NORTHRIM BANCORP INC 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion should be read in conjunction with the unaudited consolidated financial statements of Northrim BanCorp, Inc. (the “Company”) and the notes thereto presented elsewhere in this report and with the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 . Except as otherwise noted, references to "we", "our", "us" or "the Company" refer to Northrim BanCorp, Inc. and its subsidiaries that are consolidated for financial reporting purposes. Note Regarding Forward Looking-Statements This quarterly report on Form 10-Q includes “forward-looking statements,” as that term is defined for purposes of Section 21E of the Securities Exchange Act of 1934, as amended, which are not historical facts. These forward-looking statements describe management’s expectations about future events and developments such as future operating results, growth in loans and deposits, continued success of the Company’s style of banking, the strength of the local economy, and statements related to the expected or potential impact of the novel coronavirus ("COVID-19") pandemic and related responses of the government. All statements other than statements of historical fact, including statements regarding industry prospects, future results of operations or financial position and the expected or potential impact of COVID-19 and related responses of the government, 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, whether concerning COVID-19 and the government response related thereto or otherwise, 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 uncertainties relating to the impact of COVID-19 on the Company's credit quality, business, operations and employees; the availability and terms of funding from government sources related to COVID-19; the general condition of, and changes in, the Alaska economy; our ability to maintain or expand our market share or net interest margin; 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. Many of these risks, as well as other risks that may have a material adverse impact on our operations and business, are identified in Part II. Item 1A Risk Factors of this report and Item 1A in the Company's Annual Report on Form 10-K for the year ended December 31, 2019 , as well as in our other 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 forward looking statements are made only as of the date of this report and 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. Critical Accounting Policies The preparation of the consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable; however, actual results may differ significantly from these estimates and assumptions which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and on our results of operations for the reporting periods. The accounting policies that involve significant estimates and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities, are considered critical accounting policies. The Company’s critical accounting policies include those that address the accounting for the allowance for loan losses ("Allowance"), valuation of goodwill and other intangible assets, the valuation of other real estate owned ("OREO"), and the valuation of mortgage servicing rights. These critical accounting policies are further described in Item 7, Management’s Discussion and Analysis, and in Note 1, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 . Management has applied its critical accounting policies and estimation methods consistently in all periods presented in these consolidated financial statements. 44 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. In addition, on March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was signed by the President of the United States that included an option for entities to delay the implementation of ASU 2016-13 until the earlier of the termination date of the national emergency declaration by the President or December 31, 2020. 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 current expected credit losses ("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 offbalance- 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 June 30, 2020, and the Company's current economic forecast, had we elected to early adopt CECL as of June 30, 2020, we estimate the impact of adoption to be an overall decrease in our allowance for credit losses ("ACL") for loans between $5.0 million and $6.0 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 June 30, 2020. 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. 45 Update on Economic Conditions The COVID-19 pandemic has disrupted economies all around the world. In Alaska, the tourism and hospitality industries have been most affected with job losses. Oil prices dropped precipitously at the beginning of the pandemic, but have rebounded recently to healthier levels. The government’s fiscal and monetary response has been far reaching. This has greatly eased the short run impacts of the virus for most of the Company’s customers. The State of Alaska Department of Labor reported that a year and a half of positive job growth came to an abrupt end in April of 2020. The seasonally adjusted unemployment rate jumped from 5.6% in March to 13.5% in April. This moderated slightly to 12.6% in May. The comparable U.S. rate peaked at 14.7% in April and decreased to 13.3% in May, according to the State of Alaska Department of Labor. In Alaska, every major job sector reported declines year-over-year (“YoY”) in May 2020 according to the State of Alaska Department of Labor. Leisure and Hospitality was the most severely impacted, declining 39.7% for a loss of 15,300 jobs in Alaska in May 2020. Also in Alaska, government declined by 7,400 jobs or 9.1%, primarily due to a loss of 6,200 local government jobs. State government declined by 1,000 jobs and Federal government by only 200 jobs. Other major sectors to decline in Alaska YoY in May of 2020 were: Health Care -2,900; Transportation, Warehousing and Utilities -2,700; Retail Trade -2,600; and Construction -2,400. Oil prices have been fluctuating significantly in 2020 as the global economy reacts to the COVID-19 pandemic. Average monthly Alaska North Slope (“ANS”) crude oil prices began the year averaging $65.48 for the month of January. The virus concerns began to have an effect when monthly ANS prices declined to $54.48 in February and $33.21 in March. In the second quarter of 2020, ANS prices hit a monthly low of $16.54 in April and increased to $28.21 in May. The ANS price improved throughout June and averaged $41.78. Trillions of dollars in federal assistance programs have helped mitigate some of the negative impacts of the COVID-19 pandemic in the short run. The Fed Funds rate was decreased 1.5% in March. This helped reduce borrowers’ interest expense dramatically. The Federal Reserve is buying corporate bonds, lending to state and municipal governments, and even aiding foreign central banks of our allies to help stabilize global markets. The Fed is adding liquidity to the system to ensure credit markets don’t freeze up. The U.S. Small Business Administration ("SBA") Paycheck Protection Program ("PPP") and the Economic Injury Disaster loan program have provided hundreds of billions of dollars to businesses around the country. The Federal Reserve’s Main Street Lending Program is also now available to help businesses weather current economic disruptions. Direct grants to states from the CARES Act provided approximately $1.25 billion to Alaska. An increase of $600 in weekly unemployment insurance benefits helped millions of people out of work maintain cash flow. A moratorium on housing foreclosures, coupled with widespread payment forbearance arrangements, has kept Americans in their homes. Alaska’s seasonally adjusted gross state product ("GSP") was $54 billion in the first quarter of 2020, according to the U.S. Bureau of Economic Analysis ("BEA") in a report released on July 7, 2020. Alaska’s real GSP decreased 4% annualized for the quarter. The BEA reported real GSP decreased in all 50 states in the first quarter of 2020 and averaged a decline of 5% for the nation. Alaska’s performance was above average, placing it 13th best of the 50 U.S. states for the quarter. This is following positive growth in Alaska in 2019 of 2.5%, compared to U.S. growth of 2.3% last year. The largest sectors of decline in GSP in Alaska in the first quarter of 2020 were Health Care, Accommodation and food services, and Government. Alaska’s personal income grew 3.7% in 2019 according to a report by the Federal Bureau of Economic Analysis. Total income from all sources in Alaska grew from $44.4 billion at the end of 2018 to $46.1 billion in the first quarter of 2020. Most of the increase came from over $1 billion in improvement of wages in 2019. The first quarter of 2020 was an annualized growth rate of 1.3% in Alaska. Alaska’s delinquency and foreclosure levels continue to be better than most of the nation. According to the Mortgage Bankers Association, Alaska’s foreclosure rate was 0.60% at the end of the first quarter 2020. That compares to 0.63% at the end of 2019. The comparable national average rate was 0.73% in the first quarter of 2020 and 0.78% at the end of 2019. The national survey reported that the percentage of delinquent mortgage loans in Alaska was 3.23% in the first quarter of 2020. This compares to 2.85% at the end of 2019. The delinquency rate for the entire country was higher at 4% in the first quarter of 2020 and 4.07% at the end of 2019. 46 COVID-19 Issues: • Industry Exposure: Northrim has identified various industries that may be adversely impacted by the COVID-19 pandemic and the significant decline in oil prices. Though the industries affected may change through the progression of the pandemic, the following sectors for which the Company has exposure, as a percent of the total loan portfolio as of June 30, 2020 are being impacted: Tourism (4%), Oil and Gas (5%), Aviation (non-tourism) (4%), Healthcare (4%), Accommodations (2%), Retail (2%) and Restaurants (2%). The Company's exposure as a percent of the total loan portfolio excluding SBA PPP loans as of June 30, 2020 are: Tourism (6%), Oil and Gas (6%), Aviation (non-tourism) (5%), Healthcare (5%), Accommodations (3%), Retail (2%) and Restaurants (2%). • Customer Accommodations: The Company has proactively implemented several forms of assistance to help our customers in the event that they experience financial hardship as a result of COVID-19 in addition to our participation in PPP lending. These accommodations include interest only and deferral options on loan payments, as well as the waiver of various fees related to loans, deposits and other services. The PPP administered by the SBA under the CARES Act has provided some relief on requests to modify loans. As of June 30, 2020, the Company has made the following loan modifications due to the impacts of COVID-19: Loan Modifications due to COVID-19 (Dollars in thousands) Interest Only Full Payment Deferral Total Portfolio loans $64,298 $293,224 $357,522 Number of modifications 76 403 479 Consumer loans represent 1% of total loan modifications identified above. • Loan Loss Reserve: The Company booked a loan loss provision of $404,000 for the quarter ended June 30, 2020. This compares to a $300,000 provision for loan losses in the second quarter a year ago. The increased provision is the result of growth in the loan portfolio and an increase in qualitative factors based on management's assessment of increased risks in our loan portfolio primarily associated with the COVID-19 pandemic and the reduction in oil prices compared to the prior year. • Credit Quality: Net adversely classified loans improved to $15.7 million at June 30, 2020, as compared to $22.3 million at December 31, 2019. Net loan chargeoffs were $768,000 in the second quarter of 2020, compared to net loan recoveries of $9,000 in the second quarter of 2019. • Branch Operations: All but one branch remained open throughout the second quarter. Branch lobbies were available by appointment from March 23 to June 17. All but one branch was fully reopened on June 17 with a number of customers and employee safety measures implemented. • Growth and Paycheck Protection Program: • The Company’s asset base increased during the quarter ended June 30, 2020, due primarily to loans originated under the SBA's PPP. • Through June 30, 2020,the Company had funded approximately 2,500 PPP loans totaling $353.5 million to both existing and new customers. The deadline for PPP loan applications to the SBA has been extended to August 8, 2020. The Company is continuing to accept new PPP applications based on this extended deadline and is assisting small businesses with other borrowing options a they become available. • According to the SBA, the Company originated more SBA PPP loans in the State of Alaska than any other financial institution, funding 23% of the number and 28% of the value of all Alaska PPP loans for the period ending June 30, 2020. • The Company initially utilized the Federal Reserve Bank's Paycheck Protection Program Liquidity Facility ("PPPLF") to fund PPP loans but has since repaid those funds in full and has funded the SBA PPP loans through core deposits and maturity of long-term investments. • Capital Management: At June 30, 2020, the Company’s and the Bank’s capital ratios were well in excess of all regulatory requirements. As previously announced, the Company suspended its previously announced stock repurchasing activity effective March 26, 2020. 47 Highlights and Summary of Performance - Second Quarter of 2020 The Company reported net income and diluted earnings per share of $9.9 million and $1.52, respectively, for the second quarter of 2020 compared to net income and diluted earnings per share of $4.3 million and $0.62, respectively, for the second quarter of 2019 . The Company reported net income and diluted earnings per share of $10.9 million and $1.68, respectively, for the first six months of 2020 compared to net income and diluted earnings per share of $8.6 million and $1.24, respectively, for the same period in 2019 . The increase in net income in the second quarter of 2020 compared to the same quarter last year is primarily due to an increase in mortgage banking income. • Total revenue in the second quarter of 2020, which includes net interest income plus other operating income, increased 37% to $35.0 million from $25.5 million in the second quarter a year ago, primarily due to a $9.3 million increase in mortgage banking income. • Net interest income increased 9% to $17.5 million in the second quarter of 2020 compared to the same period in 2019 mainly due to increased loans and loans held for sale balances. • Net interest margin decreased to 3.98% in the second quarter of 2020 as compared to 4.71% in the second quarter a year ago primarily due to lower interest rates. • The Company paid cash dividends of $0.34 per common share in the second quarter of 2020, up 13% from $0.30 in the second quarter of 2019. Other financial measures are shown in the table below: Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Return on average assets 2.04 % 1.12 % 1.23 % 1.15 % Return on average shareholders' equity 19.44 % 8.13 % 10.65 % 8.24 % Dividend payout ratio 22.11 % 48.35 % 40.35 % 48.38 % Credit Quality Nonperforming assets: Nonperforming assets, net of government guarantees at June 30, 2020 increased $855,000, or 4% to $20.8 million as compared to $19.9 million at December 31, 2019 . OREO, net of government guarantees, increased $162,000 to $5.9 million at June 30, 2020 as compared to $5.8 million at December 31, 2019 due to the transfer of one loan to OREO during the period. Nonperforming loans, net of government guarantees decreased $1.2 million during the first six months of 2020 as compared to December 31, 2019, as paydowns and chargeoffs exceeded additions in the first six months of 2020. $10.4 million, or 50% of nonperforming assets are nonaccrual loans and nonperforming purchased receivables related to five commercial relationships. Two of these relationships, which totaled $5.8 million at the end of the second quarter of 2020, are businesses in the medical industry. While it is too early to determine the effect that the COVID-19 pandemic will ultimately have on our non-performing assets, based on the current trajectory, significant increases may occur in subsequent quarters. 48 The following table summarizes nonperforming activity for the three-month periods ending June 30, 2020 and 2019 : Writedowns Transfers to (In Thousands) Balance at March 31, 2020 Additions this quarter Payments this quarter /Charge-offs this quarter Transfers to OREO Performing Status this quarter Sales this quarter Balance at June 30, 2020 Commercial loans $9,340 $1,055 ($534 ) ($804 ) ($695 ) $— $— $8,362 Commercial real estate 4,635 508 (20 ) — — — — 5,123 Construction loans 915 — (213 ) — — — — 702 Consumer loans 184 — (6 ) — — — — 178 Nonperforming loans guaranteed by government (1,671 ) (54 ) 90 — — — — (1,635 ) Total nonperforming loans 13,403 1,509 (683 ) (804 ) (695 ) — — 12,730 Other real estate owned 7,205 — — — — — — 7,205 Repossessed assets 231 695 (7 ) — — — — 919 Nonperforming purchased receivables — 1,226 — — — — — 1,226 Other real estate owned guaranteed by government (1,279 ) — — — — — — (1,279 ) Total nonperforming assets, net of government guarantees $19,560 $3,430 ($690 ) ($804 ) ($695 ) $— $— $20,801 Writedowns Transfers to (In Thousands) Balance at March 31, 2019 Additions this quarter Payments this quarter /Charge-offs this quarter Transfers to OREO Performing Status this quarter Sales this quarter Balance at June 30, 2019 Commercial loans $12,457 $405 ($1,591 ) ($64 ) $— $— $— $11,207 Commercial real estate 4,230 1,087 (276 ) — — — — 5,041 Construction loans 2,423 — (931 ) — — — — 1,492 Consumer loans 406 97 (159 ) (4 ) — — — 340 Nonperforming loans guaranteed by government (1,038 ) (101 ) — — — — — (1,139 ) Total nonperforming loans 18,478 1,488 (2,957 ) (68 ) — — — 16,941 Other real estate owned 7,043 — — — — — — 7,043 Repossessed assets 1,242 — — — — — (60 ) 1,182 Other real estate owned guaranteed by government (1,279 ) — — — — — — (1,279 ) Total nonperforming assets, net of government guarantees $25,484 $1,488 ($2,957 ) ($68 ) $— $— ($60 ) $23,887 Potential problem loans: Potential problem loans are loans which are currently performing in accordance with contractual terms but that have developed negative indications that the borrower may not be able to comply with present payment terms and which may later be included in nonaccrual, past due, or impaired loans. These loans are closely monitored and their performance is reviewed by management on a regular basis. At June 30, 2020 , management had identified potential problem loans of $3.6 million as compared to potential problem loans of $9.0 million at December 31, 2019 . The decrease in potential problem loans from December 31, 2019 to June 30, 2020 is primarily the result of $3.1 million in paydowns and the addition of a government guarantee on one loan totaling $1.4 million. One commercial relationship totaling $423,000 as of December 31, 2019, net of government guarantees, was transferred to nonaccrual status, and there was one new potential problem loan during the first six months of 2020 totaling $281,000. Troubled debt restructurings (“TDRs”): TDRs are those loans for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower, have been granted due to the borrower’s weakened financial condition. Interest on TDRs will be accrued at the restructured rates when it is anticipated that no loss of original principal will occur, and the interest can be collected, which is generally after a period of six months. The Company had $2.9 million in loans classified as TDRs that were performing and $7.7 million in TDRs included in nonaccrual loans at June 30, 2020 for a total of approximately 49 $10.6 million . There are $1.9 million in government guarantees associated with TDRs, so total TDRs, net of government guarantees, total $8.7 million at June 30, 2020 . At December 31, 2019 there were $1.4 million in loans classified as TDRs that were performing and $8.7 million in TDRs included in nonaccrual loans for a total of $10.1 million. See Note 4 of the Notes to Consolidated Financial Statements included in Item 1 of this report for further discussion of TDRs. RESULTS OF OPERATIONS Income Statement Net Income Net income for the second quarter of 2020 increased $5.6 million, or 132%, to $9.9 million as compared to $4.3 million for the same period in 2019 . Net income for the first half of 2020 increased $2.4 million, or 28%, to $10.9 million compared to $8.6 million for the first half of 2019. The increase in net income in both periods is primarily due to an increase in mortgage banking income. Net Interest Income/Net Interest Margin Net interest income for the second quarter of 2020 increased $1.5 million, or 9%, to $17.5 million as compared to $16.0 million for the second quarter of 2019 . Net interest margin decreased 73 basis points to 3.98% in the second quarter of 2020 as compared to 4.71% in the second quarter of 2019. Net interest income for the first half of 2020 increased $1.4 million, or 4%, to $33.1 million as compared to $31.7 million for the first half of 2019. Net interest margin decreased 63 basis points to 4.14% in the first half of 2020 as compared to 4.77% in the first half of 2019. The increase in net interest income in the second quarter and first six months of 2020 compared to the same periods of 2019 was primarily the result of higher interest income on loans and loans held for sale due to increased balances. The decrease in net interest margin in the second quarter and the first half of 2020 as compared to the same periods a year ago was primarily the result of the reduction in short-term interest rates in the first quarter of 2020 and the impact of the SBA PPP loans on the resulting yields in the loan portfolio. Changes in net interest margin in the three and six months ended June 30, 2020 as compared to the same period in the prior year are detailed below: Three Months Ended June 30, 2020 vs. June 30, 2019 Nonaccrual interest adjustments 0.03 % Impact of SBA Paycheck Protection Program loans (0.15 )% Interest rates and loan fees (0.55 )% Volume and mix of interest-earning assets (0.06 )% Change in net interest margin (0.73 )% Six Months Ended June 30, 2020 vs. June 30, 2019 Nonaccrual interest adjustments 0.03 % Impact of SBA Paycheck Protection Program loans (0.09 )% Interest rates and loan fees (0.51 )% Volume and mix of interest-earning assets (0.06 )% Change in net interest margin (0.63 )% 50 Components of Net Interest Margin The following table compares average balances and rates as well as net tax equivalent margins on earning assets for the three-month periods ended June 30, 2020 and 2019 : (Dollars in Thousands) Three Months Ended June 30, Interest income/ Average Balances Change expense Change Average Yields/Costs 2020 2019 $ % 2020 2019 $ % 2020 2019 Change Loans 1,2 $1,342,717 $1,003,019 $339,698 34 % $16,584 $14,825 $1,759 12 % 4.97 % 5.94 % (0.97 )% Loans held for sale 111,475 51,280 60,195 117 % 870 528 342 65 % 3.14 % 4.14 % (1.00 )% Short-term investments 3 51,448 22,850 28,598 125 % 31 135 (104 ) (77 )% 0.24 % 2.38 % (2.14 )% Long-term investments 4 256,500 281,450 (24,950 ) (9 )% 1,519 1,818 (299 ) (16 )% 2.38 % 2.60 % (0.22 )% Total investments 307,948 304,300 3,648 1 % 1,550 1,953 (403 ) (21 )% 2.02 % 2.58 % (0.56 )% Interest-earning assets 1,762,140 1,358,599 403,541 30 % 19,004 17,306 1,698 10 % 4.34 % 5.12 % (0.78 )% Nonearning assets 186,583 167,414 19,169 11 % Total $1,948,723 $1,526,013 $422,710 28 % Interest-bearing demand $379,851 $253,553 $126,298 50 % $156 $92 $64 70 % 0.17 % 0.15 % 0.02 % Savings deposits 246,379 232,675 13,704 6 % 176 289 (113 ) (39 )% 0.29 % 0.50 % (0.21 )% Money market deposits 214,532 205,364 9,168 4 % 164 295 (131 ) (44 )% 0.31 % 0.58 % (0.27 )% Time deposits 176,782 126,530 50,252 40 % 835 498 337 68 % 1.90 % 1.58 % 0.32 % Total interest-bearing deposits 1,017,544 818,122 199,422 24 % 1,331 1,174 157 13 % 0.53 % 0.58 % (0.05 )% Borrowings 73,349 44,938 28,411 63 % 216 175 41 23 % 1.18 % 1.57 % (0.39 )% Total interest-bearing liabilities 1,090,893 863,060 227,833 26 % 1,547 1,349 198 15 % 0.57 % 0.63 % (0.06 )% Demand deposits and other noninterest-bearing liabilities 652,989 452,623 200,366 44 % Equity 204,841 210,330 (5,489 ) (3 )% Total $1,948,723 $1,526,013 $422,710 28 % Net interest income $17,457 $15,957 $1,500 9 % Net interest margin 3.98 % 4.71 % (0.73 )% Average loans to average interest-earning assets 76.20 % 73.83 % Average loans to average total deposits 82.88 % 80.93 % Average non-interest deposits to average total deposits 37.19 % 33.99 % Average interest-earning assets to average interest-bearing liabilities 161.53 % 157.42 % 1 Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled $2.0 million and $766,000 in the second quarter of 2020 and 2019 , respectively. 2 Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loan balances were $14.6 million and $18.5 million in the second quarter of 2020 and 2019 , respectively . 3 Consists of interest bearing deposits in other banks. 4 Consists of investment debt securities available for sale, equity securities, investment securities held to maturity, and investment in Federal Home Loan Bank stock. 51 The following tables set forth the changes in consolidated net interest income attributable to changes in volume and to changes in interest rates for the three-month periods ending June 30, 2020 and 2019 . 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 rates: (In Thousands) Three Months Ended June 30, 2020 vs. 2019 Increase (decrease) due to Volume Rate Total Interest Income: Loans $2,120 ($361 ) $1,759 Loans held for sale 432 (90 ) 342 Short-term investments 79 (183 ) (104 ) Long-term investments (161 ) (138 ) (299 ) Total interest income $2,470 ($772 ) $1,698 Interest Expense: Interest-bearing deposits $243 ($86 ) $157 Borrowings 88 (47 ) 41 Total interest expense $331 ($133 ) $198 52 The following table compares average balances and rates as well as net tax equivalent margins on earning assets for the six-month periods ended June 30, 2020 and 2019 : (Dollars in Thousands) Six Months Ended June 30, Interest income/ Average Balances Change expense Change Average Yields/Costs 2020 2019 $ % 2020 2019 $ % 2020 2019 Change Loans 1,2 $1,200,870 $996,009 $204,861 21 % $31,503 $29,454 $2,049 7 % 5.28 % 5.95 % (0.67 )% Loans held for sale 80,925 41,297 39,628 96 % 1,310 876 434 50 % 3.26 % 4.27 % (1.01 )% Short-term investments 3 59,762 23,521 36,241 154 % 267 278 (11 ) (4 )% 0.90 % 2.38 % (1.48 )% Long-term investments 4 270,284 280,937 (10,653 ) (4 )% 3,263 3,576 (313 ) (9 )% 2.43 % 2.56 % (0.13 )% Total investments 330,046 304,458 25,588 8 % 3,530 3,854 (324 ) (8 )% 2.15 % 2.55 % (0.40 )% Interest-earning assets 1,611,841 1,341,764 270,077 20 % 36,343 34,184 2,159 6 % 4.53 % 5.12 % (0.59 )% Nonearning assets 180,316 164,841 15,475 9 % Total $1,792,157 $1,506,605 $285,552 19 % Interest-bearing demand $350,308 $247,324 $102,984 42 % $320 $145 $175 121 % 0.18 % 0.12 % 0.06 % Savings deposits 238,009 234,201 3,808 2 % 413 544 (131 ) (24 )% 0.35 % 0.47 % (0.12 )% Money market deposits 210,288 206,436 3,852 2 % 421 544 (123 ) (23 )% 0.40 % 0.53 % (0.13 )% Time deposits 173,096 121,393 51,703 43 % 1,661 879 782 89 % 1.93 % 1.46 % 0.47 % Total interest-bearing deposits 971,701 809,354 162,347 20 % 2,815 2,112 703 33 % 0.58 % 0.52 % 0.06 % Borrowings 47,769 48,208 (439 ) (1 )% 381 346 35 10 % 1.60 % 1.44 % 0.16 % Total interest-bearing liabilities 1,019,470 857,562 161,908 19 % 3,196 2,458 738 30 % 0.63 % 0.58 % 0.05 % Demand deposits and other noninterest-bearing liabilities 566,284 439,253 127,031 29 % Equity 206,403 209,790 (3,387 ) (2 )% Total $1,792,157 $1,506,605 $285,552 19 % Net interest income $33,147 $31,726 $1,421 4 % Net interest margin 4.14 % 4.77 % (0.63 )% Average loans to average interest-earning assets 74.50 % 74.23 % Average loans to average total deposits 80.62 % 81.84 % Average non-interest deposits to average total deposits 34.77 % 33.50 % Average interest-earning assets to average interest-bearing liabilities 158.11 % 156.46 % 1 Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled $2.9 million and $1.6 million in the first six months of 2020 and 2019 , respectively. 2 Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loan balances were $14.7 million and $17.0 million in the first six months of 2020 and 2019 , respectively . 3 Consists of interest bearing deposits in other banks. 4 Consists of investment debt securities available for sale, equity securities, investment securities held to maturity, and investment in Federal Home Loan Bank stock. 53 The following tables set forth the changes in consolidated net interest income attributable to changes in volume and to changes in interest rates for the six-month periods ending June 30, 2020 and 2019 . 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 rates: (In Thousands) Six Months Ended June 30, 2020 vs. 2019 Increase (decrease) due to Volume Rate Total Interest Income: Loans $3,235 ($1,186 ) $2,049 Loans held for sale 581 (147 ) 434 Short-term investments 237 (248 ) (11 ) Long-term investments (210 ) (103 ) (313 ) Total interest income $3,843 ($1,684 ) $2,159 Interest Expense: Interest-bearing deposits $458 $245 $703 Borrowings (3 ) 38 35 Total interest expense $455 $283 $738 Provision for Loan Losses The provision for loan losses increased to $404,000 for the second quarter of 2020 compared to $300,000 in the second quarter of 2019 due to an increase in qualitative factors based on management's assessment of increased risks in our loan portfolio primarily associated with the COVID-19 pandemic and the reduction in oil prices compared to the prior year. The ratio of the Allowance to total nonperforming loans, net of government guarantees was 162% at June 30, 2020 and 137% at December 31, 2019. The provision for loan losses was $2.5 million for the first half of 2020 as compared to $1.1 million for the first six months of 2019. Similar to the second quarter of 2020 compared to the second quarter of 2019, the increase is mostly due to an increase in the qualitative factors based on management's assessment of increased risks in our loan portfolio primarily associated with the COVID-19 pandemic and the reduction in oil prices compared to the prior year. See "Analysis of Allowance for Loan Losses" under the "Financial Condition-Balance Sheet Overview" and Note 5 of the Notes to Consolidated Financial Statements included in Item 1 of this report for more information on changes in the Company's Allowance. Other Operating Income Other operating income for the three-month period ended June 30, 2020 , increased $8.0 million , or 83%, to $17.5 million as compared to $9.6 million the same period in 2019 , primarily due to the $9.3 million increase in mortgage banking income in the second quarter of 2020 compared to the same quarter in 2019. This increase in mortgage banking income in the three months ended June 30, 2020 as compared to the same period in 2019 was primarily due to increased refinance activity due to changes in the mortgage interest rates. The increase in mortgage banking income in the second quarter of 2020 was only partially offset by a decrease of $717,000 in interest rate swap income, as well as a smaller decrease in purchased receivable income, due to customers reportedly using PPP funds instead of selling receivables, and a decrease in service charges on deposit accounts due to customer accommodations related to the impacts of COVID19 as compared to the second quarter of 2019. 54 Other Operating Expense Other operating expense for the second quarter of 2020 increased $2.9 million , or 14% , to $22.7 million as compared to the same period in 2019 primarily due to higher salaries and other personnel expense related to mortgage banking operations, which fluctuate with production volumes, as well as higher data processing costs in the community banking segment due to charges for additional products and services. Income Taxes The provision for income taxes for the second quarter of 2020 increased $868,000 , or 76% , as compared to the same period in 2019 . The provision for income taxes in the first half of 2020 decreased $49,000, or 2%, as compared to the first half of 2019. The increase in the three-month period ending June 30, 2020 as compared to the same period in 2019 was primarily due to the increase in pretax income. The effective tax rate decreased to 17% in the three and six-month periods ending June 30, 2020 as compared to 21% in both the three and six-month periods ending June 30, 2019 primarily due to the reversal of a $454,000 accrual for a potential increase in tax expense related to an audit that was performed in 2018 by the State of Alaska for tax years 2014-2016. The Company appealed the State of Alaska's decision on this matter and reversed this accrual in the second quarter of 2020 because the Company believes that it is more likely than not that the court will rule in the Company's favor. FINANCIAL CONDITION Balance Sheet Overview Portfolio Investments Portfolio investments at June 30, 2020 decreased 26%, or $74.0 million, to $210.1 million from $284.1 million at December 31, 2019 as proceeds from sales, maturities, and security calls were used for loan fundings in the first six months of 2020. The table below details portfolio investment balances by portfolio investment type: June 30, 2020 December 31, 2019 Dollar Amount Percent of Total Dollar Amount Percent of Total (In Thousands) Balance % of total Balance % of total U.S. Treasury and government sponsored entities $140,003 66.6 % $211,852 74.6 % Municipal securities 2,327 1.1 % 3,297 1.2 % Corporate bonds 32,043 15.3 % 35,066 12.3 % Collateralized loan obligations 27,974 13.3 % 25,923 9.1 % Preferred stock 7,758 3.7 % 7,945 2.8 % Total portfolio investments $210,105 $284,083 Loans and Lending Activities Our loan products include short and medium-term commercial loans, commercial credit lines, construction and real estate loans, and consumer loans. From our inception, we have emphasized commercial, land development and home construction, and commercial real estate lending. This type of lending has generally provided us with market opportunities and higher net interest margins than other types of lending. However, it also involves greater risks, including greater exposure to changes in local economic conditions, than certain other types of lending. 55 Portfolio loans increased by $389.8 million, or 37%, to $1.433 billion at June 30, 2020 from $1.043 billion at December 31, 2019 , primarily as a result of increased commercial loans due to the Company's participation in the SBA PPP. PPP loans are included in commercial loans in the table below and totaled $353.5 million at June 30, 2020 and zero at December 31, 2019. As shown in the table below, real estate construction one-to-four family, real estate term owner occupied and real estate term non-owner occupied loans also increased in the first six months of 2020.These increases were partially offset by smaller decreases in consumer loans and real estate term other loans in the first six months of 2020. Real estate construction one-to-four family loans, which are mostly residential housing construction loans decreased slightly to 3% of portfolio loans at June 30, 2020 compared to 4% at December 31, 2019 . The following table details loan balances by loan type as of the dates indicated: June 30, 2020 December 31, 2019 Dollar Amount Percent of Total Dollar Amount Percent of Total (In Thousands) Commercial $780,160 54.3 % $412,690 39.5 % Real estate construction one-to-four family 38,318 2.7 % 38,818 3.7 % Real estate construction other 76,146 5.3 % 61,808 5.9 % Real estate term owner occupied 154,741 10.8 % 138,891 13.3 % Real estate term non-owner occupied 319,257 22.3 % 312,960 30.0 % Real estate term other 41,276 2.9 % 42,506 4.1 % Consumer secured by 1st deeds of trust 14,510 1.0 % 16,198 1.6 % Consumer other 23,800 1.7 % 24,585 2.4 % Subtotal $1,448,208 $1,048,456 Less: Unearned origination fee, net of origination costs (15,007 ) (1.0 )% (5,085 ) (0.5 )% Total loans $1,433,201 $1,043,371 The above table includes $353.5 million SBA PPP loans within the Commercial loan segment. Additionally, unearned origination fee, net of origination costs includes $9.8 million associated with SBA PPP loans. 56 Information about loans directly exposed to the oil and gas industry The Company defines "direct exposure" to the oil and gas industry as companies that it has identified as significantly reliant upon activity related to the oil and gas industry, such as oilfield services, lodging, equipment rental, transportation, and other logistic services specific to the industry. The Company estimates that $70.2 million, or approximately 5% of loans as of June 30, 2020 have direct exposure to the oil and gas industry as compared to $79.2 million, or approximately 8% of loans as of December 31, 2019 . The Company has no loans to oil producers or exploration companies as of June 30, 2020 or December 31, 2019, but the totals noted include a loan related to construction of an oil rig. The balance of this loan was $7.7 million and $14.2 million at June 30, 2020 and December 31, 2019 , respectively, and is classified as an Asset Quality Rating ("AQR") system pass loan in both periods. The Company's unfunded commitments to borrowers that have direct exposure to the oil and gas industry were $51.9 million and $31.1 million at June 30, 2020 and December 31, 2019 , respectively. The portion of the Company's Allowance that related to the loans with direct exposure to the oil and gas industry was estimated at $1.3 million as of June 30, 2020 and $1.6 million as of December 31, 2019 . The following table details loan balances by loan segment and class of financing receivable for loans with direct oil and gas exposure as of the dates indicated: (In Thousands) Commercial Real estate construction one-to-four family Real estate construction other Real estate term owner occupied Real estate term non-owner occupied Real estate term other Consumer secured by 1st deeds of trust Consumer other Total June 30, 2020 AQR Pass $52,940 $— $— $4,083 $— $— $— $2,120 $59,143 AQR Special Mention 717 — — 1,723 6,687 — — — 9,127 AQR Substandard 1,942 — — — — — — — 1,942 Total $55,599 $— $— $5,806 $6,687 $— $— $2,120 $70,212 December 31, 2019 AQR Pass $62,345 $— $— $4,153 $— $— $— $361 $66,859 AQR Special Mention 450 — — 1,900 6,916 — — — 9,266 AQR Substandard 3,070 — — — — — — — 3,070 Total $65,865 $— $— $6,053 $6,916 $— $— $361 $79,195 Supplemental information about significant COVID-19 exposure on directly impacted industries In addition, at June 30, 2020, the Company had $63.4 million, or 4% of portfolio loans, in the tourism sector, $56.0 million, or 5% of portfolio loans, in the aviation (non-tourism) sector, $51.5 million, or 4% of total loans, in the healthcare sector, $23.9 million, or 2%, in retail loans and $23.5 million, or 2% in the restaurant sector, and $34.4 million, or 2% in the accommodations sector. The portion of the Company's Allowance that related to the loans with exposure to these industries is estimated at the following amounts as of June 30, 2020: (In Thousands) Tourism Aviation (non-tourism) Healthcare Retail Restaurant Accommodations Total Allowance $1,213 $1,082 $885 $437 $449 $652 $4,718 Analysis of Allowance for Loan Losses The Company maintains an Allowance to reflect management's assessment of probable, estimable losses inherent in the loan portfolio. The Allowance is increased by provisions for loan losses and loan recoveries and decreased by loan charge-offs. The size of the Allowance is determined through quarterly assessments of probable estimated losses in the loan portfolio. Our methodology for making such assessments and determining the adequacy of the Allowance includes the following key elements: • A specific allocation for impaired loans. Management determines the fair value of the majority of these loans based on the underlying collateral values. This analysis is based upon a specific analysis for each impaired loan, including external appraisals on loans secured by real property, management’s assessment of the current market, recent payment history, 57 and an evaluation of other sources of repayment. In-house evaluations of fair value are used in the impairment analysis in some situations. Inputs to the in-house evaluation process include information about sales of comparable properties in the appropriate markets and changes in tax assessed values. The Company obtains appraisals on real and personal property that secure its loans during the loan origination process in accordance with regulatory guidance and its loan policy. The Company obtains updated appraisals on loans secured by real or personal property based upon its assessment of changes in the current market or particular projects or properties, information from other current appraisals, and other sources of information. Appraisals may be adjusted downward by the Company based on its evaluation of the facts and circumstances on a case by case basis. External appraisals may be discounted when management believes that the absorption period used in the appraisal is unrealistic, when expected liquidation costs exceed those included in the appraisal, or when management’s evaluation of deteriorating market conditions warrants an adjustment. Additionally, the Company may also adjust appraisals in the above circumstances between appraisal dates. The Company uses the information provided in these updated appraisals along with its evaluation of all other information available on a particular property as it assesses the collateral coverage on its performing and nonperforming loans and the impact that may have on the adequacy of its Allowance. The specific allowance for impaired loans, as well as the overall Allowance, may increase based on the Company’s assessment of updated appraisals. See Note 11 of the Notes to Consolidated Financial Statements included in Item 1 of this report for further discussion of the Company’s estimation of impaired loans measured at fair value. When the Company determines that a loss has occurred on an impaired loan, a charge-off equal to the difference between carrying value and fair value is recorded. If a specific allowance is deemed necessary for a loan, and then that loan is partially charged off, the loan remains classified as a nonperforming loan after the charge-off is recognized. • A general allocation - The Company has identified segments and classes of loans not considered impaired for purposes of establishing the general allocation allowance. The Company disaggregates the loan portfolio into segments and classes based on its assessment of how different pools of loans with like characteristics in the portfolio behave over time. This determination is based on historical experience and management’s assessment of how current facts and circumstances are expected to affect the loan portfolio. The Company first disaggregates the loan portfolio into the following eight segments: commercial, real estate construction one-to-four family, real estate construction other, real estate term owner occupied, real estate term non-owner occupied, real estate term other, consumer secured by 1st deeds of trust, and other consumer loans. After division of the loan portfolio into segments, the Company then further disaggregates each of the segments into classes. The Company has a total of five classes, which are based off of the Company's loan risk grading system known as the AQR system. The risk ratings are discussed in Note 5 to the Consolidated Financial Statements included in Item 1 of this report. There are five loan classes: pass (pass AQR grades, which are grades 1 – 6), special mention, substandard, doubtful, and loss. There have been no changes to these loan classes in 2020. After the portfolio has been disaggregated into segments and classes, the Company calculates a general reserve for each segment and class based on the average loss history for each segment and class. The Company utilizes a lookback period of five years in the calculation of average historical loss rates. After the Company calculates a general allocation using our loss history, the general reserve is then adjusted for qualitative factors by segment and class. Qualitative factors are based on management’s assessment of current trends that may cause losses inherent in the current loan portfolio to differ significantly from historical losses. Some factors that management considers in determining the qualitative adjustment to the general reserve include our concentration of large borrowers; national and local economic trends,including impacts related to COVID-19; general business conditions; trends in local real estate markets; economic, political, and industry specific factors that affect resource development in Alaska; effects of various political activities; peer group data; and internal factors such as underwriting policies and expertise of the Company’s employees. • An unallocated reserve - The unallocated portion of the Allowance provides for other credit losses inherent in our loan portfolio that may not have been contemplated in the specific and general components of the Allowance, and it acknowledges the inherent imprecision of all loss prediction models. The unallocated component is reviewed periodically based on trends in credit losses and overall economic conditions. At June 30, 2020 and December 31, 2019 , the unallocated allowance as a percentage of the total Allowance was 10% and 11% , respectively. 58 The following table sets forth information regarding changes in the Allowance for the periods indicated: Three Months Ended June 30, Six Months Ended June 30, (In Thousands) 2020 2019 2020 2019 Balance at beginning of period $21,017 $20,209 $19,088 $19,519 Charge-offs: Commercial 804 64 955 173 Consumer other — 4 14 4 Total charge-offs 804 68 969 177 Recoveries: Commercial 30 48 56 92 Real estate term other 1 25 1 27 Consumer other 5 4 13 7 Total recoveries 36 77 70 126 Net, charge-offs 768 (9 ) 899 51 Provision for loan losses 404 300 2,464 1,050 Balance at end of period $20,653 $20,518 $20,653 $20,518 While management believes that it uses the best information available to determine the Allowance, unforeseen market conditions and other events could result in adjustment to the Allowance, and net income could be significantly affected if circumstances differed substantially from the assumptions used in making the final determination of the Allowance. Moreover, bank regulators frequently monitor banks' loan loss allowances, and if regulators were to determine that the Company’s Allowance is inadequate, they may require the Company to increase the Allowance, which may adversely impact the Company’s net income and financial condition. Deposits Deposits are the Company’s primary source of funds. Total deposits increased $365.0 million , or 27% , to $1.737 billion as of June 30, 2020 compared to $1.372 billion as of December 31, 2019 . This increase is primarily due to funding PPP loans, but is also due to new client relationships as a result of the Company's significant PPP efforts during the second quarter of 2020. The following table summarizes the Company's composition of deposits as of the periods indicated: June 30, 2020 December 31, 2019 (In thousands) Balance % of total Balance % of total Demand deposits $680,033 40 % $451,896 33 % Interest-bearing demand 400,138 23 % 320,264 23 % Savings deposits 261,934 15 % 229,918 17 % Money market deposits 215,735 12 % 205,801 15 % Time deposits 179,519 10 % 164,472 12 % Total deposits $1,737,359 $1,372,351 The Company’s mix of deposits continues to contribute to a low cost of funds with balances in transaction accounts representing 90% of total deposits at June 30, 2020 and 88% of total deposits at December 31, 2019 . The only deposit category with stated maturity dates is certificates of deposit. At June 30, 2020 , the Company had $179.5 million in certificates of deposit as compared to certificates of deposit of $164.5 million at December 31, 2019 . At June 30, 2020 , $130.8 million, or 73%, of the Company’s certificates of deposits are scheduled to mature over the next 12 months as compared to $90.5 million, or 55%, of total certificates of deposit at December 31, 2019 . The aggregate amount of certificates of deposit in amounts of $100,000 and greater at June 30, 2020 and December 31, 2019 , was $134.6 million and $118.9 million, respectively. The following table sets forth the amount outstanding of deposits in amounts of $100,000 and greater by time remaining until maturity and percentage of total deposits as of June 30, 2020 : 59 Time Certificates of Deposit of $100,000 or More Percent of Total Deposits (In Thousands) Amount Amounts maturing in: Three months or less $27,843 21 % Over 3 through 6 months 24,912 19 % Over 6 through 12 months 43,624 32 % Over 12 months 38,270 28 % Total $134,649 100 % There were no depositors with deposits representing 10% or more of total deposits at June 30, 2020 or December 31, 2019 . Borrowings FHLB: The Bank is a member of the Federal Home Loan Bank of Des Moines (the "FHLB"). As a member, the Bank is eligible to obtain advances from the FHLB. FHLB advances are dependent on the availability of acceptable collateral such as marketable securities or real estate loans, although all FHLB advances are secured by a blanket pledge of the Bank’s assets. At June 30, 2020 , our maximum borrowing line from the FHLB was $901.1 million , approximately 45% of the Bank’s assets, subject to the FHLB’s collateral requirements. The Company has outstanding advances of $11.8 million as of June 30, 2020 which were originated to match fund low income housing projects that qualify for long term fixed interest rates. The first advance is a $2.0 million FHLB Community Investment Program advance which was originated on March 22, 2013. It has an 18 year term with a 30 year amortization period, which mirrors the term of the term real estate loan made to the borrower, and a fixed rate of 3.12%. The second advance is a $2.2 million FHLB Community Investment Cash Advance Program advance that was originated in the second quarter of 2016. This advance has a 20 year term with a 30 year amortization period, which mirrors the term of the term real estate loan made to the borrower, and a fixed interest rate of 2.61%. The third advance is a $3.0 million FHLB Community Investment Cash Advance Program advance that was originated in the third quarter of 2017. This advance has a 20 year term with a 30 year amortization period and a fixed interest rate of 3.25%, which mirrors the term of the loan made to the borrower. The fourth advance is a $1.0 million FHLB Community Investment Cash Advance Program advance that was originated in the third quarter of 2019. This advance has a 20 year term with a 30 year amortization period and a fixed interest rate of 2.69%, which mirrors the term of the loan made to the borrower. The fourth advance is a $769,000 FHLB Community Investment Cash Advance Program advance that was originated in the third quarter of 2019. This advance has a 20 year term with a 30 year amortization period and a fixed interest rate of 2.69%, which mirrors the term of the loan made to the borrower. The fifth advance is a $2.2 million FHLB Community Investment Cash Advance Program advance that was originated in the second quarter of 2020. This advance has a 18 year term with a 30 year amortization period and a fixed interest rate of 1.63%, which mirrors the term of the loan made to the borrower. The last advance is a $762,000 FHLB Community Investment Cash Advance Program advance that was originated in the second quarter of 2020. This advance has a 18 year term with a 16.8 year amortization period and a fixed interest rate of 1.23%, which mirrors the term of the loan made to the borrower. All of these FHLB advances are included in borrowings. Federal Reserve Bank: The Federal Reserve Bank of San Francisco (the "Federal Reserve Bank") is holding $86.9 million of loans as collateral to secure advances made through the discount window on June 30, 2020 . There were no discount window advances outstanding at June 30, 2020 or December 31, 2019 , respectively. The Company utilized the Federal Reserve Bank's PPPLF to fund SBA PPP loans during the second quarter of 2020, but has repaid those funds in full. This advance had an interest rate of 0.35%. The average balance outstanding of PPPLF was $45.2 million and $22.6 million during the three and six-month periods ending June 30, 2020, respectively. Other Short-term Borrowings: Securities sold under agreements to repurchase were zero for June 30, 2020 and December 31, 2019 , respectively. The average balance outstanding of securities sold under agreements to repurchase during the three-month periods ending June 30, 2020 and 2019 was zero and $26.8 million, respectively, and zero and $30.3 million, respectively, in the six-month periods ending June 30, 2020 and 2019. The maximum outstanding at any month-end was zero and $36.6 million, respectively, during the same three and six-month periods ending June 30, 2020 and 2019 . The securities sold under agreements to repurchase were held by the FHLB under the Company’s control. 60 The Company is subject to provisions under Alaska state law, which generally limit the amount of outstanding debt to 15% of total assets or $300.4 million at June 30, 2020 and $244.7 million at December 31, 2019 . As of April 7, 2020, the State of Alaska increased this limit to 35% of total assets. At June 30, 2020 and December 31, 2019 , the Company had no short-term (original maturity of one year or less) borrowings that exceeded 30% of shareholders’ equity. Long-term Borrowings. The Company had no long-term borrowing outstanding other than the FHLB advances noted above as of June 30, 2020 or December 31, 2019 . Liquidity and Capital Resources The Company is a single bank holding company and its primary ongoing source of liquidity is from dividends received from the Bank. Such dividends arise from the cash flow and earnings of the Bank. Banking regulations and regulatory authorities may limit the amount of, or require the Bank to obtain certain approvals before paying, dividends to the Company. Given that the Bank currently meets and the Bank anticipates that it will continue to meet, all applicable capital adequacy requirements for a “well-capitalized” institution by regulatory standards, the Company expects to continue to receive dividends from the Bank during the remainder of 2020. The Company manages its liquidity through its Asset and Liability Committee. Our primary sources of funds are customer deposits and advances from the FHLB. These funds, together with loan repayments, loan sales, other borrowed funds, retained earnings, and equity are used to make loans, to acquire securities and other assets, and to fund deposit flows and continuing operations. The primary sources of demands on our liquidity are customer demands for withdrawal of deposits and borrowers' demands that we advance funds against unfunded lending commitments. Our total unfunded commitments to fund loans and letters of credit at June 30, 2020 were $ 335.4 million. We do not expect that all of these loans are likely to be fully drawn upon at any one time. Additionally, as noted above, our total deposits at June 30, 2020 were $1.737 billion . As shown in the Consolidated Statements of Cash Flows included in Part I - Item 1 "Financial Statements" of this report, net cash used by operating activities was $46.6 million for the first six months of 2020, primarily due to cash provided by proceeds from the sale of loans held for sale being more than offset by cash used in connection with the origination of loans held for sale. Net cash used by investing activities was $316.6 million for the same period, primarily due to increases in loans, in particular PPP loans. This use of cash was only partially offset by proceeds from the maturity of securities available for sale. Net cash provided by financing activities in the same period was $357.2 million , primarily due to increases in deposits largely due to funding PPP loans that was done via deposit into customer accounts. This increase was only partially offset by the repurchase of common stock and cash dividends paid to shareholders. The sources by which we meet the liquidity needs of our customers are current assets and borrowings available through our correspondent banking relationships and our credit lines with the Federal Reserve Bank and the FHLB. As customers withdraw funds from deposit accounts that were obtained from the Company via PPP loans, the Company may need to borrow funds to meet an immediate liquidity need. At June 30, 2020 , our funds available for borrowing under our existing lines of credit were $ 964.9 million . Additionally, the Company can obtain additional nonrecourse borrowings under the Federal Reserve Bank's newly created PPPLF as a source of additional liquidity in order to meet liquidity needs created by the origination of PPP loans without excessive usage of the Company's other existing liquidity sources. The Company had $239.2 million in PPP loans eligible to be pledged for the PPPLF program as of June 30, 2020. Given these sources of liquidity and our expectations for customer demands for cash and for our operating cash needs, we believe our sources of liquidity to be sufficient to fund our ongoing operating activities and our anticipated capital requirements for at least 12 months. The Company issued 1,946 shares of its common stock in the first six months of 2020 and repurchased 192,709 shares of its common stock under the Company's previously announced repurchase program. The Company suspended its stock repurchase activities on March 26, 2020. At June 30, 2020 , the Company had 6,368,046 shares of its common stock outstanding. Capital Requirements and Ratios We are subject to minimum capital requirements. Federal banking agencies have adopted regulations establishing minimum requirements for the capital adequacy of banks and bank holding companies. The requirements address both risk-based capital and leverage capital. We believe as of June 30, 2020 , that the Company and the Bank met all applicable capital adequacy requirements for a “well-capitalized” institution by regulatory standards. 61 The table below illustrates the capital requirements in effect for the periods noted for the Company and the Bank and the actual capital ratios for each entity that exceed these requirements. Management intends to maintain capital ratios for the Bank in 2020, exceeding the FDIC’s requirements for the “well-capitalized” classification. The capital ratios for the Company exceed those for the Bank primarily because the $10 million trust preferred securities offering completed in the fourth quarter of 2005 is included in the Company’s capital for regulatory purposes, although they are accounted for as a long-term debt in our financial statements. The trust preferred securities are not accounted for on the Bank’s financial statements nor are they included in its capital. As a result, the Company has $10 million more in regulatory capital than the Bank at both June 30, 2020 and December 31, 2019 , which explains most of the difference in the capital ratios for the two entities. Minimum Required Capital Well-Capitalized Actual Ratio Company Actual Ratio Bank June 31, 2020 Total risk-based capital 8.00% 10.00% 15.24% 13.44% Tier 1 risk-based capital 6.00% 8.00% 13.99% 12.18% Common equity tier 1 capital 4.50% 6.50% 13.32% 12.19% Leverage ratio 4.00% 5.00% 11.92% 9.06% December 31, 2019 Total risk-based capital 8.00% 10.00% 15.63% 13.24% Tier 1 risk-based capital 6.00% 8.00% 14.38% 11.98% Common equity tier 1 capital 4.50% 6.50% 13.69% 11.98% Leverage ratio 4.00% 5.00% 12.41% 10.36% See Note 24 of the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2019 for a detailed discussion of the capital ratios. The requirements for "well- capitalized" come from the Prompt Corrective Action rules. See Item 1 - Business - Supervision and Regulation in the Company's Annual Report on Form 10-K for the year ended December 31, 2019. These rules apply to the Bank but not to the Company. Under the rules of the Federal Reserve Bank, a bank holding company such as the Company is generally defined to be "well capitalized" if its Tier 1 risk-based capital ratio is 8.0% or more and its total risk-based capital ratio is 10.0% or more. Off-Balance Sheet Items The Company is a party to financial instruments with off-balance sheet risk. Among the off-balance sheet items entered into in the ordinary course of business are commitments to extend credit, commitments to originate loans held for sale and the issuance of letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized on the balance sheet. Certain commitments are collateralized. We apply the same credit standards to these commitments as in all of our lending activities and include these commitments in our lending risk evaluations. As of June 30, 2020 and December 31, 2019 , the Company’s commitments to extend credit and to provide letters of credit which are not reflected on its balance sheet amounted to $335.4 million and $301.9 million, respectively. Additionally, the Company had commitments to originate loans held for sale of $206.3 million and $48.8 million, as of June 30, 2020 and December 31, 2019 , respectively. Since many of the commitments are expected to expire without being drawn upon, these total commitment amounts do not necessarily represent future cash requirements. The Company has established reserves of $167,000 and $152,000 at June 30, 2020 and December 31, 2019 respectively, for losses related to these commitments that are recorded in other liabilities on the consolidated balance sheet. Capital Expenditures and Commitments The Company has capital commitments related to improvements to the Company's corporate office building. At June 30, 2020 the Company considers these commitments to be immaterial. 62 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our assessment of market risk as of June 30, 2020 indicates that there are no material changes in the quantitative and qualitative disclosures from those in our Annual Report on Form 10-K for the year ended December 31, 2019 .