Business Combinations

Alaska Pacific

On April 1, 2014, the Company completed the acquisition of 100% of the outstanding shares of Alaska Pacific for a total purchase price of $13.9 million, which was comprised of the issuance of 290,212 shares of the Company’s common stock (at a volume weighted average closing price of $25.66 per share) and $6.4 million in cash. The assets acquired and liabilities assumed have been accounted for under the acquisition method of accounting and were recorded at their estimated fair values as of the April 1, 2014 acquisition date. Estimated fair values recorded in the transaction are subject to change for up to one year after the closing date of the acquisition. The primary reason for the acquisition was to expand the Company's geographic footprint in Alaska.

The application of the acquisition method of accounting resulted in the recognition of a bargain purchase gain of $170,000 and a core deposit intangible of $623,000, or 0.5% of core deposits. The bargain purchase gain represents the excess of the estimated fair value of the net assets acquired in excess of the purchase price and is included in Other Income in the Consolidated Statements of Net Income in this Form 10-K. This acquisition resulted in a bargain purchase gain primarily due to the inclusion of certain adjustments to the purchase price for potential risks identified by the Company during the due diligence and price negotiation stages of the acquisition that were concluded in October of 2013. The Company has concluded that the potential risks identified at that time do not represent a liability to the Company and, accordingly, they have not been allocated any value in the application of the acquisition method of accounting. The bargain purchase gain increased from April 1, 2014 to December 31, 2014, due to an adjustment to the fair value of accrued liabilities acquired.

A summary of the net assets acquired and the estimated fair value adjustments of Alaska Pacific are presented below:



	Alaska Pacific
(In Thousands)	April 1, 2014

Cost basis net assets		$14,733
Cash payment made	(6,423		)
Common stock issued	(7,446		)
Fair value adjustments:
Net loans	(1,137		)
Premises and equipment	547
Other intangible assets	623
Mortgage servicing rights	(119		)
Deposits	(844		)
Other	236
Bargain purchase gain		$170

A summary of assets acquired and liabilities assumed at their estimated fair values are presented below:



	Alaska Pacific
(In Thousands)	April 1, 2014

Assets Acquired:
Cash and equivalents		$12,956
Investment securities	7,240
Net loans	138,432
Premises and equipment	3,436
Other intangibles	623
Mortgage servicing rights	1,170
Other real estate owned	1,709
Other assets	1,645
Total assets acquired		$167,211

Liabilities Assumed:
Deposits		$151,438
Other liabilities	1,734
Total liabilities assumed		$153,172

Alaska Pacific purchased loans not subject to the requirements of FASB ASC 310-30 Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30") are presented below at acquisition:



(In Thousands)	April 1, 2014

Contractually required principal payments		$133,921
Purchase adjustment for credit, interest rate, and liquidity	612
Fair value of purchased non-credit impaired loans		$134,533

Alaska Pacific purchased loans subject to the requirements of FASB ASC 310-30 Loans and Debt Securities Acquired with Deteriorated Credit Quality. The Company identified eighteen purchased credit impaired loans as of April 1, 2014. This group of loans consists primarily of commercial and commercial real estate loans, and unlike a pool of consumer mortgages, it is not practicable for the Company to analyze the accretable yield of these loans. As such, the Company has elected the cost recovery method of income recognition for these loans, and thus no accretable difference has been identified for these loans.

Purchased credit impaired loans at acquisition are presented below:



(In Thousands)	April 1, 2014

Contractually required principal payments		$7,553
Nonaccretable difference	(3,654		)
Fair value of purchased credit impaired loans		$3,899

The acquisition of Alaska Pacific is not considered significant to the Company’s financial statements. The operations of Alaska Pacific are included in our operating results from April 1, 2014, and added revenue of $8.7 million, non-interest expense of $5.2 million, and net income of $3.5 million, before taxes, for the year ended December 31, 2015. Alaska Pacific’s results of operations prior to the acquisition are not included in our operating results. Additionally, merger-related costs of $1.5 million for the year ended December 31, 2014 were incurred and expensed in connection with the acquisition of Alaska Pacific and recognized within the merger and acquisition expense on the Consolidated Statements of Income.

The following table presents unaudited pro forma results of operations for the years ended December 31, 2014 as if the acquisition of Alaska Pacific had occurred on January 1, 2014. The proforma results have been prepared for comparative purposes only and are not necessarily indicative of the results that would have been obtained had the acquisition actually occurred on January 1, 2014.



(In Thousands, except earnings per share data)	December 31, 2014
						Pro Forma				Pro Forma
	Company		Alaska Pacific¹			Adjustments				Combined
Net interest and other income		$73,442		$2,095			($38	)	²		$75,499
Net income attributable to Northrim BanCorp, Inc.	17,408		(1,282		)	82			³	16,208
Earnings Per Share, Basic		$2.57									$2.37
Earnings Per Share, Diluted		$2.54									$2.34
Weighted Average Shares Outstanding, Basic	6,761,328									6,833,881
Weighted Average Shares Outstanding, Diluted	6,852,267									6,924,820

¹ Alaska Pacific represents results from January 1 to March 31 for 2014.

² Amount of amortization/ accretion of the fair value adjustments on loans and certificates of deposit.

³ Amount of amortization/accretion of the fair value adjustments on loans and certificates of deposit, bargain purchase gain, amortization of cored deposit intangible, and the change in the provision for income taxes.

Residential Mortgage

On December 1, 2014, the Company completed the acquisition of 76.5% of the equity interest in Residential Mortgage Holding Company, LLC ("RML"), the parent company of Residential Mortgage, LLC ("Residential Mortgage"), in a cash transaction valued at $29.5 million. The primary reason for the acquisition was to expand the Company's presence in the mortgage lending business in Alaska. The fair value of the Company's 23.5% equity interest in RML immediately prior to the acquisition was $9.0 million. The Company recorded a $3.0 million gain in the fourth quarter of 2014 as a result of remeasuring the Company's equity interest in RML immediately prior to the acquisition, which is included in the Company's Consolidated Statement of Income in the line item entitled "Gain on purchase of mortgage affiliate". The Company utilized a market value approach to value its 23.5% equity interest in RML which included analysis of current trading values and historical acquisition multiples of comparable mortgage companies. The consideration transferred or transferable to the former owners of RML and the assets acquired and liabilities assumed have been accounted for under the acquisition method of accounting and were recorded at their estimated fair values as of the December 1, 2014 acquisition date. Estimated fair values recorded in the transaction are subject to change for up to one year after the closing date of the acquisition. The application of the acquisition method of accounting resulted in the recognition of goodwill in the amount of $14.8 million and a trade name intangible of $950,000.

The former owners of RML (the "sellers") receive additional cash proceeds (the “earn-out payments”) based on the adjusted earnings of RML in all or a portion of the calendar years 2014, 2015, 2016, 2017, 2018 and 2019. The Company recorded a $7.3 million liability as of December 1, 2014 as part of its purchase accounting for future earn-out payments. Per the purchase agreement, the earn-out payments are calculated as follows:



First tier earn-out payment	Adjusted pretax earnings greater than $1,000,000 and less than or equal to $2,000,000	Payment will be calculated as product of amount of adjusted pretax earnings times 40%
Second tier earn-out payment	Adjusted pretax earnings greater than $2,000,000 and less than or equal to $3,000,000	The first tier earn-out payment, plus the product of amount of adjusted pretax earnings greater than $2,000,000 and less than $3,000,000 times 50%
Third tier earn-out payment	Adjusted pretax earnings greater than $3,000,000 and less than or equal to $4,000,000	The first tier plus the second tier earn-out payment, plus the product of amount of adjusted pretax earnings greater than $3,000,000 and less than $4,000,000 times 70%
Fourth tier earn- out payment	Adjusted pretax earnings greater than $4,000,000 and less than or equal to $6,000,000	The first, second and third tier earn-out payment, plus the product of amount of adjusted pretax earnings greater than $4,000,000 and less than $6,000,000 times 85%
Fifth tier earn-out payment	Adjusted pretax earnings greater than $6,000,000	The first, second, third and fourth tier earn-out payment, plus the product of amount of adjusted pretax earnings greater than $6,000,000 times 55%

The purchase agreement provides for these earn-out payments as a portion of the purchase price to be paid to the sellers in future periods, contingent on future events. Therefore we included an estimate of the acquisition-date fair value of the contingent consideration of $7.3 million as part of the cost of the combination. The accounting treatment of the contingent consideration to be paid to those of the sellers who continue employment with the Company was evaluated to determine whether the amounts represent purchase consideration or a separate transaction, such as post-transaction employee compensation. Factors evaluated require significant judgment and include, among other factors; consideration of the terms of continuing employment, levels of post-transaction compensation, ownership interest of the sellers/employees, linkage of the contingent consideration to the transaction date combination valuation, and any other agreements or matters related to the transaction.

Based on an evaluation of the factors surrounding the transaction and the terms of the purchase agreement, the amount due under the earn-out provision was accounted for as acquisition consideration. We concluded that the contingent consideration to be paid to the sellers/employees was a significant component of the transaction date valuation of the acquired business. The calculation of the contingent payment was based upon factors established at the date of the transaction to be paid upon meeting the established earnings criteria of RML. The post transaction employment arrangements of the continuing employees are at market rates, and the formula for determining the contingent consideration is consistent with the business valuation methodologies, based upon a multiplier of earnings recognized from RML for five twelve month periods following the acquisition.

For the year ended December 31, 2015, the Company recorded an adjustment to increase the contingent liability by $4.1 million. The increase in the contingent liability resulted from the excess of RML's pretax income from December 1, 2014 through the end of December 31, 2015 over and above estimates made at the close of the purchase of RML. The adjustment to the contingent liability for estimated future earn-out payments is recorded in the line item titled "Change in fair value, RML earn-out liability" in other operating expense on the Consolidated Statements of Income. The Company made its first earn-out payment to the sellers in the fourth quarter of 2015 for approximately $4.9 million. The total contingent liability as of December 31, 2015 is $6.6 million.

A summary of the net assets acquired and the estimated fair value adjustments of RML are presented below:



	RML
(In Thousands)	December 1, 2014

Cost basis net assets		$11,915
Cash payment made	(18,240		)
Cash surrender value of life insurance paid	(3,896		)
Liability for future earn out payments	(7,318		)
Fair value adjustments:
Net loans	(360		)
Trade name intangible	950
Rate lock derivative asset	960
Investment in Homestate	1,490
Other	(311		)
Goodwill		($14,810	)

A summary of assets acquired and liabilities assumed at their estimated fair values are presented below:



	RML
(In Thousands)	December 1, 2014

Assets Acquired:
Cash and equivalents		$10,828
Net loans	41,304
Premises and equipment	255
Trade name intangible	950
Rate lock derivative asset	960
Investment in Homestate	3,000
Other real estate owned	270
Other assets	10,291
Total assets acquired		$67,858

Liabilities Assumed:
Borrowings		$37,541
Other liabilities	6,625
Total liabilities assumed		$44,166

The acquisition of RML is not considered significant to the Company’s financial statements under Regulation S-X; however, the Company has determined that the acquisition resulted in a new reporting segment, Home Mortgage Lending.

The operations of RML are included in our operating results from December 1, 2014, and added revenue of $30.2 million, non-interest expense of $21.5 million, and net income of $8.7 million, before taxes, for the year ended December 31, 2015. RML’s results of operations prior to the December 1, 2014 acquisition are included in our operating results under the equity method. Additionally, merger-related costs of $507,000 for the year ended December 31, 2014 were incurred and expensed in connection with the acquisition of RML and recognized within the merger and acquisition expense on the Consolidated Statements of Income.

The following table presents unaudited pro forma results of operations for the year ended December 31, 2014 as if the acquisition of RML had occurred on January 1, 2014. The proforma results have been prepared for comparative purposes only and are not necessarily indicative of the results that would have been obtained had the acquisition actually occurred on January 1, 2014.



(In Thousands, except earnings per share data)	December 31, 2014
						Pro Forma				Pro Forma
	Company		RML¹			Adjustments				Combined
Net interest and other income		$73,442		$22,227	²		($1,176	)	³		$94,493
Net income attributable to Northrim BanCorp, Inc.	17,408		4,000			2,250			⁴	23,658
Earnings Per Share, Basic		$2.57									$3.50
Earnings Per Share, Diluted		$2.54									$3.45
Weighted Average Shares Outstanding, Basic	6,761,328									6,761,328
Weighted Average Shares Outstanding, Diluted	6,852,267									6,852,267

¹ RML represents results from January 1 to November 30 for 2014.

² 2014 amount is comprised of net interest income and loan origination fees of $6.0 million and $16.2 million of other income.

³ Amount of accretion of the fair value adjustments on loans and income recognized under the equity method prior to the December 2014 acquisition.

⁴ Amount of accretion of the fair value adjustments on loans, income recognized under the equity method, gain on acquisition, earn out accretion, and the change in the provision for income taxes.

Prior to December 1, 2014, the Company accounted for RML under the equity method of accounting. As of December 1, 2014, the Company owns 100% interest in RML and consolidates RML's activity into the Company's Consolidated Financial Statements.

The following table presents unaudited combined pro forma results of operations for the year ended December 31, 2014 as if the acquisition of Alaska Pacific and RML had occurred on January 1, 2014. The proforma results have been prepared for comparative purposes only and are not necessarily indicative of the results that would have been obtained had the acquisitions actually occurred on January 1, 2014.



(In Thousands, except earnings per share data)	December 31, 2014
			Alaska						Pro Forma				Pro Forma
	Company		Pacific¹			RML²			Adjustments				Combined
Net interest and other income		$73,442		$2,095			$22,227	³		($1,214	)	⁴		$96,550
Net income attributable to Northrim BanCorp, Inc.	17,408		(1,282		)	4,000			2,332			⁵	22,458
Earnings Per Share, Basic		$2.57												$3.29
Earnings Per Share, Diluted		$2.54												$3.24
Weighted Average Shares Outstanding, Basic	6,761,328												6,833,881
Weighted Average Shares Outstanding, Diluted	6,852,267												6,924,820

¹ Alaska Pacific represents results from January 1 to March 31.

² RML represents results from January 1 to November 30.

³ 2014 amount is comprised of net interest income and loan origination fees of $6.0 million and $16.2 million of other income.

⁴ Amount of amortization/ accretion of the fair value adjustments on loans and certificates of deposit for Alaska Pacific and amount of accretion of the fair value adjustments on loans and income recognized under the equity method prior to the December 2014 acquisition for RML.