10-K 1 nrim-20121231x10k.htm 10-K 369d1dd502e84fb

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC  20549

FORM 10-K

(Mark One)

þ    Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2012

o    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from_____to____

Commission File Number 000-33501

NORTHRIM BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Alaska

 

92-0175752

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

3111 C Street

Anchorage, Alaska 99503

(Address of principal executive offices)    (Zip Code)

 

(907) 562-0062

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

 

Common Stock, $1.00 par value

The NASDAQ Stock Market, LLC

(Title of Class)

(Name of Exchange on Which Listed)

 

Securities registered pursuant to Section 12(g) of the Act: N/A

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  ¨ Yes  ý No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  ¨ Yes  ý No  

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨ Yes  ý No  

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

Large Accelerated Filer ¨  Accelerated Filer ý    Non-accelerated Filer ¨ (Do not check if a smaller reporting company) Smaller Reporting Company ¨

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2012 (the last business day of the registrant’s most recently completed second fiscal quarter) was $133,414,239.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date6,512,620 shares of Common Stock, $1.00 par value, as of March 15, 2013.

DOCUMENTS INCORPORATED BY REFERENCE

The registrant’s Proxy Statement on Schedule 14A, relating to the registrant’s annual meeting of shareholders to be held on May 16, 2013, is incorporated by reference into Part III of this Form 10-K.

 

 

 

 


 

TABLE OF CONTENTS

 

 

 

 

Part  I

 

Item 1.

Business

Item 1A.

Risk Factors

10 

Item 1B.

Unresolved Staff Comments

16 

Item 2.

Properties

16 

Item 3.

Legal Proceedings

16 

Item 4.

Mine Safety Disclosures

17 

 

Part II

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

17 

Item 6.

Selected Financial Data

19 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

22 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

45 

Item 8.

Financial Statements and Supplementary Data

48 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

94 

Item 9A.

Controls and Procedures

94 

Item 9B.

Other Information

95 

 

Part III

 

Item 10.

Directors, Executive Officers and Corporate Governance

95 

Item 11.

Executive Compensation

95 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

95 

Item 13.

Certain Relationships and Related Transactions, and Director Independence

95 

Item 14.

Principal Accounting Fees and Services

95 

 

Part IV

 

Item 15.

Exhibits, Financial Statement Schedules

96 

 

Index to Exhibits

96 

 

Signatures

99 

 

 

 

 

 

1

 


 

PART I

 

Cautionary Note Regarding Forward Looking Statements

 

This Annual Report on Form 10-K includes “forward-looking statements”, within the meaning of the Private Securities Litigation Reform Act of 1995, as amended, which are not historical facts.  These forward-looking statements describe management’s expectations about future events and developments such as future operating results, growth in loans and deposits, continued success of the Company’s style of banking, and the strength of the local economy. All statements other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, made in this report are forward-looking. We use words such as “anticipate,” “believe,” “expect,” “intend” and similar expressions in part to help identify forward-looking statements. Forward-looking statements reflect management’s current plans and expectations and are inherently uncertain. Our actual results may differ significantly from management’s expectations, and those variations may be both material and adverse. Forward-looking statements are subject to various risks and uncertainties that may cause our actual results to differ materially and adversely from our expectations as indicated in the forward-looking statements. These risks and uncertainties include: the general condition of, and changes in, the Alaska economy; factors that impact our net interest margin; and our ability to maintain asset quality. Further, actual results may be affected by competition on price and other factors with other financial institutions; customer acceptance of new products and services; the regulatory environment in which we operate; and general trends in the local, regional and national banking industry and economy. Many of these risks, as well as other risks that may have a material adverse impact on our operations and business, are identified Item 1A. Risk Factors, and in our filings with the SEC. However, you should be aware that these factors are not an exhaustive list, and you should not assume these are the only factors that may cause our actual results to differ from our expectations. In addition, you should note that we do not intend to update any of the forward-looking statements or the uncertainties that may adversely impact those statements, other than as required by law.

 

ITEM 1.            BUSINESS

General

Northrim BanCorp, Inc. (the “Company”) is 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 $970.1 million in total deposits and $1.2 billion in total assets at December 31, 2012.  Through our ten branches, we are accessible to approximately 70% of the Alaska population. 

The Company has four 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 and the State of Alaska Department of Commerce, Community and Economic Development, Division of Banking, Securities and Corporations.  The Bank has ten branch locations in Alaska; seven in Anchorage, one in Fairbanks, and one each in Eagle River and Wasilla.  We also operate in the Washington market area through Northrim Funding Services (“NFS”), a factoring operation 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 to hold the Company’s 48% equity interest in Elliott Cove Capital Management, LLC, (“ECCM”), an investment advisory services company.  In the first quarter of 2006, through NISC, we purchased an  interest in Pacific Wealth Advisors, LLC (“PWA”), an investment advisory, trust, and wealth management business located in Seattle, Washington, which we now hold a 24% interest in;

 

·

Northrim Capital Trust I (“NCTI”), an entity that we formed in May of 2003 to facilitate a trust preferred securities offering by the Company; and

 

·

Northrim Statutory Trust 2 (“NST2”), an entity that we formed in December of 2005 to facilitate a trust preferred securities offering by the Company.

 

2

 


 

The Bank has two wholly-owned subsidiaries:

·

Northrim Capital Investments Co. (“NCIC”) is a wholly-owned subsidiary of the Bank, which holds a 24% interest in the profits and losses of a residential mortgage holding company, Residential Mortgage Holding Company, LLC (“RML”).  The predecessor of RML, Residential Mortgage, LLC, was formed in 1998 and has offices throughout Alaska.  RML also operates in real estate markets in the state of Washington through a joint venture.  In March and December of 2005, NCIC purchased ownership interests totaling 50.1% in Northrim Benefits Group, LLC (“NBG”), an insurance brokerage company that focuses on the sale and servicing of employee benefit plans.  In the fourth quarter of 2011, NCIC purchased a 48% interest in Elliott Cove Insurance Agency, LLC (“ECIA”); an insurance agency that offers annuity and other insurance products; and

 

·

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.

 

Segments

The Company’s major line of business is commercial banking.  Management has determined that the Company operates as a single operating segment based on accounting principles generally accepted in the United States (“GAAP”).  Measures of the Company’s revenues, profit or loss, and total assets are included in this report in Item 8, “Financial Statements and Supplementary Data”, and incorporated herein by reference.

Business Strategy

The Company’s strategy is one of value-added growth.  Management believes that calculated, sustainable market share growth coupled with good loan credit quality, operational efficiency, 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 significant land development and residential construction lender and an active lender in the commercial real estate market in our Alaskan markets.  Because of our relatively small size, our experienced senior management team can be more involved with serving customers and making credit decisions, allowing us to compete more favorably with larger competitors for lending relationships.  We believe that there is a significant 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.  In many cases, these types of customers also require multiple deposit and affiliate services that add franchise value to the Company.  Additionally, management believes that our real estate construction and term real estate loan departments have developed a strong level of expertise and are well positioned to add quality loan volume in the current business environment.  Lastly, we have dedicated additional resources to our small business lending operations and have targeted the acquisition of new customers in professional fields including physicians, dentists, accountants, and attorneys.  The Company benefits from solid capital and liquidity positions, and management believes that this provides a competitive advantage in the current business environment for growth opportunities. (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 “Customer First Service” philosophy, affording our customers the highest priority in all aspects of our operations.  We believe that our successful execution of this philosophy has created a very 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.       

The Company’s geographical expansion has historically been limited to the Anchorage, Fairbanks and Matanuska-Susitna Valley regions of Alaska and, to a lesser extent, the Washington area through the operations of NFS.  While the Company continues to consider potential expansion of its branch network in these locations, additional geographic regions will be considered if appropriate opportunities are presented. 

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 substantial 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.  As a result of these efforts, the Company’s ratio of nonperforming assets to total assets has decreased to 0.78% at December 31, 2012, as compared to 1.16% and 2.07% at December 31, 2011 and 2010, respectively.  Improvements in the overall credit quality of the loan portfolio have had a direct and positive impact on net income through a reduction of loan collection related costs, as well as decreased FDIC insurance costs.  Continued success in maintaining or further improving the credit quality of our loan portfolio is a significant aspect of the Company’s strategy for attaining sustainable, long-term market share growth to affect increased shareholder value.

3

 


 

Employees

We believe that we provide a high level of customer service. To achieve our objective of providing “Customer First Service”, 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 “Customer First Service” philosophy is combined with our emphasis on personalized, local decision making.  In keeping with this philosophy and with our strategy to increase our market share, the Company hired several new loan officers in the last two years who have valuable expertise in our niche markets.

We consider our relations with our employees to be satisfactory.  We had 245 full-time equivalent employees at December 31, 2012. None of our employees are covered by a collective bargaining agreement. 

Products and Services

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, and the Matanuska-Susitna Valley.  (See “Loans” in Item 7 of this report.)

Asset-based lending:  We provide short-term working capital to customers in the states of Washington and Oregon by purchasing their accounts receivable through NFS.  In 2013, we expect NFS to continue to penetrate these markets and to continue to contribute to the Company’s net income.    

Deposit Services: Our deposit services include noninterest-bearing checking accounts and interest-bearing time deposits, checking accounts, and savings 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.  We have two deposit products that are indexed to specific U.S. Treasury rates.

Several of our deposit services and products are:

 

·

An indexed 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;

 

·

An indexed CD that allows additional deposits, quarterly withdrawals without penalty, and tailored maturity dates; and

 

·

Arrangements to courier noncash deposits from our customers to their local Northrim Bank branch.

 

Other Services: In addition to our deposit and lending services, we offer our customers several 24-hour services:  Consumer Online Banking, Mobile Web and Text Banking, Business Online Banking, FinanceWorks™ powered by Quicken®, Online Statements, Visa Check Cards, Business Visa Check Cards, Cash Back Rewards, telebanking, faxed account statements, and automated teller services.  Other special services include personalized checks at account opening, overdraft protection from a savings account, extended banking hours (Monday through Friday, 9 a.m. to 6 p.m. for the lobby, and 8 a.m. to 7 p.m. for the drive-up, and Saturday 10 a.m. to 3 p.m.), commercial drive-up banking with coin service, automatic transfers and payments, wire transfers, direct payroll deposit, electronic tax payments, Automated Clearing House origination and receipt, cash management programs to meet the specialized needs of business customers, and courier agents who pick up noncash deposits from business customers. 

Other Services Provided through Affiliates:  The Company provides residential mortgages throughout Alaska, and to a lesser extent in the state of Washington via the Company’s ownership interest in RML.  We also sell and service employee benefit plans for small and medium sized businesses in Alaska through NBG, an insurance brokerage company.  The Company also offers annuity and other insurance products through ECIA, an insurance agency, and long term investment portfolios through ECCM, an investment advisory services company.  As of March 15, 2013, there are four Northrim Bank employees who are licensed as Investment Advisor Representatives and are actively selling the Elliott Cove investment products.  Finally, 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 our 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. However, approximately 43% of our loan portfolio at December 31, 2012 is attributable to twenty two 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, Fairbanks, and the Matanuska-Susitna Valley. 

4

 


 

Alaska Economy

Our growth and operations depend upon the economic conditions of Alaska and the specific markets we serve.  Alaska is strategically located on the Pacific Rim, within nine hours by air from 95% of the industrialized world, and Anchorage has become a worldwide cargo and transportation link between the United States and international business in Asia and Europe.  The economy of Alaska is dependent upon the natural resources industries.  Key sectors of the Alaska economy are the oil industry, government and military spending, and the construction, fishing, forest products, tourism, mining, air cargo, and transportation industries, as well as medical services.

The petroleum industry plays a significant role in the economy of Alaska.  According to the State of Alaska Department of Revenue, approximately 93% of the unrestricted revenues that fund the Alaska state government are generated through various taxes and royalties on the oil industry.  Any significant changes in the Alaska economy and the markets we serve eventually could have a positive or negative impact on the Company.  State revenues are sensitive to volatile oil prices and production levels have been in decline for 20 years; however, high oil prices have been sustained for several years now, despite the global recession.  This has allowed the Alaska state government to continue to increase operating and capital budgets and add to its reserves.  The long-run growth of the Alaska economy will most likely be determined by large scale natural resource development projects.  Several multi-billion dollar projects are progressing or can potentially advance in the near term.  Some of these projects include: a large diameter natural gas pipeline; related gas exploration at Point Thomson by ExxonMobil and partners; exploration for new wells offshore in the Outer Continental Shelf by Shell and Conoco Phillips; potential oil and gas activities in the Arctic National Wildlife Refuge; copper, gold and molybdenum production at the Pebble and Donlon Creek mines; and energy development in the National Petroleum Reserve Alaska.  Because of their size, each of these projects faces tremendous challenges.  Contentious 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 they are to advance.  If none of these projects moves forward in the next ten years, then state revenues will start to decline with falling oil production from older fields on the North Slope of Alaska.  The decline in state revenues will likely have a negative effect on Alaska’s economy.

Tourism is another major employment sector of the Alaska economy.  In 2012, according to the State of Alaska’s Department of Commerce, revenue collected from bed taxes in Anchorage increased 6% in the peak season between May through September as compared to the same period in 2011.  Additionally, the Department of Commerce reported a 2% increase in people visiting the State of Alaska in the same period in 2012 as compared to 2011.    

Alaska has weathered the “Great Recession” better than many other states in the nation, due largely to a natural resources based economy which continues to benefit from high commodity and energy prices.  According to the Legislative Finance Division of the State of Alaska, as of June 30, 2012, Alaska had more than $13.5 billion in undesignated savings.  As of December 31, 2012 the Permanent Fund had a balance of $44 billion, which pays an annual dividend to every Alaskan citizen.  In December 2012, unemployment in Alaska decreased to 6.6% according to the Alaska Department of Labor as compared to 7.8% for the United States.     

A material portion of our loans at December 31, 2012, were secured by real estate located in greater Anchorage, Matanuska-Susitna Valley, and Fairbanks, Alaska.  Moreover, 11% 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, our mortgage real estate affiliate.  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. Since 2007, the Anchorage area and Fairbanks real estate markets have experienced lower levels of sales activity.  A decline in real estate values in the greater Anchorage, Matanuska-Susitna Valley, and Fairbanks 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. In addition, at December 31, 2012, $273 million, or 39%, of our loan portfolio was represented by commercial loans in Alaska.  Commercial loans generally have greater risk than real estate loans.

Alaska’s residents are not subject to any state income or state sales taxes.  For the past 29 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 $878 per eligible resident in 2012 for an aggregate distribution of approximately $567 million.  The Anchorage Economic Development Corporation estimates that, for most Anchorage households, distributions from the Alaska Permanent Fund exceed other Alaska taxes to which those households are subject (primarily real estate taxes).

5

 


 

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.  According to information published by the State of Alaska Department of Commerce, credit unions in Alaska have a 40% share of total statewide deposits held in banks and credit unions as of December 31, 2011.  Recent changes in credit union regulations have 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 by telephone, computer and the internet, 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 “Customer First Service”. We also compete with full service investment firms for non-bank financial products and services offered by ECCM, ECIA and PWA.

In the late 1980s, eight of the thirteen commercial banks and savings and loan associations in Alaska failed, resulting in the largest commercial banks gaining significant market share.  Currently, there are eight commercial banks operating in Alaska.  At June 30, 2012, the date of the most recently available information, we had approximately a 9% share of the Alaska commercial bank deposits, 15% in the Anchorage area, and 7% in Fairbanks.

The following table sets forth market share data for the commercial banks having a presence in the greater Anchorage area as of June 30, 2012, the most recent date for which comparative deposit information is available.

 

 

 

 

 

 

 

 

 

 

 

 

Financial institution

Number of branches

Total deposits (in thousands)

Market share of deposits

Northrim Bank

9

$

818,915 
15 

%

Wells Fargo Bank Alaska

18

 

2,861,060 
51 

%

First National Bank Alaska

12

 

1,266,334 
23 

%

Key Bank

6

 

595,896 
11 

%

     Total

45

$

5,542,205 
100 

%

 

 

 

 

 

 

 

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 Northrim Bank’s deposits and also examines, supervises, and regulates Northrim Bank. The Company’s affiliated investment companies, ECCM and ECIA, and its affiliated investment advisory and wealth management company, Pacific Portfolio Consulting LLC, are 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 banking laws of the State of Washington.

The Company’s earnings and activities are affected, amoung other things, by legislation, by actions of the FRB, the Division, the FDIC and other regulators, and by local legislative and administrative bodies and decisions of courts.  For example, these include limitations on the ability of Northrim 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.

6

 


 

As a result of the recent financial crisis, regulation of banks and the financial services industry has been undergoing major changes.  Among these is the enactment in 2010 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).  The Dodd-Frank Act significantly modifies and expands legal and regulatory requirements imposed on banks and other financial institutions.  Some of these changes were effective immediately but others are being phased in over time.  The Dodd-Frank Act requires various regulators, including the FRB and the FDIC, to adopt numerous regulations, not all of which have been finalized.  Accordingly, not all of the precise requirements of the Dodd-Frank Act are yet known.

The Dodd-Frank Act will significantly impact Northrim Bank and its business and operations.  For example, the federal prohibition on paying interest on demand accounts (such as checking accounts) for businesses was eliminated, which could adversely impact Northrim Bank’s interest expense.  The Dodd-Frank Act permanently increased the maximum amount of deposit insurance coverage to $250,000 per depositor and deposit insurance assessments paid by Northrim Bank are now based on Northrim Bank’s total assets.  Other Dodd-Frank Act changes include: (i) tightened capital requirements for Northrim 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; and (v) creation of a federal Consumer Financial Protection Bureau with broad authority to regulate consumer financial products and services.

It is difficult to predict at this time what specific impacts the Dodd-Frank Act and the implementing regulations will have on Northrim Bank and the Company.  At a minimum, it is expected that they will increase our operating and compliance costs and could materially and negatively affect the profitability of our business.

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.

The activities of bank holding companies, such as the Company, that are not financial holding companies, are generally limited to managing or controlling banks and engaging in 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 and activities previously determined by the FRB by regulation or order to be closely related to banking, unless prior approval is obtained from the FRB.

The GLB Act also included extensive consumer privacy provisions.  These provisions, among other things, require full disclosure of the Company’s privacy policy to consumers and mandate offering the consumer the ability to “opt out” of having non-public personal information disclosed to third parties.  Pursuant to these provisions, the federal banking regulators have adopted privacy regulations.  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 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 Northrim Bank, to their non-bank affiliates, such as the Company.

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 expressly permitted by the 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 and 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 income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and 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.

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.

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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 banks in circumstances where it might not do so, absent such requirement.

The Company and Northrim Bank are subject to risk-based capital and leverage guidelines issued by federal banking agencies for banks and bank holding companies.  These agencies are required by law to take specific prompt corrective actions with respect to institutions that do not meet minimum capital standards and, in the case of banks, have defined five capital tiers, the highest of which is “well-capitalized.”  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Northrim Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and Northrim Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory practices.  The Company’s and Northrim Bank’s capital amounts and classification are also subject to qualitative judgment by the regulators about components, risk weightings, and other factors.

Federal banking agencies have established minimum amounts and ratios of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets.  The regulations set forth the definitions of capital, risk-weighted and average assets.  Both the Company and Northrim Bank are required to satisfy minimum capital ratios.  Currently the minimum requirements are a total risk-based capital ratio of 8.0%, a Tier 1 risk-based capital ratio of 4.0% and a leverage ratio generally of 4.0%.  As of December 31, 2012, both the Company and Northrim Bank meet these requirements

Under current prompt corrective action rules, which apply to Northrim Bank but not to the Company, a bank is: (i) ”well-capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater, and is not subject to any regulatory agreement, order or written directive to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if the bank has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, and a leverage ratio of 4.0% or greater and is not “well-capitalized”; (iii) “undercapitalized” if the bank has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 4.0%; (iv) “significantly undercapitalized” if the bank has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0% or a leverage ratio of less than 3.0%; and (v) “critically undercapitalized” if the bank’s tangible equity is equal or less than 2.0% of average quarterly tangible assets.  A bank may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters.  As of December 31, 2012, the FDIC categorized Northrim Bank as “well-capitalized” under the regulatory framework for prompt corrective action.

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 a Tier 1 risk-based capital ratio for Northrim Bank in excess of 10% in 2013, exceeding the FDIC’s “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 Northrim Bank primarily because the $18 million 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 Northrim Bank’s financial statements nor are they included in its capital (although the Company did contribute to Northrim Bank a portion of the cash proceeds from the sale of those securities).  As a result, the Company has $18 million more in regulatory capital than Northrim Bank at December 31, 2012 and 2011, which explains most of the difference in the capital ratios for the two entities.

The Dodd-Frank Act requires the federal banking regulators to issue new capital regulations.  On June 12, 2012, the three federal banking regulators (including the FRB and the FDIC) jointly announced that they were seeking comment on three sets of proposed regulations relating to capital (the “Proposed Rules”).  The Proposed Rules would apply to both depository institutions and (subject to certain exceptions not applicable to the Company) their holding companies.  Although parts of the Proposed Rules would apply only to large, complex financial institutions, substantial portions of the Proposed Rules would apply to Northrim Bank and the Company.  The Proposed Rules include requirements contemplated by the Dodd-Frank Act as well as certain standards initially adopted by the Basel Committee on Banking Supervision in December 2010, which standards are commonly referred to as “Basel III”.

The Proposed Rules include new risk-based and leverage capital ratio requirements, which are intended to be phased in beginning in 2013 and be fully implemented January 1, 2015, and would refine the definition of what constitutes “capital” for purposes of calculating those ratios. The proposed new minimum capital level requirements applicable to the Company and the Bank under the Proposed Rules would be: (i) a new common equity Tier 1 risk-based capital ratio of 4.5%; (ii) a Tier 1 risk-based capital ratio of 6% (increased from 4%); (iii) a total risk-based capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions.  Common equity Tier 1 capital would consist of retained earnings and common stock instruments, subject to certain adjustments.

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The Proposed Rules would also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum risk-based capital requirements.  The conservation buffer would consist entirely of common equity Tier 1 capital and, when added to the capital requirements, would result in the following minimum ratios: (i) a common equity Tier 1 risk-based capital ratio of 7.0%, (ii) a Tier 1 risk-based capital ratio of 8.5%, and (iii) a total risk-based capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase by that amount each year until fully implemented in January 2019.  An institution would be subject to limitations on certain activities including payment of dividends, share repurchases and discretionary bonuses to executive officers if its capital level is below the buffer amount.

The Proposed Rules would also revise the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including Northrim Bank, if their capital levels do not meet certain thresholds. These revisions are intended to be phased in beginning in 2013 and be fully implemented January 1, 2015.  The prompt corrective action rules would be modified to include a common equity Tier 1 capital component and to increase certain other capital requirements for the various thresholds.  For example, under the proposed prompt corrective action rules, insured depository institutions would be required to meet the following capital levels in order to qualify as “well capitalized”:  (i) a new common equity Tier 1 risk-based capital ratio of 6.5%; (ii) a Tier 1 risk-based capital ratio of 8% (increased from 6%); (iii) a total risk-based capital ratio of 10% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 5% (unchanged from current rules).

The Proposed Rules set forth certain changes in the methods of calculating certain risk-weighted assets, which in turn would affect the calculation of risk based ratios.  These new calculations would take effect beginning January 1, 2015.  Under the Proposed Rules, higher or more sensitive risk weights would be assigned to various categories of assets, including residential mortgages, certain credit facilities that finance the acquisition, development or construction of real property, certain exposures or credits that are 90 days past due or on nonaccrual, foreign exposures and certain corporate exposures.  In addition, the Proposed Rules include (i) alternative standards of creditworthiness consistent with the Dodd-Frank Act; (ii) greater recognition of collateral and guarantees; and (iii) revised capital treatment for derivatives and repo-style transactions.

Northrim 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.

Northrim Bank is subject to the Community Reinvestment Act of 1977 (“CRA”).  The CRA requires that Northrim 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 Northrim 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, Northrim 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”).  Among other things, the USA Patriot Act requires financial institutions, such as the Company and Northrim 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, 2012.

Available Information

The Company’s annual report on Form 10-K and quarterly reports on Form 10-Q, as well as its Form 8-K filings (and all amendments thereto), which are filed with the Securities and Exchange Commission (“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.

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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.

 

ITEM 1A.            RISK FACTORS

An investment in the Company’s common stock is subject to risks inherent to the Company’s business.  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.

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 Securities and Exchange Commission.  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 Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was enacted in July 2010.  Among other provisions, the new legislation creates a new Bureau of Consumer Financial Protection with broad powers to regulate consumer financial products such as credit cards and mortgages, creates a Financial Stability Oversight Council comprised of the heads of other regulatory agencies, will lead to new capital requirements from federal banking agencies, places new limits on electronic debt card interchange fees, and requires the Securities and Exchange Commission and national stock exchanges to adopt significant new corporate governance and executive compensation reforms.  The new legislation and regulations are expected to increase the overall costs of regulatory compliance and limit certain sources of revenue.

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.  Recently, these powers have been utilized more frequently due to the serious national economic conditions facing the financial system.  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 Federal Reserve Board.

We cannot accurately predict the full effects of recent 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 may be subject to more stringent capital and liquidity requirements which would adversely affect our net income and future growth.

            On June 12, 2012, the three federal banking regulators (including the FRB and the FDIC) jointly announced the Proposed Rules, which would 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 “Item 1 Business - Proposed Changes to Regulatory Capital Requirements” the three federal banking regulators issued the Proposed Rules that would create new increased capital requirements for United States depositary institutions and their holding companies. The Proposed Rules include risk-based and leverage capital ratio requirements, which are intended to be phased in beginning in 2013 and be fully implemented by January 1, 2015. The Proposed Rules would 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 are intended to be phased in beginning in 2013 and be fully implemented by January 1, 2015. 

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Although we currently cannot predict the specific impact and long-term affects that the Proposed Rules will have on us and the banking industry more generally, if these rules are adopted we would be required to maintain higher regulatory capital levels which could impact our operations, net income and ability to grow. Furthermore, 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.

Difficult economic and market conditions have adversely affected our industry

We are operating in a challenging and uncertain economic environment, including generally uncertain global, national and local conditions.  The capital and credit markets have also experienced volatility and disruption.  Dramatic declines in the national housing market in 2008 and 2009, with falling home prices and increasing foreclosures, unemployment and under-employment have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities as well as major commercial and investment banks.  These write-downs have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.  Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions.  This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility, and widespread reduction of business activity generally.  Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, is highly dependent upon the business environment in the markets where we operate.  Similarly, declining real estate values can adversely impact the carrying value of real estate secured loans. The downturn in the economy, the slowdown in the real estate market, and declines in some real estate values had a direct and adverse effect on our financial condition and results of operations in 2008 and 2009.  While we have experienced some stabilization in the economy since 2010, we currently do not expect that the difficult conditions in the financial markets are likely to improve significantly in the near future.  A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry.  In particular, we may face the following risks in connection with these events:

·

We expect to face continued increased regulation of our industry, including as a result of the Stabilization Act and Dodd Frank legislation.  Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.

·

Competition in our industry could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions.

·

The process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans.  The level of uncertainty concerning economic conditions could adversely affect the accuracy of our estimates which could, in turn, impact the reliability of the process.

·

We have been required to pay significantly higher FDIC premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.  

·

The value of the portfolio of investment securities that we hold could be adversely affected. 

 

We may be adversely impacted by recent volatility in the European financial markets

In 2010, a financial crisis emerged in Europe, triggered primarily by high budget deficits and rising direct and contingent sovereign debt in Greece, Ireland, Italy, Portugal and Spain, which created concerns about the ability of these EU “peripheral nations” to continue to service their sovereign debt obligations.  These conditions impacted financial markets and resulted in high and volatile bond yields on the sovereign debt of many EU nations.  Certain European nations continue to experience varying degrees of financial stress, and yields on government-issued bonds in Greece, Ireland, Italy, Portugal and Spain have risen and remain volatile.  Despite assistance packages to Greece, Ireland and Portugal, the creation of a joint EU-IMF European Financial Stability Facility in May 2010, and a recently announced plan to expand financial assistance to Greece, uncertainty over the outcome of the EU governments’ financial support programs and worries about sovereign finances persist.  Market concerns over the direct and indirect exposure of European banks and insurers to the EU peripheral nations has resulted in a widening of credit spreads and increased costs of funding for some European financial institutions.

Risks and ongoing concerns about the debt crisis in Europe could have a detrimental impact on the global economic recovery, sovereign and non-sovereign debt in these countries and the financial condition of European financial institutions.  Market and economic disruptions have affected, and may continue to affect, consumer confidence levels and spending, personal bankruptcy rates, levels of incurrence and default on consumer debt and home prices, among other factors.  There can be no assurance that the market disruptions in Europe, including the increased cost of funding for certain governments and financial institutions, will not spread, nor can there be any assurance that future assistance packages will be available or, even if provided, will be sufficient to stabilize the affected countries and markets in Europe or elsewhere. While we have no direct exposure to European financial institutions or sovereign debt, to the extent uncertainty regarding the economic recovery continues to negatively impact consumer confidence and consumer credit factors, our business and results of operations could be significantly and adversely affected.

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The downgrade of U.S. government securities by the credit rating agencies could have a material adverse effect on our operations, earnings, and financial condition.

The recent debate in Congress regarding the national debt ceiling, federal budget deficit concerns, and overall weakness in the economy resulted in actual and threatened downgrades of United States government securities by the various major credit ratings agencies, including Standard and Poor’s and Fitch Ratings. While the federal banking agencies including the FRB and the FDIC have issued guidance indicating that, for risk-based capital purposes, the risk weights for United States Treasury securities and other securities issued or guaranteed by the United States government, government agencies, and government-sponsored entities will not be affected by the downgrade, the downgrade of United States government securities by Standard and Poor’s and the possible future downgrade of the federal government’s credit rating by one or both of the other two major rating agencies (which has been forewarned by Fitch Ratings), could create uncertainty in the United States and global financial markets and cause other events which, directly or indirectly, could adversely affect our operations, earnings, and financial condition.

The operations of our business, including our interaction with customers, are increasingly done via electronic means, and this has increased our risks related to cybersecurity.

The Company is exposed to cyber-attacks in the normal course of business.  In general, cyber incidents can result from deliberate attacks or unintentional events.  We have observed an increased level of attention focused on cyber-attacks that include, but are not limited to, gaining unauthorized access to digital systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption.  Cyber-attacks may also be carried out in a manner that does not require gaining unauthorized access, such as by causing denial-of-service attacks on websites.  Cyber-attacks may be carried out by third parties or insiders using techniques that range from highly sophisticated efforts to electronically circumvent network security or overwhelm websites to more traditional intelligence gathering and social engineering aimed at obtaining information necessary to gain access.  The objectives of cyber-attacks vary widely and may include theft of financial assets, intellectual property, or other sensitive information belonging to the Company or our customers.  Cyber-attacks may also be directed at disrupting the operations of the Company’s business. 

While the Company has not incurred any material losses related to cyber-attacks, nor are we aware of any specific or threatened cyber-incidents as of the date of this report, we may incur substantial costs and suffer other negative consequences if we fall victim to successful cyber-attacks.  Such negative consequences could include remediation costs that may include liability for stolen assets or information and repairing system damage that may have been caused; increased cybersecurity protection costs that may include organizational changes, deploying additional personnel and protection technologies, training employees, and engaging third party experts and consultants; lost revenues resulting from unauthorized use of proprietary information or the failure to retain or attract customers following an attack; litigation; and reputational damage adversely affecting customer or investor confidence.

Declines in the residential housing market would have a negative impact on our residential housing market income.

The Company earns revenue from the residential housing market in the form of interest income and fees on loans and earnings from RML.  A slowdown in the residential sales cycle in our major markets and a constriction in the availability of mortgage financing have negatively impacted real estate sales, which has resulted in customers’ inability to repay loans.  In 2013, the Company expects that its revenues from earnings from RML will be lower than 2012 because we expect earnings from RML to decrease as refinance activity slows.  Declines in these areas may have a material adverse effect on our financial condition through a decline in interest income and fees.

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 net income and financial condition.

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We have a significant concentration in real estate lending. A downturn in real estate within our markets has had and is expected to continue to have a negative impact on our results of operations. 

Approximately 69% of the Bank’s loan portfolio at December 31, 2012 consisted of loans secured by commercial and residential real estate located in Alaska.  In recent years, the slowdown in the residential sales cycle in our major markets and a constriction in the availability of mortgage financing have negatively impacted residential real estate sales, which has resulted in customers’ inability to repay loans.  During 2008, we experienced a significant increase in non-performing assets relating to our real estate lending, primarily in our residential real estate portfolio.  Although non-performing assets decreased from December 31, 2008 to December 31, 2012, we will see a further increase in 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 49% of the Bank’s loan portfolio at December 31, 2012 consisted of commercial real estate loans.   Nationally, delinquencies in these types of portfolios have increased significantly in recent years.  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 conditions and results of operations. 

Real estate values may decrease leading to additional and greater than anticipated loan charge-offs and valuation write downs 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, 2012, the Bank held $4.5 million of OREO properties, many of which relate to residential construction and land development loans.   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 write downs, with a corresponding expense in our income statement.  We evaluate OREO property values periodically and write down the carrying value of the properties if the results of our evaluations require it.  Further write-downs on OREO or an inability to sell OREO properties could have a material adverse effect on our results of operations and financial condition.

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. 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.  The relationship between the rates received on loans and securities and the rates paid on deposits and borrowings is known as the net interest margin.  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.

Our financial performance depends on our ability to manage recent and possible future growth. 

Our financial performance and profitability will depend on our ability to manage recent and possible future growth.  Although we believe that we have substantially integrated the business and operations of past acquisitions, there can be no assurance that unforeseen issues relating to the acquisitions will not adversely affect us.  Any future acquisitions and continued growth may present operating and other problems that could have an adverse effect on our business, financial condition, and results of operations.  Accordingly, there can be no assurance that we will be able to execute our growth strategy or maintain the level of profitability that we have experienced in the past.

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Our concentration of operations in the Anchorage, Matanuska-Susitna Valley, and Fairbanks, 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, and Fairbanks, areas of Alaska.  The majority of our lending has been with Alaska businesses and individuals.   At December 31, 2012, approximately 69% of the Bank’s loans are secured by real estate and 31% are for general commercial uses, including professional, retail, and small businesses, respectively.  Substantially all of these loans are collateralized and 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, government and U.S. military spending for their economic success.  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 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 our results of operation 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.

The Company is a separate and distinct legal entity from our subsidiaries and 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).  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.

Various statutory provisions restrict the amount of dividends the Bank can pay to us without regulatory approval.  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 income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and 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.

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.

14

 


 

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.

We may be unable to attract and retain key employees and personnel.

We will be dependent for the foreseeable future on the services of R. Marc Langland, our Chairman of the Board and Chief Executive Officer of the Company; Joseph M. Beedle, our President and Chief Executive Officer of Northrim Bank; Christopher N. Knudson, our Executive Vice President and Chief Operating Officer; Joseph M. Schierhorn, our Executive Vice President and Chief Financial Officer; Steven L. Hartung, our Executive Vice President and Chief Credit Officer.  While we maintain keyman life insurance on the lives of Messrs. Beedle, Knudson, and Schierhorn in the amounts of $2 million, $2.1 million, and $1 million, respectively, we may not be able to timely replace Mr. Beedle, Mr. Knudson, or Mr. Schierhorn with a person of comparable ability and experience should the need to do so arise, causing losses in excess of the insurance proceeds.  Currently, we do not maintain keyman life insurance on the life of Messrs. Langland and Hartung.  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.

The expiration of unlimited FDIC insurance on certain noninterest-bearing transaction accounts may increase our interest expense and reduce our liquidity

On December 31, 2012, unlimited FDIC insurance on certain noninterest-bearing transaction accounts under the transaction account guarantee program expired. Under this program, prior to its expiration, all funds in a noninterest-bearing transaction account were insured in full by the FDIC from December 31, 2010 through December 31, 2012. This temporary unlimited coverage was in addition to, and separate from, the coverage of at least $250,000 available to depositors under the FDIC’s general deposit insurance rules.

The reduction in FDIC insurance on these noninterest-bearing transaction accounts to the standard $250,000 maximum may cause depositors to move funds previously held in such noninterest-bearing accounts to interest-bearing accounts, which would increase our costs of funds and negatively impact our results of operations, or may cause depositors to withdraw their deposits and invest funds in investments perceived as being more secure, such as securities issued by the United States Treasury. This could reduce our liquidity, or require us to pay higher interest rates to retain deposits and maintain our liquidity and could adversely affect our earnings.

The FRB’s repeal of the prohibition against payment of interest on demand deposits for businesses (Regulation Q) and the elimination of the FDIC’s TAG program may increase competition for such deposits and ultimately increase interest expense.

A major portion of our net income comes from our interest rate spread, which is the difference between the interest rates paid by us on amounts used to fund assets and the interest rates and fees we receive on our interest-earning assets. Our interest-earning assets include outstanding loans extended to our customers and securities held in our investment portfolio. We fund assets using deposits and other borrowings. On July 14, 2011, the FRB issued final rules to repeal Regulation Q, which prohibited the payment of interest on demand deposits by institutions that are member banks of the Federal Reserve System. The final rules implement Section 627 of the Dodd-Frank Act, which repealed Section 19(i) of the Federal Reserve Act in its entirety effective July 21, 2011. As a result, banks are now permitted to offer interest-bearing demand deposit accounts to commercial customers, which were previously forbidden under Regulation Q. The repeal of Regulation Q may cause increased competition from other financial institutions for these deposits. If we decide to pay interest on demand accounts, we would expect our interest expense to increase.

15

 


 

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 the Allowance, 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 results of operations.

Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, 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 imposed and is expected to expand laws and regulations relating to residential and consumer lending activities that create significant new 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.

 

ITEM 1B.            UNRESOLVED STAFF COMMENTS

None.

 

 

ITEM 2.            PROPERTIES

The following sets forth information about our 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

36th Avenue Branch

811 East 36th Avenue, Anchorage, AK

Traditional

Owned

Huffman Branch

1501 East Huffman Road, Anchorage, AK

Supermarket

Leased

Jewel Lake Branch

9170 Jewel Lake Road, Anchorage, AK

Traditional

Leased

Seventh Avenue Branch

517 West Seventh Avenue, Suite 300, Anchorage, AK

Traditional

Leased

West Anchorage Branch/Small Business Center

2709 Spenard Road, Anchorage, AK

Traditional

Owned

Eagle River Branch

12812 Old Glenn Highway, 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

 

 

 

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.

 

 

16

 


 

ITEM 4.            MINE SAFETY DISCLOSURES

Not applicable.

 

 

PART II

ITEM 5.                MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock trades on the NASDAQ under the symbol, “NRIM.”  We are aware that large blocks of our stock are held in street name by brokerage firms.  At March 15, 2013, the number of shareholders of record of our common stock was 141.

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

2012 

 

 

 

 

 

 

 

 

 

 

High

$

22.14

$

22.15

$

21.51

$

22.85

 

Low

$

17.76

$

20.43

$

19.62

$

20.06

 

 

 

 

 

 

 

 

 

 

2011 

 

 

 

 

 

 

 

 

 

 

High

$

19.59

$

20.04

$

19.90

$

19.26

 

Low

$

18.45

$

18.30

$

18.22

$

16.95

 

 

 

 

 

 

 

 

 

 

 

In 2012 we paid cash dividends of $0.13 per share in the first and second quarters and $0.15 per share in the third and fourth quarters.  In 2011 we paid cash dividends of $0.12 per share in the first and second quarters and $0.13 per share in the third and fourth quarters.  Cash dividends totaled $3.7 million, $3.3 million, and $2.8 million in 2012, 2011, and 2010, respectively.  On February 21, 2013, the Board of Directors approved payment of a $0.15 per share dividend on March 14, 2013, to shareholders of record on March 22, 2013.  The Company and the Bank are subject to restrictions on the payment of dividends pursuant to applicable federal and state banking regulations.  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 remains “well-capitalized”, the Company expects to receive dividends from the Bank.

Repurchase of Securities

The Company did not repurchase any of its common stock during the fourth quarter of 2012.

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, 2012. Additional information regarding the Company’s equity plans is presented in Note 19 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) (1)

Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights             (b)

Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a))  (c)

Equity compensation plans approved by security holders

267,302 

$

15.78 
153,226 

Total

267,302 

$

15.78 
153,226 

1  Includes 155,614 options awarded under previous stock option plans.

 

We do not have any equity compensation plans that have not been approved by our shareholders.

17

 


 

Stock Performance Graph

The graph shown below depicts the total return to shareholders during the period beginning after December 31, 2007, and ending December 31, 2012.  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 three indices was $100 on December 31, 2007, and that all dividends were reinvested.

Picture 2

 

 

 

18

 


 

ITEM 6.            SELECTED FINANCIAL DATA (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In Thousands, Except  Share Data)

2012

 

2011

 

2010

 

2009

 

2008

 

 

(Unaudited)

Net interest income

$

42,223 

 

$

42,364 

 

$

44,213 

 

$

46,421 

 

$

45,814 

Provision (benefit) for loan losses

 

(1,559)

 

 

1,999 

 

 

5,583 

 

 

7,066 

 

 

7,199 

Other operating income

 

15,432 

 

 

13,090 

 

 

12,377 

 

 

13,084 

 

 

11,354 

Other operating expense

 

39,600 

 

 

36,755 

 

 

37,624 

 

 

41,357 

 

 

40,394 

    Income before provision for  income taxes

$

19,614 

 

$

16,700 

 

$

13,383 

 

$

11,082 

 

$

9,575 

Provision for income taxes

 

6,156 

 

 

4,873 

 

 

3,918 

 

 

2,967 

 

 

3,122 

    Net Income

 

13,458 

 

 

11,827 

 

 

9,465 

 

 

8,115 

 

 

6,453 

         Less: Net income attributable to

 

 

 

 

 

 

 

 

 

 

 

 

 

 

         noncontrolling interest

 

512 

 

 

429 

 

 

399 

 

 

388 

 

 

370 

Net income attributable to Northrim Bancorp

$

12,946 

 

$

11,398 

 

$

9,066 

 

$

7,727 

 

$

6,083 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Basic

$

2.00 

 

$

1.77 

 

$

1.42 

 

$

1.22 

 

$

0.96 

    Diluted

 

1.97 

 

 

1.74 

 

 

1.40 

 

 

1.20 

 

 

0.95 

Cash dividends per share

 

0.56 

 

 

0.50 

 

 

0.44 

 

 

0.40 

 

 

0.66 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

$

1,160,107 

 

$

1,085,258 

 

$

1,054,529 

 

$

1,003,029 

 

$

1,006,392 

Portfolio loans

 

704,213 

 

 

645,562 

 

 

671,812 

 

 

655,039 

 

 

711,286 

Deposits

 

970,129 

 

 

911,248 

 

 

892,136 

 

 

853,108 

 

 

843,252 

Borrowings

 

4,479 

 

 

4,626 

 

 

4,766 

 

 

4,897 

 

 

15,986 

Junior subordinated debentures

 

18,558 

 

 

18,558 

 

 

18,558 

 

 

18,558 

 

 

18,558 

Shareholders' equity

 

136,353 

 

 

125,435 

 

 

117,122 

 

 

111,020 

 

 

104,648 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Book value per share

$

20.93 

 

$

19.39 

 

$

18.21 

 

$

17.42 

 

$

16.53 

Tangible book value per share(2)

$

19.67 

 

$

18.09 

 

$

16.86 

 

$

16.01 

 

$

15.06 

Net interest margin (tax equivalent)(3)

 

4.40 

%

 

4.59 

%

 

4.92 

%

 

5.33 

%

 

5.26 

Efficiency ratio (4)

 

68.25 

%

 

65.78 

%

 

65.96 

%

 

68.96 

%

 

70.05 

Return on assets

 

1.19 

%

 

1.09 

%

 

0.90 

%

 

0.79 

%

 

0.62 

Return on equity

 

9.85 

%

 

9.34 

%

 

7.87 

%

 

7.08 

%

 

5.85 

Equity/assets

 

11.75 

%

 

11.56 

%

 

11.11 

%

 

11.07 

%

 

10.40 

Dividend payout ratio

 

28.39 

%

 

28.67 

%

 

31.41 

%

 

33.18 

%

 

68.93 

Nonperforming loans/portfolio loans

 

0.64 

%

 

1.14 

%

 

1.70 

%

 

2.10 

%

 

3.66 

Net charge-offs (recoveries)/average loans

 

(0.03)

%

 

(0.01)

%

 

0.66 

%

 

1.00 

%

 

0.86 

Allowance for loan losses/portfolio loans

 

2.33 

%

 

2.56 

%

 

2.14 

%

 

2.00 

%

 

1.81 

Nonperforming assets/assets

 

0.78 

%

 

1.16 

%

 

2.07 

%

 

3.10 

%

 

3.84 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effective tax rate

 

31 

%

 

29 

%

 

29 

%

 

27 

%

 

34 

Number of banking offices

 

10 

 

 

10 

 

 

10 

 

 

11 

 

 

11 

Number of employees (FTE)

 

245 

 

 

260 

 

 

268 

 

 

295 

 

 

290 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 (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.

 

(2)Tangible 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 if excludes the effect of tangible assets on the Company’s equity.  See reconciliation to comparable GAAP measurement below.

19

 


 

(3)Tax-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 41.11% in all 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 comparable GAAP measurement below. 

(4)In managing our business, we review the efficiency ratio exclusive of intangible asset amortization, which is a non-GAAP performance measurementManagement 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 "Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operation" of this report.  See reconciliation to comparable GAAP measurement below.

Reconciliation of Selected Financial Data to GAAP Financial Measures

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.

Reconciliation of tangible book value per share to book value per share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

 

2011

 

 

2010

 

 

2009

 

 

2008

Northrim BanCorp shareholders' equity

$

136,260,000 

 

$

125,383,000 

 

$

117,072,000 

 

$

110,972,000 

 

$

104,648,000 

Divided by common shares outstanding

 

6,511,649 

 

 

6,466,763 

 

 

6,427,237 

 

 

6,371,455 

 

 

6,331,371 

Book value per share

$

20.93 

 

$

19.39 

 

$

18.21 

 

$

17.42 

 

$

16.53 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

 

2011

 

 

2010

 

 

2009

 

 

2008

Northrim BanCorp shareholders' equity

$

136,260,000 

 

$

125,383,000 

 

$

117,072,000 

 

$

110,972,000 

 

$

104,648,000 

Less: goodwill and intangible assets, net

 

8,170,000 

 

 

8,421,000 

 

 

8,697,000 

 

 

8,996,000 

 

 

9,320,000 

 

$

128,090,000 

 

$

116,962,000 

 

$

108,375,000 

 

$

101,976,000 

 

$

95,328,000 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Divided by common shares outstanding

 

6,511,649 

 

 

6,466,763 

 

 

6,427,237 

 

 

6,371,455 

 

 

6,331,371 

Tangible book value per share

$

19.67 

 

$

18.09 

 

$

16.86 

 

$

16.01 

 

$

15.06 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of tax-equivalent net interest margin to net interest margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In Thousands)

 

2012

 

 

2011

 

 

2010

 

 

2009

 

 

2008

 

Net interest income(5)

$

42,223 

 

$

42,364 

 

$

44,213 

 

$

46,421 

 

$

45,814 

 

Divided by average interest-bearing assets

 

973,741 

 

 

934,732 

 

 

904,168 

 

 

876,101 

 

 

876,904 

 

Net interest margin

 

4.34 

%

 

4.53 

%

 

4.89 

%

 

5.30 

%

 

5.22 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In Thousands)

 

2012

 

 

2011

 

 

2010

 

 

2009

 

 

2008

 

Net interest income(5)

$

42,223 

 

$

42,364 

 

$

44,213 

 

$

46,421 

 

$

45,814 

 

Plus: reduction in tax expense related to

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    tax-exempt interest income

 

626 

 

 

580 

 

 

315 

 

 

300 

 

 

280 

 

 

$

42,849 

 

$

42,944 

 

$

44,528 

 

$

46,721 

 

$

46,094 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Divided by average interest-bearing assets

 

973,741 

 

 

934,732 

 

 

904,168 

 

 

876,101 

 

 

876,904 

 

Tax-equivalent net interest margin

 

4.40 

%

 

4.59 

%

 

4.92 

%

 

5.33 

%

 

5.26 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

20

 


 

Calculation of efficiency ratio

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In Thousands)

 

2012

 

 

2011

 

 

2010

 

 

2009

 

 

2008

 

Net interest income(5)

$

42,223 

 

$

42,364 

 

$

44,213 

 

$

46,421 

 

$

45,814 

 

Other operating income

 

15,432 

 

 

13,090 

 

 

12,377 

 

 

13,084 

 

 

11,354 

 

  Total revenue

 

57,655 

 

 

55,454 

 

 

56,590 

 

 

59,505 

 

 

57,168 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other operating expense

 

39,600 

 

 

36,755 

 

 

37,624 

 

 

41,357 

 

 

40,394 

 

    Less intangible asset amortization

 

252 

 

 

275 

 

 

299 

 

 

323 

 

 

347 

 

Adjusted other operating expense

$

39,348 

 

$

36,480 

 

$

37,325 

 

$

41,034 

 

$

40,047 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Efficiency ratio

 

68.25 

%

 

65.78 

%

 

65.96 

%

 

68.96 

%

 

70.05 

%

 

  (5)Amount represents net interest income before provision for loan losses.

 

 

Reconciliation of total shareholders’  equity to tangible common shareholders’ equity and total assets to tangible assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In Thousands)

 

2012

 

 

2011

 

 

2010

 

 

2009

 

 

2008

 

Shareholders' equity

$

136,353 

 

$

125,435 

 

$

117,122 

 

$

111,020 

 

$

104,648 

 

Less: goodwill and other intangible assets, net

 

8,170 

 

 

8,421 

 

 

8,697 

 

 

8,996 

 

 

9,320 

 

Tangible common shareholders' equity

$

128,183 

 

$

117,014 

 

$

108,425 

 

$

102,024 

 

$

95,328 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

$

1,160,107 

 

$

1,085,258 

 

$

1,054,529 

 

$

1,003,029 

 

$

1,006,392 

 

Less: goodwill and other intangible assets, net

 

8,170 

 

 

8,421 

 

 

8,697 

 

 

8,996 

 

 

9,320 

 

Tangible assets

$

1,151,937 

 

$

1,076,837 

 

$

1,045,832 

 

$

994,033 

 

$

997,072 

 

Tangible common equity ratio

 

11.12 

%

 

10.86 

%

 

10.37 

%

 

10.26 

%

 

9.56 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 a company, they have limitations as analytical tools and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.

 

 

 

 

21

 


 

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, 2012,  2011, and 2010 included elsewhere in this report.

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

·

The Company’s net income increased 14% to $12.9 million, or $1.97 per diluted share, for the year ended December 31, 2012 from $11.4 million, or $1.74 per diluted share, for the year ended December 31, 2011, reflecting continuing improvement in credit quality and  increased other operating income.  

 

·

Our provision for loan losses in 2012 decreased by $3.6 million, or 178%, to a benefit of $1.6 million from an expense of $2.0 million in 2011 as we experienced net recoveries of $1.5 million in 2012 as compared to net recoveries of $98,000 in 2011.  In addition, our nonperforming loans at December 31, 2012 decreased by $2.8 million, or 38%, from $7.4 million at December 31, 2011 to $4.5 million at December 31, 2012

 

·

Other operating income, which includes revenues from financial services affiliates, service charges, and electronic banking contributed 27% to annual 2012 revenues, compared to a  contribution of 24% to annual 2011 revenues.

 

·

Other operating expenses increased $2.8 million, or 8% in 2012 to $39.6 million from $36.8 million in 2011 primarily due to increased OREO expense, increased salaries and benefits costs, and the creation of a reserve for purchased receivable losses.  These increases were partially offset by decreased insurance expense.

 

·

The Company’s total assets grew 7% to $1.160 billion at December 31, 2012 as compared to $1.085 billion at December 31, 2011,  primarily as a result of increases in loans, interest bearing deposits in other banks and cash offsetting reductions in investments, loans held for sale, and purchased receivables.    Year-to-date average loans were up 5% year over year at $687.9 million for 2012 as compared to $653.8 million in 2011.

 

·

Nonperforming assets decreased by 28% year-over-year to $9.1 million at December 31, 2012 or 0.78% of total assets, compared to $12.5 million or 1.16% of total assets at December 31, 2011.

 

·

The allowance for loan losses (“Allowance”) totaled 2.33% of total portfolio loans at December 31, 2012, compared to 2.56% at December 31, 2011.  The Allowance compared to nonperforming loans also increased to 362% at December 31, 2012 from 224% at December 31, 2011.

 

·

The Company continued to maintain strong capital ratios with Tier 1 Capital/risk adjusted assets of 15.34% at December 31, 2012 as compared to 15.20% a year ago.  The Company’s tangible common equity to tangible assets at year end 2012 was 11.12%, up from 10.86% at year-end 2011.  Tangible 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.  The GAAP measure of equity to assets is total equity divided by total assets.  Total equity to total assets was 11.75% at December 31, 2012 as compared to 11.56% at December 31, 2011. 

 

·

The cash dividend paid on December 14, 2012, rose 15% to $0.15 per diluted share from $0.13 per diluted share paid in the fourth quarter of 2011.  

 

Critical Accounting Estimates

The preparation of the consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances.  We believe that our estimates and assumptions are reasonable; however, actual results may differ significantly from these estimates and assumptions which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and on our results of operations for the reporting periods.

The accounting policies that involve significant estimates and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities, are considered critical accounting policies. We believe that our most critical accounting policies upon which our financial condition depends, and which involve the most complex or subjective decisions or assessments are as follows:  

22

 


 

Allowance for loan losses:  The Company maintains an Allowance to reflect inherent losses in its loan portfolio as of the balance sheet date.  In determining its total Allowance, the Company first estimates a specific allocated allowance for impaired loans.  This analysis is based upon a specific analysis for each impaired loan that is collateral dependent, including 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. 

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 qualitative factors applied to segments and classes of loans not considered impaired for purposes of establishing the allocated portion of the general reserve of the Allowance.  The Company first disaggregates the overall loan portfolio into 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 secured by 1st deeds of trust, and other consumer loans.  Then the Company further disaggregates each segment into the following classes; pass, special mention, substandard, doubtful and loss.  After the portfolio has been disaggregated into these 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 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. 

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 and prospective 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 segment, 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.

Goodwill and other intangibles:  Net assets of entities acquired in purchase transactions are recorded at fair value at the date of acquisition.  Identified intangibles are amortized over the period benefited either on a straight-line basis or on an accelerated basis depending on the nature of the intangible.  Goodwill is not amortized, although it is reviewed for impairment on an annual basis or at an interim date if events or circumstances indicate a potential impairment.  Goodwill impairment testing is performed at the reporting unit level.  We have determined that the Company has only one reporting unit. 

Under current guidance, the Company has the option to first assess qualitative factors to determine whether the existence of certain events or circumstances leads to a determination that it is more likely than not that the fair value of each reporting unit of the Company is less than the carrying amount.  If, using the qualitative assessment described above, it is determined that it is more likely than not that the carrying value exceeds the fair value of the Company, then we must move on to a more comprehensive goodwill impairment analysis. 

23

 


 

The first step of the comprehensive analysis, used to identify potential impairment, involves comparing the reporting unit’s fair value to its carrying value including goodwill.  If the fair value of a reporting unit exceeds its carrying value, applicable goodwill is considered not to be impaired.  If the carrying value exceeds fair value, there is an indication of impairment and the second step is performed to measure the amount of impairment.  

The second step involves calculating an implied fair value of goodwill for each reporting unit when the first step indicated impairment.  The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination, which is the excess of the fair value of the reporting unit, as determined in the first step, over the aggregate fair values of the individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination.  If the implied fair value of goodwill in the “pro forma” business combination accounting as described above exceeds the goodwill assigned to the reporting unit, there is no impairment.  If the goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss recognized cannot exceed the amount of goodwill, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted under applicable accounting standards. 

The Company performed its annual goodwill impairment testing at December 31, 2012 and 2011 in accordance with the policy described in Note 1 to the financial statements.  At December 31, 2012, the Company performed its annual impairment test by performing the first step of the comprehensive impairment analysis.  The Company estimated the fair value of the Company using four valuation methodologies including a comparable transactions approach, a control premium approach, a public market peers approach, and a discounted cash flow approach.  We then compared the estimated fair value of the Company to the carrying value as of December 31, 2012  and concluded that no potential impairment existed at that time.    The Company continues to monitor the Company’s goodwill for potential impairment on an ongoing basis.  No assurance can be given that we will not charge earnings during 2013 for goodwill impairment, if, for example, our stock price declines significantly, although there are many factors that we analyze in determining the impairment of goodwill.

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. 

 

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 purchased receivables products, earnings from our mortgage affiliate, sales of employee benefit plans, service charges and fees, electronic banking income, and rental income.  Our operating expenses consist in large part of compensation, employee benefits expense, occupancy, marketing, professional and outside services, equipment expense, software expense, and expenses related to OREO.  Interest income and cost of funds are affected significantly by general economic conditions, particularly changes in market interest rates, and by government policies and the actions of regulatory authorities.

We earned net income of $12.9 million in 2012, compared to net income of $11.4 million in 2011, and $9.1 million in 2010.  During these periods, net income per diluted share was $1.97, $1.74, and $1.40, respectively.  The increase in net income in 2012 was primarily due to a decrease in the provision for loan losses of $3.6 million and an increase in other operating income of $2.3 million, being partially offset by an increase of $2.8 million in other operating expenses and an increase of $1.3 million in income taxes in 2012 as compared to 2011. The increase in net income in 2011 was primarily due to decreases in the provision for loan losses and other operating expenses of $3.6 million and $869,000, respectively, and an increase in other operating income of $713,000, being partially offset by a decrease in net interest income of $1.8 million in 2011 as compared to 2010, as well as an increase in income taxes of $955,000 over the same period.

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.  Net interest income in 2012 was $42.2 million, compared to $42.4 million in 2011 and $44.2 million in 2010.  The decrease in 2012 as compared to 2011, and the decrease in 2011 as compared to 2010 was primarily due to lower yields on loans and long-term investments which were only partially offset by decreased interest expense from lower average interest rates on deposits and increased interest income from higher average loan balances. 

24

 


 

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 the level and relative mix of interest-earning assets and interest-bearing liabilities.  During the fiscal years ended December 31, 2012, 2011, and 2010, average interest-earning assets were $973.7 million, $934.7 million, and $904.2 million, respectively. During these same periods, net interest margins were 4.34%, 4.53%, and 4.89%, respectively, which reflects the changes in our balance sheet mix.  Our average yield on interest-earning assets was 4.59% in 2012, 4.91% in 2011, and 5.50% in 2010, while the average cost of interest-bearing liabilities was 0.39% in 2012, 0.57% in 2011, and 0.88% in 2010.

Our net interest margin decreased in 2012 from 2011 and in 2011 from 2010.  The year over year declines were mainly due to the fact that in both periods, interest rates on both loans and investment securities declined as compared to the prior year.  In both periods, these decreases were only partially offset by increases in net interest income due to higher average balances in interest-bearing assets.

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.  Resultant yields or costs, net interest income, and net interest margin are also presented:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years ended December 31,

 

 

2012

 

 

2011

 

 

2010

 

 

 

Average

Interest

 

Average

 

Average

Interest

 

Average

 

Average

Interest

 

Average

 

 

 

outstanding

income /

 

Yield /

 

outstanding

income /

 

Yield /

 

outstanding

income /

 

Yield /

 

(In Thousands)

 

balance

expense

 

Cost

 

balance

expense

 

Cost

 

balance

expense

 

Cost

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans (1),(2)

 

$

687,853 

$

41,515 

 

6.04 

%

$

653,820 

$

42,391 

 

6.48 

%

$

646,677 

$

44,926 

 

6.95 

%

Long-term Investments

 

 

200,600 

 

2,935 

 

1.46 

%

 

207,603 

 

3,309 

 

1.59 

%

 

187,155 

 

4,594 

 

2.45 

%

Short-term investments

 

 

85,288 

 

278 

 

0.33 

%

 

73,309 

 

208 

 

0.28 

%

 

70,336 

 

178 

 

0.25 

%

         Total interest-earning assets

 

 

973,741 

$

44,728 

 

4.59 

%

 

934,732 

$

45,908 

 

4.91 

%

 

904,168 

$

49,698 

 

5.50 

%

Noninterest-earning assets

 

 

114,678 

 

 

 

 

 

 

113,964 

 

 

 

 

 

 

106,398 

 

 

 

 

 

         Total

 

$

1,088,419 

 

 

 

 

 

$

1,048,696 

 

 

 

 

 

$

1,010,566 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits

 

$

597,445 

$

1,682 

 

0.28 

%

$

589,163 

$

2,726 

 

0.46 

%

$

588,341 

$

4,673 

 

0.79 

%

Borrowings

 

 

39,596 

 

823 

 

2.08 

%

 

37,365 

 

818 

 

2.19 

%

 

34,341 

 

812 

 

2.36 

%

         Total interest-bearing  liabilities

 

$

637,041 

$

2,505 

 

0.39 

%

$

626,528 

$

3,544 

 

0.57 

%

$

622,682 

$

5,485 

 

0.88 

%

Demand deposits and other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        non-interest bearing liabilities

 

 

320,010 

 

 

 

 

 

 

300,129 

 

 

 

 

 

 

272,645 

 

 

 

 

 

Equity

 

 

131,368 

 

 

 

 

 

 

122,039 

 

 

 

 

 

 

115,239 

 

 

 

 

 

            Total

 

$

1,088,419 

 

 

 

 

 

$

1,048,696 

 

 

 

 

 

$

1,010,566 

 

 

 

 

 

Net interest income

 

 

 

$

42,223 

 

 

 

 

 

$

42,364 

 

 

 

 

 

$

44,213 

 

 

 

Net interest margin (3)

 

 

 

 

 

 

4.34 

%

 

 

 

 

 

4.53 

%

 

 

 

 

 

4.89 

%

1Interest income includes loan fees.  Loan fees recognized during the period and included in the yield calculation totaled $2.7 million, $2.6 million and

 

    $2.6 million for 2012, 2011 and 2010, respectively.

 

2Nonaccrual loans are included with a zero effective yield.  Average nonaccrual loans included in the computation of the average loans were $5.8 million,

 

    $9.6 million, and $13.8 million in 2012, 2011 and 2010, respectively.

 

3The net interest margin on a tax equivalent basis was 4.40%, 4.59%, and 4.92%, respectively, for 2012, 2011, and 2010.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

25

 


 

 

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: