10-K 1 d267795d10k.htm FORM 10-K FORM 10-K
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

þ   

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the fiscal year ended: December 31, 2011

 

¨   

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: 0-33501

NORTHRIM BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Alaska     92-0175752
(State of Incorporation)    

(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)

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  þ  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        þ  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.    þ  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).    þ  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        þ  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   þ    Non-accelerated filer   ¨    Smaller Reporting Company   ¨
                                 (Do not check if a smaller reporting company)

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2011 (the last business day of the registrant’s most recently completed second fiscal quarter) was $116,478,456.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. 6,467,166 shares of Common Stock, $1.00 par value, as of March 13, 2012.

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 17, 2012, is incorporated by reference into Part III of this Form 10-K.

 

 

 

 


Table of Contents

Northrim BanCorp, Inc.

Annual Report on Form 10-K

December 31, 2011

Table of Contents

 

   Part I   

Item 1.

   Business      1   

Item 1A.

   Risk Factors      8   

Item 1B.

   Unresolved Staff Comments      13   

Item 2.

   Properties      13   

Item 3.

   Legal Proceedings      13   
   Part II   

Item 4.

   Mine Safety Disclosures      14   

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      14   

Item 6.

   Selected Financial Data      16   

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      18   

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk      40   

Item 8.

   Financial Statements and Supplementary Data      43   

Item 9.

   Changes in and Disagreements With Accountants on Accounting and Financial Disclosure      89   

Item 9A.

   Controls and Procedures      89   

Item 9B.

   Other Information      89   
   Part III   

Item 10.

   Directors, Executive Officers and Corporate Governance      90   

Item 11.

   Executive Compensation      90   

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      90   

Item 13.

   Certain Relationships and Related Transactions, and Director Independence      90   

Item 14.

   Principal Accounting Fees and Services      91   
   Part IV   

Item 15.

   Exhibits, Financial Statement Schedules      91   

Index to Exhibits

     92   
Signatures      94   

 


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PART I

This Annual Report on Form 10-K includes forward-looking statements, 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 fourth largest commercial bank in Alaska and the third largest in Anchorage in terms of deposits, with $911.2 million in total deposits and $1.1 billion in total assets at December 31, 2011. 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 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 and Oregon market areas through Northrim Funding Services (“NFS”), a division of the Bank that was formed 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 41% 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 23% 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.

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

 

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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 41% 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 and Oregon areas 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 five 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 1.16% at December 31, 2011 as compared to 2.07% and 3.10% at December 31, 2010 and 2009, 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 and other real estate owned (“OREO”) 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.

 

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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 2011 who have valuable expertise in our niche markets.

We consider our relations with our employees to be satisfactory. We had 260 full-time equivalent employees at December 31, 2011. 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, a division of the Bank. In 2012, 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 13, 2012, 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 38% of our loan portfolio at December 31, 2011 is attributable to sixteen large borrowing relationships. Moreover, our business activities are currently focused primarily in the state of Alaska. Consequently, our results of

 

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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.

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 92% 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 Exxon 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 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 2011, according to the State of Alaska’s Department of Commerce, revenue collected from bed taxes in Anchorage increased 7.5% in the twelve month period ended June 30, 2011 to $20.3 million from $18.9 million in the twelve month period ended June 30, 2010. Additionally, the Department of Commerce reported a 3% increase in people visiting the State of Alaska in the fall and winter seasons (the period between October 2010 and April 2011) as compared to the prior year.

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 commodities and energy prices. According to the Legislative Finance Division of the State of Alaska, as of September 13, 2011, Alaska has more than $14 billion in liquid reserves. As of December 31, 2011 the Permanent Fund has a balance of $40 billion, which pays an annual dividend to every Alaskan citizen. In 2011, unemployment in Alaska decreased to 7.7% according to the Alaska Department of Labor as compared to 8.3% for the United States. This marks the 37th consecutive month that Alaska’s unemployment rate has been lower than the national average.

A material portion of our loans at December 31, 2011, were secured by real estate located in greater Anchorage, Matanuska-Susitna Valley, and Fairbanks, Alaska. Moreover, 10% 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 a significant slowdown. Any further 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, 2011, $253 million, or 38%, 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 28 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 $1,174 per eligible resident in 2011 for an aggregate distribution of approximately $813 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).

 

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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 38% share of total statewide deposits held in banks and credit unions as of December 31, 2010. 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 a 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, 2011, the date of the most recently available information, we had approximately a 10% share of the Alaska commercial bank deposits, 16% 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, 2011, the most recent date for which comparative deposit information is available.

 

Financial institution    Number of
branches
     Total deposits      Market share of
deposits
 
     (Dollars in thousands)  

Northrim Bank

     8       $ 802,789         16

Wells Fargo Bank Alaska

     14         2,477,304         50

First National Bank Alaska

     10         1,107,740         22

Key Bank

     4         622,459         12
   

Total

     36       $ 5,010,292         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 in that capacity also 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 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.

 

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Congress enacted major federal financial institution legislation in 1999. Title I of the Gramm-Leach-Bliley Act (the “GLB Act”), which became effective March 11, 2000, allows bank holding companies to elect to become financial holding companies. 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 may utilize the new structure to accommodate an expansion of its products and services.

The activities of bank holding companies, such as the Company, that are not financial holding companies, are generally limited to managing or controlling banks. 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 activities of a bank holding company are also generally limited to the acquisition of up to 5% of the voting shares 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 the most extensive consumer privacy provisions ever enacted by Congress. 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.

Specifically with regard to the payment of dividends, there 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. Additionally, depending upon the circumstances, the FDIC or the Division could take the position that paying a dividend would constitute an unsafe or unsound banking practice.

Under longstanding FRB policy, a bank holding company is expected to act as a source of financial strength for its subsidiary banks and to commit resources to support such banks. The Company could be required to commit resources to its subsidiary banks in circumstances where it might not do so, absent such policy.

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 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 the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgment by the regulators about components, risk weightings, and other factors.

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. As of December 15, 2011, the most recent notification from the FDIC categorized the Bank as “well-capitalized” under the

 

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regulatory framework for prompt corrective action. Management believes, as of December 31, 2011, that the Company and Northrim Bank met all capital adequacy requirements for a “well-capitalized” institution.

Under the regulations adopted by the federal regulatory authorities, a bank will be: (i) ”well-capitalized” if the institution 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 order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if the institution 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 institution 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 institution 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 institution’s tangible equity is equal or less than 2.0% of average quarterly tangible assets. An institution 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.

Banks that are downgraded from “well-capitalized” to “adequately capitalized” face significant additional restrictions. For example, an “adequately capitalized” status affects a bank’s ability to accept brokered deposits and enter into reciprocal Certificate of Deposit Account Registry System (“CDARS”) contracts without the prior approval of the FDIC, and may cause greater difficulty obtaining retail deposits. CDARS is a network of over 3,000 banks throughout the United States. The CDARS system was founded in 2003 and allows participating banks to exchange FDIC insurance coverage so that 100% of the balance of their customers’ certificates of deposit are fully subject to FDIC insurance. The system also allows for investment of banks’ own investment dollars in the form of domestic certificates of deposit. 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 the Bank in excess of 10% in 2012, exceeding the FDIC’s “well-capitalized” capital requirement classification. The dividends that the Bank pays to the Company are limited to the extent necessary for the Bank to meet the regulatory requirements of a “well-capitalized” bank.

The capital ratios for the Company exceed those for the Bank primarily because the $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 the Bank’s financial statements nor are they included in its capital (although the Company did contribute to the Bank a portion of the cash proceeds from the sale of those securities). As a result, the Company has $18 million more in regulatory capital than the Bank at December 31, 2011 and 2010, which explains most of the difference in the capital ratios for the two entities.

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, deposits in offices and certain claims for administrative expenses and employee compensation 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.

The Company is also subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Securities Exchange Act of 1934, as amended (the “Securities Exchange Act of 1934”), including certain requirements under the Sarbanes-Oxley Act of 2002.

The Bank is subject to the Community Reinvestment Act of 1977 (“CRA”). The CRA requires that the Bank help meet the credit needs of the communities it serves, including low and moderate income neighborhoods, consistent with the safe and sound operation of the institution. The FDIC assigns one of four possible ratings to the Bank’s CRA performance and makes the rating and the examination reports publicly available. The four possible ratings are outstanding, satisfactory, needs to improve and substantial noncompliance. A financial institution’s CRA rating can affect an institution’s future business. For example, a federal banking agency will take CRA performance into consideration when acting on an institution’s application to establish or move a branch, to merge or to acquire assets or assume liabilities of another institution. In its most recent CRA examination, 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

 

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to prevent and defeat money laundering. Management believes the Company is in compliance with the USA Patriot Act as in effect on December 31, 2011.

On October 3, 2008, the U.S. Congress passed, and the President signed into law, the Emergency Economic Stabilization Act of 2008 (the “Stabilization Act”). Among other things, the Stabilization Act temporarily increased the amount of insurance coverage of deposit accounts held at FDIC-insured depository institutions, including the Bank, from $100,000 to $250,000. This coverage was permanently increased effective in July 2010.

On October 14, 2008, using the systemic risk exception to the FDIC Improvement Act of 1991, the U.S. Treasury authorized the FDIC to provide a 100% guarantee of newly-issued senior unsecured debt and deposits in non-interest bearing transaction accounts at FDIC insured institutions. The Company elected to participate in this program as it pertains to the 100% guarantee of non-interest bearing transaction accounts by the FDIC. Banks participating in the transaction account guarantee program are required to pay an additional 10 basis points in insurance fees on the amounts guaranteed by the program. This transaction account guarantee program is scheduled to expire on January 1, 2013. The Company elected not to participate in the part of the program that guarantees newly-issued senior unsecured debt.

Under the Troubled Asset Auction Program, another initiative based on the authority granted by the Stabilization Act, the U.S. Treasury, through a newly-created Office of Financial Stability, has purchased certain troubled mortgage-related assets from financial institutions in a reverse-auction format. Troubled assets eligible for purchase by the Office of Financial Stability include residential and commercial mortgages originated on or before March 14, 2008, securities or obligations that are based on such mortgages, and any other financial instrument that the Secretary of the U.S. Treasury determines, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, is necessary to promote financial market stability.

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was signed into law which, among other things, limits the ability of certain bank holding companies to treat trust preferred security debt issuances as Tier 1 capital. This law may require many banks to raise new Tier 1 capital and will effectively close the trust-preferred securities markets from offering new issuances in the future. Since the Company had less than $15 billion in assets at December 31, 2009, under the Dodd-Frank Act, the Company will be able to continue to include its existing trust preferred securities in Tier 1 capital.

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, 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.

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

 

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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 will require 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 we are facing. 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, or the failure of these actions to help stabilize the financial markets, asset prices, market liquidity, and a continuation or worsening of current financial market and economic conditions could materially and adversely affect our business, financial condition, results of operations, and the trading price of our common stock.

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

In 2010, a financial crisis emerged in Europe, triggered 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.

We may be adversely impacted by the unprecedented volatility in the financial markets.

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, initially of mortgage-backed securities but spreading to credit default swaps and other derivative and cash securities, in turn, 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

 

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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 experienced some stabilization in the economy in 2010 and 2011, we 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.

 

   

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 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 2012, the Company expects that its revenues from the residential housing market in the form of interest income and fees on loans and earnings from RML will be higher than 2011 because of an increase in residential construction loans through the Company’s efforts to increase market share in this area, offset in part by a decline in refinance activity at RML. However, further 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. The sustained 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 68% of the Bank’s loan portfolio at December 31, 2011 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, 2011, 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, 2011 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. These trends may continue and 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 continue to 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, 2011, the Bank held $5.2 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 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 affect 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, 2011, approximately 68% of the Bank’s loans are secured by real estate and 32% 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 financial services business is intensely competitive and our success will depend on our ability to compete effectively.

The financial services business in our market areas is highly competitive. It is becoming increasingly competitive due to changes in regulation, technological advances, and the accelerating pace of consolidation among financial services providers. We face competition both in attracting deposits and in originating loans. We compete for loans principally through the pricing of interest rates and loan fees and the efficiency and quality of services. Increasing levels of competition in the banking and financial services industries may reduce our market share or cause the prices charged for our services to fall. Improvements in technology, communications, and the internet have intensified competition. As a result, our competitive position could be weakened, which could adversely affect our financial condition and results of operations.

We 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. Langland, Beedle, Knudson, and Schierhorn in the amounts of $2.5 million, $2 million, $2.1 million, and $1 million, respectively, we may not be able to timely replace Mr. Langland, Mr. Beedle, Mr. Knudson, or Mr. Schierhorn with a person of comparable ability and experience should the need to do so arise,

 

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causing losses in excess of the insurance proceeds. Currently, we do not maintain keyman life insurance on the life of Mr. Hartung. The unexpected loss of key employees could have a material adverse effect on our business and possibly result in reduced revenues and earnings.

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.

 

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

   Traditional    Land leased;

3111 C Street, Anchorage, AK

      building owned

SouthSide Financial Center

   Traditional    Land leased;

8730 Old Seward Highway, Anchorage, AK

      building owned

36th Avenue Branch

   Traditional    Owned

811 East 36th Avenue, Anchorage, AK

     

Huffman Branch

   Supermarket    Leased

1501 East Huffman Road, Anchorage, AK

     

Jewel Lake Branch

   Traditional    Leased

9170 Jewel Lake Road, Anchorage, AK

     

Seventh Avenue Branch

   Traditional    Leased

517 West Seventh Avenue, Suite 300, Anchorage, AK

     

West Anchorage Branch/Small Business Center

   Traditional    Owned

2709 Spenard Road, Anchorage, AK

     

Eagle River Branch

   Traditional    Leased

12812 Old Glenn Highway, Eagle River, AK

     

Fairbanks Financial Center

   Traditional    Owned

360 Merhar Avenue, Fairbanks, AK

     

Wasilla Financial Center

   Traditional    Owned

850 E. USA Circle, Suite A, Wasilla, AK

     
 

 

ITEM 3. LEGAL PROCEEDINGS

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

 

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PART II

 

ITEM 4. MINING SAFETY DISCLOSURES

Not applicable.

 

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 13, 2012, the number of shareholders of record of our common stock was 144.

The following are high and low closing prices as reported by NASDAQ. Prices do not include retail markups, markdowns or commissions.

 

      First
Quarter
     Second
Quarter
     Third
Quarter
     Fourth
Quarter
 

2011

           

High

   $ 19.59       $ 20.04       $ 19.90       $ 19.26   

Low

   $ 18.45       $ 18.30       $ 18.22       $ 16.95   

2010

           

High

   $ 17.20       $ 17.58       $ 17.96       $ 19.32   

Low

   $ 15.38       $ 15.48       $ 15.35       $ 16.49   
                                     

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. In 2010 we paid cash dividends of $0.10 per share in the first and second quarters and $0.12 per share in the third and fourth quarters. Cash dividends totaled $3.3 million, $2.8 million, and $2.6 million in 2011, 2010, and 2009, respectively. On February 16, 2012, the Board of Directors approved payment of a $0.13 per share dividend on March 16, 2012, to shareholders of record on March 8, 2012. 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 2011.

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, 2011. Additional information regarding the Company’s equity plans is presented in Note 18 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)
     Remaining Available for
Future Issuance Under
Equity Compensation Plans
(Excluding Securities
Reflected in Column
(a)) (c)
 

Equity compensation plans approved by security holders

     320,786       $ 14.61         230,542   
   

Total

     320,786       $ 14.61         230,542   
   

 

(1) Includes 248,628 options and restricted stock units awarded under previous stock option plans.

 

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Stock Performance Graph

The graph shown below depicts the total return to shareholders during the period beginning after December 31, 2006, and ending December 31, 2011. 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, 2006, and that all dividends were reinvested.

Total Return Performance

 

LOGO

 

                      Period Ending                  

Index

     12/31/06         12/31/07         12/31/08         12/31/09         12/31/10         12/31/11   
  

 

 

    

 

 

 
      

 

 

    

 

 

 

Northrim BanCorp, Inc.

     100.00         86.01         43.18         72.93         85.64         79.68   

Russell 3000

     100.00         105.14         65.92         84.60         98.92         99.93   

SNL Bank $1B-$5B

     100.00         72.84         60.42         43.31         49.09         44.77   
  

 

 

    

 

 

 
      

 

 

    

 

 

 

 

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ITEM 6. SELECTED FINANCIAL DATA (1)

 

      2011      2010      2009      2008      2007  
    

Unaudited

(In Thousands Except Per Share Amounts)

 

Net interest income

     $42,364         $44,213         $46,421         $45,814         $49,830   

Provision for loan losses

     1,999         5,583         7,066         7,199         5,513   

Other operating income

     13,090         12,377         13,084         11,354         9,844   

Other operating expense

     36,755         37,624         41,357         40,394         34,953   
            

Income before income taxes

     16,700         13,383         11,082         9,575         19,208   

Income taxes

     4,873         3,918         2,967         3,122         7,260   
            

Net Income

     11,827         9,465         8,115         6,453         11,948   

Less: Net income attributable to noncontrolling interest

     429         399         388         370         290   
            

Net income attributable to Northrim Bancorp

     $11,398         $9,066         $7,727         $6,083         $11,658   
            

Earnings per share:

              

Basic

     $1.77         $1.42         $1.22         $0.96         $1.82   

Diluted

     1.74         1.40         1.20         0.95         1.80   

Cash dividends per share

     0.50         0.44         0.40         0.66         0.57   

Assets

     $1,085,258         $1,054,529         $1,003,029         $1,006,392         $1,014,714   

Portfolio loans

     645,562         671,812         655,039         711,286         714,801   

Deposits

     911,248         892,136         853,108         843,252         867,376   

Borrowings

     4,626         4,766         4,897         15,986         1,774   

Junior subordinated debentures

     18,558         18,558         18,558         18,558         18,558   

Shareholders’ equity

     125,435         117,122         111,020         104,648         101,391   

Book value per share

     $19.39         $18.21         $17.42         $16.53         $16.09   

Tangible book value per share(2)

     $18.09         $16.86         $16.01         $15.06         $14.51   

Net interest margin (tax equivalent)(3)

     4.59%         4.92%         5.33%         5.26%         5.89%   

Efficiency ratio (4)

     65.78%         65.96%         68.96%         70.05%         58.01%   

Return on assets

     1.09%         0.90%         0.79%         0.62%         1.24%   

Return on equity

     9.34%         7.87%         7.08%         5.85%         11.70%   

Equity/assets

     11.56%         11.11%         11.07%         10.40%         10.00%   

Dividend payout ratio

     28.67%         31.41%         33.18%         68.93%         30.54%   

Nonperforming loans/portfolio loans

     1.14%         1.70%         2.10%         3.66%         1.59%   

Net charge-offs/average loans

     -0.01%         0.66%         1.00%         0.86%         0.86%   

Allowance for loan losses/portfolio loans

     2.56%         2.14%         2.00%         1.81%         1.64%   

Nonperforming assets/assets

     1.16%         2.07%         3.10%         3.84%         1.56%   

Tax rate

     29%         29%         27%         34%         38%   

Number of banking offices

     10         10         11         11         10   

Number of employees (FTE)

     260         268         295         290         302   
            

 

(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 that represents shareholder's equity, less intangible assets, divided by common stock outstanding.

 

(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 both 2011 and 2010.

 

(4) In managing our business, we review the efficiency ratio exclusive of intangible asset amortization (see definition in table below), which is not defined in accounting principles generally accepted in the United States ("GAAP"). The efficiency ratio is calculated by dividing noninterest expense, exclusive of intangible asset amortization, by the sum of net interest income and noninterest income. Other companies may define or calculate this data differently. We believe this presentation provides investors with a more accurate picture of our operating efficiency. In this presentation, noninterest expense is adjusted for intangible asset amortization. For additional information see the "Noninterest Expense" section in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation" of this report.

 

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Reconciliation of Selected Financial Data to GAAP Financial Measures (1)

 

Years ended December 31,    2011      2010      2009      2008      2007  
     (In Thousands)  

Net interest income(2)

   $ 42,364       $ 44,213       $ 46,421       $ 45,814       $ 49,830   

Noninterest income

     13,090         12,377         13,084         11,354         9,844   

Noninterest expense

     36,755         37,624         41,357         40,394         34,953   

Less intangible asset amortization

     275         299         323         347         337   
            

Adjusted noninterest expense

   $ 36,480       $ 37,325       $ 41,034       $ 40,047       $ 34,616   
            

Efficiency ratio

     65.78%         65.96%         68.96%         70.05%         58.01%   
            

 

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

 

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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, 2011, 2010, and 2009 included elsewhere in this report.

Executive Overview

 

   

The Company’s net income increased 26% to $11.4 million, or $1.74 per diluted share, for the year ended December 31, 2011 from $9.1 million, or $1.40 per diluted share, for the year ended December 31, 2010, reflecting continuing improvement in credit quality, increased other operating income, and lower other operating expenses.

 

   

Our provision for loan losses in 2011 decreased by $3.6 million, or 64%, to $2 million from $5.6 million in 2010 as we experienced net recoveries of $98,000 in 2011 as compared to net charge-offs of $4.3 million in 2010. In addition, our nonperforming loans at December 31, 2011 decreased by $4 million, or 36%, from $11.4 million at December 31, 2010 to $7.4 million at December 31, 2011.

 

   

Other operating income, which includes revenues from financial services affiliates, service charges, and electronic banking contributed 23.6% to annual 2011 revenues, compared to contributions of 21.9% to annual 2010 revenues.

 

   

Other operating expenses decreased $869,000, or 2% in 2011 to $36.8 million from $37.6 million in 2010 primarily due to decreased salaries and benefits costs and decreased FDIC insurance expense. These decreases were partially offset by decreased gains on sale and rental income from OREO. The gains on sale and rental income generated from OREO are included as negative expense items in the other operating expense section of the Consolidated Statement of Income.

 

   

The Company’s total assets grew 3% to $1.085 billion at December 31, 2011 as compared to $1.055 billion at December 31, 2010, with increases in cash and investments, loans held for sale and purchased receivables offsetting reductions in OREO and portfolio loans. While loans decreased 4% at December 31, 2011 as compared to the prior year, year-to-date average loans were up 1% year over year at $653.8 million for 2011 as compared to $646.7 million in 2010.

 

   

The allowance for loan losses (“Allowance”) totaled 2.56% of total portfolio loans at December 31, 2011, compared to 2.14% at December 31, 2010. The Allowance to nonperforming loans also increased to 224% at December 31, 2011 from 126% at December 31, 2010.

 

   

Nonperforming assets were reduced 43% year-over-year to $12.5 million at December 31, 2011 or 1.16% of total assets, compared to $21.8 million or 2.07% of total assets at December 31, 2010.

 

   

The Company continued to maintain strong capital ratios with Tier 1 Capital/risk adjusted assets of 15.20% at December 31, 2011 as compared to 14.08% a year ago. The Company’s tangible common equity to tangible assets at year end 2011 was 10.86%, up from 10.36% at year-end 2010. 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 11.56% at December 31, 2011 as compared to 11.11% at December 31, 2010.

 

   

The cash dividend paid on December 16, 2011, rose 8% to $0.13 per diluted share from $0.12 per diluted share paid in the fourth quarter of 2010.

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

 

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critical accounting policies upon which our financial condition depends, and which involve the most complex or subjective decisions or assessments are as follows:

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, real estate term, and home equity lines and other consumer loans. Then the Company further disaggregates each segment into the following classes, which are also known as risk classifications: excellent, good, satisfactory, watch, 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 four 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 be further adjusted 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 risk ratings and inherent 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 risk ratings 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

 

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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.

In 2011, the Company early implemented Accounting Standards Update 2011-08, “Testing for Goodwill Impairment” (“ASU 2011-08”). Under this new guidance, the Company implemented 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. We have determined that the Company has only one reporting unit. If it is determined that it is more likely than not that the fair value of the Company exceeds the carrying amount, the Company need not move on to step one of the impairment test, and goodwill is not impaired.

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. The first step, used to identify potential impairment, involves comparing each 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, 2011 and 2010 in accordance with the policy described in Note 1. At December 31, 2011, the Company performed its annual impairment test by applying the qualitative assessment described in ASU 2011-08. Significant positive inputs to the qualitative assessment included the Company’s capital position; the Company’s increasing historical trends and budget-to-actual results of operations; the Company’s decreasing trends in, and current level of nonperforming assets; results of regulatory examinations; trends and peer comparisons of net interest margin; and trends in the Company’s cash flows. Significant negative inputs to the qualitative assessment included general local, national, and international economic conditions and how they may negatively affect our business as well as the current volatility and uncertainty related to market capitalization of financial institutions in general. We believe that the positive inputs to the qualitative assessment noted above outweigh the negative inputs, and we therefore concluded that it is more likely than not that the fair value of the Company exceeds the carry value at December 31, 2011 and 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 2012 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.

Reductions in the carrying value of other real estate owned subsequent to acquisition are determined based on management’s estimate of the fair value of individual properties. Significant inputs into this estimate include estimated costs to complete projects as well as our assessment of current market conditions.

Results of Operations

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, service charges and fees, sales of employee benefit plans, electronic banking income, earnings from our mortgage affiliate, and rental income. Our operating expenses consist in large part of compensation, employee benefits expense, occupancy, marketing, professional and outside services, insurance 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.

 

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We earned net income of $11.4 million in 2011, compared to net income of $9.1 million in 2010, and $7.7 million in 2009. During these periods, net income per diluted share was $1.74, $1.40, and $1.20, respectively. The increase in 2011 was 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. These changes were 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 the provision for income taxes of $955,000 over the same period.

Net Interest Income

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 2011 was $42.4 million, compared to $44.2 million in 2010 and $46.4 million in 2009. The decrease in 2011 was primarily due to the lower yield on loans and investments in 2011 as compared to 2010 which was only partially offset by decreased interest expense from lower average interest rates on deposits. The decrease in 2010 was primarily due to lower average loan balances, coupled with a slightly lower yield on loans in 2010 as compared to 2009 which was only partially offset by decreased interest expense from lower average interest rates on both deposits and borrowings.

Changes in net interest income result from changes in volume and spread, which in turn affect our margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Changes in net interest income are influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities. During the fiscal years ended December 31, 2011, 2010, and 2009, average interest-earning assets were $934.7 million, $904.2 million, and $876.1 million, respectively. During these same periods, net interest margins were 4.53%, 4.89%, and 5.30%, respectively, which reflects the changes in our balance sheet mix. Our average yield on interest-earning assets was 4.91% in 2011, 5.50% in 2010, and 6.11% in 2009, while the average cost of interest-bearing liabilities was 0.57% in 2011, 0.88% in 2010, and 1.14% in 2009.

Our net interest margin decreased in 2011 from 2010 mainly due to the fact that in 2011, interest rates on both loans and investment securities declined as compared to 2010. These decreases were only partially offset by increases in net interest income due to higher average balances in interest-bearing assets. The net interest margin decreased in 2010 from 2009 mainly due to the fact that in 2010, the mix of average interest-earning assets included lower average loan balances and higher average balances in securities and short term investments as compared to 2009. Loans have a significantly higher yield than securities and short term investments, so the shift in average balances in these asset categories significantly impacts the overall yield on interest-earnings assets.

 

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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,          2011                   2010                   2009         
     Average
outstanding
balance
    Interest
earned/
paid (1)
    Yield/
rate
    Average
outstanding
balance
    Interest
earned/
paid (1)
    Yield/
rate
    Average
outstanding
balance
    Interest
earned/
paid (1)
    Yield/
rate
 
    (In Thousands)  

Assets:

                 

Loans (2)

  $ 653,820      $ 42,391        6.48   $ 646,677      $ 44,926        6.95   $ 688,347      $ 48,830        7.09

Investment securities

    207,603        3,309        1.59     187,155        4,594        2.45     144,713        4,499        3.11

Interest bearing deposits in other banks

    73,309        208        0.28     70,336        178        0.25     43,041        161        0.37
                                           

Total interest-earning assets

    934,732      $ 45,908        4.91     904,168        49,698        5.50     876,101        53,490        6.11

Noninterest-earning assets

    118,400            106,398            105,578       
                                           

Total assets

  $ 1,053,132          $ 1,010,566          $ 981,679       
                                           

Liabilities and Shareholders’ Equity:

                 

Deposits:

                 

Interest-bearing demand

  $ 132,860      $ 111        0.08   $ 125,360      $ 176        0.14   $ 115,065      $ 170        0.15

Money market

    152,464        591        0.39     132,264        673        0.51     127,651        740        0.58

Savings

    175,813        622        0.35     183,636        1,120        0.61     169,812        1,240        0.73

Certificates of deposit

    128,026        1,402        1.10     147,081        2,704        1.84     173,777        3,651        2.10
                                           

Total interest-bearing deposits

    589,163        2,726        0.46     588,341        4,673        0.79     586,305        5,801        0.99

Securities sold under repurchase agreements and borrowings

    37,365        818        2.19     34,341        812        2.36     35,935        1,268        3.53
                                           

Total interest-bearing liabilities

    626,528        3,544        0.57     622,682        5,485        0.88     622,240        7,069        1.14

Demand deposits and other noninterest-bearing liabilities

    300,129            272,645            250,342       
                                           

Total liabilities

    926,657            895,327            872,582       

Shareholders’ equity

    122,039            115,239            109,097       
                                           

Total liabilities and shareholders’ equity

  $ 1,048,696          $ 1,010,566          $ 981,679       
                                           

Net interest income

    $ 42,364          $ 44,213          $ 46,421     
                                           

Net interest margin (3)

        4.53         4.89         5.30
                                           

 

(1) Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totalled $2.6 million, $2.6 million and $2.7 million for 2011, 2010 and 2009, respectively.

 

(2) Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loans were $9.6 million, $13.8 million, and $19.1 million in 2011, 2010 and 2009, respectively.

 

(3) The net interest margin on a tax equivalent basis was 4.59%, 4.92%, and 5.33%, respectively, for 2011, 2010, and 2009.

 

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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.

 

      2011 compared to 2010     2010 compared to 2009  
     Increase (decrease) due to     Increase (decrease) due to  
      Volume     Rate     Total     Volume     Rate     Total  
     (In Thousands)  

Interest Income:

            

Loans

     $503        ($3,038     ($2,535     ($2,911     ($993     ($3,904

Securities

     581        (1,867     (1,286     337        (242     95   

Short term investments

     8        22        30        35        (18     17   
                   

Total interest income

     $1,092        ($4,883     ($3,791     ($2,539     ($1,253     ($3,792
                   

Interest Expense:

            

Deposits:

            

Interest-bearing demand accounts

     $12        ($76     ($64     $13        ($7     $6   

Money market accounts

     146        (227     (81     29        (96     (67

Savings accounts

     (46     (452     (498     118        (238     (120

Certificates of deposit

     (316     (986     (1,302     (522     (425     (947
                   

Total interest on deposits

     (204     (1,741     (1,945     (362     (766     (1,128

Borrowings

     503        (499     4        (54     (402     (456
                   

Total interest expense

     $299        ($2,240     ($1,941     ($416     ($1,168     ($1,584
                   

Provision for Loan Losses

The provision for loan losses in 2011 was $2 million, compared to $5.6 million in 2010 and $7.1 million in 2009. We decreased the provision for loan losses in 2011 primarily because there were net recoveries of $98,000 in 2011 as compared to net charge offs of $4.3 million in 2010. Additionally, impaired loans decreased to $9.5 million at December 31, 2011 from $18.3 million at December 31, 2010. We decreased the provision for loan losses in 2010 primarily because net charge offs decreased from $6.9 million in 2009 to $4.3 million in 2010. Additionally, impaired loans decreased to $18.3 million at December 31, 2010 from $46.3 million at December 31, 2009. These decreases were partially offset in the provision for loans losses by an increase in gross loans, which grew to $671.8 million at December 31, 2010 from $655 million at December 31, 2009. See the “Allowance for Loan Loss” section under “Financial Condition” for further discussion of these decreases. Net loan recoveries were 0.01% in 2011 and net loan charge-offs were 0.66% and 1% of average loans in 2011, 2010, and 2009, respectively. See Note 6 of the Notes to Consolidated Financial Statements included in Item 8 of this report for further discussion of the change in the Allowance.

 

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Other Operating Income

Total other operating income increased $713,000, or 6%, in 2011 as compared to 2010, after decreasing $707,000, or 5%, in 2010, as compared to 2009. The following table separates the more routine (operating) sources of other income from those that can fluctuate significantly from period to period:

 

Years ended December 31,    2011      $ Change     % Change     2010      $ Change     % Change     2009  
     (In Thousands)  

Other Operating Income

                

Purchased receivable income

   $ 2,703       $ 864        47   $ 1,839       ($ 267     -13   $ 2,106   

Deposit service charges

     2,296         (340     -13     2,636         (347     -12     2,983   

Employee benefit plan income

     2,167         267        14     1,900         161        9     1,739   

Electronic banking fees

     1,945         187        11     1,758         216        14     1,542   

Equity in earnings from RML

     1,201         (200     -14     1,401         (948     -40     2,349   

Rental income

     776         (34     -4     810         (40     -5     850   

Merchant credit card transaction fees

     426         (58     -12     484         78        19     406   

Gain on sale of securities available for sale, net

     419         (230     -35     649         429        195     220   

Loan service fees

     343         (58     -14     401         (107     -21     508   

Other income

     814         315        63     499         118        31     381   
                            

Total other operating income

   $ 13,090       $ 713        6   $ 12,377       ($ 707     -5   $ 13,084   
                            

2011 Compared to 2010

Other operating income increased in 2011 primarily due to the increases in purchased receivable income, employee benefit plan services income, and electronic banking fees. Income from the Company’s purchased receivable products increased in 2011 due to increased average purchased receivable balances outstanding during the year. The Company expects the income level from this product to continue to increase as the Company adds new customers in this line of business. Employee benefit plan services income represents income generated by the Company’s 50.1% owned affiliate, NBG. The Company consolidates the balance sheet and income statement of NBG into its financial statements. The increase in income from employee benefit plan income from NBG in 2011 is a reflection of NBG’s ability to continue to provide additional products and services to an increasing client base. We expect employee benefit plan income from NBG to continue to increase as NBG’s business continues to grow. The increase in the Company’s electronic banking fees in 2011 resulted from additional fees collected from increased point-of-sale transactions and additional fees collected related to ATM services. Point-of-sale fees have increased as overall usage of this type of transaction has increased. ATM fees increased due to increases in the fees the Company charges for these services. In addition to these increases, the Company’s net income from its affiliate PWA, which is included in the other income line above, increased $107,000 in 2011 as compared to 2010 as PWA’s assets under management increased.

The increases in other operating income noted above were partially offset by decreases in deposit service charges, earnings from RML, and net gains on the sale of securities available for sale. Deposit service charges decreased in 2011 because of decreases in fees collected on nonsufficient funds transactions due to a decrease in the number of overdraft transactions processed in 2011 as compared to 2010. This decrease resulted from changes in regulations that were effective starting in the third quarter of 2010 that restrict the Company’s ability to assess service charges on point-of-sale transactions unless its customers request this service. Earnings from RML have fluctuated with activity in the housing market, which has been affected by local economic conditions and changes in mortgage interest rates. Earnings from RML decreased in 2011 as refinance activity, which reached nearly record highs in 2009, continued to slow. The Company expects that its income from RML will decrease in 2012 as compared to 2011 as the refinance activity continues to decrease.

2010 Compared to 2009

Other operating income decreased in 2010 primarily due to the decreases in earnings from RML, deposit service charges, and purchased receivable income. Earnings from RML decreased in 2010 as refinance activity, which reached nearly record highs in 2009, began to slow. Similar to 2011, deposit service charges decreased in 2010 because of decreases in fees collected on nonsufficient funds transactions due to a decrease in the number of overdraft transactions processed in 2010 as compared to 2009 as result of the changes in regulations noted above. Lastly, although year-end purchased receivable balances in 2010 exceed those of 2009, income from the Company’s purchased receivable products decreased in 2010 due to decreases in the average purchased receivable balances outstanding during the year.

 

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The decreases in other operating income noted above were partially offset by increases in net gains on the sale of securities available for sale, electronic banking fees, and employee benefit plan income. The increase in the Company’s electronic banking fees in 2010 resulted from additional fees collected from increased point-of-sale transactions. The increase in income from employee benefit plan income from NBG in 2010 is a reflection of NBG’s ability to continue to provide additional products and services to an increasing client base.

Other Operating Expense

Other operating expense decreased $869,000, or 2%, in 2011 as compared to 2010, and decreased $3.7 million, or 9%, in 2010 as compared to 2009. The following table breaks out the other operating expense categories:

 

Years ended December 31,    2011     $ Change     % Change      2010     $ Change     % Change      2009  
     (In Thousands)  

Other Operating Expense

                

Salaries and other personnel expense

   $ 21,006      ($ 631     -3%       $ 21,637      ($ 537     -2%       $ 22,174   

Occupancy

     3,764        60        2%         3,704        17        0%         3,687   

Marketing

     1,771        (11     -1%         1,782        465        35%         1,317   

Professional and outside services

     1,386        71        5%         1,315        (483     -27%         1,798   

Insurance expense

     1,333        (569     -30%         1,902        (813     -30%         2,715   

Equipment

     1,200        84        8%         1,116        (102     -8%         1,218   

Software expense

     1,005        85        9%         920        (59     -6%         979   

Amortization of low income housing tax investments

     902        33        4%         869        79        10%         790   

Internet banking expense

     648        26        4%         622        64        11%         558   

Intangible asset amortization

     275        (24     -8%         299        (24     -7%         323   

Impairment on purchased receivables, net

     57        (345     -86%         402        236        142%         166   

OREO expense, net rental income and gains on sale:

                

OREO operating expense

     335        (547     -62%         882        109        14%         773   

Impairment on OREO

     92        (154     -63%         246        (579     -70%         825   

Rental income on OREO

     (248     362        -59%         (610     (584     2246%         (26

Gains on sale of OREO

     (889     774        -47%         (1,663     (1,210     267%         (453
                            

Subtotal

     (710     435        -38%         (1,145     (2,264     -202%         1,119   

Prepayment penalty on long term debt

                   NA                (718     NA         718   

Other expenses

     4,118        (83     -2%         4,201        406        11%         3,795   
                            

Total other operating expense

   $ 36,755        ($869     -2%       $ 37,624      ($ 3,733     -9%       $ 41,357   
                            

2011 Compared to 2010

Other operating expense decreased in 2011 primarily due to decreased salaries and other personnel expenses, insurance expenses, and impairment on purchased receivables net of recoveries. Salaries and other personnel expense decreased in 2011 due to decreased group health costs through decreased medical claims and a decrease in the Company’s workforce. Insurance expense decreased in 2011 mainly due to decreased FDIC insurance premiums as a the result of a decrease in the rate assessed on the Company in 2011. Lastly, the Company’s impairment on purchased receivables decreased in 2011. The Company recognizes impairment on purchased receivables when there is significant doubt as to the collectability of the receivable.

These decreases in operating expenses were partially offset by increases in net costs related to OREO properties. Gains on the sale of OREO decreased significantly in 2011 due to a decrease in overall sales activity. Rental income on OREO also decreased significantly in 2011 as the result of the sale of a large condominium development in the second quarter of 2011. These decreases in income items were partially offset set by lower operating expenses associated with OREO properties as the overall inventory of OREO has continued to decrease. The Company expects net costs related to OREO properties to increase in 2012 due to the fact that we do not expect to have significant rental income or gains on the sale of OREO properties in the future.

 

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2010 Compared to 2009

Other operating expense decreased in 2010 primarily due to decreased net costs related to OREO properties, and decreased insurance expense, prepayment penalties for long term debt, salaries and other personnel expenses, and professional and outside services. Gains on the sale of OREO increased significantly in 2010 due to an increase in overall sales activity and $422,000 in previously deferred gain that was recognized in 2010 related to one commercial property that was sold in 2007. Rental income on OREO also increased significantly in 2010 as the result of the transfer of a large condominium development into OREO in December 2009. Impairment expense on OREO decreased significantly in 2010. Impairment charges arise from adjustments to the Company’s estimate of the fair value of certain properties based on changes in estimated costs to complete the projects and overall market conditions in the Anchorage, Matanuska-Susitna Valley, and Fairbanks markets. Insurance expense decreased in 2010 mainly due to decreased FDIC insurance premiums that was primarily the result of the one-time special assessment that the Company incurred in the second quarter of 2009, as well as a decrease in the rate assessed on the Company in 2010. Prepayment penalties on long term debt decreased in 2010 because the Company did not prepay any debt in 2010. Salaries and other personnel expense decreased in 2010 primarily due to a decrease in the Company’s workforce. Additionally, stock-based compensation expense decreased in 2010 due to decreases in the number of stock options vested in 2010 as compared to 2009. Lastly, professional and outside services decreased in 2010 due to decreases in audit and accounting consulting fees.

The decreases in operating expenses were partially offset by increases in marketing expense and in other expenses. Marketing costs increased in 2010 due to increases in advertising expenses and charitable contributions. Other expenses increased due to increased hardware costs related to the Company’s telephone system, the reserve for unfunded commitments, impairment on purchased receivables, and losses on the sale of repossessed assets.

Income Taxes

The provision for income taxes increased $955,000, or 24%, to $4.9 million in 2011. The provision for income taxes increased $951,000, or 32%, to $3.9 million in 2010. These increases are due primarily to the 25% and 21% increases in income before income taxes in 2011 and 2010, respectively. Additionally, the effective tax rate increased to 29% in 2011 and 2010 from 27% in 2009. The increase in the effective tax rate in 2010 as compared to 2009 is the result of a decrease in tax exempt income on investments and tax credits relative to the level of taxable income in 2010.

Financial Condition

Investment Securities Portfolio

Our investment portfolio consists primarily of government sponsored entity securities, corporate bonds, and municipal securities. Investment securities totaled $225.9 million at December 31, 2011, reflecting an increase of $5.8 million, or 3%, from year-end 2010 as our deposits have continued to increase while loan demand remains relatively flat. The average maturity of the investment portfolio was approximately two years at December 31, 2011.

The composition our investment securities portfolio reflects management’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of interest income. The investment securities portfolio also mitigates interest rate and credit risk inherent in the loan portfolio, while providing a vehicle for the investment of available funds, a source of liquidity (by pledging as collateral or through repurchase agreements), and collateral for certain public funds deposits.

Our investment portfolio is divided into two classes: securities available for sale and securities held to maturity. Available for sale securities are carried at fair value with any unrealized gains or losses reflected as an adjustment to other comprehensive income included in shareholders’ equity. Securities held to maturity are carried at amortized cost. Investment securities designated as available for sale comprised 98% of the portfolio and are available to meet liquidity requirements.

Both available for sale and held to maturity securities may be pledged as collateral to secure public deposits. At December 31, 2011 and 2010, $32.1 million and $26.2 million in securities were pledged for deposits and borrowings, respectively. Pledged securities increased at December 31, 2011 as compared to December 31, 2010 because the Company had higher balances in securities sold under repurchase agreements, which are secured by pledged securities, at December 31, 2011.

 

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The following tables set forth the composition of our investment portfolio at the dates indicated:

 

December 31,   

Amortized

Cost

     Fair Value  
     (In Thousands)  

Securities Available for Sale:

     

2011:

     

U.S. Treasury & government sponsored entities

   $ 160,529       $ 161,104   

Muncipal Securities

     16,260         16,935   

U.S. Agency Mortgage-backed Securities

     52         54   

Corporate Bonds

     43,767         42,991   

Preferred Stock

     996         999   
   

Total

   $ 221,604       $ 222,083   
   

2010:

     

U.S. Treasury & government sponsored entities

   $ 164,604       $ 164,685   

Muncipal Securities

     9,503         9,624   

U.S. Agency Mortgage-backed Securities

     71         73   

Corporate Bonds

     38,732         39,628   
   

Total

   $ 212,910       $ 214,010   
   

2009:

     

U.S. Treasury & government sponsored entities

   $ 141,371       $ 142,000   

Muncipal Securities

     6,184         6,270   

U.S. Agency Mortgage-backed Securities

     85         87   

Corporate Bonds

     28,242         29,802   
   

Total

   $ 175,882       $ 178,159   
   

Securities Held to Maturity:

     

2011:

     

Municipal Securities

   $ 3,819       $ 4,077   
   

Total

   $ 3,819       $ 4,077   
   

2010:

     

Municipal Securities

   $ 6,125       $ 6,286   
   

Total

   $ 6,125       $ 6,286   
   

2009:

     

Municipal Securities

   $ 7,285       $ 7,516   
   

Total

   $ 7,285       $ 7,516   
   

For the periods ending December 31, 2011 and 2010, we held Federal Home Loan Bank (“FHLB”) stock with a book value approximately equal to its market value in the amounts of $2.0 million for each year. The Company evaluated its investment in FHLB stock for other-than-temporary impairment as of December 31, 2011, consistent with its accounting policy. Based on the Company’s evaluation of the underlying investment, including the long-term nature of the investment, the liquidity position of the FHLB of Seattle, the actions being taken by the FHLB of Seattle to address its regulatory capital situation, and the Company’s intent and ability to hold the investment for a period of time sufficient to recover the par value, the Company did not recognize an other-than-temporary impairment loss. Even though the Company did not recognize an other-than-temporary impairment loss during the twelve-month period ending December 31, 2011, continued deterioration in the FHLB of Seattle’s financial position may result in future impairment losses.

 

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The following table sets forth the market value, maturities and weighted average pretax yields of our investment portfolio for the periods indicated as of December 31, 2011:

 

              Maturity                  
      Within
1 Year
     1-5 Years      5-10 Years      Over
10 Years
     Total  
     (In Thousands)  

Securities Available for Sale:

              

U.S. Treasury & government sponsored entities

              

Balance

     $60,095         $101,009         $—         $—         $161,104   

Weighted average yield

     0.91%         0.76%         0.00%         0.00%         0.81%   

Municipal securities

              

Balance

     845         6,183         6,525         3,382         16,935   

Weighted average yield

     0.94%         2.04%         4.57%         4.79%         3.48%   

U.S. Agency Mortgage-backed Securities

              

Balance

                     54                 54   

Weighted average yield

     0.00%         0.00%         4.45%         0.00%         4.45%   

Corporate bonds

              

Balance

     1,211         41,780                         42,991   

Weighted average yield

     6.39%         2.16%         0.00%         0.00%         2.27%   

Preferred stock

              

Balance

                             999         999   

Weighted average yield

     0.00%         0.00%         0.00%         5.00%         5.00%   

Total

              

Balance

     62,151         148,972         6,579         4,381         222,083   

Weighted average yield

     1.01%         1.21%         4.56%         4.84%         1.32%   

Securities Held to Maturity:

              

Municipal Securities

              

Balance

     $950         $1,231         $1,896         $—         $4,077   

Weighted average yield

     3.69%         4.29%         4.32%         0.00%         4.16%   
            

In addition to the above investments, the Company also holds $999,000 in preferred stock at December 31, 2011. This type of investment does not have a maturity date, but it does earn dividends quarterly. The weighted average yield on preferred stock at December 31, 2011 is 5%. At December 31, 2011, we held no securities of any single issuer (other than government sponsored entities) that exceeded 10% of our shareholders’ equity.

Loans

Our loan products include short and medium-term commercial loans, commercial credit lines, construction and real estate loans, and consumer loans. We emphasize providing financial services to small and medium-sized businesses and to individuals. From our inception, we have emphasized commercial, land development and home construction, and commercial real estate lending. These types of lending have provided us with needed market opportunities and higher net interest margins than other types of lending. However, they also involve greater risks, including greater exposure to changes in local economic conditions, than certain other types of lending.

All of our loans and credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness and commitments to us, including the indebtedness of any guarantor. Generally, we are permitted to make loans to one borrower of up to 15% of the unimpaired capital and surplus of the Bank. The loan-to-one-borrower limitation for the Bank was $22 million at December 31, 2011. At December 31, 2011, the Company had four relationships whose total direct and indirect commitments exceeded $22 million; however, no individual direct relationship exceeded the limit. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Provision for Loan Losses.”

 

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Our lending operations are guided by loan policies, which outline the basic policies and procedures by which lending operations are conducted. Generally, the policies address our desired loan types, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations, and compliance with laws and regulations. The policies are reviewed and approved annually by the Board of Directors. We supplement our own supervision of the loan underwriting and approval process with periodic loan reviews by experienced officers in our internal audit department who examine quality, loan documentation, and compliance with laws and regulations. Our Quality Assurance department also provides independent, detailed financial analysis of our largest, most complex loans. In addition, the department, along with the Chief Lending Officer and others in the Loan Administration department, has developed processes to analyze and manage various concentrations of credit within the overall loan portfolio. The Loan Administration department has also enhanced the procedures and processes for the analysis and reporting of problem loans along with the development of strategies to resolve them. Finally, our Internal Audit Department also performs an independent review of each loan portfolio for compliance with loan policy as well as a review of credit quality. The Internal Audit review follows the FDIC sampling guidelines, and a review of each portfolio is performed on an annual basis.

Loans decreased to $645.6 million at December 31, 2011, compared to $671.8 million at December 31, 2010, and $655 million December 31, 2009. Total loans represented 59% and 64% of total assets at December 31, 2011 and 2010, respectively.

The following table sets forth at the dates indicated our loan portfolio composition by type of loan, excluding loans held for sale:

 

December 31,   2011            2010            2009            2008            2007         
     Amount     Percent
of total
    Amount     Percent
of total
    Amount     Percent
of total
    Amount     Percent
of total
    Amount     Percent
of total
 
    (In Thousands)  

Commercial loans

  $ 252,689        39.14%      $ 256,971        38.25%      $ 248,205        37.89%      $ 293,249        41.23%      $ 284,956        39.87%   

Real estate loans:

                   

Construction

    40,182        6.22%        62,620        9.32%        62,573        9.55%        100,438        14.12%        138,070        19.32%   

Real estate term

    315,860        48.93%        312,128        46.46%        301,816        46.08%        268,864        37.80%        243,245        34.03%   

Home equity lines and other consumer

    39,834        6.17%        43,264        6.44%        45,243        6.91%        51,447        7.23%        51,274        7.17%   
                                                   

Total

    648,565        100.47%        674,983        100.47%        657,837        100.43%        713,998        100.39%        717,545        100.38%   

Less:

                   

Unearned loan fees net of origination costs

    (3,003     -0.47%        (3,171     -0.47%        (2,798     -0.43%        (2,712     -0.39%        (2,744     -0.38%   
                                                   

Net loans

  $ 645,562        100.00%      $ 671,812        100.00%      $ 655,039        100.00%      $ 711,286        100.00%      $ 714,801        100.00%   
                                                   

Commercial Loans: Our commercial loan portfolio includes both secured and unsecured loans for working capital and expansion. Short-term working capital loans generally are secured by accounts receivable, inventory, or equipment. We also make longer-term commercial loans secured by equipment and real estate. We also make commercial loans that are guaranteed in large part by the Small Business Administration or the Bureau of Indian Affairs and commercial real estate loans that are participated with the Alaska Industrial Development and Export Authority (“AIDEA”). Commercial loans represented 39% of our total loans outstanding as of December 31, 2011 and reprice more frequently than other types of loans, such as real estate loans. More frequent repricing means that interest cash flows from commercial loans are more sensitive to changes in interest rates. In a rising interest rate environment, our philosophy is to emphasize the pricing of loans on a floating rate basis, which allows these loans to reprice more frequently and to contribute positively to our net interest margin. The majority of these loans reprice to an index based upon the prime rate of interest. The Company also uses floors in its commercial loan pricing as loans are originated or renewed during the year.

Commercial Real Estate: We are an active lender in the commercial real estate market. At December 31, 2011, our commercial real estate loans were $315.9 million, or 49% of our loan portfolio. These loans are typically secured by office buildings, apartment complexes or warehouses. Loan maturities range from 10 to 25 years, ordinarily subject to our right to call the loan within 10 to 15 years of its origination. The interest rate for approximately 74% of these loans originated by Northrim resets every one to five years based on the spread over an index rate, and 7% reset on either a daily or monthly basis. The indices for these loans include prime or the respective Treasury or Federal Home Loan Bank of Seattle rate. The Company also uses floors in its commercial real estate loan pricing as loans are originated or renewed during the year.

 

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We may sell all or a portion of our commercial real estate loans to two State of Alaska entities that were established to provide long-term financing in the State, AIDEA, and the Alaska Housing Finance Corporation (“AHFC”). We may sell up to a 90% loan participation to AIDEA. AIDEA’s portion of the participated loan typically features a maturity twice that of the portion retained by us and bears a lower interest rate. The blend of our and AIDEA’s loan terms allows us to provide competitive long-term financing to our customers, while reducing the risk inherent in this type of lending. We also originate and sell to AHFC loans secured by multifamily residential units. Typically, 100% of these loans are sold to AHFC and we provide ongoing servicing of the loans for a fee. AIDEA and AHFC make it possible for us to originate these commercial real estate loans and enhance fee income while reducing our exposure to risk.

Construction Loans: We provide construction lending for commercial real estate projects. Such loans generally are made only when there is a firm take-out commitment upon completion of the project by a third party lender. Additionally, we provide land development and residential subdivision construction loans. We originate one-to-four-family residential and condominium construction loans to builders for construction of homes.

The Company’s construction loans decreased in 2011 to $40.2 million, down from $62.6 million in 2010 due to the continued decrease in new construction activity. The Company expects that the residential construction market will be relatively flat in 2012. However, due to its efforts to increase market share, the Company expects its construction loan totals to increase in 2012.

Home Equity Lines and Other Consumer Loans: We provide personal loans for automobiles, recreational vehicles, boats, and other larger consumer purchases. We provide both secured and unsecured consumer credit lines to accommodate the needs of our individual customers, with home equity lines of credit serving as the major product in this area.

Maturities and Sensitivities of Loans to Change in Interest Rates: The following table presents the aggregate maturity data of our loan portfolio, excluding loans held for sale, at December 31, 2011:

 

              Maturity                  
      Within 1
Year
     1-5 Years      Over 5
Years
     Total  
     (In Thousands)  

Commercial

   $ 118,436       $ 75,155       $ 59,098       $ 252,689   

Construction

     38,087         1,125         970         40,182   

Real estate term

     23,568         45,361         246,931         315,860   

Home equity lines and other consumer

     1,083         6,502         32,249         39,834   
   

Total

   $ 181,174       $ 128,143       $ 339,248       $ 648,565   
   

Fixed interest rate

   $ 90,552       $ 61,024       $ 57,968       $ 209,544   

Floating interest rate

     90,622         67,119         281,280         439,021   
   

Total

   $ 181,174       $ 128,143       $ 339,248       $ 648,565   
   

At December 31, 2011, 59% of the portfolio was scheduled to mature or reprice in 2012 with 37% scheduled to mature or reprice between 2013 and 2016.

Loans Held for Sale: During 2009, the Company entered into an agreement to purchase residential loans from our mortgage affiliate, RML, in anticipation of higher than normal refinance activity in the Anchorage market. The Company then sold these loans in the secondary market. All loans purchased and sold in 2011 and 2010 were newly originated loans that did not affect nonperforming loans. The Company purchased $82.9 million and sold $60.7 million in residential loans during 2011 and recognized $11,000 in gains related to these transactions in the 2011. The Company purchased $70.4 million and sold $64.9 million in residential loans during 2010 and recognized $23,000 in gains related to these transactions in the 2010. There were $27.8 million and $5.6 million in loans held for sale as of December 31, 2011 and 2010, respectively.

 

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Credit Quality and Nonperforming Assets

Nonperforming assets consist of nonaccrual loans, accruing loans that are 90 days or more past due, and other real estate owned. The following table sets forth information regarding our nonperforming loans and total nonperforming assets:

 

December 31,    2011      2010      2009      2008      2007  
            (In Thousands)                

Nonperforming loans

              

Nonaccrual loans

   $ 7,361       $ 11,414       $ 12,738       $ 20,593       $ 9,673   

Accruing loans past due 90 days or more

                     1,000         5,411         1,665   
            

Total nonperforming loans

   $ 7,361       $ 11,414       $ 13,738       $ 26,004       $ 11,338   

Real estate owned & repossessed assets

     5,183         10,403         17,355         12,617         4,445   
            

Total nonperforming assets

   $ 12,544       $ 21,817       $ 31,093       $ 38,621       $ 15,783   
            

Performing restructured loans

   $ 2,305       $       $ 3,754       $       $   

Allowance for loan losses to portfolio loans

     2.56%         2.14%         2.00%         1.81%         1.64%   

Allowance for loan losses to nonperforming loans

     224%         126%         95%         50%         104%   

Nonperforming loans to portfolio loans

     1.14%         1.70%         2.10%         3.66%         1.59%   

Nonperforming assets to total assets

     1.16%         2.07%         3.10%         3.84%         1.56%   
            

Nonaccrual, Accruing Loans 90 Days or More Past Due, and Troubled Debt Restructuring (“TDR”): The Company’s financial statements are prepared on the accrual basis of accounting, including recognition of interest income on its loan portfolio, unless a loan is placed on a nonaccrual basis. Loans are placed on a nonaccrual basis when management believes serious doubt exists about the collectability of principal or interest. Our policy generally is to discontinue the accrual of interest on all loans 90 days or more past due unless they are well secured and in the process of collection. Cash payments on nonaccrual loans are directly applied to the principal balance. The amount of unrecognized interest on nonaccrual loans was $464,000, $1.2 million, and $1.4 million, in 2011, 2010, and 2009, respectively. There was interest income of $175,000 included in net income for 2011 related to nonaccrual loans whose principal has been paid down to zero. There was no interest income included in net income for the years ended 2010 or 2009 related to nonaccrual loans. The Company had two relationships that represented more than 10% of nonaccrual loans as of December 31, 2011.

TDRs are those loans for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower, have been granted due to the borrower’s weakened financial condition. Interest on TDRs will be accrued at the restructured rates when it is anticipated that no loss of original principal will occur, and the interest can be collected, which is generally after a period of six months. The Company had $2.3 million in loans classified as TDRs that were performing as of December 31, 2011. Additionally, there were $2.2 million in TDRs included in nonaccrual loans at December 31, 2011 for a total of $4.5 million. There were no TDRs, either performing or included in nonaccrual loans, as of December 31, 2010. At December 31, 2009 the Company had $3.8 million in performing TDRs and no TDRs included in nonaccrual loans. See Note 5 of the Notes to Consolidated Financial Statements included in Item 8 of this report for further discussion of TDRs.

Loans Measured for Impairment, OREO and Repossessed Assets, and Potential Problem Loans: At December 31, 2011, the Company had $9.5 million in loans measured for impairment and $5.2 million in OREO, as compared to $18.3 million in loans measured for impairment and $10.4 million in OREO at December 31, 2010.

At December 31, 2011, management had identified potential problem loans of $4.6 million as compared to potential problem loans of $8.8 million at December 31, 2010. Potential problem loans are loans which are currently performing and are not included in nonaccrual, accruing loans 90 days or more past due, or restructured loans that have developed negative indications that the borrower may not be able to comply with present payment terms and which may later be included in nonaccrual, past due, or restructured loans. The $4.2 million decrease in potential problem loans at December 31, 2011 from December 31, 2010 is primarily due to the transfer of several loans to nonaccrual status in 2011 as well as pay downs on one potential problem loan. Charge offs, pay downs, and upgrades, which were only partially offset by $1.1 million in additions in 2011, also contributed to the decrease in 2011.

At December 31, 2011 and 2010 the Company held $5.2 million and $10.4 million, respectively, of OREO assets. At December 31, 2011, OREO consists of $3 million in residential lots in various stages of development, a $1 million commercial lot, a $650,000 single family residence, and a $529,000 commercial property. All OREO property is located in Alaska. The Bank

 

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initiates foreclosure proceedings to recover and sell collateral pledged by a debtor to secure a loan based on various events of default and circumstances related to loans that are secured by either commercial or residential real property. These events and circumstances include delinquencies, the Company’s relationship with the borrower, and the borrower’s ability to repay the loan via a source other than the collateral. If the loan has not yet matured, the debtors may cure the events of default up to the time of sale to retain their interest in the collateral. Failure to cure the defaults will result in the debtor losing ownership interest in the property, which is taken by the creditor, or high bidder at a foreclosure sale.

During 2011, additions to OREO totaled $2.3 million and included a $1 million commercial lot, $350,000 in residential lots, a $31,000 single family residence, and $874,000 in commercial buildings. During 2011, the Company received approximately $8.4 million in proceeds from the sale of OREO which included $5.5 million from the sale of condominiums, $1.7 million from the sale of residential lots, $564,000 from the sale of single family residences, and $707,000 from the sale of commercial buildings.

The Company recognized $953,000 in gains and $90,000 in losses on the sale of eighty two individual OREO properties in 2011. The Company also recognized $26,000 in gains on sales previously deferred, for a net gain of $889,000 for the year ended December 31, 2011. The Company had accumulated deferred $397,000 in gains on the sale of OREO properties at December 31, 2011. The Company recognized $1.3 million in gains and $120,000 in losses on the sale of seventy nine individual OREO properties in 2010. The Company also recognized $522,000 in gains on sales previously deferred, for a net gain of $1.7 million for the year ended December 31, 2010. The Company had deferred $153,000 in gains on the sale of OREO properties at December 31, 2010.

The Company made loans to facilitate the sale of OREO of $1.8 million, $6.1 million, and $2.6 million in 2011, 2010, and 2009, respectively. Our underwriting policies and procedures for loans to facilitate the sale of other real estate owned are no different than our standard loan policies and procedures.

The Company recognized impairments of $192,000, $246,000 and $825,000 in 2011, 2010, and 2009, respectively, due to adjustments to the Company’s estimate of the fair value of certain properties based on changes in estimated costs to complete the projects and changes in the Anchorage and Fairbanks real estate markets.

The following summarizes OREO activity for the periods indicated:

 

December 31,    2011     2010     2009  
     (In Thousands)  

Balance, beginning of the year

   $ 10,355      $ 17,355      $ 12,617   

Transfers from loans

     2,155        2,841        12,441   

Investment in other real estate owned

     57        235        1,699   

Proceeds from the sale of other real estate owned

     (8,425     (11,124     (9,120

Gain on sale of other real estate owned, net

     889        1,663        453   

Deferred gain on sale of other real estate owned

     244        (369     90   

Impairment on other real estate owned

     (92     (246     (825
   

Balance, End of Year

   $ 5,183      $ 10,355      $ 17,355   
   

Allowance for Loan Losses

The Company maintains an Allowance to reflect losses inherent in the loan portfolio. The Allowance is increased by provisions for loan losses and loan recoveries and decreased by loan charge-offs. The size of the Allowance is determined through quarterly assessments of probable estimated losses in the loan portfolio. Our methodology for making such assessments and determining the adequacy of the Allowance includes the following key elements:

 

   

A specific allocation for impaired loans.    Management determined the fair value of the majority of these loans based on the underlying collateral values. This analysis is based upon a specific analysis for each impaired loan, including external appraisals on loans secured by real property, management’s assessment of the current market, recent payment history, and an evaluation of other sources of repayment. In-house evaluations of fair value are used in the impairment analysis in some situations. Inputs to the in-house evaluation process include information about sales of comparable properties in the appropriate markets and changes in tax assessed values. The Company obtains appraisals on real and personal property that secure its loans during the loan origination process in accordance with regulatory guidance and its loan policy. The Company obtains updated appraisals on loans secured by real or personal property based upon its assessment of changes in the current market or particular projects or properties, information from other current appraisals, and other

 

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sources of information. Appraisals may be adjusted downward by the Company based on its evaluation of the facts and circumstances on a case by case basis. External appraisals may be discounted when management believes that the absorption period used in the appraisal is unrealistic, when expected liquidation costs exceed those included in the appraisal, or when management’s evaluation of deteriorating market conditions warrants an adjustment. Additionally, the Company may also adjust appraisals in the above circumstances between appraisal dates. The Company uses the information provided in these updated appraisals along with its evaluation of all other information available on a particular property as it assesses the collateral coverage on its performing and nonperforming loans and the impact that may have on the adequacy of its Allowance. The specific allowance for impaired loans, as well as the overall Allowance, may increase based on the Company’s assessment of updated appraisals. See Note 21 of the Notes to Consolidated Financial Statements included in Item 8 of this report for further discussion of the Company’s estimation of the fair value of impaired loans.

When the Company determines that a loss has occurred on an impaired loan, a charge-off equal to the difference between carrying value and fair value is recorded. If a specific allowance is deemed necessary for a loan, and then that loan is partially charged off, the loan remains classified as a nonperforming loan after the charge-off is recognized. Loans measured for impairment based on collateral value and all other loans measured for impairment are accounted for in the same way. The total annualized charge-off rate for nonperforming loans as of December 31, 2011 and 2010 was 28% and 24%, respectively.

 

   

A general allocation.    The Company has identified segments and classes of loans not considered impaired for purposes of establishing the general allocation allowance. The Company determined the disaggregation of the loan portfolio into segments and classes based on its assessment of how different pools of loans with like characteristics in the portfolio behave over time. This determination is based on historical experience and management’s assessment of how current facts and circumstances are expected to affect the loan portfolio.

The Company first disaggregates the loan portfolio into the following segments: commercial, real estate construction, real estate term, and home equity lines and other consumer loans. Then the Company further disaggregates each of these segments into the following classes, which are also known as risk classifications: excellent, good, satisfactory, watch, special mention, substandard, doubtful, and loss.

After the portfolio has been disaggregated into segments and classes, the Company calculates a general reserve for each segment and class based on the average year loss history for each segment and class. The Company’s loan portfolio continues to include a concentration in a small number of large borrowers. In 2011, the Company increased the look-back period used in the calculation of average historical loss rates from three years to four years. Management made this change because we believe that including the elevated loss experience from 2007 that occurred as a result of the economic downturn from that time is appropriate. Management believes that including the loss experience from 2007 in the current Allowance calculation appropriately captures the inherent risk this concentration brings to our loan portfolio.

After the Company calculates a general allocation using our loss history, the general reserve is then adjusted for qualitative factors by segment and class. Qualitative factors are based on management’s assessment of current trends that may cause losses inherent in the current loan portfolio to differ significantly from historical losses. Some factors that management considers in determining the qualitative adjustment to the general reserve include 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.

 

   

An unallocated reserve.    The unallocated portion of the Allowance provides for other credit losses inherent in our loan portfolio that may not have been contemplated in the specific and general components of the Allowance, and it acknowledges the inherent imprecision of all loss prediction models. The unallocated component is reviewed periodically based on trends in credit losses and overall economic conditions.

At December 31, 2011 and 2010, the unallocated allowance as a percentage of the total Allowance was 14%, respectively. The unallocated allowance as a percentage of the total Allowance was 55% at December 31, 2009 as reported in the Company’s Form 10-K for the year ended December 31, 2009. The decrease in the unallocated allowance as a percentage of the total Allowance at December 31, 2011 and 2010 is due in part to an enhancement to the Company’s methodology. The Company refined its method of estimating the Allowance in the third quarter of 2010. The Company elected this enhanced method of estimating the Allowance because we believe that it more accurately allocates expected losses by loan segment and class. The Company performed a retrospective review of the Allowance as of December 31, 2009, March 31, 2010 and June 30, 2010 and determined that this refinement does not have an effect on the Company’s financial position, results of operations, or earnings per share for any period; rather, the refined method of estimating the Allowance changes how the total Allowance is allocated among the Company’s loan types and the unallocated portion of the Allowance.

 

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The following table shows the allocation of the Allowance for the periods indicated and includes allocations calculated under the enhanced methodology for 2011 and 2010. Allocations shown for 2009, 2008, and 2007 were calculated using the legacy methodology and were reported as such in prior years:

 

December 31,            2011             2010             2009             2008             2007  
Allowance applicable to:    Amount      % of
Total
Loans (1)
    Amount      % of
Total
Loans(1)
    Amount      % of
Total
Loans (1)
    Amount      % of
Total
Loans(1)
    Amount      % of
Total
Loans(1)
 
                               (In Thousands)                            

Commercial

   $ 6,783         39   $ 6,374         38   $ 3,962         38   $ 5,558         41   $ 6,496         40

Construction

     1,143         6     1,035         9     1,365         9     1,736         14     940         19

Real estate term

     5,529         49     4,270         46     565         47     306         38     1,661         34

Home equity lines and other consumer

     792         6     741         7     50         6     61         7     16         7

Unallocated

     2,256         0     1,986         0     7,166         0     5,239         0     2,622         0
                                                      

Total

   $ 16,503         100   $ 14,406         100   $ 13,108         100   $ 12,900         100   $ 11,735         100
                                                      

 

(1) Represents percentage of this category of loans to total loans.

The following table sets forth information regarding changes in our Allowance for the periods indicated:

 

December 31,    2011     2010     2009     2008     2007  
           (In Thousands)        

Balance at beginning of period

   $ 14,406      $ 13,108      $ 12,900      $ 11,735      $ 12,125   

Charge-offs:

          

Commercial loans

     (1,225     (3,919     (3,372     (4,187     (4,291

Construction loans

     (133     (1,519     (1,308     (1,004     (2,982

Real estate loans

     (90     (342     (2,478     (1,402     (599

Home equity and other consumer loans

     (71     (322     (509     (132     (45
           

Total charge-offs

     (1,519     (6,102     (7,667     (6,725     (7,917
           

Recoveries:

          

Commercial loans

     1,426        1,490        736        577        1,723   

Construction loans

     91        4        7        61        50   

Real estate loans

     54        232        11        3          

Home equity and other consumer loans

     46        91        55        50        21   
           

Total recoveries

     1,617        1,817        809        691        1,794   
           

Charge-offs net of recoveries

     98        (4,285     (6,858     (6,034     (6,123
           

Allowance acquired with Alaska First acquisition

                                 220   

Provision for loan losses

     1,999        5,583        7,066        7,199        5,513   
           

Balance at end of period

   $ 16,503      $ 14,406      $ 13,108      $ 12,900      $ 11,735   
           

Ratio of net charge-offs to average loans outstanding during the period

     -0.01%        0.66%        1.00%        0.86%        0.86%   
           

The decrease in commercial charge-offs in 2011 as compared to 2010 is related to three borrowers, and the decrease in construction charge-offs in 2011 as compared to 2010 is related to one borrower. The decrease in real estate charge-offs in 2010 as compared to 2009 and the increase in 2009 as compared to 2008 is related to one borrower. The increase in real estate charge-offs in 2008 as compared to 2007 related to two borrowers. The decrease in the provision for loan losses in 2011 as compared to 2010 is due primarily to the decrease in net charge offs for the year.

While management believes that it uses the best information available to determine the Allowance, unforeseen market conditions and other events could result in adjustment to the Allowance, and net income could be significantly affected if circumstances differed substantially from the assumptions used in making the final determination of the Allowance.

 

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Purchased Receivables

We purchase accounts receivable from our business customers and provide them with short-term working capital. We provide this service to our customers in Alaska and in Washington and Oregon through NFS. Our purchased receivable activity is guided by policies that outline risk management, documentation, and approval limits. The policies are reviewed and approved annually by the Board of Directors.

Our purchased receivable balances increased in 2011 to $30.2 million, as compared to $16.5 million in 2010. This increase is due to the addition of new customers as well as additional fundings for existing customers. The Company expects that purchased receivable balances will increase in the future as NFS continues to expand its customer base.

Deposits

Deposits are our primary source of funds. Total deposits increased 2% to $911.2 million at December 31, 2011 from $892.1 million at December 31, 2010. Our deposits generally are expected to fluctuate according to the level of our market share, economic conditions, and normal seasonal trends.

The following table sets forth the average balances outstanding and average interest rates for each major category of our deposits, for the periods indicated:

 

December 31,    2011     2010     2009  
      Average
balance
     Average
rate paid
    Average
balance
     Average
rate paid
    Average
balance
     Average
rate paid
 
                  (In Thousands)               

Interest-bearing demand accounts

   $ 132,860         0.08   $ 125,360         0.14   $ 115,065         0.15

Money market accounts

     152,464         0.39     132,264         0.51     127,651         0.58

Savings accounts

     175,813         0.35     183,636         0.61     169,812         0.73

Certificates of deposit

     128,026         1.10     147,081         1.84     173,777         2.10
                    

Total interest-bearing accounts

     589,163         0.46     588,341         0.79     586,305         0.99

Noninterest-bearing demand accounts

     293,695           264,853           241,547      
                    

Total average deposits

   $ 882,858         $ 853,194         $ 827,852      
                    

Certificates of Deposit: The only deposit category with stated maturity dates is certificates of deposit. At December 31, 2011, we had $108.7 million in certificates of deposit, of which $75.1 million, or 69%, are scheduled to mature in 2012. At December 31, 2011, the Company’s certificates of deposit decreased to $108.7 million as compared to $138.2 million at December 31, 2010 as customers moved from certificates of deposit to other interest-bearing accounts. The aggregate amount of certificates of deposit in amounts of $100,000 or more at December 31, 2011, and 2010, was $63.2 million and $84.3 million, respectively. The following table sets forth the amount outstanding of certificates of deposits in amounts of $100,000 or more by time remaining until maturity and percentage of total deposits as of December 31, 2011:

 

     

Time Certificates of Deposits of
$100,000 or More

 
      Amount        Percent of
Total
Deposits
 
     (In Thousands)  

Amounts maturing in:

       

Three months or less

   $ 11,538           18

Over 3 through 6 months

     4,945           8

Over 6 through 12 months

     26,721           42

Over 12 months

     19,984           32
   

Total

   $ 63,188           100
   

 

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The Company is also a member of the Certificate of Deposit Account Registry System (“CDARS”) which is a network of over 3,000 banks throughout the United States. The CDARS system was founded in 2003 and allows participating banks to exchange FDIC insurance coverage so that 100% of the balance of their customers’ certificates of deposit is fully subject to FDIC insurance. At December 31, 2011, the Company had $250,000 in CDARS certificates of deposit as compared to none at December 31, 2010.

Alaska Certificates of Deposit: The Alaska Certificate of Deposit (“Alaska CD”) is a savings deposit product with an open-ended maturity, interest rate that adjusts to an index that is tied to the two-year United States Treasury Note, and limited withdrawals. The total balance in the Alaska CD at December 31, 2011, was $102.4 million, an increase of $2.1 million as compared to the balance of $100.3 million at December 31, 2010.

Alaska Permanent Fund: The Alaska Permanent Fund may invest in certificates of deposit at Alaska banks in an aggregate amount with respect to each bank not to exceed its capital and at specified rates and terms. The depository bank must collateralize the deposit. We did not hold any certificates of deposit for the Alaska Permanent Fund at December 31, 2011 or 2010.

Borrowings

FHLB: At December 31, 2011, our maximum borrowing line from the FHLB was $117.3 million, approximately 11% of the Company’s assets, subject to the FHLB’s collateral requirements. FHLB advances are dependent on the availability of acceptable collateral such as marketable securities or real estate loans, although all FHLB advances are secured by a blanket pledge of the Company’s assets. There was no outstanding balance on this line at December 31, 2011 or 2010.

Federal Reserve Bank: The Company entered into a note agreement with the Federal Reserve Bank on December 27, 1996 for the payment of tax deposits. See “Other Short-term Borrowings” below for additional detail regarding this agreement.

The Federal Reserve Bank is holding $91.4 million of loans as collateral to secure advances made through the discount window on December 31, 2011. There were no discount window advances outstanding at December 31, 2011 or 2010.

Other Long-term Borrowings: The Company purchased its main office facility for $12.9 million on July 1, 2008. In this transaction, the Company, through NBL, assumed an existing loan secured by the building in an amount of approximately $5.1 million. At December 31, 2011, the outstanding balance on this loan was $4.6 million. This loan has a maturity date of April 1, 2014.

Other Short-term Borrowings: The Company entered into a note agreement with the Federal Reserve Bank on December 27, 1996 for the payment of tax deposits. Under this agreement, the Company takes in tax payments from customers and reports these payments to the Federal Reserve Bank. The Federal Reserve has the option to call the tax deposits at any time. The balance at December 31, 2011, and 2010, was zero and $620,000, respectively, which was secured by investment securities.

Securities sold under agreements to repurchase were $16.3 million and $12.9 million, respectively, for December 31, 2011 and 2010. The average balance outstanding of securities sold under agreements to repurchase during 2011 and 2010 was $13.8 million and $10.2 million, respectively, and the maximum outstanding at any month-end was $17.2 million and $14.2 million, respectively, during the same time periods. The securities sold under agreements to repurchase are held by the Federal Home Loan Bank under the Company’s control.

The Company did not have any other short-term borrowings at December 31, 2011 and December 31, 2010. There were no short-term (original maturity of one year or less) borrowings for which the average balance outstanding during 2011, 2010 and 2009 exceeded 30% of shareholders’ equity at December 31, 2011, December 31, 2010, and December 31, 2009.

 

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Contractual Obligations

The following table references contractual obligations of the Company for the periods indicated:

 

              Payments Due by Period          
     

Within

1 Year

     1-3 Years      3-5
Years
    

Over

5 Years

     Total  
December 31, 2011:           (In Thousands)                

Certificates of deposit

   $ 75,064       $ 33,186       $ 406       $       $ 108,656   

Short-term debt obligations

     16,348                                 16,348   

Long-term debt obligations

     147         4,479                         4,626   

Junior subordinated debentures

                             18,558         18,558   

Operating lease obligations

     716         865         653         4,083         6,317   

Other long-term liabilities

     52                                 52   
            

Total

   $ 92,327       $ 38,530       $ 1,059       $ 22,641       $ 154,557   
            

December 31, 2010:

              

Certificates of deposit

   $ 103,704       $ 34,137       $ 332       $       $ 138,173   

Short-term debt obligations

     13,494                                 13,494   

Long-term debt obligations

     141         304         4,321                 4,766   

Junior subordinated debentures

                             18,558         18,558   

Operating lease obligations

     748         1,076         781         4,381         6,986   

Other long-term liabilities

     317                                 317   
            

Total

   $ 118,404       $ 35,517       $ 5,434       $ 22,939       $ 182,294   
            

Long-term debt obligations consist of (a) $4.6 million amortizing note that was assumed by NBL on July 1, 2008, when the Company’s main office facility was purchased that matures on April 1, 2014 and bears interest at 5.95%, (b) $8.2 million junior subordinated debentures that were originated on May 8, 2003, mature on May 15, 2033, and bear interest at a rate of 90-day LIBOR plus 3.15%, adjusted quarterly, and (c) $10.3 million junior subordinated debentures that were originated on December 16, 2005, mature on March 15, 2036, and bear interest at a rate of 90-day LIBOR plus 1.37%, adjusted quarterly. The operating lease obligations are more fully described in Note 20 of the Company’s Financial Statements attached to this report. Other long-term liabilities consist of amounts that the Company owes for its investments in Delaware limited partnerships that develop low-income housing projects throughout the United States. The Company purchased a $3 million interest in U.S.A. Institutional Tax Credit Fund LVII L.P. (“USA 57”) in December 2006. The investment in USA 57 is expected to be fully funded in 2012.

Off-Balance Sheet Arrangements — Commitments and Contingent Liabilities

The Company is a party to financial instruments with off-balance sheet risk. Among the off-balance sheet items entered into in the ordinary course of business are commitments to extend credit and the issuance of letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized on the balance sheet. Certain commitments are collateralized. We apply the same credit standards to these commitments as in all of our lending activities and include these commitments in our lending risk evaluations.

As of December 31, 2011 we had commitments to extend credit of $173.8 million which were not reflected on our balance sheet. Commitments to extend credit are agreements to lend to customers. These commitments have specified interest rates and generally have fixed expiration dates but may be terminated by the Company if certain conditions of the contract are violated. Collateral held relating to these commitments varies, but generally includes real estate, inventory, accounts receivable, and equipment. Our exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. Since many of the commitments are expected to expire without being drawn upon, these total commitment amounts do not necessarily represent future cash requirements. For additional information regarding the Company’s off-balance sheet arrangement, see Note 19 and “Liquidity and Capital Resources” below.

As of December 31, 2011 we had standby letters of credit of $16.2 million which were not reflected on our balance sheet. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer

 

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to a third party. Credit risk arises in these transactions from the possibility that a customer may not be able to repay the Company upon default of performance. Collateral held for standby letters of credit is based on an individual evaluation of each customer’s creditworthiness.

Our total unfunded lending commitments at December 31, 2011, which includes commitments to extend credit and standby letters of credit, were $190 million. We do not expect that all of these loans are likely to be fully drawn upon at any one time. The Company has established reserves of $94,000 and $98,000 at December 31, 2011 and 2010, respectively, for losses related to these commitments that is recorded in other liabilities on the consolidated balance sheet.

Liquidity and Capital Resources

The Company is a single bank holding company and its primary ongoing source of liquidity is from dividends received from the Bank. Such dividends arise from the cash flow and earnings of the Bank. Banking regulations and regulatory authorities may limit the amount of, or require the Bank to obtain certain approvals before paying, dividends to the Company. Given that the Bank is currently “well-capitalized”, the Company expects to continue to receive dividends from the Bank.

The Bank manages its liquidity through its Asset and Liability Committee. Our primary sources of funds are customer deposits and advances from the Federal Home Loan Bank of Seattle. These funds, together with loan repayments, loan sales, other borrowed funds, retained earnings, and equity are used to make loans, to acquire securities and other assets, and to fund deposit flows and continuing operations. The primary sources of demands on our liquidity are customer demands for withdrawal of deposits and borrowers’ demands that we advance funds against unfunded lending commitments. Our total unfunded commitments to fund loans and letters of credit at December 31, 2011, were $190 million. We do not expect that all of these loans are likely to be fully drawn upon at any one time. Additionally, as noted above, our total deposits at December 31, 2011, were $911.2 million.

As shown in the Consolidated Statements of Cash Flows, net cash used by operating activities was $5.0 million in 2011, and net cash provided by operating activities was $18.1 million and $9.9 million for 2010 and 2009, respectively. The primary reason that net cash from operating activities was negative in 2011 was the fact that we purchased $82.9 million in loans held for sale and only sold $60.7 million of those loans as of December 31, 2011. This is a timing difference in cash flows that we expect to reverse for the most part in the first quarter of 2012. The primary source of cash provided by operating activities for all periods presented was positive net income in each of these periods. Net cash of $216,000 and $30.5 million was provided in investing activities in 2011 and 2009 as the Company collected funds from loan pay offs that exceeded net cash outlays related to portfolio investments. Net cash of $60.7 million was used in investing activities in 2010 as the Company invested available cash primarily in available for sale securities. The $18.3 million and $41.9 million of cash provided by financing activities in 2011 and 2010, respectively, primarily consisted of the $19.1 million and $39 million increases in deposits during 2011 and 2010. Net cash used in financing activities in 2009 of $11.5 million was the result of the pay down of borrowings taken on in 2008, which was partially offset by increased deposit balances.

The sources by which we meet the liquidity needs of our customers are current assets and borrowings available through our correspondent banking relationships and our credit lines with the Federal Reserve Bank and the FHLB. At December 31, 2011, our current assets were $368.4 million and our funds available for borrowing under our existing lines of credit were $211.7 million. Given these sources of liquidity and our expectations for customer demands for cash and for our operating cash needs, we believe our sources of liquidity to be sufficient in the foreseeable future. However, continued deterioration in the FHLB of Seattle’s financial position may result in impairment in the value of our FHLB stock, the requirement that the Company contribute additional funds to recapitalize the FHLB of Seattle, or a reduction in the Company’s ability to borrow funds from the FHLB of Seattle, impairing the Company’s ability to meet liquidity demands.

On February 16, 2012, the Board of Directors approved payment of a $0.13 per share dividend on March 16, 2012, to shareholders of record on March 8, 2012. This dividend is consistent with the Company’s dividends that were declared and paid in 2011.

In September 2002, our Board of Directors approved a plan whereby we would periodically repurchase for cash up to approximately 5% of our shares of common stock in the open market. We purchased as aggregate of 688,442 shares of our stock under this program through December 31, 2009 at a total cost of $14.2 million at an average price of $20.65, which left a balance of 227,242 shares available under the stock repurchase program. We intend to continue to repurchase our stock from time to time depending upon market conditions, but we can make no assurances that we will continue this program or that we will repurchase all of the authorized shares. No repurchases occurred during 2010 and 2011.

 

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The stock repurchase program had a positive effect on earnings per share because it decreased the total number of shares outstanding in 2007 by 137,500 shares. The Company did not repurchase any of its shares in 2011, 2010, 2009 or 2008. The table below shows this effect on diluted earnings per share.

 

Years Ending:    Diluted EPS
as Reported
     Diluted
EPS without
Stock Repurchase
 

2011

   $ 1.74       $ 1.56   

2010

   $ 1.40       $ 1.25   

2009

   $ 1.20       $ 1.08   

2008

   $ 0.95       $ 0.85   

2007

   $ 1.80       $ 1.64   
   

On May 8, 2003, the Company’s newly formed subsidiary, NCT1, issued trust preferred securities in the principal amount of $8 million. These securities carry an interest rate of 90-day LIBOR plus 3.15% per annum that was initially set at 4.45% adjusted quarterly. The securities have a maturity date of May 15, 2033, and are callable by the Company on or after May 15, 2008. These securities are treated as Tier 1 capital by the Company’s regulators for capital adequacy calculations. The interest cost to the Company of the trust preferred securities was $281,000 in 2011. At December 31, 2011, the securities had an interest rate of 3.61%.

On December 16, 2005, the Company’s newly formed subsidiary, NST2, issued trust preferred securities in the principal amount of $10 million. These securities carry an interest rate of 90-day LIBOR plus 1.37% per annum that was initially set at 5.86% adjusted quarterly. The securities have a maturity date of March 15, 2036, and are callable by the Company on or after March 15, 2011. These securities are treated as Tier 1 capital by the Company’s regulators for capital adequacy calculations. The interest cost to the Company of these securities was $171,000 in 2011. At December 31, 2011, the securities had an interest rate of 1.92%.

Our shareholders’ equity at December 31, 2011, was $125.4 million, as compared to $117.1 million at December 31, 2010. The Company earned net income of $11.4 million during 2011 and issued 39,526 shares through the exercise of stock options. The Company did not repurchase any shares of its common stock in 2011. At December 31, 2011, the Company had 6.4 million shares of its common stock outstanding.

We are subject to minimum capital requirements. Federal banking agencies have adopted regulations establishing minimum requirements for the capital adequacy of banks and bank holding companies. The requirements address both risk-based capital and leverage capital. We believe as of December 31, 2011, that the Company and Northrim Bank met all applicable capital adequacy requirements for a “well-capitalized” institution by regulatory standards.

The FDIC has in place qualifications for banks to be classified as “well-capitalized.” As of December 15, 2011, the most recent notification from the FDIC categorized Northrim Bank as “well-capitalized.” There were no conditions or events since the FDIC notification that we believe have changed Northrim Bank’s classification.

 

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The table below illustrates the capital requirements for the Company and the Bank and the actual capital ratios for each entity that exceed these requirements. Based on recent turmoil in the financial markets, management intends to maintain a Tier 1 risk-based capital ratio for the Bank in excess of 10% in 2012, exceeding the FDIC’s “well-capitalized” capital requirement classification. The capital ratios for the Company exceed those for the Bank primarily because the $8 million trust preferred securities offering that the Company completed in the second quarter of 2003 and another offering of $10 million completed in the fourth quarter of 2006 are included in the Company’s capital for regulatory purposes although they are accounted for as a long-term debt in our financial statements. The trust preferred securities are not accounted for on the Bank’s financial statements nor are they included in its capital. As a result, the Company has $18 million more in regulatory capital than the Bank, which explains most of the difference in the capital ratios for the two entities.

 

December 31, 2011    Adequately -
  Capitalized  
    Well -
Capitalized
    Actual
Ratio
Company
    Actual
Ratio Bank
 

Tier 1 risk-based capital

     4.00     6.00     15.20     13.89

Total risk-based capital

     8.00     10.00     16.46     15.14

Leverage ratio

     4.00     5.00     12.83     11.72
   

(See Note 20 of the Consolidated Financial Statements for a detailed discussion of the capital ratios.)

Effects of Inflation and Changing Prices:    The primary impact of inflation on our operations is increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates, which could affect the degree and timing of the repricing of our assets and liabilities. In addition, inflation has an impact on our customers’ ability to repay their loans.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The disclosures in this item are qualified by the Risk Factors set forth in Item 1A and the Section entitled “Note Regarding Forward-Looking Statements” included in Part I in this report and any other cautionary statements contained herein.

The Company’s results of operations depend substantially on our net interest income and are largely dependent upon our ability to manage market risks. The Company does not presently use derivatives such as forward and futures contracts, options, or interest rate swaps to manage interest rate risk. Other types of market risk such as foreign currency exchange rate risk and commodity price risk do not arise in the normal course of the Company’s business. Like most financial institutions, our interest income and cost of funds are affected by general economic conditions, by competition, by changes in interest rates, and in addition, our community banking focus makes our results of operations particularly dependent on the Alaska economy.

Interest Rate Risk:    The Company is exposed to interest rate risk. Interest rate risk is the risk that financial performance will decline over time due to changes in prevailing interest rates and resulting yields on interest-earning assets and costs of interest-bearing liabilities. Generally, there are three sources of interest rate risk as described below:

 

   

Re-pricing Risk:    Generally, re-pricing risk is the risk of adverse consequences from a change in interest rates that arises because of differences in the timing of when those interest rate changes affect an institution’s assets and liabilities.

 

   

Basis Risk:    Basis risk is the risk of adverse consequences resulting from unequal changes in the spread between two or more rates for different instruments with the same maturity.

 

   

Option Risk:    In banking, option risks are known as borrower options to prepay loans and depositor options to make deposits, withdrawals, and early redemptions. Option risk arises whenever bank products give customers the right, but not the obligation, to alter the quantity of the timing of cash flows.

Asset/Liability and Interest Rate Risk Management:    The purpose of asset/liability management is to provide stable net interest income growth by protecting our earnings from undue interest rate risk, which arises from changes in interest rates and changes in the balance sheet mix, and by managing the risk/return relationships between liquidity, interest rate risk, market risk, and capital adequacy. We maintain an asset/liability management policy that provides guidelines for controlling exposure to interest rate risk by setting a target range and minimum for the net interest margin and running simulation models under different interest rate scenarios to measure the risk to earnings over the next 12-month period.

A number of measures are used to monitor and manage interest rate risk, including interest sensitivity (gap) analyses and income simulations. An income simulation model is the primary tool used to assess the direction and magnitude of changes in net

 

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interest income resulting from changes in interest rates. Key assumptions in the model include loan and deposit volumes and pricing, prepayment speeds on fixed rate assets, and cash flows and maturities of other investment securities. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes, changes in market conditions and management strategies, among other factors.

Interest Rate Sensitivity:    Although analysis of interest rate gap (the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time) is one standard tool for the measurement of exposure to interest rate risk, we believe that because interest rate gap analysis does not address all factors that can affect earnings performance it should not be used as the primary indicator of exposure to interest rate risk and the related volatility of net interest income in a changing interest rate environment. Interest rate gap analysis is primarily a measure of liquidity based upon the amount of change in principal amounts of assets and liabilities outstanding, as opposed to a measure of changes in the overall net interest margin.

The following table sets forth the estimated maturity or repricing, and the resulting interest rate gap, of our interest-earning assets and interest-bearing liabilities at December 31, 2011. The amounts in the table are derived from internal data based upon regulatory reporting formats and, therefore, may not be wholly consistent with financial information appearing elsewhere in the audited financial statements that have been prepared in accordance with generally accepted accounting principles. The amounts shown below could also be significantly affected by external factors such as changes in prepayment assumptions, early withdrawals of deposits, and competition.

 

      Estimated maturity or repricing at December  31, 2011  
      Within 1 year      1-5 years      ³5 years      Total  
            (In Thousands)         

Interest -Earning Assets:

           

Interest bearing deposits in other banks

     $60,886         $—         $—         $60,886   

Portfolio investments

     145,503         77,376         3,023         225,902   

Loans:

           

Commercial

     188,151         58,215         2,963         249,329   

Real estate construction

     35,790         1,261         776         37,827   

Real estate term

     142,337         165,240         6,806         314,383   

Loans held for sale

     27,822                         27,822   

Home equity line and other consumer

     14,127         12,550         12,988         39,665   
   

Total interest-earning assets

     $614,616         $314,642         $26,556         $955,814   

Percent of total interest-earning assets

     64%         33%         3%         100%   
   

Interest-Bearing Liabilities:

           

Interest-bearing demand accounts

     $141,572         $—         $—         $141,572   

Money market accounts

     154,987                         154,987   

Savings accounts

     181,994                         181,994   

Certificates of deposit

     73,406         35,250                 108,656   

Short-term borrowings

     16,348                         16,348   

Long-term borrowings

     1,833         2,793                 4,626   

Junior subordinated debentures

     18,558                         18,558   
   

Total interest-bearing liabilities

     $588,698         $38,043         $—         $626,741   

Percent of total interest-bearing liabilities

     94%         6%         0%         100%   
   

Interest sensitivity gap

     $25,918         $276,599         $26,556         $329,073   

Cumulative interest sensitivity gap

     $25,918         $302,517         $329,073      

Cumulative interest sensitivity gap as a percentage of total assets

     2%         28%         30%      
   

 

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As stated previously, certain shortcomings, including those described below, are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market interest rates. Additionally, certain assets have features that restrict changes in their interest rates, both on a short-term basis and over the lives of the assets. Further, in the event of a change in market interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables as can the relationship of rates between different loan and deposit categories. Moreover, the ability of many borrowers to service their adjustable-rate debt may decrease in the event of an increase in market interest rates.

As indicated in the table above, at December 31, 2011, the Company’s interest-earning assets reprice or mature faster than the Company’s interest-bearing liabilities by a margin of $25.9 million over the next 12 months. As of December 31, 2010, the Company’s interest-bearing liabilities repriced or matured faster than the Company’s earning assets by a margin of $90.3 million over the next 12 months.

The following table sets forth the results of the estimated impact on our net interest income over a time horizon of one year based on the results of our interest rate simulation model as of December 31, 2011 and 2010. For the scenarios shown below, the interest rate simulation assumes an immediate parallel shift in market interest rates at the beginning of a twelve-month period and no changes in the composition or size of the balance sheet.

 

      2011     2010  
      Change in net
interest income
from base scenario
    Percentage
change
    Change in net
interest income
from base scenario
    Percentage
change
 
Scenario:          (Dollars in Thousands)        

Up 100 basis points

   $ 228        0.55   ($ 120     -0.27

Up 200 basis points

     (134     -0.32     (929     -2.11

Down 100 basis points

     NM        NM        385        0.87
   

The increase in the change in net interest income from the up 100 and up 200 basis point scenarios above is a result of the shift to an asset sensitive position at December 31, 2011 as compared to the liability sensitive position at December 31, 2010. The results of the down 100 basis point scenario at December 31, 2011 are not measurable since interest rates were already at a low point and a further decrease resulted in some indexes being nonexistent.

Impact of Inflation and Changing Prices:    The primary impact of inflation on the Company’s operations is increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature and as a result, interest rates generally have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following reports, audited consolidated financial statements and the notes thereto are set forth in this Annual Report on Form 10-K on the pages indicated:

 

Report of the Independent Registered Public Accounting Firms

     44   

Consolidated Balance Sheets at December 31, 2011 and 2010

     46   

For the Years Ended December 2011, 2010 and 2009:

  

Consolidated Statements of Income

     47   

Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income

     48   

Consolidated Statements of Cash Flows

     49   

Notes to Consolidated Financial Statements

     50   

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors of

Northrim BanCorp, Inc.:

We have audited the accompanying consolidated balance sheets of Northrim BanCorp, Inc. and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of income, shareholders' equity and comprehensive income, and cash flows for the years then ended. We also have audited the Company’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company's internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial consolidated statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risks. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Northrim BanCorp, Inc. and subsidiaries as of December 31, 2011 and 2010, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Northrim BanCorp, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/ Moss Adams LLP

Bellingham, Washington

March 13, 2012

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors

Northrim BanCorp, Inc.:

We have audited the accompanying consolidated statements of income, shareholders’ equity and comprehensive income, and cash flows of Northrim BanCorp, Inc. and subsidiaries (the Company) for the year ended December 31, 2009. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Northrim BanCorp, Inc. and subsidiaries for the year ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.

/s/ KPMG LLP

Anchorage, Alaska

March 15, 2010

 

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Consolidated Financial Statements

NORTHRIM BANCORP, INC.

Consolidated Balance Sheets

December 31, 2011 and 2010

 

      2011        2010  
     (In Thousands Except Share Amounts)  

Assets

       

Cash and due from banks

     $30,644           $15,953   

Interest bearing deposits in other banks

     60,886           50,080   

Investment securities available for sale

     222,083           214,010   

Investment securities held to maturity

     3,819           6,125   
   

Total Portfolio Investment Securities

     225,902           220,135   

Investment in Federal Home Loan Bank stock, at cost

     2,003           2,003   

Loans held for sale

     27,822           5,558   

Loans

     645,562           671,812   

Allowance for loan losses

     (16,503)           (14,406)   

Net Loans

     656,881           662,964   

Purchased receivables, net

     30,209           16,531   

Accrued interest receivable

     2,898           3,401   

Other real estate owned

     5,183           10,355   

Premises and equipment, net

     27,993           29,048   

Goodwill and intangible assets, net

     8,421           8,697   

Other assets

     34,238           35,362   
   

Total Assets

     $1,085,258           $1,054,529   
   

Liabilities

       

Deposits:

       

Demand

     $324,039           $289,061   

Interest-bearing demand

     141,572           138,072   

Savings

     79,610           77,411   

Alaska CDs

     102,384           100,315   

Money market

     154,987           149,104   

Certificates of deposit less than $100,000

     45,468           53,858   

Certificates of deposit greater than $100,000

     63,188           84,315   
   

Total Deposits

     911,248           892,136   

Securities sold under repurchase agreements

     16,348           12,874   

Borrowings

     4,626           5,386   

Junior subordinated debentures

     18,558           18,558   

Other liabilities

     9,043           8,453   
   

Total Liabilities

     959,823           937,407   
   

Commitments and contingencies

       

Shareholders’ Equity

       

Preferred Stock, $1 par value, 2,500,000 shares authorized, none issued or outstanding