10-K 1 nrim2019-10k.htm 10-K Document


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC  20549
FORM 10-K
(Mark One)
þ    Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2019
o    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from_____to____
Commission File Number 000-33501
NORTHRIM BANCORP, INC.
(Exact name of registrant as specified in its charter)
Alaska
 
92-0175752
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
3111 C Street
Anchorage, Alaska 99503
(Address of principal executive offices)    (Zip Code) 
(907) 562-0062
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1.00 par value
The NASDAQ Stock Market, LLC
(Title of Class)
(Name of Exchange on Which Listed)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  ¨ Yes  ý No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  ¨ Yes  ý No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ý Yes  ¨ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).  ý Yes  ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  
Large Accelerated Filer ¨  Accelerated Filer ý    Non-accelerated Filer ¨ (Do not check if a smaller reporting company) Smaller Reporting Company ý Emerging Growth Company ¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 12(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).       ¨ Yes  ý No
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2019 (the last business day of the registrant’s most recently completed second fiscal quarter) was $235,097,358.
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.  6,460,204 shares of Common Stock, $1.00 par value, as of March 6, 2020.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement on Schedule 14A, relating to the registrant’s annual meeting of shareholders to be held on May 28, 2020, are incorporated by reference into Part III of this Form 10-K.




TABLE OF CONTENTS
 
 
 
 
Part  I
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
Part II
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
Part III
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
Part IV
 
Item 15.
 
 


1



PART I
 
Cautionary Note Regarding Forward Looking Statements

This Annual Report on Form 10-K includes “forward-looking statements”, within the meaning of the Private Securities Litigation Reform Act of 1995, as amended, which are not historical facts.  These forward-looking statements describe management’s expectations about future events and developments such as future operating results, growth in loans and deposits, continued success of the Northrim BanCorp Inc.’s style of banking, and the outlook of the local economy in which we operate. 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; our ability to implement our marketing and growth strategies; and our ability to execute our business plan. 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 as those factors relate to our cost of funds and return on assets. In addition, there are risks inherent in the banking industry relating to collectability of loans and changes in interest rates. 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 Securities and Exchange Commission. 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
In this document, please note that references to "we", "our", "us", or the "Company" mean Northrim BanCorp, Inc. and its subsidiaries, unless the context suggests otherwise.
General
We are a publicly traded bank holding company headquartered in Anchorage, Alaska.  The Company’s common stock trades on the Nasdaq Global Select Stock Market (“NASDAQ”) under the symbol, “NRIM.”  The Company is regulated by the Board of Governors of the Federal Reserve System.  We began banking operations in Anchorage in December 1990, and formed the Company as an Alaska corporation in connection with our reorganization into a holding company structure; that reorganization was completed effective December 31, 2001.  The Company has grown to be the third largest commercial bank in Alaska and in Anchorage in terms of deposits, with $1.4 billion in total deposits and $1.6 billion in total assets at December 31, 2019.  Through our sixteen banking branches and twelve mortgage origination offices, we are accessible to approximately 90% of the Alaska population.
The Company has three direct wholly-owned subsidiaries:
Northrim Bank (the “Bank”), a state chartered, full-service commercial bank headquartered in Anchorage, Alaska.  The Bank is regulated by the Federal Deposit Insurance Corporation (the "FDIC") and the State of Alaska Department of Commerce, Community and Economic Development, Division of Banking, Securities and Corporations.  The Bank has sixteen branch locations in Alaska; eight in Anchorage, one in Wasilla, two in Juneau, one in Fairbanks, one in Ketchikan, one in Sitka, one in Eagle River, and one in Soldotna.  We operate in Washington State through Northrim Funding Services (“NFS”), a factoring business that the Bank started in 2004.  We offer a wide array of commercial and consumer loan and deposit products, investment products, and electronic banking services over the Internet;
Northrim Investment Services Company (“NISC”) was formed in November 2002. In the first quarter of 2006, through NISC, we purchased an equity interest in Pacific Wealth Advisors, LLC (“PWA”), an investment advisory, trust, and wealth management business located in Seattle, Washington, in which we hold 24% of PWA's total outstanding equity interests. PWA is a holding company that owns Pacific Portfolio Consulting, LLC and Pacific Portfolio Trust Company;

2



Northrim Statutory Trust 2 (“NST2”), an entity that we formed in December of 2005 to facilitate a trust preferred securities offering by the Company.
The Bank has three direct wholly-owned subsidiaries:
Northrim Capital Investments Co. (“NCIC”) is a wholly-owned subsidiary of the Bank, which holds a 100% interest in a residential mortgage holding company, Residential Mortgage Holding Company, LLC (“RML”).  The predecessor of RML, Residential Mortgage, LLC, was formed in 1998 and has twelve offices throughout Alaska.  RML became a wholly-owned subsidiary of NCIC on December 1, 2014. Prior to that, the Company held a 23.5% interest in RML. RML holds a 30% investment in Homestate Mortgage, LLC. In March and December of 2005, NCIC purchased ownership interests totaling 50.1% in Northrim Benefits Group, LLC (“NBG”), an insurance brokerage company that focused on the sale and servicing of employee benefit plans. In August 2017, the Company sold all of its interest in the assets of NBG. 
Northrim Building, LLC (“NBL”) is a wholly-owned subsidiary of the Bank that owns and operates the Company’s main office facility at 3111 C Street in Anchorage. 
Northrim Building LO, LLC is a wholly-owned subsidiary of the Bank that owns and operates the Company’s community branch facility at 2270 E. 37th Avenue in Anchorage. 
Segments
The Company operates in two primary segments: Community Banking and Home Mortgage Lending. Measures of the revenues, profit or loss, and total assets for each of the Company's segments are included in this report, Item 8. "Financial Statements and Supplementary Data", which is incorporated herein by reference.
Business Strategy
The Company’s primary objective is to become Alaska's most trusted financial institution by adding value for our customers, communities, and shareholders. We aspire to be Alaska's premier bank and employer of choice as a leader in financial expertise, products, and services. We value our state, and we are proud to be Alaskan. We embody Alaska's frontier spirit and values, and we support our communities. We have a sincere appreciation for our customers, and we strive to deliver superior customer first service that is reliable, ethical, and secure. We look for growth opportunities for our customers, our institution, and our employees.
Our strategy is one of value-added growth.  Management believes that calculated, sustainable organic and inorganic market share growth coupled with good asset quality, an appropriate core deposit and capital base, operational efficiency, diversified sources of other operating income, and improved profitability is the most appropriate means of increasing shareholder value.
Our business strategy emphasizes commercial lending products and services through relationship banking with businesses and professional individuals.  Additionally, we are a land development and residential construction lender and an active lender in the commercial real estate market in Alaska.  Because of our relatively small size, our experienced senior management team can be more involved with serving customers and making credit decisions, all of which are made in Alaska, allowing us to compete more favorably with larger competitors for business lending relationships.  Our business strategy also emphasizes the origination of a variety of home mortgage loan products, which we sell to the secondary market. We retain servicing for home mortgages that we originate and sell to the Alaska Housing Finance Corporation. We believe that there is opportunity to increase the Company’s loan portfolio, particularly in the commercial portion of the portfolio, in the Company’s current market areas through existing and new customers.
Management believes that our real estate construction and term real estate loan departments have developed a strong level of expertise and will continue to compete favorably in our markets.  We have also targeted the acquisition of new customers in professional fields including physicians, dentists, accountants, and attorneys.  In addition to lending products, in many cases commercial customers also require multiple deposit and affiliate services that add franchise value to the Company.  While we expect that opportunities for growth in 2020 will be modest mainly due to the lower oil prices compared to pre-2014 levels, which has led to a slower economy in Alaska, we believe that these strategies will continue to benefit the Company, and we intend to continue to grow our balance sheet through increasing our market share. The Company benefits from solid capital and liquidity positions, and management believes that this provides a competitive advantage in the current business environment. (See “Liquidity and Capital Resources” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.)

3



The Company’s business strategy also stresses the importance of customer deposit relationships to support its lending activities.  Our guiding principle is to serve our market areas by operating with a “Superior Customer First Service” philosophy, affording our customers the highest priority in all aspects of our operations.  We believe that our successful execution of this philosophy has created a strong core deposit franchise that provides a stable, low cost funding source for expanded growth in all of our lending areas.  We have devoted significant resources to future deposit product development, expansion of electronic services for both personal and business customers, and enhancement of information security related to these services.
In addition to market share growth, a significant aspect of the Company’s business strategy is focused on managing the credit quality of our loan portfolio.  Over the last several years, the Company has allocated more resources to the credit management function of the Bank to provide enhanced financial analysis of our largest, most complex loan relationships to further develop our processes for analyzing and managing various concentrations of credit within the overall loan portfolio, and to develop strategies to improve or collect our existing loans.  Continued success in maintaining or further improving the credit quality of our loan portfolio and managing our level of other real estate owned is a significant aspect of the Company’s strategy for attaining sustainable, long-term market growth to produce increased shareholder value.
Employees
We believe that we provide a high level of customer service. To achieve our objective of providing “Superior 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 “Superior Customer First Service” philosophy is combined with our emphasis on personalized, local decision making.  The Company continues to enhance our company-wide employee training program which focuses on Northrim culture, Superior Customer First Service, general sales skills, and various technical areas.
We consider our relations with our employees to be highly satisfactory.  We had 431 full-time equivalent employees at December 31, 2019. None of our employees are covered by a collective bargaining agreement.  Of the 431 full-time equivalent employees, 311 were Community Banking employees and 120 were Home Mortgage Lending employees.
Products and Services
Community Banking
Lending Services: We have an emphasis on commercial and real estate lending.  We also believe we have a significant niche in construction and land development lending in Anchorage, Fairbanks, the Matanuska-Susitna Valley, the Kenai Peninsula, and Southeast Alaska.  (See “Loans” in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.)
Purchase of accounts receivable:  We provide short-term working capital to customers primarily in our Alaska markets as well as Washington, Oregon and some other states by purchasing their accounts receivable through NFS.  In 2020, we expect NFS to continue to penetrate these markets and to continue to contribute to the Company’s profitability.
Deposit Services: Our deposit services include business and personal noninterest-bearing checking accounts and interest-bearing time deposits, checking accounts, savings accounts, and individual retirement accounts.  Our interest-bearing accounts generally earn interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits.  
Several of our deposit services and products are:
A specialized business checking account customized to account activity;
A money market deposit account;
A “Jump-Up” certificate of deposit (“CD”) that allows additional deposits with the opportunity to increase the rate to the current market rate for a similar term CD;
 A savings account that is priced like a money market account that allows additional deposits, quarterly withdrawals without penalty, and tailored maturity dates; and
Insured cash sweep and business sweep.

4



Other Services: In addition to our traditional deposit and lending services, we offer our customers several convenience services:  Consumer Online Banking, Mobile App and Mobile Deposit, Mobile Web and Text Banking, Business Online Banking, Business Mobile App and Business Mobile Deposit, consumer online account opening, Personal Finance, Online Documents, Consumer Debit Cards, Business Debit Cards, instantly issued debit cards at account opening, My Rewards for consumer debit cards, card controls, Consumer Credit Cards, Business Credit Cards, Business Employee Purchase Cards, home equity advantage access cards, telebanking, and automated teller services.  Other special services include personalized checks at account opening, overdraft protection from a savings account, extended banking hours and commercial drive-up banking at many locations, automatic transfers and payments, People Pay (a peer-to-peer payment functionality), external transfers, Bill Pay, wire transfers, direct payroll deposit, electronic tax payments, Automated Clearing House origination and receipt, remote deposit capture, account reconciliation and positive pay, merchant services, cash management programs and sweep options to meet the specialized needs of business customers, annuity products, and long term investment portfolios. 
Other Services Provided Through Affiliates and Former Affiliates Whom We Continue To Work With:  Prior to August of 2017, the Company sold and serviced employee benefit plans for small and medium sized businesses in Alaska through NBG, an insurance brokerage company.  In August 2017, we sold our interest in the assets of NBG, but we have continued our relationship with Acrisure, LLC, who purchased the assets of NBG, through an ongoing referral agreement. Our affiliate PWA provides investment advisory, trust, and wealth management services for customers who are primarily located in the Pacific Northwest and Alaska.  We plan to continue to leverage these affiliate relationships to strengthen our existing customer base and bring new customers into the Bank.
Significant Business Concentrations:    No individual or single group of related accounts is considered material in relation to our total assets or total revenues, or to the total assets, deposits or revenues of the Bank, or in relation to our overall business. Based on classification by North American Industry Classification System ("NAICS"), there are no segments that exceed 10% of portfolio loans, except for real estate (see Note 5, Loans and Credit Quality, of the Notes to Consolidated Financial Statements included in Item 8 of this report for a breakout of real estate loans). In addition to its review of NAICS codes, the Company has also identified concentrations in one specialized industry. We estimate that as of December 31, 2019 approximately 8% of portfolio loans have direct exposure to the oil and gas industry in Alaska. Additionally, approximately 40% of our loan portfolio at December 31, 2019 is attributable to 31 large borrowing relationships. Moreover, our business activities are currently focused primarily in the state of Alaska.  Consequently, our results of operations and financial condition are dependent upon the general trends in the Alaska economy and, in particular, the residential and commercial real estate markets in Anchorage, Juneau, Fairbanks, the Matanuska-Susitna Valley, Ketchikan, Sitka, and to a lesser extent, the Kenai Peninsula. 
Home Mortgage Lending
Lending Services: The Company originates 1-4 family residential mortgages throughout Alaska which we sell to the secondary market. Residential mortgage choices include several products from the Alaska Housing Finance Corporation including first-time homebuyer, veteran's and rural community programs; Federal Housing Authority, or "FHA" loans; Veterans Affairs, or "VA" loans; Jumbo loans; and various conventional mortgages. The Company retains servicing rights on loans sold to the Alaska Housing Finance Corporation since implementing a new loan servicing program in July 2015.
Alaska Economy
Our growth and operations are impacted by the economic conditions of Alaska and the specific markets we serve.  Significant changes in the Alaska economy and the markets we serve eventually could have a positive or negative impact on the Company. Alaska is strategically located on the Pacific Rim, within nine hours by air from 95% of the northern hemisphere, and Anchorage has become a worldwide air cargo and transportation link between the United States and international business in Asia and Europe.  The economy of Alaska is dependent upon natural resource industries.  Key sectors of the Alaska economy are the oil industry, government and military spending, and the fishing, mining, tourism, air cargo, transportation, and construction industries, as well as health services.
We believe the long-term growth of the Alaska economy will most likely be determined by large scale natural resource development projects. Several multi-billion dollar projects can potentially advance in the moderate-term.  Some of these projects include copper, gold and molybdenum production at the Donlin mine and continued exploration in the National Petroleum Reserve Alaska and potential oil exploration in the Arctic National Wildlife Refuge. Because of their size, we believe each of these projects faces tremendous challenges.  We believe various political decisions need to be made by government regulators, issues need to be resolved in the court system, and multi-billion dollar financial commitments need to be made by the private sector if these large natural resource projects are to advance.  If none of these projects moves forward in the next ten years, we believe state revenues will continue to decline with falling oil production from older fields on the North Slope of Alaska.  We anticipate the decline in state revenues will likely have a negative effect on Alaska’s economy.

5



The oil industry plays a significant role in the economy of Alaska, but revenues for the State of Alaska are less dependent on the oil industry than they have been historically due to the implementation of a percent of market value ("POMV") concept that has balanced and created more certainty in state revenue streams. Part of the POMV concept creates an allocation of a portion of investment earnings to unrestricted revenue instead of restricted revenue. According to the State of Alaska Department of Revenue, approximately 23% of total state revenues of $11.1 billion in the fiscal year ending June 30, 2019 were generated through various taxes and royalties on the oil industry. Investment earnings were 36% of the total, and federal dollars were 30%. In the fiscal year ending June 30, 2018, 20% of total state revenues were generated through taxes and royalties on the oil industry while investment earnings and federal dollars accounted for 46% and 25%, respectively. However, in 2019 investment earnings represented 52% of unrestricted revenues as compared to 1% in 2018 for the fiscal year ending June 30. As of December 31, 2019, Alaska's Constitutional Budget Reserve was $2.2 billion and the Alaska Permanent Fund had a balance of $67 billion.  Investment revenue generated by the Alaska Permanent Fund is also used to pay an annual dividend to every eligible Alaskan citizen.
Even though we believe that the implementation of the POMV concept is a positive for the state of Alaska's financial well-being, we anticipate that if oil prices remain at their current relatively low levels in the longer term it will be a concern for Alaska's long-term economic growth. However, we believe Alaska's economy is less sensitive to oil price volatility in the short-term than Alaska's state government budget. While state government revenue from oil royalties is immediately and directly impacted by a drop in oil prices, we believe that the large scale and nature of oil wells in Alaska are such that project commitments that currently exist will most likely not be disrupted by short-term price volatility. We continue to be encouraged by announcements from several oil exploration companies announcing new oil fields on the North Slope resulting from increased exploration activity that began in 2018 that could lead to future increases in oil production over time.     
After three consecutive years of a mild recession, the Alaska economy began to show a positive change in the fourth quarter of 2018, with improvements continuing throughout 2019. The State Department of Labor reported growth of 1,900 jobs, or 0.6%, in December of 2019 compared to December of 2018. After 37 months of year-over-year declines, Alaska had 15 consecutive months of year-over-year job increases as of December 2019. The Alaska Department of Labor predicts a recovery of another 1,100 jobs, or an approximately 0.3% increase in total employment in 2020. While this is an improvement compared to the job losses that occurred in 2016-2018, the Company anticipates this relatively slow growth rate will have an impact on our ability to grow organically in the next few years.
 
Alaska’s home mortgage delinquency and foreclosure levels continue to be better than most of the nation. According to the Mortgage Bankers Association, Alaska’s foreclosure rate was 0.71% at the end of the third quarter of 2019. The comparable national average rate was 0.84% for the same time period 2019. The national rate continues to improve, while the Alaska rate remains relatively lower. The survey also reported that the percentage of delinquent mortgage loans in Alaska was 3.16% for the third quarter of 2019. The comparable delinquency rate for the entire country was higher at 4.09%.

We believe our exposure to the tourism industry diversifies the Company's customer base. We believe this helps mitigate the effect that the decline in natural resource industries, specifically the oil industry, in Alaska has had on the Company's operations. Southeast Alaska is the primary destination for cruise ships that visit Alaska. Based on the latest information from Rain Coast Data, approximately one million cruise ship tourists have visited Southeast Alaska annually in recent years and in 2019, this increased 7% to 1.2 million.

A material portion of our loans at December 31, 2019, were secured by real estate located in greater Anchorage, Matanuska-Susitna Valley, Fairbanks, and Southeast Alaska. In 2019, 31% of our revenue was derived from the residential housing market in the form of loan fees and interest on residential construction and land development loans and income from RML as compared to 29% and 30% in 2018 and 2017, respectively.  Real estate values generally are affected by economic and other conditions in the area where the real estate is located, fluctuations in interest rates, changes in tax and other laws, and other matters outside of our control. A decline in real estate values in the greater Anchorage, Matanuska-Susitna Valley, Fairbanks, and Southeast Alaska areas could significantly reduce the value of the real estate collateral securing our real estate loans and could increase the likelihood of defaults under these loans. At December 31, 2019, $412.7 million, or 39%, of our loan portfolio was represented by commercial loans in Alaska.  
Alaska’s residents are not subject to any state income or state sales taxes.  For over 30 years, Alaska residents have received annual distributions payable in October of each year from the Alaska Permanent Fund Corporation, which is supported by royalties from oil production.  The distribution was $1,600 per eligible resident in 2019 for an aggregate distribution of approximately $1 billion.  The Anchorage Economic Development Corporation estimates that, for most Anchorage households, distributions from the Alaska Permanent Fund Corporation exceed other Alaska taxes to which those households are subject (primarily real estate taxes).

6



Competition
We operate in a highly competitive and concentrated banking environment.  We compete not only with other commercial banks, but also with many other financial competitors, including credit unions (including Alaska USA Federal Credit Union, one of the nation’s largest credit unions), finance companies, mortgage banks and brokers, securities firms, insurance companies, private lenders, and other financial intermediaries, many of which have a state-wide or regional presence, and in some cases, a national presence.  Many of our competitors have substantially greater resources and capital than we do and offer products and services that are not offered by us.  Our non-bank competitors also generally operate under fewer regulatory constraints, and in the case of credit unions, are not subject to income taxes.  We estimate that credit unions in Alaska have a 44% share of total deposits held in banks and credit unions in the state as of June 30, 2019.  Changes in credit union operating practices have effectively eliminated the “common bond” of membership requirement and liberalized their lending authority to include business and real estate loans on par with commercial banks.  The differences in resources and regulation may make it harder for us to compete profitably, to reduce the rates that we can earn on loans and investments, to increase the rates we must offer on deposits and other funds, and adversely affect our financial condition and earnings.
As our industry becomes increasingly dependent on and oriented toward technology-driven delivery systems, permitting transactions to be conducted electronically, non-bank institutions are able to attract funds and provide lending and other financial services even without offices located in our primary service area. Some insurance companies and brokerage firms compete for deposits by offering rates that are higher than may be appropriate for the Company in relation to its asset and liability management objectives.  However, we offer a wide array of deposit products and services and believe we can compete effectively through relationship based pricing and effective delivery of “Superior Customer First Service”. We also compete with full service investment firms for non-bank financial products and services offered by PWA and through retail investment advisory services and annuity investment products that we offer through a third-party vendor.
Currently, there are seven commercial banks operating in Alaska.  At June 30, 2019, the date of the most recently available information, Northrim Bank had approximately a 12% share of the Alaska bank deposits, 17% in the Anchorage area, 14% in Juneau, 14% in Sitka, 11% in Matanuska-Susitna, 6% in Ketchikan, and 5% in Fairbanks.
The following table sets forth market share data for the banks and credit unions having a presence in Alaska as of June 30, 2019, the most recent date for which comparative deposit information is available.
Financial institution
Number of branches
Total deposits (in thousands)
Market share of total financial institution deposits
Market share of total bank deposits
Northrim Bank(1)
16

$1,305,714

6
%
12
%
Wells Fargo Bank Alaska(1)
44
6,065,826

30
%
51
%
First National Bank Alaska(1)
28
2,362,101

11
%
20
%
Key Bank(1)
14
931,445

4
%
8
%
First Bank(1)
9
519,903

2
%
4
%
Mt. McKinley Bank(1)
5
353,493

2
%
3
%
Denali State Bank(1)
5
263,117

1
%
2
%
Total bank branches
121

$11,801,599

56
%
100
%
Credit unions(2)
93

$9,143,492

44
%
NA

Total financial institution branches
214

$20,945,091

100
%
100
%
 (1) FDIC Summary of Deposits as of June 30, 2019.
 (2) SNL Financial Deposit Market Share Summary as of June 30, 2019.





7



Supervision and Regulation
The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956 (the “BHC Act”) registered with and subject to examination by the Board of Governors of the Federal Reserve System (the “FRB”).  The Company’s bank subsidiary is an Alaska-state chartered commercial bank and is subject to examination, supervision, and regulation by the Alaska Department of Commerce, Community and Economic Development, Division of Banking, Securities and Corporations (the “Division”).  The FDIC insures the Bank’s deposits and also examines, supervises, and regulates the Bank. The Company’s affiliated investment advisory and wealth management company, Pacific Portfolio Consulting, LLC, is subject to and regulated under the Investment Advisors Act of 1940 and applicable state investment advisor rules and regulations.  The Company’s affiliated trust company, Pacific Portfolio Trust Company, is regulated as a non-depository trust company under the trust company laws of the State of Washington and is subject to supervision and examination by the Department of Financial Institutions of Washington State.
The Company’s earnings and activities are affected, among other things, by legislation, by actions of the FRB, the Division, the FDIC and other regulators, by local legislative and administrative bodies, and decisions of courts.  These include limitations on the ability of the Bank to pay dividends to the Company, numerous federal and state consumer protection laws imposing requirements on the making, enforcement, and collection of consumer loans, and restrictions on and regulation of the sale of mutual funds and other uninsured investment products to customers.
Regulation of banks and the financial services industry has been undergoing major changes in recent years, including the enactment in 2010 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).  The Dodd-Frank Act significantly modifies and expands legal and regulatory requirements imposed on banks and other financial institutions.  
The Dodd-Frank Act has significantly affected the Bank and its business and operations. The Dodd-Frank Act permanently increased the maximum amount of deposit insurance coverage to $250,000 per depositor and deposit insurance assessments paid by the Bank are now based on the Bank’s total assets.  Other Dodd-Frank Act changes include: (i) tightened capital requirements for the Bank and the Company; (ii) new requirements on parties engaged in residential mortgage origination, brokerage, lending and securitization; (iii) expanded restrictions on affiliate and insider transactions; (iv) enhanced restrictions on management compensation and related governance procedures; (v) creation of a federal Consumer Financial Protection Bureau (the "CFPB") with broad authority to regulate consumer financial products and services; and (vi) restrictions and prohibitions on the ability of banking entities to engage in proprietary trading and to invest in or have certain relationships with hedge funds and private equity funds.
The Trump administration and various members of Congress from time to time have expressed a desire to modify or repeal parts of the Dodd-Frank Act. We cannot predict whether any modification or repeal will be enacted or, if so, any effect they would have on our business, operation or financial condition or on the financial services industry in general.    
The Gramm-Leach-Bliley Act (the “GLB Act”), which was enacted in 1999, allows bank holding companies to elect to become financial holding companies, subject to certain regulatory requirements.  In addition to the activities previously permitted bank holding companies, financial holding companies may engage in non-banking activities that are financial in nature, such as securities, insurance, and merchant banking activities, subject to certain limitations.  The Company could utilize this structure to accommodate an expansion of its products and services in the future.
Bank holding companies, such as the Company, are subject to a variety of restrictions on the activities in which they can engage and the acquisitions they can make. The activities or acquisitions of bank holding companies, such as the Company, that are not financial holding companies, are limited to those which constitute banking, managing or controlling banks or which are closely related activities.  A bank holding company is required to obtain the prior approval of the FRB for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company.  Nonbank acquisitions and activities of a bank holding company are also generally limited to the acquisition of up to 5% of the outstanding shares of any class of voting securities of a company unless the FRB has previously determined that the nonbank activities are closely related to banking, or prior approval is obtained from the FRB.
The GLB Act also included extensive consumer privacy provisions.  These provisions, among other things, 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 adopted privacy regulations.  As a result of the Dodd-Frank Act, the rule-making authority for the privacy provisions of the GLB Act has been transferred to the CFPB. In addition, the states are permitted to adopt more extensive privacy protections through legislation or regulation.

8



There are various legal restrictions on the extent to which a bank holding company and certain of its nonbank subsidiaries can borrow or otherwise obtain credit from their banking subsidiaries or engage in certain other transactions with or involving those banking subsidiaries.  With certain exceptions, federal law imposes limitations on, and requires collateral for, extensions of credit by insured depository institutions, such as the Bank, to their non-bank affiliates, such as the Company. In addition, new capital rules may affect the Company's ability to pay dividends.
Subject to certain limitations and restrictions, a bank holding company, with prior approval of the FRB, may acquire an out-of-state bank.  Banks in states that do not prohibit out-of-state mergers may merge with the approval of the appropriate federal banking agency. A state bank may establish a de novo branch out of state if such branching is permitted by the other state for state banks chartered by such other state. 
Among other things, applicable federal and state statutes and regulations which govern a bank’s activities relate to minimum capital requirements, required reserves against deposits, investments, loans, legal lending limits, mergers and consolidations, borrowings, issuance of securities, payment of dividends, establishment of branches and other aspects of its operations.  The Division and the FDIC also have authority to prohibit banks under their supervision from engaging in what they consider to be unsafe or unsound practices.
There also are certain limitations on the ability of the Company to pay dividends to its shareholders.  It is the policy of the FRB that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if the prospective rate of earnings retention is consistent with the organization’s current and expected future capital needs, asset quality and overall financial condition.  The policy provides that bank holding companies should not maintain a level of cash dividends that undermines a bank holding company’s ability to serve as a source of strength to its banking subsidiaries. Additionally, the Alaska Corporations Code generally prohibits the Company from making any distributions to the Company's shareholders unless the amount of the retained earnings of the Company immediately before the distribution equals or exceeds the amount of the proposed distribution. The Alaska Corporations Code also prohibits the Company from making any distribution to the Company's shareholders if the Company or a subsidiary of the Company making the distribution is, or as a result of the distribution would be, likely to be unable to meet its liabilities as they mature. Under Alaska law, the Bank is not permitted to pay or declare a dividend in an amount greater than its undivided profits.
Various federal and state statutory provisions also limit the amount of dividends that subsidiary banks can pay to their holding companies without regulatory approval.  The FDIC or the Division could take the position that paying a dividend would constitute an unsafe or unsound banking practice. In addition, new capital rules may affect the Bank's ability to pay dividends.
Under longstanding FRB policy and under the Dodd-Frank Act, a bank holding company is required to act as a source of financial strength for its subsidiary banks.  The Company could be required to commit resources to its subsidiary bank in circumstances where it might not do so, absent such requirement.
Both the Company and the Bank are required to maintain minimum levels of regulatory capital. In July 2013, federal banking regulators (including the FDIC and the FRB) adopted new capital requirement rules (the “Rules”). The Rules apply to both depository institutions (such as the Bank) and their holding companies (such as the Company). The Rules reflect, in part, certain standards initially adopted by the Basel Committee on Banking Supervision in December 2010 (which standards are commonly referred to as “Basel III”) as well as requirements contemplated by the Dodd-Frank Act. The Rules have applied to both the Company and the Bank since the beginning of 2015.
The Rules recognize three types, or tiers, of capital: common equity Tier 1 capital, additional Tier 1 capital and Tier 2 capital. Common equity Tier 1 capital generally consists of retained earnings and common stock instruments (subject to certain adjustments), as well as accumulated other comprehensive income ("AOCI"), except to the extent that the Company and the Bank exercise a one-time irrevocable option to exclude certain components of AOCI. Additional Tier 1 capital generally includes noncumulative perpetual preferred stock and related surplus subject to certain adjustments and limitations. Tier 2 capital generally includes certain capital instruments (such as subordinated debt) and portions of the amounts of the allowance for loan and lease losses, subject to certain requirements and deductions. The term "Tier 1 capital" means common equity Tier 1 capital plus additional Tier 1 capital, and the term "total capital" means Tier 1 capital plus Tier 2 capital.
The Rules generally measure an institution's capital using four capital measures or ratios. The common equity Tier 1 capital ratio is the ratio of the institution's common equity Tier 1 capital to its total risk-weighted assets. The Tier 1 capital ratio is the ratio of the institution's total Tier 1 capital to its total risk-weighted assets. The total capital ratio is the ratio of the institution's total capital to its total risk-weighted assets. The leverage ratio is the ratio of the institution's Tier 1 capital to its average total consolidated assets. To determine risk-weighted assets, assets of an institution are generally placed into a risk category and given a percentage weight based on the relative risk of that category. The percentage weights range from 0% to 1,250%. An asset's risk-

9



weighted value will generally be its percentage weight multiplied by the asset's value as determined under generally accepted accounting principles. In addition, certain off-balance-sheet items are converted to balance-sheet credit equivalent amounts, and each amount is then assigned to one of the risk categories. An institution's federal regulator may require the institution to hold more capital than would otherwise be required under the Rules if the regulator determines that the institution's capital requirements under the Rules are not commensurate with the institution's credit, market, operational or other risks.    
Both the Company and the Bank are required to have a common equity Tier 1 capital ratio of 4.5% as well as a Tier 1 leverage ratio of 4.0%, a Tier 1 risk-based ratio of 6.0% and a total risk-based ratio of 8.0%. In addition to the preceding requirements, both the Company and the Bank are required to have a “conservation buffer,” consisting of common equity Tier 1 capital, which is at least 2.5% above each of the preceding common equity Tier 1 capital ratio, the Tier 1 risk-based ratio and the total risk-based ratio. An institution that does not meet the conservation buffer will be subject to restrictions on certain activities including payment of dividends, stock repurchases and discretionary bonuses to executive officers.
The Rules set forth the manner in which certain capital elements are determined, including but not limited to, requiring certain deductions related to mortgage servicing rights and deferred tax assets. When the federal banking regulators initially proposed new capital rules in 2012, the rules would have phased out trust preferred securities as a component of Tier 1 capital. As finally adopted, however, the Rules permit holding companies with less than $15 billion in total assets as of December 31, 2009 (which includes the Company) to continue to include trust preferred securities issued prior to May 19, 2010 in Tier 1 capital, generally up to 25% of other Tier 1 capital.
The Rules made changes in the methods of calculating certain risk-based assets, which in turn affects the calculation of risk- based ratios. Higher or more sensitive risk weights are assigned to various categories of assets, among which are commercial real estate, credit facilities that finance the acquisition, development or construction of real property, certain exposures or credits that are 90 days past due or are nonaccrual, foreign exposures, certain corporate exposures, securitization exposures, equity exposures and in certain cases mortgage servicing rights and deferred tax assets.
Both the Company and the Bank were required to begin compliance with the Rules on January 1, 2015. The conservation buffer started to be phased in beginning in 2016 took full effect on January 1, 2019. Certain calculations under the Rules will also have phase-in periods. We believe that the current capital levels of the Company and the Bank are in compliance with the standards under the Rules including the conservation buffer.
Following the enactment of certain federal legislation in 2018, the federal banking regulators (including the FDIC and FRB) proposed a rule intended to simplify capital rules for certain community banks and their holding companies, the Community Bank Leverage Ratio ("CBLR"). Qualifying community banking organizations can elect to opt-into the CBLR and be under a new capital requirement rather than the current capital framework. To be eligible to make this election, the community banking organization would have to have less than $10 billion in assets, have a community bank leverage ratio of at least 9.00% and meet certain other criteria (including limits on off-balance sheet exposures and trading assets and liabilities). The CBLR would generally be the ratio of the organization's total bank equity capital to average assets, subject to certain adjustments. The intent of the CBLR is to simplify but not weaken capital requirements for qualifying community banks. Management is still assessing whether or not the Bank will opt into these new capital rules.
In addition to the minimum capital standards, the federal banking agencies have issued regulations to implement a system of "prompt corrective action." These regulations apply to the Bank but not the Company. The regulations establish five capital categories; under the Rules, a bank generally is:
“well capitalized” if it has a total risk-based capital ratio of 10.0% or more, a Tier 1 risk-based capital ratio of 8.0% or more, a common equity Tier 1 risk-based ratio of 6.5% or more, and a leverage capital ratio of 5.0% or more, and is not subject to any written agreement, order or capital directive to meet and maintain a specific capital level for any capital measure;

“adequately capitalized” if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 6.0% or more, a common equity Tier 1 risk-based ratio of 4.5% or more, and a leverage capital ratio of 4.0% or more;

“undercapitalized” if it has a total risk-based capital ratio less than 8.0%, a Tier 1 risk-based capital ratio less than 6.0%, a common equity risk-based ratio less than 4.5% or a leverage capital ratio less than 4.0%;


10



“significantly undercapitalized” if it has a total risk-based capital ratio less than 6.0%, a Tier 1 risk-based capital ratio less than 4.0%, a common equity risk-based ratio less than 3.0% or a leverage capital ratio less than 3.0%; and

“critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%.

A bank that, based upon its capital levels, is classified as “well capitalized,” “adequately capitalized” or “undercapitalized” may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for a hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment.

At each successive lower capital category, a bank is subject to increasing supervisory restrictions. For example, being “adequately capitalized” rather than “well-capitalized” affects a bank’s ability to accept brokered deposits without the prior approval of the FDIC, and may cause greater difficulty obtaining retail deposits.  Banks in the “adequately capitalized” classification may have to pay higher interest rates to continue to attract those deposits, and higher deposit insurance rates for those deposits. This status also affects a bank’s eligibility for a streamlined review process for acquisition proposals.
Management intends to maintain capital ratios for the Bank in 2020 that exceed the FDIC’s requirements for the “well-capitalized” capital requirement classification.  The dividends that the Bank pays to the Company will be limited to the extent necessary for the Bank to meet the regulatory requirements of a “well-capitalized” bank. 
The capital ratios for the Company exceed those for the Bank primarily because the trust preferred securities offerings that the Company completed in the second quarter of 2003 and in the fourth quarter of 2005 are included in the Company’s capital for regulatory purposes, although they are accounted for as a liability in its consolidated financial statements.  The trust preferred securities are not accounted for on the Bank’s financial statements nor are they included in its capital (although the Company did contribute to the Bank a portion of the cash proceeds from the sale of those securities).  The Company redeemed $8 million in trust preferred securities in August 2017. As a result, the Company has $10 million more in regulatory capital than the Bank at December 31, 2019 and 2018, respectively, which explains most of the difference in the capital ratios for the two entities.
The Bank is required to file periodic reports with the FDIC and the Division and is subject to periodic examinations and evaluations by those regulatory authorities.  These examinations must be conducted every 12 months, except that certain “well-capitalized” banks may be examined every 18 months.  The FDIC and the Division may each accept the results of an examination by the other in lieu of conducting an independent examination. 
In the liquidation or other resolution of a failed insured depository institution, claims for administrative expenses (including certain employee compensation claims) and deposits are afforded a priority over other general unsecured claims, including non-deposit claims, and claims of a parent company such as the Company. Such priority creditors would include the FDIC, which succeeds to the position of insured depositors to the extent it has made payments to such depositors.    
The Company is also subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Securities Exchange Act of 1934, as amended (the “Securities Exchange Act of 1934”), including certain requirements under the Sarbanes-Oxley Act of 2002.
The Bank is subject to the Community Reinvestment Act of 1977 (“CRA”).  The CRA requires that the Bank help meet the credit needs of the communities it serves, including low and moderate income neighborhoods, consistent with the safe and sound operation of the institution.  The FDIC assigns one of four possible ratings to the Bank’s CRA performance and makes the rating and the examination reports publicly available.  The four possible ratings are outstanding, satisfactory, needs to improve and substantial noncompliance.  A financial institution’s CRA rating can affect an institution’s future business.  For example, a federal banking agency will take CRA performance into consideration when acting on an institution’s application to establish or move a branch, to merge or to acquire assets or assume liabilities of another institution. In its most recent CRA examination, the Bank received a “Satisfactory” rating from the FDIC.
The Company is also subject to the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”).  Among other things, the USA PATRIOT Act requires the Company and the Bank to adopt and implement specific policies and procedures designed to prevent and defeat money laundering. Management believes the Company is in compliance with the USA PATRIOT Act as in effect on December 31, 2019.

11



In addition, the Company and its affiliates are subject to a broad array of financial and state consumer protection laws and regulations. Among other things, these laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions deal with their customers.
Available Information
The Company’s annual report on Form 10-K and quarterly reports on Form 10-Q, as well as its current reports on Form 8-K and proxy statement filings (and all amendments thereto), which are filed with the 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 public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549.  The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  The SEC maintains a website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC.
ITEM 1A.            RISK FACTORS
An investment in the Company’s common stock is subject to risks inherent to the Company’s business.  The material risks and uncertainties that management believes affect the Company are described below.  Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report.  The risks and uncertainties described below are not the only ones facing the Company.  Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations.  This report is qualified in its entirety by these risk factors.
If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the Company’s common stock could decline significantly, and you could lose all or part of your investment.
Current economic conditions in the State of Alaska pose challenges for us and could adversely affect our financial condition and results of operations.
We are operating in an uncertain economic environment. The decrease in the price of oil which began in 2014 has led to a significant deficit in the budget for the State of Alaska, which has been partially alleviated by legislative action in 2018 that now allows for the use of a portion of State's investment income from the Alaska Permanent Fund to help fund the state budget. However, we believe that this has solved only part of Alaska's structural finance problem. In the longer term, relatively low oil prices are expected to negatively impact the overall economy in Alaska on a larger scale as we estimate that one third of the Alaskan economy is related to oil. Financial institutions continue to be affected by changing conditions in the real estate and financial markets, along with an arduous regulatory climate. Dramatic declines in the United States housing market from 2008 through 2012, with falling home prices and increasing foreclosures and unemployment, resulted in significant writedowns of asset values by financial institutions. While conditions have improved nationally, a return to a recessionary economy could result in financial stress on our borrowers that would adversely affect our financial condition and results of operations. Deteriorating conditions in the regional economies of Anchorage, Matanuska-Susitna Valley, Fairbanks, and the Southeast areas of Alaska served by the Company could drive losses beyond that which is provided for in our allowance for loan losses. We may also face the following risks in connection with events:
Ineffective monetary policy could cause rapid changes in interest rates and asset values that would have a materially adverse impact on our profitability and overall financial condition.
Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, resulting in increased delinquencies and default rates on loans and other credit facilities.
Regulatory scrutiny of the industry could increase, leading to harsh regulation of our industry that could lead to a higher cost of compliance, limit our ability to pursue business opportunities and increase our exposure to the judicial system and the plaintiff’s bar.
Erosion in the fiscal condition of the U.S. Treasury could lead to new taxes that would limit the ability of the Company to pursue growth and return profits to shareholders.

12



If these conditions or similar ones develop, we could experience adverse effects on our financial condition and results of operations.
Our concentration of operations in the Anchorage, Matanuska-Susitna Valley, Fairbanks and Southeast areas of Alaska makes us more sensitive to downturns in those areas.
Substantially all of our business is derived from the Anchorage, Matanuska-Susitna Valley, Fairbanks, and Southeast areas of Alaska.  The majority of our lending has been with Alaska businesses and individuals.   At December 31, 2019, approximately 70% of the Bank’s loans are secured by real estate and 3% are unsecured. Approximately 27% are for general commercial uses, including professional, retail, and small businesses, and are secured by non-real estate assets.  Repayment is expected from the borrowers’ cash flow or, secondarily, the collateral.   Our exposure to credit loss, if any, is the outstanding amount of the loan if the collateral is proved to be of no value.  These areas rely primarily upon the natural resources industries, particularly oil production, as well as tourism and government and U.S. military spending for their economic success.  In particular, the oil industry plays a significant role in the Alaskan economy. We estimate that one third of Alaska's gross state product is currently derived from the oil industry.
Our business is and will remain sensitive to economic factors that relate to these industries and local and regional business conditions.  As a result, local or regional economic downturns, or downturns that disproportionately affect one or more of the key industries in regions served by the Company, may have a more pronounced effect upon our business than they might on an institution that is less geographically concentrated.  The extent of the future impact of these events on economic and business conditions cannot be predicted; however, prolonged or acute fluctuations could have a material and adverse impact upon our financial condition and results of operation.
Changes in market interest rates could adversely impact the Company. 
Our earnings are impacted by changing interest rates.  Changes in interest rates affect the demand for new loans, the credit profile of existing loans, the rates received on loans and securities, and rates paid on deposits and borrowings. These impacts may negatively impact our ability to attract deposits, make loans, and achieve satisfactory interest rate spreads, which could adversely affect our financial condition or results of operations. In particular, increases in interest rates will likely reduce RML’s revenues by reducing the market for refinancings, as well as the demand for RML’s other residential loan products. Additionally, increases in interest rates may impact our borrowers' ability to make loan payments, particularly in our commercial loan portfolio.
     Interest rates may be affected by many factors beyond our control, including general and economic conditions and the monetary and fiscal policies of various governmental and regulatory authorities. Since December 2015, the FRB has increased short-term interest rates nine times. However, the FRB reduced interest rates three times in 2019. While we expect the FRB to hold short-term interest rates stable in 2020, market volatility in interest rates can be difficult to predict, as unexpected interest rate changes may result in a sudden impact while anticipated changes in interest rates generally impact the mortgage rate market prior to the actual rate change.  Exposure to interest rate risk is managed by monitoring the repricing frequency of our rate-sensitive assets and rate-sensitive liabilities over any given period.  Although we believe the current level of interest rate sensitivity is reasonable, significant fluctuations in interest rates could potentially have an adverse effect on our business, financial condition and results of operations.
We operate in a highly regulated environment and changes of or increases in banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us.
We are subject to extensive regulation, supervision and examination by federal and state banking authorities.  In addition, as a publicly-traded company, we are subject to regulation by the SEC and NASDAQ.  Any change in applicable regulations or federal or state legislation or in policies or interpretations or regulatory approaches to compliance and enforcement, income tax laws and accounting principles could have a substantial impact on us and our operations.  Changes in laws and regulations may also increase our expenses by imposing additional fees or taxes or restrictions on our operations.  Additional legislation and regulations that could significantly affect our authority and operations may be enacted or adopted in the future, which could have a material adverse effect on our financial condition and results of operations.  Failure to appropriately comply with any such laws, regulations or principles could result in sanctions by regulatory agencies or damage to our reputation, all of which could adversely affect our business, financial condition or results of operations.
In that regard, the Dodd-Frank Act was enacted in July 2010.  Among other provisions, the Dodd-Frank Act created the Consumer Financial Protection Bureau with broad powers to regulate consumer financial products such as credit cards and mortgages, created a Financial Stability Oversight Council comprised of the heads of other regulatory agencies, has resulted in new capital requirements from federal banking agencies, placed new limits on electronic debt card interchange fees, and requires

13



banking regulators, the SEC and national stock exchanges to adopt significant new corporate governance and executive compensation reforms.  
Certain provisions of these new rules have phase-in periods, including a 2.5% conservation buffer, which began to be phased-in in 2016 and took full effect on January 1, 2019. Further, regulators have significant discretion and authority to prevent or remedy practices that they deem to be unsafe or unsound, or violations of laws or regulations by financial institutions and holding companies in the performance of their supervisory and enforcement duties.  These powers have been utilized more frequently in recent years due to the serious national economic conditions that faced the financial system in late 2008 and early 2009.  The exercise of regulatory authority may have a negative impact on our financial condition and results of operations. Additionally, our business is affected significantly by the fiscal and monetary policies of the U.S. federal government and its agencies, including the FRB.
We cannot accurately predict the full effects of recent or future legislation or the various other governmental, regulatory, monetary and fiscal initiatives which have been and may be enacted on the financial markets and on the Company.  The terms and costs of these activities could materially and adversely affect our business, financial condition, results of operations and the trading price of our common stock.
We are subject to more stringent capital and liquidity requirements which may adversely affect our net income and future growth.
In July 2013, the FRB and the FDIC announced the new capital rules, which apply to both depository institutions and (subject to certain exceptions not applicable to the Company) their holding companies.  As described in further detail above in “Item 1 Business - Supervision and Regulation” these rules created increased capital requirements for United States depository institutions and their holding companies. These rules include risk-based and leverage capital ratio requirements, which became effective on January 1, 2015. These rules also revise the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels do not meet certain thresholds. These revisions also became effective January 1, 2015. 
Our failure to comply with the minimum capital requirements could result in our regulators taking formal or informal actions against us which could restrict our future growth or operations.     
Our information systems or those of our third party vendors may be subject to an interruption or breach in security, including as a result of cyber attacks.
The Company’s technologies, systems, networks and software, and those of other financial institutions have been, and are likely to continue to be, the target of cybersecurity threats and attacks, which may range from uncoordinated individual attempts to sophisticated and targeted measures directed at us. These cybersecurity threats and attacks may include, but are not limited to, breaches, unauthorized access, misuse, malicious code, computer viruses and denial of service attacks that could result in unauthorized access, misuse, loss or destruction of data (including confidential customer information), account takeovers, unavailability of service or other events. These types of threats may result from human error, fraud or malice on the part of external or internal parties, or from accidental technological failure. Further, to access our products and services our customers may use computers and mobile devices that are beyond our security control systems. The risk of a security breach or disruption, particularly through cyber-attack or cyber intrusion, including by computer hackers, has increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased.
Our business requires the collection and retention of large volumes of customer data, including payment card numbers and other personally identifiable information in various information systems that we maintain and in those maintained by third parties with whom we contract to provide data services. We also maintain important internal company data such as personally identifiable information about our employees and information relating to our operations. The integrity and protection of that customer and company data is important to us. As customer, public, legislative and regulatory expectations and requirements regarding operational and information security have increased, our operations systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions and breakdowns.
Our customers and employees have been, and will continue to be, targeted by parties using fraudulent e-mails and other communications in attempts to misappropriate passwords, payment card numbers, bank account information or other personal information or to introduce viruses or other malware through “trojan horse” programs to our customers’ computers. These communications may appear to be legitimate messages sent by the Bank or other businesses, but direct recipients to fake websites operated by the sender of the e-mail or request that the recipient send a password or other confidential information via e-mail or download a program. Despite our efforts to mitigate these threats through product improvements, use of encryption and

14



authentication technology to secure online transmission of confidential consumer information, and customer and employee education, such attempted frauds against us or our merchants and our third party service providers remain a serious issue. The pervasiveness of cyber security incidents in general and the risks of cyber-crime are complex and continue to evolve. In light of several recent high-profile data breaches involving customer personal and financial information, we believe the potential impact of a cyber security incident involving the Company, any exposure to consumer losses and the cost of technology investments to improve security could cause customer and/or Bank losses, damage to our brand, and increase our costs.
Although we make significant efforts to maintain the security and integrity of our information systems and have implemented various measures to manage the risk of a security breach or disruption, there can be no assurance that our security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. Even the most well-protected information, networks, systems and facilities remain potentially vulnerable because attempted security breaches, particularly cyber-attacks and intrusions, or disruptions will occur in the future, and because the techniques used in such attempts are constantly evolving and generally are not recognized until launched against a target, and in some cases are designed not to be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures, and thus it is virtually impossible for us to entirely mitigate this risk. A security breach or other significant disruption could: disrupt the proper functioning of our networks and systems and therefore our operations and/or those of certain of our customers;  result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of confidential, sensitive or otherwise valuable information of ours or our customers, including account numbers and other financial information; result in a violation of applicable privacy, data breach and other laws, subjecting the Bank to additional regulatory scrutiny and exposing the Bank to civil litigation, governmental fines and possible financial liability; require significant management attention and resources to remedy the damages that result; or harm our reputation or cause a decrease in the number of customers that choose to do business with us or reduce the level of business that our customers do with us. The occurrence of any such failures, disruptions or security breaches could have a negative impact on our financial condition and results of operations.    
A failure in or breach of the Company's operational systems, information systems, or infrastructure, or those of the Company's third party vendors and other service providers, may result in financial losses, or loss of customers.
The Company relies heavily on communications and information systems to conduct our business. In addition, we rely on third parties to provide key components of our infrastructure, including the processing of sensitive consumer and business customer data, internet connections, and network access. These types of information and related systems are critical to the operation of our business and essential to our ability to perform day-to-day operations, and, in some cases, are critical to the operations of many of our customers. These third parties with which the Company does business or that facilitate our business activities, including exchanges, financial intermediaries or vendors that provide services or security solutions for our operations, could also be sources of operational and information security risk to us, including breakdowns or failures of their own systems or capacity constraints. Although the Company has implemented safeguards and business continuity plans, our business operations may be adversely affected by significant and widespread disruption to our physical infrastructure or operating systems that support our business and our customers, resulting in financial losses or loss of customers.
Our business is highly reliant on third party vendors.
We rely on third parties to provide services that are integral to our operations. These vendors provide services that support our operations, including the storage and processing of sensitive consumer and business customer data. The loss of these vendor relationships, or a failure of these vendors' systems, could disrupt the services we provide to our customers and cause us to incur significant expense in connection with replacing these services.
We continually encounter technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our clients by using technology to provide products and services that will satisfy client demands for convenience, as well as to create additional efficiencies in our operations. Many national vendors provide turn-key services to community banks, such as Internet banking and remote deposit capture that allow smaller banks to compete with institutions that have substantially greater resources to invest in technological improvements. We may not be able, however, to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.

15



     Residential mortgage lending is a market sector that experiences significant volatility and is influenced by many factors beyond our control.
The Company earns revenue from the residential mortgage lending activities primarily in the form of gains on the sale of mortgage loans that we originate and sell to the secondary market.  Residential mortgage lending in general has experienced substantial volatility in recent periods primarily due to changes in interest rates and other market forces beyond our control. Interest rate changes, such as rate increases implemented by the FRB, may result in lower rate locks and closed loan volume, which may adversely impact the earnings and results of operations of RML. In addition, an increase in interest rates may materially and adversely affect our future loan origination volume and margins.
If we do not comply with the agreements governing servicing of loans, if these agreements change materially, or if others allege non-compliance, our business and results of operations may be harmed.
We have contractual obligations under the servicing agreements pursuant to which we service mortgage loans. Many of our servicing agreements require adherence to general servicing standards, and certain contractual provisions delegate judgment over various servicing matters to us. If the terms of these servicing agreements change, we may sustain higher costs. Our servicing practices, and the judgments that we make in our servicing of loans, could also be questioned by parties to these agreements. We could also become subject to litigation claims seeking damages or other remedies arising from alleged breaches of our servicing agreements. 
Additionally, under our loan servicing program we retain servicing rights on mortgage loans originated by RML and sold to the Alaska Housing Finance Corporation. If we breach any of the representations and warranties in our servicing agreements with the Alaska Housing Finance Corporation, we may be required to repurchase any loan sold under this program and record a loss upon repurchase and/or bear any subsequent loss on the loan. We may not have any remedies available to us against third parties for such losses, or the remedies might not be as broad as the remedies available to the Alaska Housing Finance Corporation against us.
Certain hedging strategies that we use to manage interest rate risk may be ineffective to offset any adverse changes in the fair value of these assets due to changes in interest rates and market liquidity.
We use derivative instruments to economically hedge the interest rate risk in our residential mortgage loan commitments. Our hedging strategies are susceptible to prepayment risk, basis risk, market volatility and changes in the shape of the yield curve, among other factors. In addition, hedging strategies rely on assumptions and projections regarding assets and general market factors. If these assumptions and projections prove to be incorrect or our hedging strategies do not adequately mitigate the impact of changes in interest rates, we may incur losses that would adversely impact our financial condition and results of operations.
Our loan loss allowance may not be adequate to cover future loan losses, which may adversely affect our earnings.
We have established a reserve for probable losses we expect to incur in connection with loans in our credit portfolio. This allowance reflects our estimate of the collectability of certain identified loans, as well as an overall risk assessment of total loans outstanding.  Our determination of the amount of loan loss allowance is highly subjective; although management personnel apply criteria such as risk ratings and historical loss rates; these factors may not be adequate predictors of future loan performance.  Accordingly, we cannot offer assurances that these estimates ultimately will prove correct or that the loan loss allowance will be sufficient to protect against losses that ultimately may occur.  If our loan loss allowance proves to be inadequate, we may suffer unexpected charges to income, which would adversely impact our results of operations and financial condition.  Moreover, bank regulators frequently monitor banks' loan loss allowances, and if regulators were to determine that the allowance is inadequate, they may require us to increase the allowance, which also would adversely impact our financial condition and results of operations.
We have a significant concentration in real estate lending. A downturn in real estate within our markets would have a negative impact on our results of operations. 
Approximately 70% of the Bank’s loan portfolio at December 31, 2019 consisted of loans secured by commercial and residential real estate located in Alaska. Additionally, all of the Company's loans held for sale are secured by residential real estate. A slowdown in the residential sales cycle in our major markets and a constriction in the availability of mortgage financing, such as what occurred during the financial crisis in the United States housing market from 2008 through 2012, would negatively impact residential real estate sales, which would result in customers’ inability to repay loans.  This would result in an increase in our non-performing assets if more borrowers fail to perform according to loan terms and if we take possession of real estate properties. Additionally, if real estate values decline, the value of real estate collateral securing our loans could be significantly reduced.  If

16



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 47% of the Bank’s loan portfolio at December 31, 2019 consisted of commercial real estate loans.   While our investments in these types of loans have not been as adversely impacted as residential construction and land development loans, there can be no assurance that the credit quality in these portfolios will remain stable.  Commercial construction and commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers.  Consequently, an adverse development with respect to one commercial loan or one credit relationship exposes us to significantly greater risk of loss compared to an adverse development with respect to a consumer loan.  The credit quality of these loans may deteriorate more than expected which may result in losses that exceed the estimates that are currently included in our loan loss allowance, which could adversely affect our financial conditions and results of operations. 
Real estate values may decrease leading to additional and greater than anticipated loan charge-offs and valuation writedowns on our other real estate owned (“OREO”) properties.
Real estate owned by the Bank and not used in the ordinary course of its operations is referred to as “other real estate owned” or “OREO” property.  We foreclose on and take title to the real estate serving as collateral for defaulted loans as part of our business.  At December 31, 2019, the Bank held $7.0 million of OREO properties, most of which relate to a commercial real estate loan.   Increased OREO balances lead to greater expenses as we incur costs to manage and dispose of the properties.  Our ability to sell OREO properties is affected by public perception that banks are inclined to accept large discounts from market value in order to quickly liquidate properties.  Any decrease in market prices may lead to OREO writedowns, with a corresponding expense in our income statement.  We evaluate OREO property values periodically and writedown the carrying value of the properties if the results of our evaluations require it.  Further writedowns on OREO or an inability to sell OREO properties could have a material adverse effect on our results of operations and financial condition.
Natural disasters and adverse weather could negatively affect real estate property values and Bank operations.
Real estate and real estate property values play an important role for the Bank in several ways. The Bank owns or leases many real estate properties in connection with its operations, located in Anchorage, Juneau, Fairbanks, the Matanuska-Susitna Valley, Ketchikan, Sitka, and the Kenai Peninsula. Real estate is also utilized as collateral for many of our loans. A natural disaster could cause property values to fall, which could require the Bank to record an impairment on its financial statements. A natural disaster could also impact collateral values, which would increase our exposure to loan defaults. Our business operations could also suffer to the extent the Bank cannot utilize its branch network due to a natural disaster or other weather-related damage.
Epidemics, climate change, severe weather, natural disasters, and other external events could significantly impact our business.
Public health or similar issues, such as epidemics or pandemics, including the current outbreak of novel coronavirus (“2019-nCoV”), for which the World Health Organization declared a global emergency on January 30, 2020, may result in health or other government authorities requiring the closure of our branch offices and the offices or other businesses of our customers and could significantly disrupt our operations and the operations of our customers. The extent of the adverse impact that any expansion of the current 2019-nCoV outbreak could have on the economy and on us cannot be predicted at this time. In addition, severe weather events of increasing strength and frequency due to climate change cannot be predicted and may be exacerbated by global climate change, natural disasters, including volcanic eruptions and earthquakes, and other adverse external events could have a significant impact on our ability to conduct business or upon third parties who perform operational services for us. In addition, there is continuing uncertainty over demand for oil and gas in part due to regulatory changes from climate change related policies. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in lost revenue, or cause us to incur additional expenses. Although management has established disaster recovery policies and procedures, there can be no assurance of the effectiveness of such policies and procedures, and the occurrence of any such event could have a material adverse effect on our business, financial condition and results of operations.

17



Changes in the FRB’s monetary or fiscal policies could adversely affect our results of operations and financial condition.
Our earnings will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The FRB has, and is likely to continue to have, an important impact on the operating results of depository institutions through its power to implement national monetary policy, among other things, in order to curb inflation or combat a recession. The FRB affects the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. Since December 2015, the FRB has increased short-term interest rates nine times. However, the FRB reduced interest rates three times in 2019. While we expect the FRB to hold short-term interest rates stable in 2020, we cannot predict the nature or impact of future changes in monetary and fiscal policies.
Changes in income tax laws and interpretations, or in accounting standards, could materially affect our financial condition or results of operations.
Further changes in income tax laws could be enacted, or interpretations of existing income tax laws could change, causing an adverse effect on our financial condition or results of operations. Similarly, our accounting policies and methods are fundamental to how we report our financial condition and results of operations. Some of these policies require the use of estimates and assumptions that may affect the value of our assets, liabilities, and financial results. Periodically, new accounting standards are issued or existing standards are revised, changing the methods for preparing our financial statements. These changes are not within our control and may significantly impact our financial condition and results of operations.

Changes in accounting standards may require us to increase our Allowance for Loan Losses and could materially impact our financial statements.
From time to time, the Financial Accounting Standards Board (the "FASB") and the SEC change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can materially impact how we record and report our financial condition and results of operations. For example, in June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (“ASU 2016-13”) which changes, among other things, the way companies must record expected credit losses on financial instruments that are not accounted for at fair value through net income, including loans held for investment, available for sale and held-to-maturity debt securities, trade and other receivables, net investment in leases and other commitments to extend credit held by a reporting entity at each reporting date. ASU 2016-13 requires that financial assets measured at amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. This differs from current US GAAP which is based on incurred losses inherent in the loan portfolio and moves to a current estimate of all expected credit losses based on relevant information about past events including historical experience, current conditions and reasonable and supportable forecasts that affect the collectability of the reported amount. However, on October 16, 2019 the FASB voted to delay ASU 2016-13 for Smaller Reporting Companies, which will change the effective date for the Company to fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2022. Based on our loan portfolio composition at December 31, 2019, we currently estimate that the impact of this standard would result in an overall decrease in our allowance for loan losses; however, given that this standard will not apply to the Company until late 2022, the ultimate effect of this standard will depend on the size and composition of our loan portfolio, the loan portfolio’s credit quality and economic conditions at the time of adoption, as well as any refinements to our models, methodology and other key assumptions. The actual impact on the Company’s consolidated financial position and results of operations upon adoption cannot be determined at this time; in the event that our loan portfolio, the credit quality of the loan portfolio or economic conditions change materially prior to adoption of the standard the implementation of this standard and may result in an increase in the allowance for loan losses as compared to current levels.

We conduct substantially all of our operations through Northrim Bank, our banking subsidiary; our ability to pay dividends, repurchase our shares, or to repay our indebtedness depends upon liquid assets held by the holding company and the results of operations of our subsidiaries and their ability to pay dividends.
The Company is a separate legal entity from our subsidiaries. It receives substantially all of its revenue from dividends paid from the Bank.  There are legal limitations on the extent to which the Bank may extend credit, pay dividends or otherwise supply funds to, or engage in transactions with us.  Our inability to receive dividends from the Bank could adversely affect our business, financial condition, results of operations and prospects.
Our net income depends primarily upon the Bank’s net interest income, which is the income that remains after deducting from total income generated by earning assets the expense attributable to the acquisition of the funds required to support earning assets (primarily interest paid on deposits and borrowings).  The amount of interest income is dependent on many factors including

18



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. In 2016, a requirement to have a capital conservation buffer started to be phased in and this requirement, which went into full effect on January 1, 2019 could adversely affect the Bank's ability to pay dividends.
Various statutory provisions restrict the amount of dividends the Bank can pay to us without regulatory approval.  Under Alaska law, a bank may not declare or pay a dividend in an amount greater than its net undivided profits then on hand. In addition, the Bank may not pay cash dividends if that payment could reduce the amount of its capital below that necessary to meet the “adequately capitalized” level in accordance with regulatory capital requirements.  It is also possible that, depending upon the financial condition of the Bank and other factors, regulatory authorities could conclude that payment of dividends or other payments, including payments to us, is an unsafe or unsound practice and impose restrictions or prohibit such payments.   It is the policy of the FRB that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if prospective rate of earnings retention is consistent with the organization’s current and expected future capital needs, asset quality and overall financial condition.  The policy provides that bank holding companies should not maintain a level of cash dividends that undermines a bank holding company’s ability to serve as a source of strength to its banking subsidiaries.
There can be no assurance that the Company will continue to declare cash dividends or repurchase stock.
During 2019, the Company repurchased 347,676 shares of common stock at an average price of $36.15 per share under its previously announced share repurchase program. On January 27, 2020, the Board authorized the repurchase of up to an additional 327,000 shares of common stock. The Company also paid cash dividends of $1.26 per diluted share in 2019. On February 27, 2020, the Board of Directors approved payment of a $0.34 per share dividend on the Company’s outstanding shares.
Whether we continue, and the amount and timing of, such dividends and/or stock repurchases is subject to capital availability and periodic determinations by our Board. The Company continues to evaluate the potential impact that regulatory proposals may have on our liquidity and capital management strategies, including Basel III and those required under the Dodd-Frank Act. The actual amount and timing of future dividends and share repurchases, if any, will depend on market and economic conditions, applicable SEC rules, federal and state regulatory restrictions, and various other factors. In addition, the amount we spend and the number of shares we are able to repurchase under our stock repurchase program may further be affected by a number of other factors, including the stock price and blackout periods in which we are restricted from repurchasing shares. Our dividend payments and/or stock repurchases may change from time to time, and we cannot provide assurance that we will continue to declare dividends and/or repurchase stock in any particular amounts or at all. A reduction in or elimination of our dividend payments and/or stock repurchases could have a negative effect on our stock price.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure. There can be no assurance that any such losses would not materially and adversely affect our results of operations.
The financial services business is intensely competitive and our success will depend on our ability to compete effectively.
The financial services business in our market areas is highly competitive.  It is becoming increasingly competitive due to changes in regulation, technological advances, and the accelerating pace of consolidation among financial services providers.  We face competition both in attracting deposits and in originating loans. We compete for loans principally through the pricing of interest rates and loan fees and the efficiency and quality of services.  Increasing levels of competition in the banking and financial services industries may reduce our market share or cause the prices charged for our services to fall.   Improvements in technology, communications, and the internet have intensified competition. As a result, our competitive position could be weakened, which could adversely affect our financial condition and results of operations.

19



We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so could materially adversely affect our performance.
We are a community bank, and our reputation is one of the most valuable components of our business. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected, by the actions of our employees or otherwise, our business and, therefore, our operating results could be materially adversely affected.
We may be unable to attract and retain key employees and personnel.
We will be dependent for the foreseeable future on the services of Joseph M. Schierhorn, our Chairman of the Board, President, Chief Executive Officer, and Chief Operating Officer of the Company; Michael Martin, our Executive Vice President, General Counsel and Corporate Secretary; and Jed W. Ballard, our Executive Vice President and Chief Financial Officer.  While we maintain keyman life insurance on the lives of Messrs. Schierhorn, Martin, and Ballard in the amounts of $2 million each, we may not be able to timely replace Mr. Schierhorn, Mr. Martin, or Mr. Ballard with a person of comparable ability and experience should the need to do so arise, causing losses in excess of the insurance proceeds.  The unexpected loss of key employees could have a material adverse effect on our business and possibly result in reduced revenues and earnings.
Liquidity risk could impair our ability to fund operations and jeopardize our financial conditions.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings and other sources could have a substantial negative effect on our liquidity and severely constrain our financial flexibility. Our primary source of funding is deposits gathered through our network of branch offices. Our access to funding sources in amounts adequate to finance our activities on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or the economy in general. Factors that could negatively impact our access to liquidity sources include:
a decrease in the level of our business activity as a result of an economic downturn in the markets in which our loans are concentrated;
adverse regulatory actions against us; or
our inability to attract and retain deposits. 
Our ability to borrow could be impaired by factors that are not specific to us or our region, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry and unstable credit markets.
A failure of a significant number of our borrowers, guarantors and related parties to perform in accordance with the terms of their loans would have an adverse impact on our results of operations.
A source of risk arises from the possibility that losses will be sustained if a significant number of our borrowers, guarantors and related parties fail to perform in accordance with the terms of their loans.  We have adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of our allowance for loan losses, which we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance, and diversifying our credit portfolio.  These policies and procedures, however, may not prevent unexpected losses that could materially affect our financial condition and results of operations.
Uncertainty about the continuing availability of the London Inter-Bank Offered Rate ("LIBOR") may adversely affect our business.

On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates the LIBOR announced that after December 31, 2021 it would no longer compel banks to submit the rates required to calculate LIBOR.  With this announcement there is uncertainty about the continued availability of LIBOR after 2021.  If LIBOR ceases to be available or the methods of calculating LIBOR change from the current methods, financial products with interest rates tied to LIBOR may be adversely affected.  Even if LIBOR remains available it is uncertain whether it will continue to be viewed as an acceptable market benchmark, what rate or rates may become accepted alternatives to LIBOR or what the effect of any such changes in views or alternatives may be on the markets for LIBOR-indexed financial instruments.  We have loans, derivative contracts, and other financial instruments, including debentures related to our trust preferred securities, with rates that are either directly or indirectly tied to LIBOR.  If any of the foregoing were to occur, the interest rates on these instruments, as well as the revenue and expenses associated

20



with the same, may be adversely affected.  Furthermore, failure to adequately manage this transition process with our customers could adversely impact our reputation.


Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, Real Estate Settlement Procedures Act, Truth-in-Lending Act or other laws and regulations could result in fines, sanctions or other adverse consequences.
Financial institutions are required under the USA PATRIOT Act and Bank Secrecy Act to develop programs to prevent financial institutions from being used for money-laundering and terrorist activities. Financial institutions are also obligated to file suspicious activity reports with the United States Treasury Department’s Office of Financial Crimes Enforcement Network if such activities are detected. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure or the inability to comply with these regulations could result in fines or penalties, intervention or sanctions by regulators, and costly litigation or expensive additional controls and systems. In recent years, several banking institutions have received large fines for non-compliance with these laws and regulations. In addition, the federal government has in place laws and regulations relating to residential and consumer lending, as well as other activities with customers, that create significant compliance burdens and financial risks. We have developed policies and continue to augment procedures and systems designed to assist in compliance with these laws and regulations; however, it is possible for such safeguards to fail or prove deficient during the implementation phase to avoid non-compliance with such laws.

ITEM 1B.            UNRESOLVED STAFF COMMENTS
None.

21




ITEM 2.            PROPERTIES
The following sets forth information about our Community Banking branch locations:
Locations
Type
Leased/Owned
Midtown Financial Center: Northrim Headquarters
3111 C Street, Anchorage, AK
Traditional
Land partially leased, partially owned, building owned
SouthSide Financial Center
8730 Old Seward Highway, Anchorage, AK
Traditional
Land leased, building owned
Lake Otis Community Branch
2270 East 37th Avenue, Anchorage, AK
Traditional
Land leased, building owned
Huffman Branch
1501 East Huffman Road, Anchorage, AK
In-store
Leased
Jewel Lake Branch
9170 Jewel Lake Road Suite 101, Anchorage, AK
Traditional
Leased
Seventh Avenue Branch
517 West Seventh Avenue, Suite 300, Anchorage, AK
Traditional
Leased
Eastside Community Branch
7905 Creekside Center Drive, Suite 100, Anchorage, AK
Traditional
Leased
West Anchorage Branch
2709 Spenard Road, Anchorage, AK
Traditional
Owned
Eagle River Branch
12812 Old Glenn Highway, Suite C03, Eagle River, AK
Traditional
Leased
Fairbanks Financial Center
360 Merhar Avenue, Fairbanks, AK
Traditional
Owned
Wasilla Financial Center
850 E. USA Circle, Suite A, Wasilla, AK
Traditional
Owned
Soldotna Financial Center
44384 Sterling Highway, Suite 101, Soldotna, AK
Traditional
Leased
Juneau Financial Center
2094 Jordan Avenue, Juneau, AK
Traditional
Leased
Juneau Downtown Branch
301 North Franklin Street, Juneau, AK
Traditional
Leased
Sitka Financial Center
315 Lincoln Street, Suite 206, Sitka, AK
Traditional
Leased
Ketchikan Financial Center
2491 Tongass Avenue, Ketchikan, AK
Traditional
Owned

22




The following sets forth information about our Home Mortgage Lending branch locations, operated by RML:
Locations
Leased/Owned
Main Office at Calais
100 Calais Drive, Anchorage, AK
Leased
ReMax/Dynamic Office
3350 Midtown Place, Suite 101, Anchorage, AK
Leased
Midtown Office
101 W. Benson Boulevard, #201, Anchorage, AK
Leased
Eagle River Office
11901 Business Boulevard, #203, Eagle River, AK
Leased
Fairbanks Office
308 Old Steese Highway, Suite 7, Fairbanks, AK
Leased
Fairbanks Northrim Office
360 Merhar Avenue, Fairbanks, AK
Leased
Fairbanks Office
711 Gaffney Road, Suite 202, Fairbanks, AK
Leased
Juneau Office
8800 Glacier Highway, #232, Juneau, AK
Leased
Kodiak Office
2011 Mill Bay Road, #101, Kodiak, AK
Leased
Soldotna Office
44296 Sterling Highway, #1, Soldotna, AK
Leased
Wasilla Remax Dynamic Branch
892 E USA Circle, Suite 105, Wasilla, AK
Leased
Wasilla Northrim Branch
850 E USA Circle, Suite B, Wasilla, AK
Leased


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.

ITEM 4.            MINE SAFETY DISCLOSURES
Not applicable.

23



PART II
ITEM 5.                MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the NASDAQ Global Select Stock Market under the symbol, “NRIM.”    At March 6, 2020, the number of shareholders of record of our common stock was 233. As many of our shares of common stock are held of record in "street name" by brokers and other institutions on behalf of shareholders, we are unable to estimate the total number of beneficial holders of our common stock represented by these record holders.
The following are high and low closing prices as reported by NASDAQ. Prices do not include retail markups, markdowns or commissions.
 
 
First
Second
Third
Fourth
 
 
Quarter
Quarter
Quarter
Quarter
2019
 
 
 
 
 
 
High
$39.60
$36.71
$41.82
$39.79
 
Low
$32.36
$33.22
$34.72
$36.46
2018
 
 
 
 
 
 
High
$36.05
$40.45
$45.35
$43.00
 
Low
$32.80
$34.05
$38.80
$30.70
 
In 2019, we paid cash dividends of $0.30 per share in the first and second quarters and $0.33 per share in the third and fourth quarters.  In 2018, we paid cash dividends of $0.24 per share in the first and second quarters and $0.27 per share in the third and fourth quarters.  Cash dividends totaled $8.5 million, $7.1 million, and $6.0 million in 2019, 2018, and 2017, respectively.  On February 27, 2020, the Board of Directors approved payment of a $0.34 per share cash dividend on March 20, 2020, to shareholders of record on March 12, 2020.  The Company and the Bank are subject to restrictions on the payment of dividends pursuant to applicable federal and state banking regulations and Alaska corporate law.  The dividends that the Bank pays to the Company are limited to the extent necessary for the Bank to meet the regulatory requirements of a “well-capitalized” bank.  Given the fact that the Bank believes it will remain “well-capitalized” and exceed the capital conservation buffer; the Company expects to receive dividends from the Bank in 2020.
Repurchase of Securities
At December 31, 2019, there were no shares available under the stock repurchase program. The Company repurchased 347,676 shares in 2019 and 15,468 shares in 2018. On January 27, 2020, the Board authorized the repurchase of up to an additional 327,000 shares of its common stock. The Company intends to continue to repurchase its stock from time to time depending upon market conditions, but we can make no assurances that we will continue this program.

24



    
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, 2019. Additional information regarding the Company’s equity plans is presented in Note 23 of the Notes to Consolidated Financial Statements included in Item 8 of this report.
Plan Category
Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights (a) (2)
Weighted-Average Exercise Price of Outstanding Options,
Warrants and Rights
Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a))
Equity compensation plans approved by security holders1
227,734
$21.21
99,665
Total
227,734
$21.21
99,665
1Consists of the Company's 2017 Stock Incentive Plan, which replaced the 2014 Stock Incentive Plan (the "2014 Plan")
2 Includes 94,125 options awarded under the 2014 Plan and other previous stock option plans.
    
We do not have any equity compensation plans that have not been approved by our shareholders.

25



Stock Performance Graph
The graph shown below depicts the total return to shareholders during the period beginning after December 31, 2014, and ending December 31, 2019.  The definition of total return includes appreciation in market value of the stock, as well as the actual cash and stock dividends paid to shareholders.  The comparable indices utilized are the Russell 3000 Index, representing approximately 98% of the U.S. equity market, and the SNL Financial Bank Stock Index, comprised of publicly traded banks with assets of $1 billion to $5 billion, which are located in the United States.  The graph assumes that the value of the investment in the Company’s common stock and each of the two indices was $100 on December 31, 2014, and that all dividends were reinvested.
capture.jpg
 
Period Ending
Index
12/31/14
12/31/15
12/13/16
12/31/17
12/31/18
12/31/19
Northrim BanCorp, Inc.
100.00

104.22

127.61

140.52

140.13

169.02

Russell 3000
100.00

100.48

113.27

137.21

130.02

170.35

SNL Bank $1B-$5B
100.00

111.94

161.04

171.69

150.42

182.85



26



ITEM 6.            SELECTED FINANCIAL DATA (1) 
 
Years Ended December 31,
 
 
(In thousands, except per share data and shares outstanding amounts)
 

2019
2018
2017
2016
2015
2014
Five Year Compound Growth Rate
 
(Unaudited)
Net interest income

$64,442


$61,208


$57,678


$56,357


$56,909


$52,293

4
%
Provision (benefit) for loan losses
(1,175
)
(500
)
3,200

2,298

1,754

(636
)
NM

Other operating income
37,346

32,167

40,474

43,263

44,608

20,034

13
 %
Compensation expense, RML acquisition payments
468


130

4,775

4,094


NM

Other operating expense
76,370

69,800

71,023

71,505

68,551

46,923

10
 %
Income before provision for income taxes

$26,125


$24,075


$23,799


$21,042


$27,118


$26,040

%
Provision for income taxes
5,434

4,071

10,321

6,052

8,784

8,173

(8
)%
Net Income
20,691

20,004

13,478

14,990

18,334

17,867

3
 %
Less: Net income attributable to
 
 
 
 
 
 

noncontrolling interest


327

579

551

459

NM

Net income attributable to Northrim Bancorp, Inc.

$20,691


$20,004


$13,151


$14,411


$17,783


$17,408

4
%
 
 
 
 
 
 
 
 
Year End Balance Sheet
 
 
 
 
 
 
 
Assets

$1,643,996


$1,502,988


$1,518,596


$1,525,851


$1,498,691


$1,448,327

3
 %
Portfolio loans
1,043,371

984,346

954,953

974,074

979,682

923,122

2
 %
Deposits
1,372,351

1,228,088

1,258,283

1,267,653

1,240,792

1,179,747

3
 %
Securities sold under repurchase agreements

34,278

27,746

27,607

31,420

19,843

(100
)%
Borrowings
8,891

7,241

7,362

4,338

2,120

26,304

(20
)%
Junior subordinated debentures
10,310

10,310

10,310

18,558

18,558

18,558

(11
)%
Shareholders' equity
207,117

205,947

192,802

186,712

177,214

164,441

5
 %
Common shares outstanding
6,558,809

6,883,216

6,871,963

6,897,890

6,877,140

6,854,189

(1
)%
 
 
 
 
 
 
 
 
Average Balance Sheet
 
 
 
 
 
 
 
Assets

$1,555,707


$1,493,385


$1,511,052


$1,506,522


$1,480,913


$1,335,929

3
 %
Earning assets
1,386,557

1,346,449

1,367,203

1,361,913

1,334,102

1,212,291

3
 %
Portfolio loans
1,010,098

971,548

981,001

976,613

968,752

893,031

2
 %
Deposits
1,276,407

1,227,272

1,248,333

1,250,243

1,219,445

1,111,594

3
 %
Securities sold under repurchase agreements
15,167

29,940

29,690

27,322

24,447

20,909

(6
)%
Borrowings
8,071

7,309

5,767

4,215

14,552

4,697

11
 %
Junior subordinated debentures
10,310

10,310

15,066

18,558

18,558

18,558

(11
)%
Shareholders' equity
208,602

201,022

193,129

181,628

169,802

155,591

6
 %
Basic common shares outstanding
6,708,622

6,877,573

6,889,621

6,883,663

6,859,209

6,761,328

 %
Diluted common shares outstanding
6,808,209

6,981,557

6,977,910

6,974,864

6,948,474

6,852,267

 %
 
 
 
 
 
 
 
 
Per Common Share Data
 
 
 
 
 
 
 
Basic earnings

$3.08


$2.91


$1.91


$2.09


$2.59


$2.57

4
 %
Diluted earnings

$3.04


$2.86


$1.88


$2.06


$2.56


$2.54

4
 %
Book value per share

$31.58


$29.92


$28.06


$27.07


$25.77


$23.99

6
 %
Tangible book value per share(2)

$29.12


$27.57


$25.70


$24.70


$22.31


$20.48

7
 %
Cash dividends per share

$1.26


$1.02


$0.86


$0.78


$0.74


$0.70

12
 %

27



 
Years Ended December 31,
 
 
2019
2018
2017
2016
2015
2014
Five Year Compound Growth Rate
 
(Unaudited)
 
Performance Ratios
 
 
 
 
 
 
 
Return on average assets
1.33
 %
1.34
%
0.87
%
0.96
%
1.20
%
1.30
 %
 %
Return on average equity
9.92
 %
9.95
%
6.81
%
7.93
%
10.47
%
11.19
 %
(2
)%
Equity/assets
12.60
 %
13.70
%
12.70
%
12.24
%
11.82
%
11.35
 %
2
 %
Tangible common equity/tangible assets(3)
11.73
 %
12.76
%
11.75
%
11.29
%
10.40
%
9.86
 %
4
 %
Net interest margin
4.65
 %
4.55
%
4.22
%
4.14
%
4.27
%
4.31
 %
2
 %
Net interest margin (tax equivalent)(4)
4.70
 %
4.60
%
4.28
%
4.20
%
4.32
%
4.36
 %
2
 %
Non-interest income/total revenue
36.69
 %
34.45
%
41.24
%
43.43
%
43.94
%
27.70
 %
6
 %
Efficiency ratio (5)
75.43
 %
74.68
%
72.39
%
76.44
%
71.31
%
64.48
 %
3
 %
Dividend payout ratio
40.79
 %
35.08
%
45.44
%
37.59
%
28.81
%
27.40
 %
8
 %
 
 
 
 
 
 
 
 
Asset Quality
 
 
 
 
 
 
 
Nonperforming loans, net of government guarantees

$13,951


$14,694


$21,411


$12,936


$2,125


$3,496

32
 %
Nonperforming assets, net of government guarantees
19,946

22,619

28,729

19,315

5,178

7,231

22
 %
Nonperforming loans/portfolio loans, net of government guarantees
1.34
 %
1.49
%
2.24
%
1.33
%
0.22
%
0.38
 %
29
 %
Net charge-offs (recoveries)/average loans
(0.07
)%
0.15
%
0.15
%
0.08
%
0.03
%
(0.12
)%
NM

Allowance for loan losses/portfolio loans
1.83
 %
1.98
%
2.25
%
2.02
%
1.85
%
1.81
 %
 %
Nonperforming assets/assets, net of government guarantees
1.21
 %
1.50
%
1.89
%
1.27
%
0.35
%
0.50
 %
19
 %
 
 
 
 
 
 
 
 
Other Data
 
 
 
 
 
 
 
Effective tax rate (6)
21
 %
17
%
43
%
29
%
32
%
31
 %
(7
)%
Number of banking offices(7)
16

16

14

14

14

14

3
 %
Number of employees (FTE) (8)
431

430

429

451

441

426

 %
These unaudited schedules provide selected financial information concerning the Company that should be read in conjunction with Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report.
 
2Tangible book value per share is a non-GAAP ratio defined as shareholders’ equity, less intangible assets, divided by common shares outstanding. Management believes that tangible book value is a useful measurement of the value of the Company’s equity because it excludes the effect of intangible assets on the Company’s equity.  See reconciliation to book value per share, the most comparable GAAP measurement below.
3Tangible common equity to tangible assets is a non-GAAP ratio that represents total equity less goodwill and intangible assets divided by total assets less goodwill and intangible assets. Management believes this ratio is important as it has received more attention over the past several years from stock analysts and regulators. The most comparable GAAP measure of shareholders' equity to total assets is calculated by dividing total shareholders' equity by total assets. See reconciliation to shareholders' equity to total assets below.

4Tax-equivalent net interest margin is a non-GAAP performance measurement in which interest income on non-taxable investments and loans is presented on a tax-equivalent basis using a combined federal and state statutory rate of 28.43% in 2019 and 2018 and 41.11% in all other years presented.  Management believes that tax-equivalent net interest margin is a useful financial measure because it enables investors to evaluate net interest margin excluding tax expense in order to monitor our effectiveness in growing higher interest yielding assets and managing our costs of interest bearing liabilities over time on a fully tax equivalent basis.  See reconciliation to net interest margin, the comparable GAAP measurement below. 

28



5In managing our business, we review the efficiency ratio exclusive of intangible asset amortization, which is a non-GAAP performance measurement.  Management believes that this is a useful financial measurement because we believe this presentation provides investors with a more accurate picture of our operating efficiency.  The efficiency ratio is calculated by dividing other operating expense, exclusive of intangible asset amortization, by the sum of net interest income and other operating income.  Other companies may define or calculate this data differently.  For additional information see the "Other Operating Expense" section in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report.  See reconciliation to comparable GAAP measurement below.
6The Company’s 2017 results included the impact of the enactment of the Tax Cuts and Jobs Act, which was signed into law on December 22, 2017.  The law includes significant changes to the U.S. corporate tax system, including a Federal corporate rate reduction from 35% to 21%.  In 2017, the Company applied the newly enacted corporate federal income tax rate of 21%, reducing the value of the Company's net deferred tax asset, resulting in approximately a $2.7 million increase in tax expense.  In 2018, the Company finalized changes related to the reduction in the federal tax rate which resulted in a $470,000 reduction in tax expense.
7Number of banking offices does not include RML locations. 2018 number of banking offices includes 15 full service branches and 1 loan production office.
8FTE includes 311, 320, 314, 321, 317, and 309 Community Banking employees in 2019, 2018, 2017, 2016, 2015 and 2014, respectively. FTE includes 120, 110, 115, 130, 124, and 117 Home Mortgage Lending employees in 2019, 2018, 2017, 2016, 2015 and 2014, respectively.
Reconciliation of Selected Financial Data to GAAP Financial Measures
These unaudited schedules provide selected financial information concerning the Company that should be read in conjunction with "Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report.
Reconciliation of total shareholders'  equity to tangible common shareholders’ equity (Non-GAAP) and total assets to tangible assets:
(In Thousands)
2019
2018
2017
2016
2015
2014
Total shareholders' equity

$207,117


$205,947


$192,802


$186,712


$177,214


$164,441

Total assets
1,643,996

1,502,988

1,518,596

1,525,851

1,498,691

1,448,327

Total shareholders' equity to total assets ratio
12.60
%
13.70
%
12.70
%
12.24
%
11.82
%
11.35
%
(In Thousands)
2019
2018
2017
2016
2015
2014
Total shareholders' equity

$207,117


$205,947


$192,802


$186,712


$177,214


$164,441

Less: goodwill and other intangible assets, net
16,094

16,154

16,224

16,324

23,776

24,035

Tangible common shareholders' equity

$191,023


$189,793


$176,578


$170,388


$153,438


$140,406

Total assets

$1,643,996


$1,502,988


$1,518,596


$1,525,851


$1,498,691


$1,448,327

Less: goodwill and other intangible assets, net
16,094

16,154

16,224

16,324

23,776

24,035

Tangible assets

$1,627,902


$1,486,834


$1,502,372


$1,509,527


$1,474,915


$1,424,292

Tangible common equity to tangible assets ratio
11.73
%
12.76
%
11.75
%
11.29
%
10.40
%
9.86
%
Reconciliation of tangible book value per share to book value per share
(In thousands, except per share data)
2019
2018
2017
2016
2015
2014
Total shareholders' equity

$207,117


$205,947


$192,802


$186,712


$177,214


$164,441

Divided by common shares outstanding
6,558,809

6,883,216

6,871,963

6,897,890

6,877,140

6,854,189

Book value per share

$31.58


$29.92


$28.06


$27.07


$25.77


$23.99


29



(In thousands, except per share data)
2019
2018
2017
2016
2015
2014
Total shareholders' equity

$207,117


$205,947


$192,802


$186,712


$177,214


$164,441

Less: goodwill and intangible assets, net
16,094

16,154

16,224

16,324

23,776

24,035

 

$191,023


$189,793


$176,578


$170,388


$153,438


$140,406

Divided by common shares outstanding
6,558,809

6,883,216

6,871,963

6,897,890

6,877,140

6,854,189

Tangible book value per share

$29.12


$27.57


$25.70


$24.70


$22.31


$20.48


Reconciliation of tax-equivalent net interest margin to net interest margin
(In Thousands)
2019
2018
2017
2016
2015
2014
Net interest income(9)

$64,442


$61,208


$57,678


$56,357


$56,909


$52,293

Divided by average interest-bearing assets
1,386,557

1,346,449

1,367,203

1,361,913

1,334,102

1,212,291

Net interest margin
4.65
%
4.55
%
4.22
%
4.14
%
4.27
%
4.31
%
(In Thousands)
2019
2018
2017
2016
2015
2014
Net interest income(9)

$64,442


$61,208


$57,678


$56,357


$56,909


$52,293

Plus: reduction in tax expense related to
 
 
 
 
 
 
tax-exempt interest income
722

726

872

808

722

583

 

$65,164


$61,934


$58,550


$57,165


$57,631


$52,876

Divided by average interest-bearing assets
1,386,557

1,346,449

1,367,203

1,361,913

1,334,102

1,212,291

Tax-equivalent net interest margin
4.70
%
4.60
%
4.28
%
4.20
%
4.32
%
4.36
%

Calculation of efficiency ratio
(In Thousands)
2019
2018
2017
2016
2015
2014
Net interest income(9)

$64,442


$61,208


$57,678


$56,357


$56,909


$52,293

Other operating income
37,346

32,167

40,474

43,263

44,608

20,034

Total revenue
101,788

93,375

98,152

99,620

101,517

72,327

Other operating expense
76,838

69,800

71,153

76,280

72,645

46,923

Less intangible asset amortization
60

70

100

135

258

289

Adjusted other operating expense

$76,778


$69,730


$71,053


$76,145


$72,387


$46,634

Efficiency ratio
75.43
%
74.68
%
72.39
%
76.44
%
71.31
%
64.48
%

9Amount represents net interest income before provision for loan losses.

Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited.  Although we believe these non-GAAP financial measures are frequently used by stakeholders in the evaluation of the Company, they have limitations as analytical tools and should not be considered in isolation or as a substitute for analysis of results as reported under GAAP.

30



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, 2019, 2018 and 2017 included in Item 8 of this report. Discussions of 2017 items and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for fiscal year ended December 31, 2018.
This annual report contains forward-looking statements that involve risks and uncertainties.  Our actual results may differ materially from those indicated in forward-looking statements.  See “Cautionary Note Regarding Forward-Looking Statements.”

Executive Overview
Net income attributable to the Company increased 3% to $20.7 million or $3.04 per diluted share for the year ended December 31, 2019, from $20.0 million, or $2.86 per diluted share, for the year ended December 31, 2018. Significant items contributing to the increase in 2019 compared to 2018 were:

an increase in mortgage banking income due to increased mortgage production;
an increase in net interest income resulting from higher average net interest-earning asset balances and higher average rates;
an increase in the gain on marketable equity securities from changes in fair value; and
a benefit in the provision for loan losses primarily resulting from improvements in credit quality and recoveries.

Highlights for the year ended December 31, 2019 are as follows:  
Total revenues, which include net interest income plus other operating income, increased 9% to $101.8 million in 2019 from $93.4 million in 2018. This increase mainly reflects increases in net interest income, mortgage banking income, changes in the fair value of marketable equity securities, and higher interest rate swap income. These increases were partially offset by a decrease in commercial servicing revenue.
The net interest margin increased to 4.65% in 2019 from 4.55% in 2018 mostly due to an increase in average loans to $1.01 billion in 2019 compared to $971.5 million in 2018, as well as increases in average interest rates.
The provision for loan losses decreased in 2019 to a benefit of $1.2 million from a benefit of $500,000 in 2018. Our nonperforming loans, net of government guarantees, decreased to $14.0 million at the end of 2019 compared to $14.7 million at the end of 2018, while total adversely classified loans, net of government guarantees at December 31, 2019 decreased to $22.3 million from $27.2 million at December 31, 2018. The allowance for loan losses (“Allowance”) totaled 1.83% of total portfolio loans at December 31, 2019, compared to 1.98% at December 31, 2018.  The Allowance compared to nonperforming loans, net of government guarantees, was 137% at December 31, 2019 compared to 133% at the end of 2018.
Return on average assets was 1.33% in 2019 compared to 1.34% in 2018.
The Company continued to maintain strong capital ratios with Tier 1 Capital to Risk Adjusted Assets of 14.38% at December 31, 2019 as compared to 15.47% at December 31, 2018
The aggregate cash dividends paid by the Company in 2019 rose 21% to $8.5 million from $7.1 million paid in 2018.
The Company repurchased 347,676 shares of its common stock in 2019 at an average price of $36.15 per share.

31



Critical Accounting Policies
The SEC defines "critical accounting policies" as those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Our significant accounting policies are described in Note 1 in the Notes to Consolidated Financial Statements in Item 8 of this report. Not all of these significant accounting policies require management to make difficult, subjective or complex judgments or estimates. Management believes that the following accounting policies would be considered critical under the SEC's definition.
Allowance for loan losses:  The Company maintains an Allowance to reflect inherent losses in its loan portfolio as of the balance sheet date.  The Company performs regular credit reviews of the loan portfolio to determine the credit quality and adherence to underwriting standards. When loans are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the credit review process. The Company's risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. These risk ratings are then consolidated into five classes, which include pass, special mention, substandard, doubtful and loss. These classes are a primary factor in determining an appropriate amount for the allowance for loan losses. Each class is assessed an inherent credit loss factor that determines an amount of allowance for loan losses provided for that group of loans. This allowance is then adjusted for qualitative factors, by segment and class.  Qualitative factors are based on management’s assessment of current trends that may cause losses inherent in the current loan portfolio to differ significantly from historical losses.  Some factors that management considers in determining the qualitative adjustment to the general reserve include loan quality trends in our own portfolio, the degree of concentrations of large borrowers in our loan portfolio, national and local economic trends, business conditions, underwriting policies and standards, trends in local real estate markets, effects of various political activities, peer group data, and internal factors such as underwriting policies and expertise of the Company’s employees. 
Regular credit reviews of the portfolio also identify loans that are considered potentially impaired. A loan is considered impaired when based on current information and events, we determine that we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. The analysis of collateral dependent loans includes appraisals on loans secured by real property, management’s assessment of the current market, recent payment history and an evaluation of other sources of repayment.  The Company obtains appraisals on real and personal property that secure its loans during the loan origination process in accordance with regulatory guidance and its loan policy.  The Company obtains updated appraisals on loans secured by real or personal property based upon its assessment of changes in the current market or particular projects or properties, information from other current appraisals and other sources of information.  The Company uses the information provided in these updated appraisals along with its evaluation of all other information available on a particular property as it assesses the collateral coverage on its performing and nonperforming loans and the impact that may have on the adequacy of its Allowance. 
If we determine that the value of the impaired loan is less than the recorded investment in the loan, we either recognize an impairment reserve as a specific component to be provided for in the Allowance or charge-off the impaired balance on collateral dependent loans if it is determined that such amount represents a confirmed loss. The combination of the risk rating-based allowance component and the impairment reserve allowance component lead to an allocated allowance for loan losses.     
Finally, the Company assesses the overall adequacy of the Allowance based on several factors including the level of the Allowance as compared to total loans and nonperforming loans in light of current economic conditions.  This portion of the Allowance is deemed “unallocated” because it is not allocated to any segment or class of the loan portfolio.  This portion of the Allowance provides for coverage of credit losses inherent in the loan portfolio but not captured in the credit loss factors that are utilized in the risk rating-based component or in the specific impairment component of the Allowance and acknowledges the inherent imprecision of all loss prediction models.
The unallocated portion of the Allowance is based upon management’s evaluation of various factors that are not directly measured in the determination of the allocated portions of the Allowance.  Such factors include uncertainties in identifying triggering events that directly correlate to subsequent loss rates, uncertainties in economic conditions, risk factors that have not yet manifested themselves in loss allocation factors, and historical loss experience data that may not precisely correspond to the current portfolio.  In addition, the unallocated reserve may fluctuate based upon the direction of various risk indicators.  Examples of such factors include the risk as to current 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.

32



Based on our methodology and its components, management believes the resulting Allowance is adequate and appropriate for the risk identified in the Company's loan portfolio.  Given current processes employed by the Company, management believes the segments, classes, and estimated loss rates currently assigned are appropriate.  It is possible that others, given the same information, may at any point in time reach different reasonable conclusions that could be material to the Company's financial statements.  In addition, current loan classes and fair value estimates of collateral are subject to change as we continue to review loans within our portfolio and as our borrowers are impacted by economic trends within their market areas.  Although we have established an Allowance that we consider adequate, there can be no assurance that the established Allowance will be sufficient to offset losses on loans in the future. In addition, a substantial percentage of our loan portfolio is secured by real estate; as a result, a significant decline in real estate market values may require an increase in the Allowance.
Valuation of goodwill and other intangibles:  Goodwill and other intangible assets with indefinite lives are not amortized but instead are periodically tested for impairment. Management performs an impairment analysis for the intangible assets with indefinite lives on an annual basis as of December 31. Additionally, goodwill and other intangible assets with indefinite lives are evaluated on an interim basis when events or circumstances indicate impairment potentially exists. The impairment analysis requires management to make subjective judgments. Events and factors that may significantly affect the estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures, technology, changes in discount rates and specific industry and market conditions. There can be no assurance that changes in circumstances, estimates or assumptions may result in additional impairment of all, or some portion of, goodwill or other intangible assets. The Company performed its annual goodwill impairment testing at December 31, 2019 and 2018 in accordance with the policy described in Note 1 to the financial statements included with this report.  At December 31, 2019, the Company performed its annual impairment test by performing a qualitative assessment. Significant positive inputs to the qualitative assessment included the Company’s increasing net income as compared to historical trends, the Company's stable budget-to-actual results of operations; results of regulatory examinations; peer comparisons of the Company's net interest margin; trends in the Company’s cash flows; improvements in the Alaskan economy in 2019; increases in the volume of mortgage originations in Alaska; and increases in the Company's stock price. Significant negative inputs to the qualitative assessment included the continued lower level of oil prices and the muted pace of growth in the Alaska economy. We believe that the positive inputs to the qualitative assessment noted above outweigh the negative inputs for both of the Company's operating segments, and we therefore concluded that it is more likely than not that the fair value of the Company exceeds its carrying value at December 31, 2019 and that no potential impairment existed at that time.
Valuation of OREO:  OREO represents properties acquired through foreclosure or its equivalent.  Prior to foreclosure, the carrying value is adjusted to the fair value, less cost to sell, of the real estate to be acquired by an adjustment to the allowance for loan loss.  The amount by which the fair value less cost to sell is greater than the carrying amount of the loan plus amounts previously charged off is recognized in earnings.  Any subsequent reduction in the carrying value is charged against earnings. Management's evaluation of fair value is based on appraisals or discounted cash flows of anticipated sales. The amounts ultimately recovered from the sale of OREO may differ from the carrying value of the assets because of market factors beyond the Company's control or due to changes in the Company's strategies for recovering the investment.
Servicing rights:  The Company measures mortgage servicing rights ("MSRs") and commercial servicing rights ("CSRs") at fair value on a recurring basis with changes in fair value going through earnings in the period in which the change occurs. Changes in the fair value of MSRs are recorded in mortgage banking income, and changes in the fair value of CSRs are recorded in commercial servicing revenue. Fair value adjustments encompass market-driven valuation changes and the decrease in value that occurs from the passage of time, which are separately reported. Retained servicing rights are measured at fair value as of the date of sale. Initial and subsequent fair value measurements are determined using a discounted cash flow model. In order to determine the fair value of servicing rights, the present value of expected net future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, escrow calculations, delinquency rates and ancillary fee income net of servicing costs. The model assumptions for MSRs are also compared to publicly filed information from several large MSR holders, as available.
Fair Value:   A hierarchical disclosure framework associated with the level of pricing observability is utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no pricing observability and a higher degree of judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction.



33



Impact of accounting pronouncements to be implemented in future periods
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (“ASU 2016-13”). ASU 2016-13 is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates, but will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. ASU 2016-13 is effective for the Company for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2019, and must be applied prospectively. However, on October 16, 2019 the FASB voted to delay ASU 2016-13 for Smaller Reporting Companies. The Company has elected Small Reporting Company status, which changes the effective date for ASU 2016-13 for the Company to fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2022.
Our implementation process includes loss forecasting model development, evaluation of technical accounting topics, updates to our allowance documentation, reporting processes and related internal controls, and overall operational readiness for our adoption of the ASU 2016-13, which will continue until adoption, including parallel runs for CECL alongside our current allowance process.
We are in the process of developing, validating, and implementing models used to estimate credit losses under CECL. We have completed substantially all of our loss forecasting models, and we expect to complete the validation process for our loan models during 2020. Our current planned approach for estimating expected life-time credit losses for loans includes the following key components:
An initial loss forecast period of one year for all loan portfolio segments and classes of financing receivables and off-balance-sheet credit exposures. This period reflects management’s expectation of losses based on forward-looking economic scenarios over that time.
A historical loss forecast period covering the remaining contractual life, adjusted for prepayments, by segment and class of financing receivables based on the change in key historical economic variables during representative historical expansionary and recessionary periods.
A reversion period of up to two years connecting the initial loss forecast to the historical loss forecast based on economic conditions at the measurement date.
Utilization of discounted cash flow ("DCF") methods to measure credit impairment for loans modified in a troubled debt restructuring, unless they are collateral dependent and measured at the fair value of collateral. The DCF methods would obtain estimated life-time credit losses using the conceptual components described above.
As a Smaller Reporting Company, the Company is not required to adopt CECL before January 1, 2023, and we have elected not to early adopt as of January 1, 2020. However, we have the option to early adopt CECL as of either January 1, 2021, or January 1, 2022. Based on our loan portfolio composition at December 31, 2019, and the Company's current economic forecast, had we elected to early adopt CECL as of January 1, 2020, we estimate the impact of adoption to be an overall decrease in our allowance for credit losses ("ACL") for loans between $7.5 million and $9 million. The reduction reflects an expected decrease for all loan segments given their short contractual maturities. The Company does not hold a material amount of residential mortgage loans with long or indeterminate maturities as of December 31, 2019. In most instances the Company believes that the ACL for these types of loans would lead to an increase in the ACL. We will continue to evaluate and refine the results of our loss estimates until adoption of ASU 2016-13.
The ultimate effect of CECL on our ACL will depend on the size and composition of our loan portfolio, the loan portfolio’s credit quality and economic conditions at the time of adoption, as well as any refinements to our models, methodology and other key assumptions. At adoption, we will have a cumulative-effect adjustment to retained earnings for our change in the ACL. We currently estimate an overall decrease in our ACL, which will result in an increase to our retained earnings and regulatory capital amounts and ratios.



34



RESULTS OF OPERATIONS
Income Statement
Net Income
Our results of operations are dependent to a large degree on our net interest income.  We also generate other income primarily through mortgage banking income, purchased receivables products, sales of employee benefit plans (through August of 2017, when we sold our interest in the assets of NBG), service charges and fees, and bankcard fees.  Our operating expenses consist in large part of salaries and other personnel costs, occupancy, data processing, marketing, and professional services expenses. Interest income and cost of funds, or interest expense, are affected significantly by general economic conditions, particularly changes in market interest rates, by government policies and the actions of regulatory authorities, and by competition in our markets.
We earned net income attributable to the Company of $20.7 million in 2019, compared to net income of $20.0 million in 2018.  During these periods, net income per diluted share was $3.04 and $2.86, respectively.  The increase in net income in 2019 compared to 2018 was primarily due to increases in other operating income, net interest income, and the benefit for loan losses.
Net Interest Income / Net Interest Margin
Net interest income is the difference between interest income from loan and investment securities portfolios and interest expense on customer deposits and borrowings.  Changes in net interest income result from changes in volume and spread, which in turn affect our margin.  For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets.  Changes in net interest income are influenced by yields and the level and relative mix of interest-earning assets and interest-bearing liabilities.
Net interest income in 2019 was $64.4 million, compared to $61.2 million in 2018.  The increase in 2019 as compared to 2018 was the result of higher net average interest-earning asset balances as well as higher average interest rates. During 2019 and 2018, net interest margins were 4.65% and 4.55%, respectively. The increase in net interest margin in 2019 as compared to 2018 is the result of increases in the spread between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.  

35



The following table sets forth for the periods indicated information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities.  Average yields or costs, net interest income, and net interest margin are also presented:
Years ended December 31,
2019

2018

2017
 
Average outstanding balance
Interest income / expense
Average Yield / Cost

Average outstanding balance
Interest income / expense
Average Yield / Cost

Average outstanding balance
Interest income / expense
Average Yield / Cost
 
(In Thousands)
Loans (1),(2)

$1,010,098


$59,919

5.93
%


$971,548


$55,526

5.72
%


$981,001


$53,301

5.43
%
Loans held for sale
56,344

2,231

3.96
%
 
46,089

2,016

4.37
%
 
44,047

1,740

3.95
%
Long-term Investments(3)
273,711

7,011

2.56
%

286,426

5,829

2.04
%

305,211

4,634

1.52
%
Short-term investments(4)
46,404

922

1.99
%

42,386

806

1.90
%

36,944

433

1.17
%
Total interest-earning assets

$1,386,557


$70,083

5.05
%


$1,346,449


$64,177

4.77
%


$1,367,203


$60,108

4.40
%
Noninterest-earning assets
169,150

 
 

146,936

 
 

143,849

 
 
Total

$1,555,707

 

 



$1,493,385

 

 



$1,511,052

 

 

Interest-bearing deposits

$850,202


$4,961

0.58
%


$809,808


$2,307

0.28
%


$829,918


$1,707

0.21
%
Borrowings
33,730

680

2.02
%

47,570

662

1.37
%

50,523

723

1.43
%
Total interest-bearing  liabilities

$883,932


$5,641

0.64
%


$857,378


$2,969

0.35
%


$880,441


$2,430

0.28
%
Noninterest-bearing demand deposits
426,205

 
 

417,464

 
 

418,415

 
 
Other liabilities
36,968

 
 

17,521

 
 

19,067

 
 
Equity
208,602

 
 

201,022

 
 

193,129

 
 
Total

$1,555,707

 
 


$1,493,385

 
 


$1,511,052

 
 
Net interest income
 

$64,442

 

 

$61,208

 

 

$57,678

 
Net interest margin
 
 
4.65
%

 
 
4.55
%

 
 
4.22
%
Average portfolio loans to average-earnings assets
72.85
%
 
 
 
72.16
%
 
 
 
71.75
%
 
 
Average portfolio loans to average total deposits
79.14
%
 
 
 
79.16
%
 
 
 
78.58
%
 
 
Average non-interest deposits to average total deposits
33.39
%
 
 
 
34.02
%
 
 
 
33.52
%
 
 
Average interest-earning assets to average interest-bearing liabilities
156.86
%
 
 
 
157.04
%
 
 
 
155.29
%
 
 
1Interest income includes loan fees.  Loan fees recognized during the period and included in the yield calculation totaled $3.3 million, $3.0 million and $3.2 million for 2019, 2018 and 2017, respectively.

2Nonaccrual loans are included with a zero effective yield.  Average nonaccrual loans included in the computation of the average loans were $16.9 million, $17.5 million, and $18.1 million in 2019, 2018 and 2017, respectively.

3Consists of investment securities available for sale, investment securities held to maturity, marketable equity securities, and investment in Federal Home Loan Bank stock.
4Consists of interest bearing deposits in other banks and domestic CDs.

36



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:
 
2019 compared to 2018
2018 compared to 2017
 
Increase (decrease) due to
Increase (decrease) due to
(In Thousands)
Volume
Rate
Total
Volume
Rate
Total
Interest Income:
 
 
 
 
 
 
Loans

$2,246


$2,147


$4,393


($508
)

$2,733


$2,225

Loans held for sale
374

(159
)
215

83

193

276

Long-term investments
(245
)
1,427

1,182

(264
)
1,459

1,195

Short term investments
79

37

116

71

302

373

Total interest income

$2,454


$3,452


$5,906


($618
)

$4,687


$4,069

Interest Expense:
 
 
 
 
 
 
Interest-bearing deposits

$120


$2,534


$2,654


($40
)

$640


$600

Borrowings
(29
)
47

18

(35
)
(26
)
(61
)
Total interest expense

$91


$2,581


$2,672


($75
)

$614


$539

 
    
Provision for Loan Losses 
We recorded a benefit for loan losses in 2019 of $1.2 million, compared to a benefit for loan losses of $500,000 in 2018.  The loan loss provision decreased in 2019 compared to 2018 primarily due to an improvement in credit quality as nonperforming loans and adversely classified loans decreased, the Alaskan economy improved, and the Company recorded net recoveries for the year. See the “Allowance for Loan Losses” section under “Financial Condition” and Note 6 of the Notes to Consolidated Financial Statements included in Item 8 of this report for further discussion of these decreases and changes in the Company’s Allowance. 
Other Operating Income
The following table details the major components of other operating income for the years ended December 31:
(In Thousands)
2019
$ Change
% Change
2018
$ Change
% Change
2017
Other Operating Income
 
 
 
 
 
 
 
Mortgage banking income

$24,201


$3,357

16
 %

$20,844


($2,443
)
(10
)%

$23,287

Purchased receivable income
3,271

16

 %
3,255

280

9
 %
2,975

Bankcard fees
2,976

165

6
 %
2,811

214

8
 %
2,597

Service charges on deposit accounts
1,557

49

3
 %
1,508

(106
)
(7
)%
1,614

Interest rate swap income
964

880

1,048
 %
84

58

223
 %
26

Gain (loss) on marketable equity securities
911

1,536

246
 %
(625
)
(625
)
(100
)%

Commercial servicing revenue
624

(798
)
(56
)%
1,422

1,050

282
 %
372

Rental income
497

(195
)
(28
)%
692

160

30
 %
532

Other loan fees
269

77

40
 %
192

(2
)
(1
)%
194

Gain on loans acquired - APB
30

(227
)
(88
)%
257

68

36
 %
189

Gain (loss) on sale of securities
23

23

100
 %

(11
)
(100
)%
11

Gain on sale of Northrim Benefits Group


 %

(4,445
)
(100
)%
4,445

Employee benefit plan income


 %

(2,506
)
(100
)%
2,506

Other income
2,023

296

17
 %
1,727

1

 %
1,726

     Total other operating income

$37,346


$5,179

16
 %

$32,167


($8,307
)
(21
)%

$40,474



37



2019 Compared to 2018
The most significant changes in other operating income in 2019 were increases in mortgage banking income and gains on marketable equity securities, as well as higher interest rate swap income. Mortgage banking income consists of gross income from the origination and sale of mortgages as well as mortgage loan servicing fees and is the largest component of other operating income at 65% of total other operating income in 2019. Mortgage banking income increased in 2019 compared to 2018 mainly due to an increase in mortgage loans originated and sold as this volume increased to $684 million in 2019 from $528 million in 2018. The overall increase in mortgage originations is primarily the result of the decrease in interest rates during the year. The Company recognized $964,000 in interest rate swap income in 2019 on the execution of five interest rate swaps which totaled $40.6 million in notional value compared to the execution of two interest rate swaps with a total notional value of $2.8 million in 2018. These interest rate swaps are related to the Company's commercial lending operations. Lastly, commercial servicing revenue decreased in 2019 because in 2018 the Company recorded for the first time in other operating income the fair value of its commercial loan servicing portfolio of $1.0 million. In 2019, only changes in the fair value of the Company's commercial loan servicing portfolio are reflected in other operating income, which comprised a portion of the decrease in other income in 2019 as compared to 2018.    
Other Operating Expense
The following table details the major components of other operating expense for the years ended December 31:
(In Thousands)
2019
$ Change
% Change
2018
$ Change
% Change
2017
Other Operating Expense
 
 
 
 
 
 
 
Salaries and other personnel expense

$51,317


$6,667

15
 %

$44,650


($71
)
 %

$44,721

Data processing expense
7,128

1,093

18
 %
6,035

486

9
 %
5,549

Occupancy expense
6,607

471

8
 %
6,136

(616
)
(9
)%
6,752

Professional and outside services
2,531

78

3
 %
2,453

88

4
 %
2,365

Marketing expense
2,373

55

2
 %
2,318

(248
)
(10
)%
2,566

Insurance expense
557

(305
)
(35
)%
862

(299
)
(26
)%
1,161

Compensation expense - RML acquisition payments
468

468

100
 %

(130
)
(100
)%
130

Intangible asset amortization
60

(10
)
(14
)%
70

(30
)
(30
)%
100

Loss on sale of premise and equipment

(2
)
(100
)%
2

(1
)
(33
)%
3

OREO (income) expense, net rental income and gains on sale:
 
   OREO operating expense
693

(109
)
(14
)%
802

382

91
 %
420

   Impairment on OREO


 %

(904
)
(100
)%
904

   Rental income on OREO
(506
)
35

6
 %
(541
)
(425
)
(366
)%
(116
)
   Gains on sale of OREO
(380
)
(377
)
NM

(3
)
368

99
 %
(371
)
         Subtotal
(193
)
(451
)
(175
)%
258

(579
)
(69
)%
837

Other expenses
5,990

(1,026
)
(15
)%
7,016

47

1
 %
6,969

     Total other operating expense

$76,838


$7,038

10
 %

$69,800


($1,353
)
(2
)%

$71,153

 

38



2019 Compared to 2018
Other operating expense increased in 2019 as compared to the prior year primarily due to increases in salaries and other personnel expense, data processing expense, occupancy expense, and compensation expense related to RML acquisition payments. These increases were only partially offset by a decrease in other expenses. The fourth quarter of 2019 marked the end of the five-year period following the acquisition of RML during which the Company was required to make additional payments to the former owners of RML when profitability hit certain targets. Per the terms of the purchase agreement, no further payments are scheduled, and therefore no additional expense for RML acquisition payments will be recorded in the future. The $6.7 million increase in salaries and other personnel expense is the result of the following items. Salaries increased $2.2 million, or approximately 8% in 2019 compared to 2018 due to salary increases as total FTE remained consistent from 2018 to 2019. Profit sharing expense increased $1.5 million, or 112%, in 2019 as compared to 2018. While a portion of this increase is due to improvement in the Company's financial results in 2019, the majority of the increase is due to a redesign of the profit sharing plan that results in a higher payout to employees when the Company's financial results are higher. Commission expense for mortgage originations increased $1.4 million, or 27%, as a result of higher mortgage production in 2019. Lastly, group medical expense increased $1.1 million, or 23%, due to higher claims in the Company's self-insured medical benefit plan in 2019 compared to 2018. Data processing expense increased $1.1 million in 2019 as compared to 2018 due to costs associated with the addition of two new branches in 2019, costs for improved functionality for digital products and services, and the addition of various software applications related to our lending activities. Occupancy expense increased in 2019 as compared to 2018 primarily due to a one-time technical correction that decreased depreciation expense by $670,000 in 2018. The reserve for purchased receivable losses decreased $87,000 and employee recruitment expense decreased $76,000 in 2019 as compared to 2018.
Income Taxes
The provision for income taxes increased $1.4 million or 33%, to $5.4 million in 2019 as compared to 2018.  The increase in 2019 is primarily due to higher pretax income, less tax exempt income, and fewer low income housing tax credits as a percentage of pre-tax income as compared to 2018. Additionally, in 2018 the Company finalized its valuation of net deferred tax assets related to the decrease in the federal tax rate after completing a fixed asset cost segregation study for tax planning purposes which resulted in a $470,000 decrease in tax expense that was not repeated in 2019. The Company's effective tax rates were 21% and 17% in 2019 and 2018, respectively. The changes in the Company's effective tax rates for 2019 and 2018 are primarily due to the items discussed regarding the changes in tax expense for these periods.

FINANCIAL CONDITION
Investment Securities
The composition of our investment securities portfolio, which includes securities available for sale and marketable equity securities, reflects management’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of interest income.  The investment securities portfolio also mitigates interest rate and credit risk inherent in the loan portfolio, while providing a vehicle for the investment of available funds, a source of liquidity (by pledging as collateral or through repurchase agreements), and collateral for certain public funds deposits. Investment securities designated as available for sale comprised 97% of the portfolio as of December 31, 2019 and are available to meet liquidity requirements. 
Our investment portfolio consists primarily of government sponsored entity securities, corporate securities, collateralized loan obligations, and municipal securities.  Investment securities at December 31, 2019 increased $5.2 million, or 2%, to $284.1 million from $278.9 million at December 31, 2018.  The increase at December 31, 2019 as compared to December 31, 2018 is primarily due to investment of funds received as deposit balances increased, as well as proceeds from sales, maturities, and security calls being reinvested as of December 31, 2019. The average maturity of the investment portfolio was approximately one and a half years at December 31, 2019.
Investment securities may be pledged as collateral to secure public deposits or borrowings.  At December 31, 2019 and 2018, $30.6 million and $58.4 million in securities were pledged for deposits and borrowings, respectively.  Pledged securities decreased at December 31, 2019 as compared to December 31, 2018 because the Company had decreased balances in securities sold under agreements to repurchase accounts at December 31, 2019.

39



The following tables set forth the composition of our investment portfolio at December 31 for the years indicated:
(In Thousands)
Amortized Cost

Fair Value
Securities Available for Sale:
 


 

2019:
 


 

    U.S. Treasury and government sponsored entities

$210,756



$211,852

    Municipal Securities
3,288


3,297

    Corporate Bonds
34,764


35,066

    Collateralized Loan Obligations
25,980

 
25,923

            Total

$274,788



$276,138

   2018:
 


 

    U.S. Treasury and government sponsored entities

$209,908



$208,860

    Municipal Securities
9,089


9,084

    Corporate Bonds
40,139


39,780

    Collateralized Loan Obligations
13,990

 
13,886

             Total

$273,126



$271,610

   2017:
 


 

    U.S. Treasury and government sponsored entities

$250,794



$249,461

    Municipal Securities
14,395


14,421

    Corporate Bonds
36,654


37,132

    Collateralized Loan Obligations
6,000


6,005

    Preferred Stock
5,422


5,731

             Total

$313,265



$312,750

Marketable Equity Securities:
 
 
 
2019:
 
 
 
    Preferred Stock

$7,349

 

$7,945

             Total

$7,349

 

$7,945

   2018:
 
 
 
    Preferred Stock

$7,580

 

$7,265

             Total

$7,580

 

$7,265

 
    

40



The following table sets forth the market value, maturities, and weighted average pretax yields of our investment portfolio as of December 31, 2019:
 
Maturity
 
Within
 
 
Over
 
(In Thousands)
1 Year
1-5 Years
5-10 Years
10 Years