital commitments related to the planned improvements of two of the Company’s existing branches, as well as a new branch location. At December 31, 2020 the Company considers these commitments to be immaterial. There were no other material changes outside of the ordinary course of business to any of our material contractual obligations during 2020.
NOTE 21 - Derivatives
Interest rate swaps related to community banking activities
The Company enters into interest rate swaps with commercial banking customers which are offset with a corresponding swap agreement with a third party financial institution (“counterparty”). The Company has agreements with its counterparties that contain provisions that provide that if the Company fails to maintain its status as a well-capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements. These agreements also require that the Company and the counterparty collateralize any fair value shortfalls that exceed $250,000 with eligible collateral, which includes cash and securities backed with the full faith and credit of the federal government. Similarly, the Company could be required to settle its obligations under the agreement if specific regulatory events occur, such as if the Company were issued a prompt corrective action directive or a cease and desist order, or if certain regulatory ratios fall below specified levels. The Company pledged $10.7 million and $4.7 million in available for sale securities to collateralize fair value shortfalls on interest rate swap agreements as of December 31, 2020 and 2019, respectively.
The Company had interest rate swaps with an aggregate notional amount of $196.0 million and $94.4 million at December 31, 2020 and 2019, respectively. At December 31, 2020, the notional amount of interest rate swaps is made up of sixteen variable to fixed rate swaps to commercial loan customers totaling $98.0 million, and sixteen fixed to variable rate swap with a counterparty totaling $98.0 million. Changes in fair value from these thirty-two interest rate swaps offset each other in 2020 and 2019. The Company recognized $949,000, $964,000, and $84,000 in fee income related to interest rate swaps in 2020 and 2019, and 2018, respectively. Interest rate swap income is recorded in "Other income" on the Consolidated Statements of Income. None of these interest rate swaps are designated as hedging instruments.
The Company has an interest rate swap to hedge the variability in cash flows arising out of its junior subordinated debentures, which is floating rate debt, by swapping the cash flows with an interest rate swap which receives floating and pays fixed. The Company has designated this interest rate swap as a hedging instrument. The interest rate swap effectively fixes the Company's interest payments on the $10.0 million of junior subordinated debentures held under Trust 2 at 3.72% through its maturity date. The floating rate that the dealer pays is equal to the three month LIBOR plus 1.37%, which reprices quarterly on the payment date. This rate was 1.59% as of December 31, 2020. The Company pledged $2.9 million and $1.3 million in cash to collateralize initial margin and fair value exposure of our counterparty on this interest rate swap as of December 31, 2020 and 2019, respectively. Changes in the fair value of this interest rate swap are reported in other comprehensive income. The unrealized loss on this interest rate swap was $1.7 million and $534,000 as of December 31, 2020 and 2019, respectively.
Interest rate swaps related to home mortgage lending activities
The Company also uses derivatives to hedge the risk of changes in the fair values of interest rate lock commitments. The Company enters into commitments to originate residential mortgage loans at specific rates; the value of these commitments are detailed in the table below as "interest rate lock commitments". The Company also hedges the interest rate risk associated with its residential mortgage loan commitments using interest rate swaps, which are referred to as "retail interest rate contracts" in the table below. Market risk with respect to commitments to originate loans arises from changes in the value of contractual positions due to changes in interest rates. At December 31, 2020 and 2019, RML had commitments to originate mortgage loans held for sale totaling $150.3 million and $48.8 million, respectively. Changes in the value of RML's interest rate derivatives are recorded in "Mortgage banking income" on the Consolidated Statements of Income. None of these home mortgage lending derivatives are designated as hedging instruments.
The following table presents the fair value of derivatives not designated as hedging instruments:
(In Thousands) Asset Derivatives
December 31, 2020 December 31, 2019
Balance Sheet Location Fair Value Fair Value
Interest rate swaps Other assets $7,387 $2,950
Interest rate lock commitments Other assets 4,034 810
Total $11,421 $3,760
(In Thousands) Liability Derivatives
December 31, 2020 December 31, 2019
Balance Sheet Location Fair Value Fair Value
Interest rate swaps Other liabilities $7,387 $2,950
Retail interest rate contracts Other liabilities 880 71
Total $8,267 $3,021
The following table presents the net gains (losses) of derivatives not designated as hedging instruments:
(In Thousands) Income Statement Location December 31, 2020 December 31, 2019
Retail interest rate contracts Mortgage banking income ($7,980) ($922)
Interest rate lock commitments Mortgage banking income 3,062 (170)
Total ($4,918) ($1,092)
Our derivative transactions with counterparties under International Swaps and Derivative Association master agreements that include “right of set-off” provisions. “Right of set-off” provisions are legally enforceable rights to offset recognized amounts and there may be an intention to settle such amounts on a net basis. We do not offset such financial instruments for financial reporting purposes.
The following table summarizes the derivatives that have a right of offset as of December 31, 2020 and 2019:
December 31, 2020 Gross amounts not offset in the Statement of Financial Position
(In Thousands) Gross amounts of recognized assets and liabilities Gross amounts offset in the Statement of Financial Position Net amounts of assets and liabilities presented in the Statement of Financial Position Financial Instruments Collateral Posted Net Amount
Asset Derivatives
Interest rate swaps $7,387 $- $7,387 $- $- $7,387
Liability Derivatives
Interest rate swaps $7,387 $- $7,387 $- $7,387 $-
Retail interest rate contracts 880 - 880 - - 880
December 31, 2019 Gross amounts not offset in the Statement of Financial Position
(In Thousands) Gross amounts of recognized assets and liabilities Gross amounts offset in the Statement of Financial Position Net amounts of assets and liabilities presented in the Statement of Financial Position Financial Instruments Collateral Posted Net Amount
Asset Derivatives
Interest rate swaps $2,950 $- $2,950 $- $- $2,950
Liability Derivatives
Interest rate swaps $2,950 $- $2,950 $- $2,950 $-
Retail interest rate contracts 71 - 71 - - 71
NOTE 22 - Common Stock
Quarterly cash dividends were paid aggregating to $8.8 million, $8.5 million, and $7.1 million, or $1.38 per share, $1.26 per share, and $1.02 per share, in 2020, 2019, and 2018, respectively. On February 25, 2021, the Board of Directors declared a $0.37 per share cash dividend payable on March 19, 2021, to shareholders of record on March 11, 2021. Federal and State regulations place certain limitations on the payment of dividends by the Company.
In January 2020, the Company’s Board of Directors approved a plan whereby it would periodically repurchase for cash up to approximately 5% of its shares of common stock in the open market. At December, 31, 2020, there were no shares available under the stock repurchase program. However, on February 1, 2021 the Company announced that its Board of Directors authorized the repurchase of up to an additional 313,000 shares of common stock. The Company intends to continue to repurchase its stock from time to time depending upon market conditions. The Company can make no assurances that it will continue this program or that it will authorize additional shares for repurchase. During 2020, 2019 and 2018, 327,000, 347,676 and 15,468 shares were repurchased, respectively.
NOTE 23 - Stock-Based Compensation
The Company adopted the 2020 Stock Option Plan (“2020 Plan”) following shareholder approval of the 2020 Plan at the 2020 Annual Meeting. Subsequent to the adoption of the 2020 Plan, no additional grants may be issued under the prior plans. The 2020 Plan provides for grants of up to 325,000 shares, which includes any shares subject to stock awards under the previous stock option plans.
Stock Options: Under the 2020 Plan and previous plans, certain key employees have been granted the option to purchase set amounts of common stock at the market price on the day the option was granted. Optionees, at their own discretion, may pay cash to cover the cost of exercise, may cover the cost of exercise through the exchange at the then fair value of already owned shares of the Company’s stock, or they may cover the cost of exercise through net settlement of a portion of the stock options exercised in satisfaction of the exercise price and applicable tax withholding requirements. The two latter options are referred to as cashless stock option exercises. Options are granted for a 10-year period and vest on a pro-rata basis over the initial three years from the grant date.
The Company measures the fair value of each stock option at the date of grant using the Black-Scholes option pricing model using assumptions noted in the following table. Expected volatility is based on the historical volatility of the price of the Company’s common stock. The Company uses historical data to estimate option exercise and stock option forfeiture rates within the valuation model. The expected term of options granted is determined based on historical experience with similar options and represents the period of time that options granted are expected to be outstanding. The expected dividend yield is based on dividend trends and the market value of the Company’s common stock at the time of grant. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
The following assumptions were used to determine the fair value of stock options as of the grant date to determine compensation expense for the years ended December 31, 2020, 2019, and 2018:
Stock Options: 2020 2019 2018
Grant date fair value $6.55 $5.34 $7.69
Expected life of options 8 years 8 years 8 years
Risk-free interest rate 0.79 % 1.74 % 3.01 %
Dividend yield rate 4.55 % 4.11 % 2.91 %
Price volatility 35.44 % 24.34 % 23.47 %
The following table summarizes stock option activity during 2020:
Number of Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Life, in Years
Outstanding at January 1, 2020 158,620 $30.45
Granted 20,173 32.09
Forfeited - -
Exercised - -
Outstanding at December 31, 2020 178,793 $30.64 6.29
At December 31, 2020, 2019, and 2018, there were 136,038, 112,319, and 100,824 options exercisable, with weighted average exercise prices of $29.42, $28.17, and $26.50, respectively.
The aggregate intrinsic value of the stock options is the total pretax intrinsic value (i.e., the difference between the Company’s closing stock price on December 31, 2020 and the exercise price, times the number of shares) that would have been received by the option holders had all the option holders exercised their options on December 31, 2020. This amount changes based on the fair value of the Company’s stock. The total intrinsic value of options outstanding and exercisable as of December 31, 2020, 2019, and 2018 was $682,000, $1.1 million, and $646,000, respectively. The total intrinsic value of options exercised for the years ended December 31, 2020, 2019, and 2018 was zero, $203,000, and $383,000, respectively.
As noted above, the Company allows stock options to be exercised through cash or cashless transactions. In 2020, 2019, and 2018 the Company received cash of zero, zero, and $195,000, respectively, for cash stock option exercises. In 2020, 2019, and 2018 the Company net settled zero, $282,000, and $193,000 respectively, for cashless stock option exercises. The Company withheld zero, $317,000, and $227,000 to pay for stock option exercises or income taxes that resulted from the exercise of stock options in 2020, 2019, and 2018, respectively.
For the years ended December 31, 2020, 2019 and 2018, the Company recognized $148,000, $143,000, and $183,000, respectively, in stock option compensation expense as a component of "Salaries and other personnel expense". As of
December 31, 2020, there was approximately $258,000 of total unrecognized compensation expense related to non-vested options, which is expected to be recognized over the weighted-average vesting period of 2.2 years.
Restricted Stock Units: Under the 2020 Plan and previous plans, the Company grants restricted stock units to certain key employees periodically. Recipients of restricted stock units do not pay any cash consideration to the Company for the shares and receive all dividends with respect to such shares when the shares vest. Restricted stock units cliff vest at the end of a three-year time period.
The following table summarizes restricted stock unit activity during 2020:
Number of Shares Weighted Average Grant Date Fair Value Weighted Average Remaining Contractual Life, in Years
Outstanding at January 1, 2020 71,952 $34.16
Granted 22,709 32.09
Dividend equivalents awarded 3,688 27.65
Vested (25,532) 29.75
Forfeited - -
Outstanding at December 31, 2020 72,817 $33.33 2.21
The total intrinsic value of restricted stock units vested for the years ended December 31, 2020, 2019, and 2018 was $735,000, $906,000, and $654,000, respectively.
For the years ended December 31, 2020, 2019 and 2018, the Company recognized $795,000, $689,000, and $633,000, respectively, in restricted stock unit compensation expense as a component of "Salaries and other personnel expense". As of December 31, 2020, there was approximately $1.5 million of total unrecognized compensation expense related to non-vested options, which is expected to be recognized over the weighted-average vesting period of 2.2 years.
NOTE 24 - Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum requirements can initiate certain mandatory, and possibly discretionary, actions by regulators that, if undertaken, could have a direct material effect on a company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgment by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the following table) of total capital, Tier 1 capital, and common equity Tier 1 to risk-weighted assets, and of Tier 1 capital to average assets (as defined in the regulations).
The tables below illustrate the capital requirements for the Company and the Bank and the actual capital ratios for each entity that exceed these requirements. The dividends that the Bank pays to the Company are limited to the extent necessary for the Bank to meet the regulatory requirements of a “well-capitalized” bank. The capital ratios for the Company exceed those for the Bank primarily because the $10 million trust preferred securities offerings that the Company completed in the fourth quarter of 2005 are included in the Company’s capital for regulatory purposes although they are accounted for as a liability in its financial statements. The trust preferred securities are not included in the Bank's capital ratios.
Northrim BanCorp, Inc. Actual Adequately-Capitalized Well-Capitalized
(In Thousands) Amount Ratio Amount Ratio Amount Ratio
As of December 31, 2020:
Common equity tier 1 capital (to risk-weighted assets) $205,717 13.75 % $67,326 ≥ 4.5 % NA NA
Total Capital (to risk-weighted assets) $234,363 15.46 % $121,275 ≥ 8 % NA NA
Tier I Capital (to risk-weighted assets) $215,380 14.20 % $91,006 ≥ 6 % NA NA
Tier I Capital (to average assets) $215,380 10.25 % $84,051 ≥ 4 % NA NA
As of December 31, 2019:
Common equity tier 1 capital (to risk-weighted assets) $190,807 13.69 % $62,720 ≥ 4.5 % NA NA
Total Capital (to risk-weighted assets) $217,912 15.63 % $111,535 ≥ 8 % NA NA
Tier I Capital (to risk-weighted assets) $200,465 14.38 % $83,643 ≥ 6 % NA NA
Tier I Capital (to average assets) $200,465 12.41 % $64,614 ≥ 4 % NA NA
Northrim Bank Actual Adequately-Capitalized Well-Capitalized
(In Thousands) Amount Ratio Amount Ratio Amount Ratio
As of December 31, 2020:
Common equity tier 1 capital (to risk-weighted assets) $178,532 11.89 % $67,569 ≥ 4.5 % $97,599 ≥ 6.5 %
Total Capital (to risk-weighted assets) $197,233 13.13 % $120,172 ≥ 8 % $150,216 ≥ 10 %
Tier I Capital (to risk-weighted assets) $178,429 11.88 % $90,116 ≥ 6 % $120,154 ≥ 8 %
Tier I Capital (to average assets) $178,429 8.55 % $83,476 ≥ 4 % $104,344 ≥ 5 %
As of December 31, 2019:
Common equity tier 1 capital (to risk-weighted assets) $165,963 11.98 % $62,340 ≥ 4.5 % $90,047 ≥ 6.5 %
Total Capital (to risk-weighted assets) $183,299 13.24 % $110,755 ≥ 8 % $138,443 ≥ 10 %
Tier I Capital (to risk-weighted assets) $165,963 11.98 % $83,120 ≥ 6 % $110,827 ≥ 8 %
Tier I Capital (to average assets) $165,963 10.36 % $64,078 ≥ 4 % $80,098 ≥ 5 %
As of the most recent notification from its regulatory agencies, the Bank was categorized as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s regulatory capital category. Management believes, as of December 31, 2020, that the Company and Bank meets all capital adequacy requirements to which they are subject.
The Company and Bank are required to have a “conservation buffer,” consisting of a common equity Tier 1 capital amount equal to 2.5% of risk-weighted assets. An institution that does not meet the conservation buffer requirement will be subject to restrictions on certain activities including payment of dividends, stock repurchases, and discretionary bonuses to executive officers. Management believes, as of December 31, 2020, that the Company and Bank meet all conservation buffer requirements to which they are subject.
NOTE 25 - Income Taxes
Components of the provision for income taxes are as follows:
(In Thousands) Current Tax Expense (Benefit) Deferred Expense (Benefit) Total Expense
2020:
Federal $3,607 $371 $3,978
State 1,891 184 2,075
Amortization of investment in low income housing tax credit partnerships 3,506 - 3,506
Total $9,004 $555 $9,559
2019:
Federal $1,078 $476 $1,554
State 977 235 1,212
Amortization of investment in low income housing tax credit partnerships 2,668 - 2,668
Total $4,723 $711 $5,434
2018:
Federal ($1,549) $2,017 $468
State (85) 997 912
Amortization of investment in low income housing tax credit partnerships 2,691 - 2,691
Total $1,057 $3,014 $4,071
The actual expense for 2020, 2019, and 2018, differs from the “expected” tax expense (computed by applying the U.S. Federal Statutory Tax Rate of 21% for the years ended December 31, 2020, 2019 and 2018) as follows:
(In Thousands) 2020 2019 2018
Computed “expected” income tax expense $8,914 $5,486 $5,056
State income taxes, net 1,639 957 720
Tax-exempt interest on investment securities and loans (256) (300) (307)
Amortization of investment in low income housing tax credit partnerships 3,506 2,668 2,691
Low income housing credits (3,168) (2,721) (2,821)
Revaluation of deferred tax assets - - (470)
Other (1,076) (656) (798)
Total $9,559 $5,434 $4,071
The components of the net deferred tax asset are as follows:
(In Thousands) 2020 2019 2018
Deferred Tax Asset:
Allowance for loan losses $5,772 $5,190 $5,313
Other real estate owned 69 58 160
Deferred compensation 1,130 1,224 1,121
Equity compensation 481 429 435
Loan discount 93 98 79
Fair market value adjustment on certificates of deposit 76 100 123
Operating lease liabilities 3,519 4,045 -
Other 2,330 1,866 1,069
Total Deferred Tax Asset $13,470 $13,010 $8,300
Deferred Tax Liability:
Intangible amortization ($1,022) ($587) ($288)
Mortgage servicing rights (3,530) (3,767) (3,424)
Depreciation and amortization (2,066) (1,848) (1,873)
FHLB stock repurchase and dividends (30) (174) (178)
Operating lease right-of-use assets (3,537) (4,067) -
Loan fees, net of costs (635) 741 818
Unrealized loss on available for sale investment securities, net (187) (384) 270
Other (483) (389) (379)
Total Deferred Tax Liability ($11,490) ($10,475) ($5,054)
Net Deferred Tax Asset $1,980 $2,535 $3,246
A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The primary source of recovery of the deferred tax asset will be future taxable income. Management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax asset. The deferred tax asset is included in "Other assets" in the Consolidated Balance Sheets.
As of December 31, 2020, the Company had no unrecognized tax benefits. In 2020 the Company reversed an accrual of $454,000 for a potential increase in tax expense related to an audit that was performed in 2018 by the State of Alaska for tax years 2014-2016. The Company has appealed the State of Alaska's decision on this matter and reversed this accrual in the second quarter of 2020 because the Company believes that it is more likely than not that the court will rule in the Company's favor. In 2019 the Company reversed an accrual of $250,000 related to interest and penalties that was recognized in 2018.
The tax years subject to examination by federal taxing authorities are the years ending December 31, 2020, 2019, 2018, and 2017. The tax years subject to examination by the State of Alaska are the years ending December 31, 2020, 2019, 2018, 2017, 2016 and 2015.
NOTE 26 - Fair Value Measurements
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Investment securities available for sale and marketable securities: Fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Servicing rights: MSRs and CSRs are measured at fair value on a recurring basis. These assets are classified as Level 3 as quoted prices are not available. In order to determine the fair value of MSRs and CSRs, the present value of net expected future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, escrow calculations,
delinquency rates, and ancillary fee income net of servicing costs. The model assumptions are also compared to publicly filed information from several large MSR holders, as available.
Derivative instruments: The fair value of the interest rate lock commitments are estimated using quoted or published market prices for similar instruments, adjusted for factors such as pull-through rate assumptions based on historical information, where appropriate. The pull-through rate assumptions are considered Level 3 valuation inputs and are significant to the interest rate lock commitment valuation; as such, the interest rate lock commitment derivatives are classified as Level 3. Interest rate contracts are valued in a model, which uses as its basis a discounted cash flow technique incorporating credit valuation adjustments to reflect nonperformance risk in the measurement of fair value. Although the Company has determined that the majority of inputs used to value its interest rate derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of December 31, 2020, the Company has assessed the significance of the impact of these adjustments on the overall valuation of its interest rate positions and has determined that they are not significant to the overall valuation of its interest rate derivatives. As a result, the Company has classified its interest rate derivative valuations in Level 2 of the fair value hierarchy.
Commitments to extend credit and standby letters of credit: The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligation with the counterparties at the reporting date.
Assets Subject to Nonrecurring Adjustment to Fair Value:
The Company is also required to measure certain assets such as equity method investments, goodwill, intangible assets, loans held for sale, impaired loans, and OREO at fair value on a nonrecurring basis in accordance with GAAP. Any nonrecurring adjustments to fair value usually result from the writedown of individual assets.
The Company uses either in-house evaluations or external appraisals to estimate the fair value of OREO and impaired loans as of each reporting date. In-house appraisals are considered Level 3 inputs and external appraisals are considered Level 2 inputs. The Company’s determination of which method to use is based upon several factors. The Company takes into account compliance with legal and regulatory guidelines, the amount of the loan, the size of the assets, the location and type of property to be valued and how critical the timing of completion of the analysis is to the assessment of value. Those factors are balanced with the level of internal expertise, internal experience and market information available, versus external expertise available such as qualified appraisers, brokers, auctioneers and equipment specialists.
The Company uses external sources to estimate fair value for projects that are not fully constructed as of the date of valuation. These projects are generally valued as if complete, with an appropriate allowance for cost of completion, including contingencies developed from external sources such as vendors, engineers and contractors. The Company believes that recording other real estate owned that is not fully constructed based on as if complete values is more appropriate than recording other real estate owned that is not fully constructed using as is values. We concluded that as-is-complete values are appropriate for these types of projects based on the accounting guidance for capitalization of project costs and subsequent measurement of the value of real estate. GAAP specifically states that estimates and cost allocations must be reviewed at the end of each reporting period and reallocated based on revised estimates. The Company adjusts the carrying value of other real estate owned in accordance with this guidance for increases in estimated cost to complete that exceed the fair value of the real estate at the end of each reporting period.
Limitations
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Estimated fair values as of the periods indicated are as follows:
December 31, 2020 December 31, 2019
(In Thousands) Carrying Amount Fair Value Carrying Amount Fair Value
Financial assets:
Level 1 inputs:
Cash, due from banks and deposits in other banks $115,965 $115,965 $95,424 $95,424
Investment securities available for sale 58,865 58,865 75,456 75,456
Marketable equity securities 9,052 9,052 7,945 7,945
Level 2 inputs:
Investment securities available for sale 188,768 188,768 200,682 200,682
Investment in Federal Home Loan Bank Stock 2,551 2,551 2,138 2,138
Accrued interest receivable 7,979 7,979 4,512 4,512
Interest rate swaps 7,387 7,387 2,950 2,950
Level 3 inputs:
Investment securities held to maturity 10,000 10,000 - -
Loans and loans held for sale 1,590,229 1,560,357 1,111,205 1,095,031
Purchased receivables, net 13,922 13,922 24,373 24,373
Interest rate lock commitments 4,034 4,034 810 810
Mortgage servicing rights 11,218 11,218 11,920 11,920
Commercial servicing rights 1,310 1,310 1,214 1,214
Financial liabilities:
Level 2 inputs:
Deposits $1,824,981 $1,826,990 $1,372,351 $1,373,647
Borrowings 14,817 15,538 8,891 9,216
Accrued interest payable 65 65 23 23
Interest rate swaps 9,122 9,122 3,484 3,484
Retail interest rate contracts 880 880 71 71
Level 3 inputs:
Junior subordinated debentures 10,310 10,475 10,310 11,000
The following table sets forth the balances as of the periods indicated of assets measured at fair value on a recurring basis:
(In Thousands) Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3)
December 31, 2020
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities $174,601 $37,548 $137,053 $-
Municipal securities 856 - 856 -
Corporate bonds 30,492 21,317 9,175 -
Collateralized loan obligations 41,684 - 41,684 -
Total available for sale securities $247,633 $58,865 $188,768 $-
Marketable equity securities $9,052 $9,052 $- $-
Total marketable equity securities $9,052 $9,052 $- $-
Corporate bonds $10,000 $- $- $10,000
Total held to maturity securities $10,000 $- $- $10,000
Interest rate swaps $7,387 $- $7,387 $-
Interest rate lock commitments 4,034 - - 4,034
Mortgage servicing rights 11,218 - - 11,218
Commercial servicing rights 1,310 - - 1,310
Total other assets $23,949 $- $7,387 $16,562
Liabilities:
Interest rate swaps $9,122 $- $9,122 $-
Retail interest rate contracts 880 - 880 -
Total other liabilities $10,002 $- $10,002 $-
December 31, 2019
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities $211,852 $57,480 $154,372 $-
Municipal securities 3,297 - 3,297 -
Corporate bonds 35,066 17,976 17,090 -
Collateralized loan obligations 25,923 - 25,923 -
Total available for sale securities $276,138 $75,456 $200,682 $-
Marketable equity securities $7,945 $7,945 $- $-
Total marketable equity securities $7,945 $7,945 $- $-
Interest rate swaps $2,950 $- $2,950 $-
Interest rate lock commitments 810 - - 810
Mortgage servicing rights 11,920 - - 11,920
Commercial servicing rights 1,214 - - 1,214
Total other assets $16,894 $- $2,950 $13,944
Liabilities:
Interest rate swaps $3,484 $- $3,484 $-
Retail interest rate contracts 71 - 71 -
Total other liabilities $3,555 $- $3,555 $-
The following table provides a reconciliation of the assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the years ended December 31, 2020 and 2019:
(In Thousands) Beginning balance Change included in earnings Purchases and issuances Sales and settlements Ending balance
December 31, 2020
Investment securities held to maturity $- $- $10,000 $- $10,000
Interest rate lock commitments 810 (5,680) 49,186 (40,282) 4,034
Mortgage servicing rights 11,920 (5,526) 4,824 - 11,218
Commercial servicing rights 1,214 (99) 195 - 1,310
Total $13,944 ($11,305) $64,205 ($40,282) $26,562
December 31, 2019
Interest rate lock commitments $978 ($1,942) $15,904 ($14,130) $810
Mortgage servicing rights 10,821 (2,608) 3,707 - 11,920
Commercial servicing rights 1,030 6 178 - 1,214
Total $12,829 ($4,544) $19,789 ($14,130) $13,944
During 2020 and 2019, no impairment or valuation adjustment was recognized for assets recognized at fair value on a nonrecurring basis, except for certain assets as shown in the following table. For loans measured for impairment, the Company classifies fair value measurements using observable inputs, such as external appraisals, as Level 2 valuations in the fair value hierarchy, and unobservable inputs, such as in-house evaluations, as Level 3 valuations in the fair value hierarchy.
(In Thousands) Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3)
December 31, 2020
Loans measured for impairment $308 $- $- $308
Total $308 $- $- $308
December 31, 2019
Loans measured for impairment $561 $- $- $561
Total $561 $- $- $561
The following table presents the (income) losses resulting from nonrecurring fair value adjustments for the periods ended December 31, 2020, 2019 and 2018, respectively:
(In Thousands) 2020 2019 2018
Loans measured for impairment ($4) $3 ($952)
Other operating expense - impairment on equity method investment - - 804
Total (income) loss from nonrecurring measurements ($4) $3 ($148)
Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3)
The following table provides a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value at December 31, 2020 and 2019:
Financial Instrument Valuation Technique Unobservable Input Weighted Average or Rate Range
December 31, 2020
Loans measured for impairment In-house valuation of collateral Discount rate 30 %
Interest rate lock commitment External pricing model Pull through rate 90.65 %
Mortgage servicing rights Discounted cash flow Constant prepayment rate 7.77% - 13.17%
Discount rate 7.75%
Commercial servicing rights Discounted cash flow Constant prepayment rate 7.38% - 9.94%
Discount rate 9.46 %
December 31, 2019
Loans measured for impairment In-house valuation of collateral Discount rate 25 %
Interest rate lock commitment External pricing model Pull through rate 92.65 %
Mortgage servicing rights Discounted cash flow Constant prepayment rate 9.11% - 9.87%
Discount rate 8.51% - 10.47%
Commercial servicing rights Discounted cash flow Constant prepayment rate 7.64% - 15.67%
Discount rate 11.70 %
NOTE 27 - Segment Information
The Company's operations are managed along two operating segments: Community Banking and Home Mortgage Lending. The Community Banking segment's principal business focus is the offering of loan and deposit products to business and consumer customers in its primary market areas. As of December 31, 2020, the Community Banking segment operated 16 branches throughout Alaska. The Home Mortgage Lending segment's principal business focus is the origination and sale of mortgage loans for 1-4 family residential properties.
Summarized financial information for the Company's reportable segments and the reconciliation to the consolidated financial results is shown in the following tables:
December 31, 2020
(In Thousands) Community Banking Home Mortgage Lending Consolidated
Interest income $73,435 $3,281 $76,716
Interest expense 5,788 263 6,051
Net interest income 67,647 3,018 70,665
Provision for loan losses 2,432 - 2,432
Other operating income 10,693 52,635 63,328
Other operating expense 57,614 31,500 89,114
Income before provision for income taxes 18,294 24,153 42,447
Provision for income taxes 2,694 6,865 9,559
Net income $15,600 $17,288 $32,888
Total assets $1,935,871 $185,927 $2,121,798
Loans held for sale $- $146,178 $146,178
December 31, 2019
(In Thousands) Community Banking Home Mortgage Lending Consolidated
Interest income $67,770 $2,313 $70,083
Interest expense 4,569 1,072 5,641
Net interest income 63,201 1,241 64,442
Benefit for loan losses (1,175) - (1,175)
Other operating income 13,145 24,201 37,346
Compensation expense, RML acquisition payments 468 - 468
Other operating expense 54,520 21,850 76,370
Income before provision for income taxes 22,533 3,592 26,125
Provision for income taxes 4,408 1,026 5,434
Net income $18,125 $2,566 $20,691
Total assets $1,540,869 $103,127 $1,643,996
Loans held for sale $- $67,834 $67,834
December 31, 2018
(In Thousands) Community Banking Home Mortgage Lending Consolidated
Interest income $62,097 $2,080 $64,177
Interest expense 2,370 599 2,969
Net interest income 59,727 1,481 61,208
Provision for loan losses (500) - (500)
Other operating income 11,323 20,844 32,167
Other operating expense 49,956 19,844 69,800
Income before provision for income taxes 21,594 2,481 24,075
Provision for income taxes 3,361 710 4,071
Net income $18,233 $1,771 $20,004
Total assets $1,443,745 $59,243 $1,502,988
Loans held for sale $- $34,710 $34,710
NOTE 28 - Parent Company Information
Balance Sheets at December 31, 2020 2019
(In Thousands)
Assets
Cash and cash equivalents $24,742 $25,294
Marketable equity securities 9,052 7,945
Investment in Northrim Bank 196,002 183,285
Investment in NISC 1,472 1,530
Investment in NST2 310 310
Taxes receivable, net 1,973 -
Other assets 497 6
Total Assets $234,048 $218,370
Liabilities
Junior subordinated debentures $10,310 $10,310
Other liabilities 2,163 943
Total Liabilities 12,473 11,253
Shareholders' Equity
Common stock 6,251 6,559
Additional paid-in capital 41,808 50,512
Retained earnings 173,498 149,615
Accumulated other comprehensive income 18 431
Total Shareholders' Equity 221,575 207,117
Total Liabilities and Shareholders' Equity $234,048 $218,370
Statements of Income for Years Ended: 2020 2019 2018
(In Thousands)
Income
Interest income $599 $635 $477
Equity in undistributed earnings from Northrim Bank 33,570 20,680 20,888
Equity in undistributed earnings from NISC 174 218 166
Income (loss) on marketable equity securities 61 911 (625)
Other income 108 44 5
Total Income $34,512 $22,488 $20,911
Expense
Interest expense 385 389 389
Administrative and other expenses 2,748 2,168 2,524
Total Expense 3,133 2,557 2,913
Income Before Benefit from Income Taxes 31,379 19,931 17,998
Benefit from income taxes (1,509) (760) (2,006)
Net Income $32,888 $20,691 $20,004
Statements of Cash Flows for Years Ended: 2020 2019 2018
(In Thousands)
Operating Activities:
Net income $32,888 $20,691 $20,004
Adjustments to Reconcile Net Income to Net Cash:
Gain on sale of securities, net (98) - -
Equity in undistributed earnings from subsidiaries (33,744) (20,897) (20,920)
Change in fair value marketable equity securities (61) (911) 625
Stock-based compensation 943 832 816
Changes in other assets and liabilities (2,118) 8,556 (6,428)
Net Cash Used from Operating Activities (2,190) 8,271 (5,903)
Investing Activities:
Purchases of marketable equity securities (1,552) - (3,000)
Proceeds from sales/calls/maturities of marketable equity securities 503 229 783
Investment in Northrim Bank, NISC & NST2 21,423 19,488 17,877
Net Cash Provided by Investing Activities 20,374 19,717 15,660
Financing Activities:
Dividends paid to shareholders (8,844) (8,512) (7,064)
Proceeds from issuance of common stock 84 73 243
Repurchase of common stock (9,976) (12,569) (494)
Net Cash Used from Financing Activities (18,736) (21,008) (7,315)
Net change in Cash and Cash Equivalents (552) 6,980 2,442
Cash and Cash Equivalents at beginning of year 25,294 18,314 15,872
Cash and Cash Equivalents at end of year $24,742 $25,294 $18,314
NOTE 29 - Quarterly Results of Operations (Unaudited)
2020 Quarter Ended Dec. 31 Sept. 30 June 30 March 31
(In Thousands Except Per Share Amounts)
Total interest income $20,579 $19,794 $19,004 $17,339
Total interest expense 1,355 1,500 1,547 1,649
Net interest income 19,224 18,294 17,457 15,690
(Benefit) provision for loan losses (599) 567 404 2,060
Other operating income 17,732 21,628 17,535 6,433
Other operating expense 24,147 23,506 22,674 18,787
Income before provision for income taxes 13,408 15,849 11,914 1,276
Provision for income taxes 3,308 3,994 2,014 243
Net income $10,100 $11,855 $9,900 $1,033
Earnings per share, basic $1.62 $1.87 $1.54 $0.16
Earnings per share, diluted $1.59 $1.84 $1.52 $0.16
2019 Quarter Ended Dec. 31 Sept. 30 June 30 March 31
(In Thousands Except Per Share Amounts)
Total interest income $18,062 $17,837 $17,306 $16,878
Total interest expense 1,652 1,531 1,349 1,109
Net interest income 16,410 16,306 15,957 15,769
(Benefit) provision for loan losses (150) (2,075) 300 750
Other operating income 9,735 10,509 9,569 7,533
Compensation expense, RML acquisition payments 468 - - -
Other operating expense 20,147 19,324 19,819 17,080
Income before provision for income taxes 5,680 9,566 5,407 5,472
Provision for income taxes 1,100 2,028 1,146 1,160
Net income $4,580 $7,538 $4,261 $4,312
Earnings per share, basic $0.70 $1.13 $0.62 $0.63
Earnings per share, diluted $0.69 $1.11 $0.62 $0.62
2018 Quarter Ended Dec. 31 Sept. 30 June 30 March 31
(In Thousands Except Per Share Amounts)
Total interest income $17,207 $16,580 $15,595 $14,795
Total interest expense 1,070 761 606 532
Net interest income 16,137 15,819 14,989 14,263
Benefit for loan losses (200) - (300) -
Other operating income 7,718 8,673 8,314 7,462
Other operating expense 18,300 18,099 16,606 16,795
Income before provision for income taxes 5,755 6,393 6,997 4,930
Provision for income taxes 907 1,129 1,167 868
Net income $4,848 $5,264 $5,830 $4,062
Earnings per share, basic $0.70 $0.77 $0.85 $0.59
Earnings per share, diluted $0.69 $0.75 $0.84 $0.58

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS OF ACCOUNTING AND FINANCIAL DISCLOSURE
None.

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ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9A. CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
As of the end of the period covered by this report, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) under the Securities Exchange Act of 1934). Our principal executive and financial officers supervised and participated in this evaluation. Based on this evaluation, our principal executive and financial officers each concluded that our disclosure controls and procedures were effective in timely alerting them to material information required to be included in our periodic reports to the SEC. The design of any system of controls is based in part upon various assumptions about the likelihood of future events, and there can be no assurance that any of our plans, products, services or procedures will succeed in achieving their intended goals under future conditions.
Changes in Internal Control
There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15f and 15d-15(f) of the Securities Exchange Act of 1934) that occurred during the period covered by this report that have materially affected, or are likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining internal control over financial reporting as defined in Rules 13a-15(f) and 15(d)-15(f) of the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of our financial statements; providing reasonable assurance that receipts and expenditures are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use or disposition of Company assets that could have a material effect on our financial statements would be prevented or detected on a timely basis.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020. In making this assessment management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework.
Based on our assessment and the criteria discussed above, management believes that, as of December 31, 2020, the Company maintained effective internal control over financial reporting.
The Company’s independent registered public accounting firm has issued an attestation report on the Company’s effectiveness of internal control over financial reporting. This report appears under Part II. Item 8 of this report.

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ITEM 9B. OTHER INFORMATION
ITEM 9B. OTHER INFORMATION
None.
PART III

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning the officers and directors of the Company required to be included in this item is incorporated by reference from the Company’s definitive proxy statement for its annual meeting of shareholders to be held in 2021 which will be filed with the Securities and Exchange Commission (the "SEC") within 120 days of our most recently completed fiscal year.

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ITEM 11. EXECUTIVE COMPENSATION
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation and director compensation and certain matters regarding participation in the Company’s compensation committee required by this item is incorporated by reference from the Company’s definitive proxy statement for its annual meeting of shareholders to be held in 2021 which will be filed with the SEC within 120 days of our most recently completed fiscal year.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information concerning the security ownership of certain beneficial owners and management required by this item is incorporated by reference from the Company’s definitive proxy statement for its annual meeting of shareholders to be held in 2021 which will be filed with the SEC within 120 days of our most recently completed fiscal year.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information concerning certain relationships and related transactions required by this item is incorporated by reference from the Company’s definitive proxy statement for its annual meeting of shareholders to be held in 2021 which will be filed with the SEC within 120 days of our most recently completed fiscal year.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information concerning fees paid to our independent auditors required by this item is incorporated by reference from the Company’s definitive proxy statement for its annual meeting of shareholders to be held in 2021 which will be filed with the SEC within 120 days of our most recently completed fiscal year.
PART IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Financial Statements
(a) The following documents are filed as part of this Annual Report on Form 10-K:
Consolidated Balance Sheets as of December 31, 2020 and 2019
Consolidated Statements of Income for the years ended December 31, 2020, 2019, and 2018
Consolidated Statements of Comprehensive Income for the years ended December 31, 2020, 2019, and 2018
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2020, 2019, and 2018
Consolidated Statements of Cash Flows for the years ended December 31, 2020, 2019, and 2018
Notes to Consolidated Financial Statements
Exhibits
3.1 Amended and Restated Articles of Incorporation (Incorporated by reference to Exhibit 3.1 of the Company's Form 8-A filed with the SEC on January 14, 2002.)
3.2 Articles of Amendment to the Amended and Restated Articles of Incorporation (Incorporated by reference to Exhibit 3.3 of the Company’s Form 10-Q for the quarter ended June 30, 2009, filed with the SEC on August 10, 2009.)
3.3 Bylaws of Northrim BanCorp, Inc. as amended (Incorporated by reference to Exhibit 3.4 of the Company’s Current Report on Form 8-K filed with the SEC on November 22, 2016.)
4.1 Description of Securities (Incorporated by reference to Exhibit 4.1 of the Company's Form 10-K for the year ended December 31, 2019, filed with the SEC on March 6, 2020.)
4.2 Pursuant to Item 601 (b)(4)(iii)(A) of Regulation S-K, copies of instruments defining rights of holders of long-term debt and preferred securities are not filed. The Company agrees to furnish a copy thereof to the SEC upon request.
4.3 Indenture dated as of December 16, 2005 (Incorporated by reference to Exhibit 4.3 of the Company’s Form 10-K for the year ended December 31, 2005, filed with the SEC on March, 16, 2006.)
4.4 Form of Junior Subordinated Debt Security due 2036 (Incorporated by reference to Exhibit 4.4 of the Company’s Form 10-K for the year ended December 31, 2005, filed with the SEC on March, 16, 2006.)
10.01 Northrim Bancorp, Inc. 2010 Stock Incentive Plan (Incorporated by reference to Exhibit A to Northrim Bancorp, Inc.’s definitive proxy statement on Schedule 14A filed with the SEC on March 15, 2010.)
10.02 Northrim Bancorp, Inc. 2014 Stock Incentive Plan (Incorporated by reference to Exhibit 4.1 of the Company’s Form S-8 filed with the SEC on July 8, 2014.)
10.03 Northrim Bancorp, Inc. 2017 Stock Incentive Plan (Incorporated by reference to Exhibit 4.1 of the Company’s Form S-8 filed with the SEC on June 6, 2017.)
10.04 Northrim Bancorp, Inc. Profit Sharing Plan (Incorporated by reference to Exhibit 10.41 to the Company’s Current Report on Form 8-K, filed with the SEC on November 22, 2011.)
10.05 Employment Agreement with Joseph M. Schierhorn dated January 1, 2021 (Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K, filed on January 4, 2021.)
10.06 Employment Agreement with Michael Martin dated January 1, 2021 (Incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K, filed on January 4, 2021.)
10.07 Employment Agreement with Jed W. Ballard dated January 1, 2021 (Incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K, filed on January 4, 2021.)
10.08 Employment Agreement with Michael Huston dated January 1, 2021 (Incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K, filed on January 4, 2021.)
10.09 Employment Agreement with Benjamin Craig dated January 1, 2021 (Incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K, filed on January 4, 2021.)
10.10 Supplemental Executive Retirement Plan originally effective as of July 1, 1994, amended effective as of January 6, 2000, January 8, 2004, January 1, 2005 and January 1, 2015 (Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on September 2, 2015).
10.11 Supplemental Executive Retirement Deferred Compensation Plan originally effective as of February 1, 2002, amended effective as of January 1, 2005 and January 1, 2015 (Incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on September 2, 2015).
10.12 Northrim BanCorp, Inc. 2020 Stock Incentive Plan (Incorporated by reference to Exhibit D to the Company's Proxy Statement filed with the SEC on April 27, 2020.)
21.1 Subsidiaries
23.1 Consent of Moss Adams LLP
24.1 Power of Attorney
31.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
101.SCH Inline XBRL Taxonomy Extension Schema Document
101.CAL Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB Inline XBRL Taxonomy Extension Labels Linkbase Document
101.PRE Inline XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF Inline XBRL Taxonomy Extension Definition Linkbase Document
104 The cover page for the Company's Annual Report on 10-K for the year ended December 31, 2020 - formatted in Inline XBRL (included in Exhibit 101)