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Item 7. Management’s Discussion and Analysis

2021-03-05 compared with 2020-03-06 · 288 added, 235 removed, 628 unchanged (45% of the section changed)

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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.

Item 8 of this report.

Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 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, 2019.

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Significant items contributing to the increase in 2020 compared to 2019 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;

a benefit in the provision for loan losses primarily resulting from improvements in credit quality and recoveries.

• an increase in mortgage banking income due to increased mortgage production and refinance activity;

• an increase in net interest income resulting from higher average net interest-earning asset balances.

Highlights for the year ended December 31, 2020 are as follows:

• Total revenues, which include net interest income plus other operating income, increased 32% to $134.0 million in 2020 from $101.8 million in 2019.

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 .

This increase mainly reflects increases in net interest income and mortgage banking income.

These increases were partially offset by a decreases in purchased receivable income and unrealized gains on marketable equity securities.

• The net interest margin decreased to 4.02% in 2020 from 4.65% in 2019 mostly due to a decrease in average yields on interest earning assets to 4.36% in 2020 compared to 5.05% in 2019 as a result of lower interest rates.

Additionally, the mix of earning assets, specifically the addition of lower yielding PPP loans, also contributed to the decrease in the net interest margin in 2020 as compared to the prior year.

• The provision for loan losses increased in 2020 to a provision of $2.4 million from a benefit of $1.2 million in 2019 primarily due to management's assessment of risks associated with the COVID-19 pandemic, which were only partially offset by improvement in the overall credit quality of the loan portfolio.

Our nonperforming loans, net of government guarantees, decreased to $10.0 million at the end of 2020 compared to $14.0 million at the end of 2019, while total adversely classified loans, net of government guarantees at December 31, 2020 decreased to $12.8 million from $22.3 million at December 31, 2019.

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• The Company repurchased 327,000 shares of its common stock in 2020 at an average price of $30.51 per share.

COVID-19 Issues:

• Industry Exposure:

Northrim has identified various industries that may be adversely impacted by the COVID-19 pandemic and the decline in oil prices that occurred in 2020.

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 December 31, 2020 are being impacted:

Tourism (5%), Oil and Gas (4%), Aviation (non-tourism) (4%), Healthcare (7%), Accommodations (3%), Retail (1%) and Restaurants (2%).

The Company's exposure as a percent of the total loan portfolio excluding PPP loans as of December 31, 2020 are:

Tourism (7%), Oil and Gas (6%), Aviation (non-tourism) (5%), Healthcare (8%), Accommodations (3%), Retail (2%) and Restaurants (3%).

• Customer Accommodations:

The Company has implemented several forms of assistance to help customers experiencing financial challenges as a result of COVID-19 in addition to our participation in PPP lending.

The provisions of the CARES Act included an election to not apply the guidance on accounting for certain troubled debt restructurings related to COVID-19 and allow certain accommodations to borrowers.

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 Company has elected to adopt these provisions of the CARES Act.

The outstanding principal balance of loan modifications due to the economic impacts of COVID-19 for the periods below were as follows:

Loan Modifications due to COVID-19 as of December 31, 2020

(Dollars in thousands) Interest Only Full Payment Deferral Total

Portfolio loans $43,379 $22,165 $65,544

Number of modifications 23 11 34

Loan Modifications due to COVID-19 as of September 30, 2020

(Dollars in thousands) Interest Only Full Payment Deferral Total

Portfolio loans $46,056 $74,337 $120,393

Number of modifications 16 59 75

Loan Modifications due to COVID-19 as of June 30, 2020

(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 less than 1% of total loan modifications identified above.

Of the $65.5 million and 34 loan modifications as of December 31, 2020, approximately $53.9 million and 31 loans have entered into a second modification.

• Loan Loss Reserve:

The Company booked a loan loss provision of $2.4 million in 2020 compared to a benefit for loan loss provisions of $1.2 million in 2019.

• Credit Quality:

Net adversely classified loans were $12.8 million at December 31, 2020, compared to $22.3 million at December 31, 2019.

• Branch Operations:

All branches are fully operational, while a number of customer and employee safety measure continue to be implemented.

• Growth and Paycheck Protection Program:

• Northrim funded 2,888 PPP loans totaling $375.6 million to both existing and new customers in 2020.

• According to the SBA, the Company originated more 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 September 30, 2020.

• As of December 31, 2020, Northrim customers had received forgiveness through the SBA on 537 PPP loans totaling $65.1 million.

• The Company initially utilized the Federal Reserve Bank's Paycheck Protection Program Liquidity Facility (the "PPPLF") to fund PPP loans, but paid those funds back in full during the second quarter and has since funded the PPP loans through core deposits and maturity of long-term investments.

• Capital Management:

At December 31, 2020, the capital of Northrim Bank (the "Bank") was well in excess of all regulatory requirements.

Critical Accounting Policies

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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.

Examples of such factors include the risk as to current 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.

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The Company performed its annual goodwill impairment testing at December 31, 2020 and 2019 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.

At December 31, 2020, the Company performed its annual impairment test by performing a quantitative assessment.

The Company estimated the fair value of the Company using two valuation methodologies including a control premium approach and a discounted cash flow approach.

We then compared the estimated fair value of each segment to the carrying value and concluded that no potential impairment existed at of December 31, 2020

Valuation of OREO:

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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”).

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (“ASU 2016-13” or "CECL").

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.

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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.

Early application was permitted for specified periods.

The Company early adopted ASU 2016-13 on January 1, 2021 after finalizing data and model validation and our internal governance framework.

The guidance was applied on a modified retrospective basis with the cumulative effect of initially applying the amendments recognized in retained earnings at January 1, 2021.

However, certain provisions of the guidance are only required to be applied on a prospective basis.

Adoption of CECL as of January 1, 2021 resulted in an allowance for loan losses of $16.6 million, which is a $4.5 million decrease in the allowance under the incurred loss model as of December 31, 2020.

This decrease will increase the Company's total shareholder's equity by $3.2 million.

The reduction reflects a 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, 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.

In most instances the Company believes that the ACL for residential mortgage loans with long or indeterminate maturities would lead to an increase in the ACL.

Adoption of CECL as of January 1, 2021 resulted in a reserve for unfunded commitments of $1.4 million, which is a $1.2 million increase in the reserve under the incurred loss model as of December 31, 2020.

This increase will decrease the Company's total shareholder's equity by $880,000.

See the “A ccounting pronouncements to be implemented in future periods ” section in Note 1 of the Notes to Consolidated Financial Statements included in Part II.

Item 8 of this report for further discussion of the Company's implementation of CECL.

RESULTS OF OPERATIONS

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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.

We also generate other income primarily through mortgage banking income, purchased receivables products, 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 .

We earned net income of $32.9 million in 2020, compared to net income of $20.7 million in 2019.

During these periods, net income per diluted share was $5.11 and $3.04, 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.

The increase in net income in 2020 compared to 2019 was primarily due to increases in other operating income, specifically mortgage banking income, as well as improved net interest income.

Net Interest Income / Net Interest Margin

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Net interest income in 2020 was $70.7 million, compared to $64.4 million in 2019.

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.

The increase in 2020 as compared to 2019 was the result of higher net average interest-earning asset balances which was only partially offset by a decrease in net interest income as a result of decreased interest rates.

Additionally, the Company recognized $5.6 million in loan fee income from PPP loans in 2020.

During 2020 and 2019, net interest margins were 4.02% and 4.65%, 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.

The decrease in net interest margin in 2020 as compared to 2019 is the result of decreases in the spread between the average yield on interest-earning assets and the average cost of interest-bearing liabilities which was impacted by a decrease in interest rates.

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.

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Years ended December 31, 2020 2019 2018

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

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)

$1,339,908 $67,876 5.07 % $1,010,098 $59,919 5.93 % $971,548 $55,526 5.72 %

Loans held for sale 105,287 3,215 3.05 % 56,344 2,231 3.96 % 46,089 2,016 4.37 %

Long-term Investments (3)

247,384 5,316 2.15 % 273,711 7,011 2.56 % 286,426 5,829 2.04 %

Short-term investments (4)

66,260 309 0.47 % 46,404 922 1.99 % 42,386 806 1.90 %

Total interest-earning assets $1,758,839 $76,716 4.36 % $1,386,557 $70,083 5.05 % $1,346,449 $64,177 4.77 %

Noninterest-earning assets 177,208 169,150 146,936

Total $1,936,047 $1,555,707 $1,493,385

Interest-bearing deposits $1,040,606 $5,279 0.51 % $850,202 $4,961 0.58 % $809,808 $2,307 0.28 %

Borrowings 35,918 772 2.15 % 33,730 680 1.37 % 47,570 662 1.39 %

Total interest-bearing liabilities $1,076,524 $6,051 0.56 % $883,932 $5,641 0.64 % $857,378 $2,969 0.35 %

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Other liabilities 50,192 36,968 17,521

Equity 211,721 208,602 201,022

Total $1,936,047 $1,555,707 $1,493,385

Net interest income $70,665 $64,442 $61,208

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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

(In Thousands)

2020 compared to 2019 2019 compared to 2018

Increase (decrease) due to Increase (decrease) due to

(In Thousands) Volume Rate Total Volume Rate Total

Interest Income:

Loans $17,590 ($9,633) $7,957 $2,246 $2,147 $4,393

Loans held for sale 1,336 (352) 984 374 (159) 215

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Interest-bearing deposits $763 ($445) $318 $120 $2,534 $2,654

Borrowings 9 83 92 (29) 47 18

Total interest expense $772 ($362) $410 $91 $2,581 $2,672

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.

We recorded a provision for loan losses in 2020 of $2.4 million, compared to a benefit for loan losses of $1.2 million in 2019.

The loan loss provision increased in 2020 compared to 2019 primarily due to an increase in the loan portfolio, excluding loans that are guaranteed by the government, and management's assessment about increased risks in the loan portfolio association with the economic impacts of COVID-19.

See the “Allowance for Loan Losses” section under “Financial Condition” and Note 6 of the Notes to Consolidated Financial Statements included in Part II.

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)

(In Thousands) 2020 $ Change % Change 2019 $ Change % Change 2018

Other Operating Income

Mortgage banking income $52,635 $28,434 117 % $24,201 $3,357 16 % $20,844

Purchased receivable income

Bankcard fees 2,837 (139) (5) % 2,976 165 6 % 2,811

Purchased receivable income 2,650 (621) (19) % 3,271 16 — % 3,255

Service charges on deposit accounts 1,102 (455) (29) % 1,557 49 3 % 1,508

Interest rate swap income 949 (15) (2) % 964 880 1,048 % 84

Gain (loss) on marketable equity securities

Commercial servicing revenue 527 (97) (16) % 624 (798) (56) % 1,422

Rental income 278 (219) (44) % 497 (195) (28) % 692

Other loan fees

Gain on loans acquired - APB

Gain (loss) on sale of securities 98 75 326 % 23 23 100 % —

Gain on sale of Northrim Benefits Group

Employee benefit plan income

Gain (loss) on marketable equity securities 61 (850) (93) % 911 1,536 246 % (625)

Other income 2,191 (131) (6) % 2,322 146 7 % 2,176

Total other operating income $63,328 $25,982 70 % $37,346 $5,179 16 % $32,167

2020 Compared to 2019

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.

The most significant change in other operating income in 2020 was an increase in mortgage banking income which was only partially offset by decreases in gains on marketable equity securities, as well as decreases in purchased receivable income and service charges on deposit accounts.

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 83% of total other operating income in 2020.

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.

Mortgage banking income increased in 2020 compared to 2019 mainly due to an increase in mortgage loans originated and sold as this volume increased to $1.30 billion in 2020 from $684 million in 2019.

The overall increase in mortgage originations in 2020 as compared to the prior year is primarily the result of the decrease in interest rates during the year that led to increased refinance activity.

The Company recognized $61,000 in unrealized gains on marketable equity securities in 2020, an $850,000 decrease as compared to 2019, due to market volatility.

Purchased receivable income and service charges on deposit accounts saw significant decreases as compared to 2019.

Purchased receivable income decreased as customers reportedly used PPP loans to fund liquidity needs, resulting in decreased outstanding purchased receivable balances.

Service charges on deposit accounts decreased due to customer accommodations made by the Company for customers impacted by COVID-19.

Other Operating Expense

The following table details the major components of other operating expense for the years ended December 31:

(In Thousands)

(In Thousands) 2020 $ Change % Change 2019 $ Change % Change 2018

Other Operating Expense

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Intangible asset amortization 48 (12) (20) % 60 (10) (14) % 70

Loss on sale of premise and equipment

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

OREO operating expense 658 (35) (5) % 693 (109) (14) % 802

Impairment on OREO

Rental income on OREO (509) (3) (1) % (506) 35 6 % (541)

Gains on sale of OREO

Gains on sale of OREO (391) (11) (3) % (380) (377) NM (3)

Subtotal (242) (49) (25) % (193) (451) (175) % 258

Other expenses 7,174 1,184 20 % 5,990 (1,028) (15) % 7,018

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2020 Compared to 2019

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.

Other operating expense increased by $12.3 million to $89.1 million in 2020 as compared to $76.8 million in the prior year primarily due to increases in salaries and other personnel expense, as well as smaller increases in insurance expense, professional and outside services, and data processing expense.

These increases were only partially offset by a decrease in compensation expense related to RML acquisition payments.

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.

Per the terms of the purchase agreement, no further payments are required, and therefore no additional expense for RML acquisition payments will be recorded in the future.

The $9.8 million increase in salaries and other personnel expense in 2020 as compared to 2019 is the result of the following items.

Originator commission expenses increased $5.2 million, or approximately 82% in 2020 compared to 2019 due to increased mortgage production in the home mortgage lending segment.

Additionally, overtime expense increased $1 million, or 309% in 2020 compared to 2019 due to increased mortgage production.

Salaries increased $1.6 million, or 5%, in 2020 as compared to 2019 due to salary increases and an increase in full-time equivalent employees.

Smaller increases also occurred in bonus payments and profit share expense due to the increased mortgage production in the Home Mortgage Lending segment and increased net income for the Community Banking segment.

These increases were only partially offset by a $1.6 million increase in salary deferral related to loan production costs and a $696,000 decrease in group medical insurance expense due to lower medical claims associated with the Company's self-insured employee health benefit plan.

Insurance expense increased $671,000 primarily as a result of increased FDIC insurance costs associated with asset growth.

Professional and outside services increased $626,000 due to costs associated with increased mortgage production volume.

Lastly, data processing expense increased $540,000 in 2020 as compared to 2019 due to costs for improved functionality for digital products and services and the addition of various software applications related to our lending activities.

The provision for income taxes increased $4.1 million or 76%, to $9.6 million in 2020 as compared to 2019.

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 increase in 2020 is primarily due to higher pretax income.

The Company's effective tax rates were 23% and 21% in 2020 and 2019, 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.

The changes in the Company's effective tax rates for 2020 and 2019 are primarily due to lower tax-exempt income and fewer low income housing tax credits as a percentage of pre-tax income as compared to 2019.

FINANCIAL CONDITION

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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 at December 31, 2020 decreased $17.4 million, or 6%, to $266.7 million from $284.1 million at December 31, 2019.

The decrease at December 31, 2020 as compared to December 31, 2019 is primarily due to proceeds from sales, maturities, and security calls being used for loan fundings.

The average maturity of the investment portfolio was approximately three years at December 31, 2020.

Investment securities may be pledged as collateral to secure public deposits or borrowings.

At December 31, 2020 and 2019, $77.9 million and $30.6 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 .

Pledged securities increased at December 31, 2020 as compared to December 31, 2019 primarily due to increased pledges to the FHLB to increase the Company's immediate borrowing capacity at December 31, 2020.

The following tables set forth the composition of our investment portfolio at December 31 for the years indicated:

(In Thousands)

Amortized Cost

(In Thousands) Amortized Cost Fair Value

Securities Available for Sale:

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Collateralized Loan Obligations 41,782 41,684

Total $245,871 $247,633

Treasury and government sponsored entities $210,756 $211,852

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Collateralized Loan Obligations 25,980 25,923

Total $274,788 $276,138

Treasury and government sponsored entities $209,908 $208,860

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Collateralized Loan Obligations 13,990 13,886

Preferred Stock

Total $273,126 $271,610

Marketable Equity Securities:

Preferred Stock $8,395 $9,052

Total $8,395 $9,052

Preferred Stock $7,349 $7,945

Total $7,349 $7,945

Preferred Stock $7,580 $7,265

Total $7,580 $7,265

Securities Held to Maturity:

Corporate Bonds $10,000 $10,000

Total $10,000 $10,000

Corporate Bonds $— $—

The following table sets forth the market value, maturities, and weighted average pretax yields of our investment portfolio as of December 31, 2020:

(In Thousands)

(In Thousands) 1 Year 1-5 Years 5-10 Years 10 Years Total

Securities Available for Sale:

Treasury and government sponsored entities

Balance $44,601 $130,000 $— $— $174,601

Weighted average yield 2.06 % 0.82 % — % — % 1.14 %

Municipal securities

Balance $— $856 $— $— $856

Weighted average yield — % 2.14 % — % — % 2.14 %

Corporate bonds

Balance $2,257 $28,235 $— $— $30,492

Weighted average yield 1.23 % 1.36 % — % — % 1.35 %

Collateralized loan obligations

Balance $— $— $8,720 $32,964 $41,684

Weighted average yield — % — % 1.70 % 1.60 % 1.62 %

Balance $46,858 $159,091 $8,720 $32,964 $247,633

Weighted average yield 2.02 % 0.92 % 1.70 % 1.60 % 1.25 %

Security Held to Maturity

Corporate bonds

Balance $— $— $10,000 $— $10,000

Weighted average yield — % — % 5.00 % — % 5.00 %

Marketable Equity Securities

Preferred Stock

Balance $— $— $— $9,052 $9,052

Weighted average yield — % — % — % 5.08 % 5.08 %

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However, they also involve greater risks, including greater exposure to changes in local economic conditions.

Additionally in 2020, we originated a significant amount of PPP loans and we expect to originate additional PPP loans in 2021.

All of our loans and credit lines are subject to approval procedures and amount limitations.

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The loan-to-one-borrower limitation for the Bank was $29.9 million at December 31, 2020.

At December 31, 2019 , the Company had two relationships whose total direct and indirect commitments exceeded $27.8 million;

At December 31, 2020, the Company had three relationships whose total direct and indirect commitments exceeded $29.9 million;

however, no individual direct relationship exceeded the loans-to-one borrower limitation.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Provision for Loan Losses” for further discussion of the Company's concentration of loans to large borrowers.

See “Management’s Discussion and Analysis of Financial Condition and

Results of Operations – Provision for Loan Losses” for further discussion of the Company's concentration of loans to large borrowers.

Our lending operations are guided by loan policies, which outline the basic policies and procedures by which lending operations are conducted.

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The policies are reviewed and approved annually by the board of directors of the Bank.

Our Quality Assurance Department provides a detailed financial

analysis of our largest, most complex loans.

Our Quality Assurance Department provides a detailed financial analysis of our largest, most complex loans.

In addition, the Quality Assurance Department, along with the Chief Credit Officer of the Bank, have developed processes to analyze and manage various concentrations of credit within the overall loan portfolio.

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The following table sets forth the composition of our loan portfolio by loan segment:

December 31, 2019

December 31, 2018

December 31, 2017

December 31, 2016

December 31, 2015

Dollar Amount

Percent of Total

Dollar Amount

Percent of Total

Dollar Amount

Percent of Total

Dollar Amount

Percent of Total

Dollar Amount

Percent of Total

December 31, 2020 December 31, 2019 December 31, 2018 December 31, 2017 December 31, 2016

Dollar Amount Percent of Total Dollar Amount Percent of Total Dollar Amount Percent of Total Dollar Amount Percent of Total Dollar Amount Percent of Total

(In Thousands)

Commercial $780,058 54.0 % $412,690 39.5 % $342,420 34.8 % $313,514 32.8 % $277,802 28.5 %

Real estate construction one-to-four family 38,467 2.7 % 38,818 3.7 % 37,111 3.8 % 31,201 3.3 % 26,061 2.7 %

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Consumer other 22,069 1.5 % 24,585 2.4 % 23,645 2.4 % 19,919 2.1 % 25,281 2.6 %

Subtotal $1,455,785 $1,048,456 $988,833 $959,109 $978,508

Unearned origination fee,

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We also make longer-term commercial loans secured by equipment and real estate.

We also make commercial loans that are guaranteed in large part by the Small Business Administration or the Bureau of Indian Affairs and to a lesser extent guaranteed by the United States Department of Agriculture, as well as commercial real estate loans that are purchased by the Alaska Industrial Development and Export Authority (“AIDEA”).

We also make commercial loans that are guaranteed in large part by the SBA or the Bureau of Indian Affairs and to a lesser extent guaranteed by the United States Department of Agriculture, as well as commercial real estate loans that are purchased by the Alaska Industrial Development and Export Authority (“AIDEA”).

Commercial loans increased to $780.1 million at December 31, 2020 from $412.7 million at December 31, 2019 and represented approximately 54% and 40% of our total loans outstanding as of December 31, 2020 and December 31, 2019, respectively.

The increase in commercial loans at the end of 2020 is primarily due to $310.5 million in PPP loans.

The Company originated $375.6 million PPP loans in 2020.

As of December 31, 2020, $65.1 million in PPP loans had been forgiven by the SBA.

Commercial loans reprice more frequently than other types of loans, such as real estate loans.

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We are an active lender in the commercial real estate market.

At December 31, 2019 , commercial real estate loans increased slightly to $494.4 million from $494.2 million at December 31, 2018 , and represented approximately 47% and 50% of our loan portfolio as of December 31, 2019 and December 31, 2018, respectively.

At December 31, 2020, commercial real estate loans increased to $519.3 million from $494.4 million at December 31, 2019, and represented approximately 36% and 47% of our loan portfolio as of December 31, 2020 and December 31, 2019, respectively.

These loans are typically secured by office buildings, apartment complexes or warehouses.

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The loans that AIDEA purchases typically feature a maturity twice that of the loans retained by us and bear a lower interest rate.

The blend of our and AIDEA’s loan terms allows us to provide competitive long-term financing to our customers, while reducing the risk inherent in this type of lending.

The blend of our and AIDEA’s loan terms allows

us to provide competitive long-term financing to our customers, while reducing the risk inherent in this type of lending.

We also originate and sell to AHFC loans secured by multifamily residential units.

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Additionally, we provide land development and residential subdivision construction loans.

We also originate one-to-four-family residential and condominium construction loans

to builders for construction of homes.

The Company’s construction loans decreased in 2019 to $100.6 million , down from $109.4 million in 2018 , and represented approximately 10% and 11% of our loan portfolio in December 31, 2019 and December 31, 2018, respectively.

We also originate one-to-four-family residential and condominium construction loans to builders for construction of homes.

The Company’s construction loans increased in 2020 to $118.8 million, up from $100.6 million in 2019, and represented approximately 8% and 10% of our loan portfolio in December 31, 2020 and December 31, 2019, respectively.

As of December 31, 2020, approximately $6.0 million or 5%, of the Company's construction loans were for low income housing tax credit projects as compared to $24.0 million or 24% as of December 31, 2019.

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The Company estimates that $65.1 million, or approximately 4% of loans as of December 31, 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 drilling and exploration companies as of the end of 2019 or 2018, but the $79.2 million outstanding as of December 31, 2019 noted above does include $14.2 million related to the construction of an oil rig.

The Company's exposure as a percent of the total loan portfolio excluding PPP loans as of December 31, 2020 was 6%.

The Company has no loans to oil producers or drilling and exploration companies as of the end of 2020 or 2019, but the $65.1 million outstanding as of December 31, 2020 noted above does include $3.0 million related to the construction of an oil drilling rig.

The Company's unfunded commitments to borrowers that have direct exposure to the oil and gas industry were $63.5 million and $31.1 million at December 31, 2020 and 2019, respectively.

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The following table details loan balances by loan segment asset quality rating ("AQR") and class of financing receivable for loans with direct oil and gas exposure as of the dates indicated:

(In Thousands)

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

(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

December 31, 2020

AQR Pass $46,943 $— $— $4,023 $— $— $— $— $50,966

AQR Special Mention 4,597 — — 1,541 6,606 — — — 12,744

AQR Substandard 1,412 — — — — — — — 1,412

Total loans $52,952 $— $— $5,564 $6,606 $— $— $— $65,122

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 loans $65,865 $— $— $6,053 $6,916 $— $— $361 $79,195

Supplemental information about significant COVID-19 exposure on directly impacted industries:

In addition, at December 31, 2020, the Company had $78.9 million, or 5% of portfolio loans, in the tourism sector, $56.1 million, or 4% of portfolio loans, in the aviation (non-tourism) sector, $96.9 million, or 7% of total loans, in the healthcare sector, $17.4 million, or 1%, in retail loans and $31.0 million, or 2% in the restaurant sector, and $37.2 million, or 3% in the accommodations sector.

At December 31, 2020, the Company had $78.9 million, or 7% of portfolio loans excluding PPP loans, in the tourism sector, $56.1 million, or 5% of portfolio loans excluding PPP loans, in the aviation (non-tourism) sector, $96.9 million, or 8% of total loans excluding PPP loans, in the healthcare sector, $17.4 million, or 2% of total loans excluding PPP loans, in retail loans and $31.0 million, or 3% of total loans excluding PPP loans in the restaurant sector, and $37.2 million, or 3% of total loans excluding PPP loans 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 December 31, 2020:

(In Thousands) Tourism Aviation (non-tourism) Healthcare Retail Restaurant Accommodations Total

Allowance $1,481 $1,049 $1,758 $309 $581 $695 $5,873

Maturities and Sensitivities of Loans to Change in Interest Rates:

The following table presents the aggregate maturity data of our loan portfolio, excluding loans held for sale, at December 31, 2020:

(In Thousands)

Within 1 Year

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

Commercial $133,528 $418,031 $228,499 $780,058

Real estate construction one-to-four family 36,673 1,794 — 38,467

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Consumer other 1,196 4,330 16,543 22,069

Total $238,970 $549,782 $667,033 $1,455,785

Fixed interest rate $92,040 $391,531 $175,677 $659,248

Floating interest rate 146,930 158,251 491,356 796,537

Total $238,970 $549,782 $667,033 $1,455,785

At December 31, 2020, 59% of the portfolio was scheduled to mature or reprice in 2021 with 36% scheduled to mature or reprice between 2022 and 2025.

As of December 31, 2020, approximately 44% of commercial loans are variable rate loans, of which 57% reprice within one year.

The majority of these loans reprice to an index based upon the prime rate of interest or the respective Federal Home Loan Bank of Boston (the "Boston FHLB") rate.

Approximately 38% of variable rate commercial loans reprice to an index based upon the prime rate of interest, 30% reprice based the respective Federal Home Loan Bank of Boston (the "Boston FHLB") rate, and 29% reprice based on one-month LIBOR.

The Company also uses floors in its commercial loan pricing as loans are originated or renewed during the year.

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The Company also uses floors in its commercial real estate loan pricing as loans are originated or renewed during the year.

Loans Held for Sale and Mortgage Servicing Rights:

Loans Held for Sale and Mortgage Servicing Rights ("MSRs"):

The Company originates residential mortgage loans and sells them in the secondary market through our wholly-owned subsidiary, RML.

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The Company retains servicing rights on all mortgage loans originated by RML and sold to AHFC.

Mortgages originated by RML and sold to AHFC represent approximately 23% and 32% of the mortgages originated by RML in 2019 and 2018, respectively.

Mortgages originated by RML and sold to AHFC represented approximately 16% and 23% of the mortgages originated by RML in 2020 and 2019, respectively.

MSRs are adjusted to fair value quarterly with the change recorded in mortgage banking income.

The value of MSRs at December 31, 2019 and 2018 were $11.9 million and $10.8 million, respectively.

value of MSRs at December 31, 2020 and 2019 were $11.2 million and $11.9 million, respectively.

The value of MSRs is impacted by market rates for mortgage loans primarily due to how changes in interest rates affect prepayments of mortgage loans.

To the extent loans are prepaid sooner than estimated at the time servicing assets are originally recorded, it is possible that certain residential MSR assets may decrease in value.

Generally, the fair value of our residential MSRs are expected to increase as market rates for mortgage loans rise and decrease if market rates fall.

Generally, the fair value of our residential MSRs is expected to increase as market rates for mortgage loans rise and decrease if market rates fall.

Credit Quality and Nonperforming Assets

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Nonperforming assets, net of government guarantees to total assets 0.77 % 1.21 % 1.50 % 1.89 % 1.27 %

Performing restructured loans

Performing restructured loans, net of government guarantees $832 $1,448 $3,413 $7,668 $6,131

Nonperforming loans plus performing restructured loans, net of government guarantees $10,880 $15,399 $18,107 $29,079 $19,067

Nonperforming loans plus performing restructured loans to portfolio loans, net of government guarantees

Nonperforming assets plus performing restructured loans to total assets, net of government guarantees

Nonperforming loans plus performing restructured loans, net of government guarantees to portfolio loans 0.75 % 1.48 % 1.84 % 3.05 % 1.96 %

Nonperforming assets plus performing restructured loans, net of government guarantees to total assets 0.81 % 1.30 % 1.73 % 2.40 % 1.67 %

Adversely classified loans, net of government guarantees $12,768 $22,330 $27,217 $33,845 $35,634

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There was interest income of $924,000 and $301,000 recognized in net income for 2020 and 2019, respectively, related to interest collected on nonaccrual loans whose principal has been paid down to zero.

The Company had three relationships that represented more than 10% of nonaccrual loans as of December 31, 2019 .

The Company had $1.4 million and $3.4 million in loans classified as troubled debt restructuring loans ("TDRs") that were performing as of December 31, 2019 and 2018 , respectively.

Additionally, there were $8.7 million and $11.4 million in TDRs included in nonaccrual loans at December 31, 2019 and 2018 for total TDRs of $10.1 million and $14.8 million at December 31, 2019 and 2018 , respectively.

The Company had four relationships that each represented more than 10% of nonaccrual loans as of December 31, 2020.

The Company had $832,000 and $1.4 million in loans classified as troubled debt restructuring loans ("TDRs"), net of government guarantees that were performing as of December 31, 2020 and 2019, respectively.

Additionally, there were $4.5 million and $8.7 million in TDRs included in nonaccrual loans at December 31, 2020 and 2019 for total TDRs, net of government guarantees of $5.3 million and $10.1 million at December 31, 2020 and 2019, respectively.

The decrease in TDRs at December 31, 2020 as compared to 2019 was primarily due to payoffs and paydowns on loans classified as TDRs that were only partially offset by additions to TDRs in 2020.

See Note 5 of the Notes to Consolidated Financial Statements included in Item 8 of this report for further discussion of TDRs.

See Note 5 of the Notes to Consolidated Financial Statements included in Part II.

Item 8 of this report for further discussion of TDRs.

At December 31, 2020, management had identified potential problem loans of $6.1 million as compared to potential problem loans of $9.0 million at December 31, 2019.

Potential problem loans are loans which are currently performing 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.

The $8.1 million decrease in potential problem loans at December 31, 2019 from December 31, 2018 was primarily due to the transfer of eight relationships totaling $7.0 million to nonaccrual loans, the payoff of two relationships totaling $3.8 million and $1.7 million of other loan paydowns.

These decreases were partially offset by the addition of several relationships totaling $3.5 million in 2019.

The $2.9 million decrease in potential problem loans at December 31, 2020 from December 31, 2019 was primarily due to paydowns and additional government guarantees that were partially offset by the addition of new potential problem loans in 2020.

The Company acquired other assets consisting of aircraft totaling $1.2 million in the fourth quarter of 2018 through foreclosure proceedings related to one lending relationship.

These assets were sold in the third quarter of 2019.

The Company acquired a vessel totaling $231,000 in the third quarter of 2019 through foreclosure proceedings related to one lending relationship.

The Company acquired a vessel totaling $231,000 in the third quarter of 2019 through foreclosure proceedings related to one lending relationship that is still held as of the end of 2020.

The following summarizes OREO activity for the periods indicated:

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At December 31, 2020 and 2019 the Company held $6.0 million and $5.8 million, respectively, of OREO assets, net of government guarantees.

At December 31, 2019 , OREO consists of $1.4 million in residential lots in various stages of development and a $5.6 million commercial building.

At December 31, 2020, OREO consists of $1.2 million in residential lots in various stages of development, a $5.6 million commercial building, and $490,000 of undeveloped land.

All OREO property is located in Alaska.

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Failure to cure the defaults will result in the debtor losing ownership interest in the property, which is taken by the creditor, or high bidder at a foreclosure sale.

During 2019 , the Company had no additions to OREO.

During 2019 , the Company received approximately $1.3 million in proceeds from the sale of OREO which included $1.1 million from the sale of lots and land and $214,000 from the sale of single-family residences.

The Company recognized $380,000 and $144,000 in gains and $0 and $141,000 in losses on the sale of OREO properties in 2019 and 2018 , respectively, for net gains of $380,000 and $3,000 in 2019 and 2018 , respectively.

During 2020, the Company transferred two loans to OREO totaling $652,000.

During 2020, the Company received approximately $797,000 in proceeds from the sale of OREO.

The Company recognized $391,000 and $380,000 in gains and no losses on the sale of OREO properties in 2020 and 2019, respectively.

The Company had remaining accumulated deferred gains on the sale of OREO properties of $123,000 and $231,000 at December 31, 2020 and 2019, respectively.

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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 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.

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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 26 of the Notes to Consolidated Financial Statements included in Item 8 of this report for further discussion of the Company’s estimation of impaired loans measured at fair value.

See Note 26 of the Notes to Consolidated Financial Statements included in Part II.

Item 8 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.

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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 Asset Quality Rating (“AQR”) system.

The risk ratings are discussed in Note 5 to the Consolidated Financial Statements included in Item 8 of this report.

The risk ratings are discussed in Note 5 to the Consolidated Financial Statements included in Part II.

Item 8 of this report.

There are five loan classes:

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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.

• 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.

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The following table shows the allocation of the Allowance for the years indicated:

2020 2019 2018 2017 2016

% of Loans (1)

3 unchanged sentences

% of Loans (1)

(In Thousands)

(In Thousands) Amount Amount Amount Amount Amount

Commercial $7,973 39 % $6,604 39 % $5,660 35 % $6,172 34 % $5,535 28 %

Real estate construction one-to-four family 679 3 % 643 4 % 675 4 % 629 3 % 550 3 %

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Consumer other 400 2 % 436 2 % 426 2 % 307 2 % 408 2 %

Unallocated 2,107 — % 2,079 — % 2,635 — % 3,510 — % 1,396 — %

Total $21,136 100 % $19,088 100 % $19,519 100 % $21,461 100 % $19,697 100 %

1 Represents percentage of this category of loans to total portfolio loans.

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Balance at beginning of year $19,088 $19,519 $21,461 $19,697 $18,153

Commercial (1,021) (195) (1,716) (1,611) (903)

Real estate construction one-to-four family — — — — (535)

Real estate term owner occupied (85) — — — —

Real estate term other — — (28) (5) —

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Total charge-offs (1,121) (217) (1,926) (1,744) (1,482)

Commercial 710 908 442 293 699

Real estate term other 2 28 3 2 —

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Total recoveries 737 961 484 308 728

Net, recoveries (charge-offs)

Net, (charge-offs) recoveries (384) 744 (1,442) (1,436) (754)

Provision (benefit) for loan losses 2,432 (1,175) (500) 3,200 2,298

Balance at end of year $21,136 $19,088 $19,519 $21,461 $19,697

Ratio of net (recoveries) charge-offs to average loans

Ratio of net charge-offs (recoveries) to average loans

outstanding during the period 0.03 % (0.07) % 0.15 % 0.15 % 0.08 %

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Purchased credit impaired loans were evaluated on a loan by loan basis and the valuation allowance for these loans was netted against the carrying value.

Loans acquired from Alaska Pacific have been classified as impaired loans and evaluated for specific impairment using the same methodology as all other loans since April 1, 2014.

Loans acquired from Alaska Pacific have been classified as impaired loans and evaluated for specific impairment using the same methodology as all other

loans since April 1, 2014.

A general allowance for loans acquired from Alaska Pacific was established if there was deterioration in credit quality of the acquired loans subsequent to acquisition from April 1, 2014 through December 31, 2017.

As of December 31, 2020, 2019 and 2018, loans acquired from Alaska Pacific are included in the Company's general allowance using the same methodology as all other loans as described above due to the amount of time that has passed since the loans were purchased.

There was no specific

impairment on acquired loans at December 31, 2019 or 2018 .

There was no specific impairment on acquired loans at December 31, 2020 or 2019.

The purchase discount related to acquired credit impaired loans was $328,000 and $345,000 as of December 31, 2020 and 2019, respectively.

The provision for loan losses in 2020 as compared to 2019 increased $3.6 million to provision for loan losses of $$2.4 million compared to a benefit of $1.2 million in 2019.

This increase is primarily due to management's assessment of risk associated with the economic impacts of the COVID-19 pandemic, the reduction in oil prices and a slowing Alaska economy, as well as growth in the unguaranteed portion of the loan portfolio.

The Company determined that an Allowance of $21.1 million, or 1.46% of portfolio loans, is appropriate as of December 31, 2020 based on our analysis of the current credit quality of the portfolio and current economic conditions.

The provision for loan losses in 2019 as compared to 2018 decreased $675,000 to a benefit of $1.2 million compared to a benefit of $500,000 in 2018.

This decrease is primarily due to net recoveries on loans and a decrease in qualitative factors mostly due to strengthening in the Alaska economy in 2019.

The Company determined that an Allowance of $19.1 million, or 1.83% of portfolio loans, is appropriate as of December 31, 2019 based on our analysis of the current credit quality of the portfolio and current economic conditions.

The provision for loan losses in 2018 as compared to 2017 decreased $3.7 million to a benefit of $500,000 compared to a provision of $3.2 million in 2017.

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This increase was primarily due to an increase in nonperforming loans and the portion of the Allowance specific to impaired loans.

The provision for loan losses in 2016 as compared to 2015 increased $544,000 to $2.3 million compared to $1.8 million in 2015.

This increase was primarily due to an increase in nonperforming loans in 2016 compared to the prior year as well as an increase in qualitative factors mostly due to softening in the Alaska economy in 2016.

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

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Purchased receivables are recorded on the balance sheet net of a reserve for purchased receivable losses.

Purchased receivable balances increased at December 31, 2019 to $24.4 million from $14.4 million at December 31, 2018 , and year-to-date average purchased receivable balances were $18.8 million and $17.4 million in 2019 and 2018 , respectively.

Purchased receivable income was $3.3 million in both 2019 and 2018 .

Purchased receivable income in 2019 remained consistent with 2018 despite an increase in average balances due to a decrease in average yield which varies depending on the makeup of the purchased receivable portfolio.

Purchased receivable balances decreased at December 31, 2020 to $13.9 million from $24.4 million at December 31, 2019, and year-to-date average purchased receivable balances were $14.5 million and $18.8 million in 2020 and 2019, respectively.

Purchased receivable income was $2.7 million and $3.3 million in 2020 and 2019, respectively.

Purchased receivable income in 2020 decreased from 2019 due to decreased average balances due to customers reportedly using PPP loans to fund liquidity needs instead of selling receivables.

The following table sets forth information regarding changes in the purchased receivable reserve for the years indicated:

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Balance at beginning of year $94 $190 $200

Charge-offs — — —

Recoveries — — —

Net recoveries (charge-offs) — — —

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Total deposits increased 33% to $1.825 billion at December 31, 2020 from $1.372 billion at 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 2020.

Our deposits generally are expected to fluctuate according to the level of our market share, economic conditions, and normal seasonal trends.

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

Average balance

Average rate paid

Average balance

Average rate paid

Average balance

Average rate paid

2020 2019 2018

Average balance Average rate paid Average balance Average rate paid Average balance Average rate paid

(In Thousands)

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Percent of Total Deposits

(In Thousands)

(In Thousands) Amount

Amounts maturing in:

3 unchanged sentences

Over 12 months 33,113 25 %

Total $133,282 100 %

The Company offers the Certificate of Deposit Account Registry Service® (CDARS®) as a member of Promontory Interfinancial Network, LLCSM (Network).

When a Network member places a deposit using CDARS, that certificate of deposit is divided into amounts under the standard FDIC insurance maximum ($250,000) and is allocated among member banks, making the large deposit eligible for FDIC insurance.

The Company had $1.2 million CDARS certificates of deposits at December 31, 2019 and no CDARS certificates of deposits at December 31, 2018 .

The Company had $9.4 million CDARS certificates of deposits at December 31, 2020 and $1.2 million CDARS certificates of deposits at December 31, 2019.

The Bank is a member of the Federal Home Loan Bank of Des Moines (the "FHLB").

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The Company has outstanding advances of $14.8 million as of December 31, 2020 which were originated to match fund low income housing projects that qualify for long term fixed interest rates.

The first advance is a $1.9 million FHLB Community Investment Program advance which was originated on March 22, 2013.

It has an eighteen 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 $2.1 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 last 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.

All of these FHLB advances are included in borrowings.

These advances have original terms of either 18 or 20 years with 30 year amortization periods and fixed interest rates ranging from 1.23% to 3.25%.

Federal Reserve Bank :

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There were no discount window advances outstanding at December 31, 2020 or 2019.

The Company $2,000 in interest in 2020 and paid less than $1,000 in interest in 2019 on this agreement.

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 as of June 30, 2020.

This advance had an interest rate of 0.35%.

Other Short-term Borrowings:

Securities sold under agreements to repurchase were zero and $34.3 million , as of December 31, 2019 and 2018 , respectively.

The average balance outstanding of securities sold under agreements to repurchase during 2019 and 2018 was $15.2 million and $29.9 million, respectively, and the maximum outstanding at any month-end was $36.6 million and $36.5 million, respectively, during the same time periods.

The securities sold under agreements to repurchase are held by the FHLB under the Company’s control.

The Company is subject to provisions under Alaska state law which generally limit the amount of outstanding debt to 15% of total assets or $244.7 million and $222.6 million at December 31, 2019 and 2018 , respectively.

Securities sold under agreements to repurchase were zero as of December 31, 2020 and 2019, respectively.

The average balance outstanding of securities sold under agreements to repurchase during 2020 and 2019 was zero and $15.2 million, respectively, and the maximum outstanding at any month-end was zero and $36.6 million, respectively, during the same time periods.

The securities sold under agreements to repurchase were held by the FHLB under the Company’s control.

The Company is subject to provisions under Alaska state law which generally limit the amount of outstanding debt to 35% of total assets or $736.0 million at December 31, 2020 and 15% of total assets or $244.7 million at December 31, 2019.

As of April 7, 2020, the State of Alaska increased this limit to 35% of total assets.

Long-term Borrowings:

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Payments Due by Period

Within 1 Year

(In Thousands)

Within 1 Year 1-3 Years 3-5 Years Over 5 Years

(In Thousands) Total

December 31, 2020:

Certificates of deposit $128,970 $44,237 $630 $1,794 $175,631

Short-term borrowings

Long-term borrowings 312 833 872 12,800 14,817

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Other long-term liabilities (1)

9,482 1,654 778 4,291 16,205

Capital commitments 71 — — — 71

Total $141,454 $50,864 $5,807 $34,070 $232,195

December 31, 2019:

Certificates of deposit $90,554 $70,734 $1,390 $1,794 $164,472

Short-term borrowings

Long-term borrowings 187 444 471 7,789 8,891

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Capital commitments 1,389 — — — 1,389

Total $97,732 $85,380 $6,794 $30,347 $220,253

(1) Includes principal payments related to employee benefit plans.

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Unscheduled payments for all remaining benefits are recorded "Over 5 Years".

Additional information about employee benefit plans is provided in Note 19 of the Notes to the Consolidated Financial Statements in Item 8 below.

Additional information about employee benefit plans is provided in Note 19 of the Notes to the Consolidated Financial Statements in Part II.

Item 8 below.

Short and long-term borrowings included in the table above are described in the "Borrowings" section above.

Junior subordinated debentures include $10.3 million that was originated on December 16, 2005, matures on March 15, 2036, and bears interest at a rate of 90-day LIBOR plus 1.37%, adjusted quarterly.

The Company entered into an interest rate swap in the third quarter of 2017 to hedge the variability in cash flows arising out of its junior subordinated debentures, by swapping the cash flows with an interest rate swap which receives floating and pays fixed.

The Company entered into an interest rate swap in the

third quarter of 2017 to hedge the variability in cash flows arising out of its junior subordinated debentures, by swapping the cash flows with an interest rate swap which receives floating and pays fixed.

The Company has designated this interest rate swap as a hedging instrument.

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Other long-term liabilities consist of amounts that the Company owes for its investments in Delaware limited partnerships that develop low-income housing projects throughout the United States.

Additional information about these partnerships is included at Note 8 .

Additional information about these partnerships is included at Note 8 of the Company’s Consolidated Financial Statements included in Part II.

Item 8 of this report.

The Company purchased a $10.7 million interest in R4 Frontier Housing Partners L.P., Coronado Park Senior Village L.P.

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The Company has established reserves of $187,000 and $152,000 at December 31, 2020 and 2019, respectively, for estimated losses related to these commitments that are recorded in other liabilities on the consolidated balance sheet.

Additional information regarding Off-Balance Sheet Arrangements is included in Notes 20 and 21 of the Notes to Consolidated Financial Statements included in Item 8 of this report.

Additional information regarding Off-Balance Sheet Arrangements is included in Notes 20 and 21 of the Notes to the Company’s Consolidated Financial Statements included in Part II.

Item 8 of this report.

Liquidity and Capital Resources

Our shareholders’ equity at December 31, 2020, was $221.6 million, as compared to $207.1 million at December 31, 2019.

The Company earned net income of $20.7 million , issued 23,269 shares of common stock through the exercise of stock options, and repurchased 347,676 shares during 2019 .

The Company earned net income of $32.9 million, issued 19,195 shares of common stock through the vesting of restricted stock units and repurchased 327,000 shares during 2020.

At December 31, 2020, the Company had approximately 6.3 million shares of its common stock outstanding.

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Additionally, as noted above, our total deposits at December 31, 2020, were $1.8 billion.

As shown in the Consolidated Statements of Cash Flows, net cash used by operating activities was $821,000 in 2019 and net cash provided by operating activities was $25.2 million in 2018 .

As shown in the Consolidated Statements of Cash Flows, net cash used by operating activities was $36.5 million in 2020 and net cash used by operating activities was $821,000 in 2019.

The primary source of cash provided by operating activities for all periods presented was positive net income;

however, in 2019 the origination of loans held for sale exceeded proceeds from the sale of loans held for sale which is the primary reason that operating cash flow is negative in 2019.

Net cash used by investing activities was $71.9 million in 2019 and primarily due to the fact that purchases of investment securities and net investment in loans and purchased receivables exceeded proceeds from sales and maturities of securities available for sale.

Net cash provided by investing activities was $5.6 million in 2018 as the Company's proceeds from sales and maturities of securities available for sale were greater than funds used to purchase additional investment securities in those years.

Financing activities provided cash of $90.6 million in 2019 and used cash of $31.1 million in 2018.

however, in 2020 and 2019 the origination of loans held for sale exceeded proceeds from the sale of loans held for sale which is the primary reason that operating cash flow is negative in both years.

Net cash used by investing activities was $382.8 million in 2020 primarily due to increases in loans, in particular PPP loans.

Net cash used by investing activities was $71.9 million in 2019 primarily due to the fact that purchases of investment securities and net investments in loans and purchased receivables exceeded proceeds from sales and maturities of securities available for sale.

Financing activities provided cash of $439.8 million in 2020 and $90.6 million in 2019.

Financing activities provided cash in 2020 due to an increase 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 327,000 shares of the Company's common stock for $10.0 million and the payment of dividends to shareholders.

Financing activities provided cash in 2019 due to an increase in deposits that was only partially offset by a decrease in securities sold under repurchase agreements, repurchase of 347,676 shares of the Company's common stock for $12.6 million, and the payment of cash dividends to shareholders.

Financing activities used net cash in 2018 primarily as a result of a decrease in deposit balances and payment of cash dividends 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.

At December 31, 2019 , our current assets were $431.3 million and our funds available for borrowing under our existing lines of credit were $800.7 million .

At December 31, 2020, our current assets were $423.8 million and our funds available for borrowing under our existing lines of credit were $1.01 billion.

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 $216.0 million in PPP loans eligible to be pledged for the PPPLF program as of December 31, 2020.

the Company has not obtained any other new borrowing lines or other new sources of liquidity other than the PPPLF program resulting from anticipated liquidity challenges from COVID-19.

Given these sources of liquidity and our expectations for customer demands for cash and for our operating cash needs, we believe our sources of liquidity to be sufficient in the foreseeable future.

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We expect that dividend payments will be reassessed on a quarterly basis by the Board of Directors in accordance with the dividend policy.

The payment of cash dividends is subject to regulatory limitations as described under the Supervision and Regulation section of Part I of this report.

The payment of cash dividends is subject to regulatory limitations as described under the Supervision and Regulation section of Part I.

Item 1 of this report.

There is no assurance that future cash dividends on common shares will be declared or increased.

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In 2018, we purchased an aggregate of 15,468 shares at an average price of $31.90 per share.

In April 2019, the Company’s Board of Directors

approved a plan whereby it would periodically repurchase for cash up to approximately 5% of its shares of common stock in the open market where 340,000 shares were available for repurchase.

In April 2019, the Company’s Board of Directors approved a plan whereby it would periodically repurchase for cash up to approximately 5% of its shares of common stock in the open market where 340,000 shares were available for repurchase.

In 2019 we purchased an aggregate of 347,676 shares at an average price of $36.15 per share.

On January 27, 2020, the Board authorized the repurchase of up to an additional 327,000 shares of common stock.

In 2020, the Company repurchased 327,000 shares at an average price of $30.51.

At December, 31, 2020, there were zero shares available under the stock repurchase program.

However, on January 27, 2020, the Board authorized the repurchase of up to an additional 327,000 shares of common stock.

On February 1, 2021, the Company announced that its Board of Directors had authorized the repurchase of up to an additional 313,000 shares of common stock.

We intend to continue to repurchase our stock from time-to-time depending upon market conditions, but we can make no assurances that we will continue this program or that we will authorize additional shares for repurchase.

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Years Ending:

Diluted EPS without Stock Repurchase

On May 8, 2003, the Company’s subsidiary, NCT1, issued trust preferred securities in the principal amount of $8 million.

These securities carried an interest rate of 90-day LIBOR plus 3.15% per annum that was initially set at 4.45% adjusted quarterly.

The securities had a maturity date of May 15, 2033, and were callable by the Company on or after May 15, 2008.

These securities were treated as Tier 1 capital by the Company’s regulators for capital adequacy calculations.

The Company redeemed these trust preferred securities on August 15, 2017.

Reported Diluted EPS without Stock Repurchase

2020 $5.11 $4.22

2019 $3.04 $2.59

2018 $2.86 $2.56

2017 $1.88 $1.69

2016 $2.06 $1.87

On December 16, 2005, the Company’s subsidiary, NST2, issued trust preferred securities in the principal amount of $10 million.

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The interest rate swap effectively fixes the Company's interest payments on the $10 million of junior subordinated debentures held under NST2 at 3.72% through its maturity date.

Net of the impact of the interest rate swap, interest expense on these securities was $389,000 in 2019 and 2018.

Net of the impact of the interest rate swap, interest expense on these securities was $385,000 in 2020 and $389,000 in 2019.

We are subject to minimum capital requirements.

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Management intends to maintain capital ratios for the Bank in 2021, exceeding the FDIC’s new 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 that the Company 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 December 31, 2020 and 2019, respectively, 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

Minimum Required Capital Well-Capitalized Actual Ratio Company Actual Ratio Bank

December 31, 2020

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Leverage ratio 4.00% 5.00% 10.25% 8.55%

See Note 24 of the Consolidated Financial Statements for a detailed discussion of the capital ratios.

See Note 24 of the Consolidated Financial Statements included in Part II.

Item 8 of this report for a detailed discussion of the capital ratios.

The requirements for "well-capitalized" come from the Prompt Correction Action rules.

See Item 1 Supervision and Regulation.

Item 1 Supervision and Regulation.

These rules apply to the Bank but not to the Company.

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In addition, inflation has an impact on our customers’ ability to repay their loans.

See additional discussion below in Item 7A regarding how various market risks affect the Company.

See additional discussion below in Part II.

Item 7A of this report regarding how various market risks affect the Company.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis