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, 2020. 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 impact of the results of the recent U.S. elections on the regulatory landscape, natural resource extraction industries, capital markets, and the response to and management of the COVID-19 pandemic, including the effectiveness of previously-enacted fiscal stimulus from the federal government and a potential infrastructure bill; the timing of Paycheck Protection Program ("PPP") loan forgiveness; the impact of interest rates, inflation, supply-chain constraints, trade policies and tensions, including tariffs, and potential geopolitical instability; 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 Part I. Item 1A in the Company's Annual Report on Form 10-K for the year ended December 31, 2020, 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 Our critical accounting policies are described in detail in Part II. 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, 2020. The SEC defines "critical accounting policies" as those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. As of January 1, 2021, the Company implemented ASU 2016-13, Financial Instruments - Credit Losses ("ASU 2016-13" or "CECL"), and due to the significance of the implementation, the following Allowance for Credit Losses Policy has been updated from the policies disclosed in our prior year financial statements. The Company's critical accounting policies also include valuation of goodwill and other intangible assets, the valuation of other real estate owned ("OREO"), and the valuation of mortgage servicing rights. There have been no other material changes to the valuation techniques or models, that affect our estimates during 2021. 45 Allowance for Credit Losses Policy: The Company's Executive Loan Management Committee and Asset Liability Committee are both involved in monitoring various aspects of the Company's allowances for credit losses ("ACL") methodology. The Company's Audit Committee provides board oversight of the ACL process and reviews and approves the ACL methodology on a quarterly basis. CECL is not prescriptive in the methodology used to determine the expected credit loss estimate. Therefore, management has flexibility in selecting the methodology. However, the expected credit losses must be estimated over a financial asset's contractual term, adjusted for prepayments, utilizing quantitative and qualitative factors. The estimate of current expected credit losses is based on relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. Historical loss experience is the starting point for estimating expected credit losses. Adjustments are made to historical loss experience to reflect differences in asset-specific risk characteristics, such as underwriting standards, portfolio mix or asset terms, and differences in economic conditions – both current conditions and reasonable and supportable forecasts. When the Company is not able to make or obtain reasonable and supportable forecasts for the entire life of the financial asset it has estimated expected credit losses for the remaining life after the forecasted period using an approach that reverts to historical credit loss information. Depending on the nature and size of the pool of financial assets with similar risk characteristics, the Company uses a discounted cash flow (“DCF”) method or a weighted average remaining life method to estimate expected credit losses quantitatively. Under the DCF method, the Company utilizes complex models to obtain reasonable and supportable forecasts to calculate two predictive metrics, the probability of default ("PD") and loss given default ("LGD"). The PD measures the probability that a loan will default within a given time horizon and is an assumption derived from regression models which determine the relationship between historical defaults and certain economic variables. The Company's regression models for PD utilize the Company's actual historical loan level default data. The Company determines a reasonable and supportable forecast and applies that forecast to the regression model to estimate defaults over the forecast period. Management leverages economic projections from a reputable and independent third-party to inform its loss driver forecasts over the Company's four quarter forecast period. Management utilizes and forecasts Alaska unemployment as a loss driver for all of the loans pools that utilize the DCF method. Management also utilizes and forecasts either one-year percentage change in the Alaska home price index or the one-year percentage change in the national commercial real estate price index as a second loss driver depending on the nature of the underlying loan pool and how well that loss driver correlates to expected future losses. Other internal and external indicators of economic forecasts are also considered by management when developing the forecast metrics. Following the forecast period, the economic variables used to calculate PD revert to a historical average at a constant rate over an eight quarter reversion period. Other assumptions relevant to the discounted cash flow model to derive the quantitative allowance include the LGD, which is the estimate of loss for a defaulted loan, prepayment speeds, and the discount rate applied to future cash flows. The DCF method utilizes the effective interest rate of individual assets to discount the expected credit losses over the contractual term of the loan, adjusted for prepayments. The LGD is the expected loss which would be realized presuming a default has occurred and primarily measures the value of the collateral or other secondary source of repayment related to the collateral. The Company’s estimate of the ACL reflects losses expected over the remaining contractual life of the assets. The contractual term does not consider extensions, renewals or modifications unless the Company has identified an expected troubled debt restructuring. In addition to the quantitative portion of the ACL derived using either the DCF or weighted average remaining life method, the Company also considers the effects of the following qualitative factors in its calculation of expected losses in the loan portfolio: • Lending strategy, policies, and procedures; • Quality of internal loan review; • Lending management and staff; • Trends in underlying collateral values; • Competition, legal, and regulatory changes; • Economic and business conditions including fluctuations in the price of Alaska North slope crude oil • Changes in trends, volume and severity of adversely classified loans, nonaccrual loans, and delinquencies; • Concentration of credit; and • Changes in the nature and volume of the loan portfolio. The qualitative factor methodology is based on quantitative metrics, but also includes a high degree of subjectivity and changes in any of the metrics could have a significant impact on our calculation of the ACL. 46 Loans that do not share risk characteristics with other loans in the portfolio are individually evaluated for expected credit losses and are not included in the collective evaluation. Loans are identified for individual evaluation during regular credit reviews of the portfolio. A loan is generally identified for individual evaluation when management determines that we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When we identify a loan for individual evaluation, we measure expected credit losses using DCF, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of DCF. The analysis of collateral dependent loans includes appraisals on loans secured by real property, management’s assessment of the current market, recent payment history and an evaluation of other sources of repayment. Update on Economic Conditions The Alaska economy is slowly recovering in 2021 from the effect of the global pandemic. Management believes that rising oil prices, an improvement in tourism, and strong liquidity levels in the private sector from government stimulus programs have helped Alaska rebound from the economic lows seen in 2020. The housing market remains strong with average sales prices and the number of units sold up significantly, while home foreclosure and delinquency rates continue to improve. Rising prices are starting to stress affordability levels for homes and supply chain disruptions are expected to moderate construction activity in the short run. The Alaska Department of Labor ("DOL") has released data through August of 2021. They report total payroll jobs in Alaska have grown by 13,600 compared to August of 2020. This is a total of 308,900 jobs or an improvement of 4.4% over the prior 12 months. Tourism related jobs were the hardest hit from travel restrictions and have also been the fastest to recover. According to the DOL, the Leisure and Hospitality sector added 5,600 jobs between August of 2020 and August of 2021, an increase of 19.9%. However, this is still 10,800 jobs less than August of 2019. Trade, Transport, and Utilities have added 14.3% more jobs than August of 2020 and Manufacturing, which is primarily seafood processing, is 11.3% higher over the last 12 months. Oil and Gas direct jobs continued to decline in the last 12 months, down 400 jobs compared to August of 2020 and down 3,300 jobs from August of 2019. Education and Health Care are the only private sector industries to surpass the August 2019 job levels in August of 2021 according to the DOL report. Alaska’s revised Gross State Product (“GSP”) for 2020 was $49.8 billion, compared to $54.5 billion in 2019, according to the Federal Bureau of Economic Analysis ("BEA"). The national average for the second quarter was a 6.7% increase according to an October 1, 2021 BEA report. Alaska’s seasonally adjusted personal income for the second quarter of 2021 was $47.7 billion compared to $48.5 billion for the second quarter of 2020, according to the BEA. There was a tremendous loss of jobs in 2020 that reduced wage earnings last year. This was more than compensated for by a significant amount of government transfer payments. Alaska, like the rest of the U.S., experienced a decline in government transfer payments in the second quarter of 2021. However, wage earnings are growing here and across the country as a recovery in jobs continues in 2021. Alaska North Slope (“ANS”) crude oil began 2020 at $65.48 a barrel. Prices fell quickly at the beginning of 2020, responding to fears that COVID-19 would devastate the global economy and reduce the demand for travel. The low month was April of 2020, when ANS averaged $16.54 a barrel. However, by June of last year the oil markets stabilized and for the last six months of 2020 the average monthly price remained between $40.42 and $50.32. ANS prices continued to rise throughout 2021 and averaged over $70 a barrel in June, July and August. The monthly average for September has not yet been posted by the Alaska Department of Revenue, but the daily spot price was $82.94 on October 8, 2021. Alaska’s home mortgage delinquency and foreclosure levels continue to be better than most of the nation. According to the Mortgage Bankers Association, Alaska’s foreclosure rate improved from 0.63% at the end of 2019 to 0.45% at the end of 2020. In the first quarter of 2021 the foreclosure rate improved slightly to 0.41% and again in the second quarter to 0.36%. The comparable national average rate was higher than Alaska at 0.51% in the second quarter of 2021. We believe that the foreclosure rates are somewhat misleading because the recently ended federal moratorium on foreclosure activity on occupied homes led to declining foreclosure numbers, even though job losses strained the economy and borrowers' ability to pay. The Mortgage Bankers Association survey reported that the percentage of delinquent mortgage loans at the end of 2019 in Alaska was 2.9%. This increased to 6.2% at the end of 2020 after the effects of COVID-19 impacted jobs. In the first quarter of 2021 it improved to 5.4% in Alaska and again in the second quarter to 5.1%. According to the survey, the comparable delinquency rate for the entire country remains higher than Alaska at 5.5% in the second quarter of 2021. 47 According to the Alaska Multiple Listing Services, the average sales price of a single family home in Anchorage rose 5.8% in 2020 to $396,741. In the first nine months of 2021, the average sales price has increased 7.5% to $426,445. Average sales prices in the Matanuska Susitna Borough rose 9.9% in 2020 to $301,049, continuing a decade of consecutive price gains. In the first nine months of 2021 prices have risen 15.1% to $346,353. These two markets represent where the vast majority of the Bank’s residential lending activity occurs. The number of units sold in Anchorage was up significantly in 2020 by 19.6%, climbing from 2,719 homes sold in 2019 to 3,251 last year, as reported by the Alaska Multiple Listing Services. The main difference was a record number of sales occurred in the last quarter of the year, when sales activity typically declines in the winter. The Matanuska Susitna Borough also had strong sales activity, up 9.7% in 2020 to 2,135 units sold compared to 1,946 in 2019. The Matanuska Susitna Borough also had stronger than normal sales in the second half of 2020. Through the third quarter of 2021 there have been 2,647 home sales in Anchorage, or 15.9% more than in the first nine months of 2020. The Matanuska Susitna Borough had 1,719 sales through the third quarter of 2021, an increase of 13.2% over the same time period in 2020. We believe that the low interest rate environment has been a major factor. According to the Federal Reserve Bank of St. Louis, the average 30 year fixed rate mortgage in the U.S. hit an all-time record low last year. Rates began 2020 at 3.7% in the first week of January and fell one percent to 2.7% by the end of the year. Rates began to rise slightly in 2021 and finished the third quarter at 3%. COVID-19 Issues: • Industry Exposure: Northrim has identified various industries that may be adversely impacted by the COVID-19 pandemic and the volatility in oil prices that has occurred over the last 18 months. 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 September 30, 2021 are being impacted: Healthcare (7%), Tourism (6%), Oil and Gas (4%), Aviation (non-tourism) (4%), Accommodations (4%), Retail (3%), Fishing (4%), and Restaurants (3%). The Company's exposure as a percent of the total loan portfolio excluding U.S. Small Business Administration ("SBA") PPP loans as of September 30, 2021 are: Healthcare (8%), Tourism (7%), Oil and Gas (5%), Aviation (non-tourism) (5%), Accommodations (4%), Retail (3%), Fishing (5%), and Restaurants (3%). 48 • Customer Accommodations: The Company has 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. 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 number of loans with modifications has decreased since December 31, 2020, with approximately 82% of the modifications at September 30, 2021, representing three relationships. The outstanding principal balance of loan modifications due to the impacts of COVID-19 for the periods indicated were as follows: Loan Modifications due to COVID-19 as of September 30, 2021 (Dollars in thousands) Interest Only Full Payment Deferral Total Portfolio loans $49,888 $7,533 $57,421 Number of modifications 21 3 24 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 All 24 loan modifications totaling $57.4 million as of September 30, 2021, have entered into more than one modification. • Branch Operations: As of September 30, 2021, branch operations have returned to pre-pandemic levels, while a number of customer and employee safety measures continue to be implemented. • Remote Workers: As of September 30, 2021, approximately 51% of the Company's employees are working remotely either on a full- or part-time basis directly due to the pandemic caused by COVID-19. These employees primarily hold non-customer facing positions within the Company. Prior to the pandemic, less than 8% of the Company's employees worked remotely. The increase in the number of employees that work remotely has had no material impact on the Company's operations. • Growth and Paycheck Protection Program: • Over the last 18 months, Northrim funded a total of nearly 5,800 PPP loans totaling $612.6 million to both existing and new customers. Of this amount, 745 loans totaling $33 million were originated during the second quarter of 2021 and 2,125 loans totaling $204.0 million were originated during the first quarter of 2021, through the second round of PPP funding. No additional PPP loans were originated in the third quarter of 2021. • As of September 30, 2021, PPP has resulted in 2,341 new customers totaling $68.0 million in non-PPP loans, and $125.6 million in new deposit balances. • Management estimates that we funded approximately 24% of the number and 32% of the value of all Alaska PPP second round loans. • As of September 30, 2021, Northrim customers had received forgiveness through the SBA on 3,439 PPP loans totaling $405.8 million, of which 1,118 PPP loans totaling $102.4 million were forgiven in the third quarter of 2021, and 617 PPP loans totaling $133 million were forgiven in the second quarter of 2021. Of the PPP loans forgiven in the third quarter of 2021, 578 loans totaling $35.2 million related to PPP round two. • The Company initially utilized the Federal Reserve Bank's Paycheck Protection Program Liquidity Facility ("PPPLF") to fund PPP loans, but paid back those funds in full during the second quarter of 2020 and has since funded the SBA PPP loans through core deposits and maturity of long-term investments. 49 Highlights and Summary of Performance - Third Quarter of 2021 The Company reported net income and diluted earnings per share of $8.9 million and $1.42, respectively, for the third quarter of 2021 compared to net income and diluted earnings per share of $11.9 million and $1.84, respectively, for the third quarter of 2020. The Company reported net income and diluted earnings per share of $29.4 million and $4.69, respectively, for the first nine months of 2021 compared to $22.8 million and $3.52, respectively, for the same period in 2020. The decrease in net income for the three-month period ending September 30, 2021 compared to the same period last year is primarily attributable to a decrease in net income in the Home Mortgage Lending segment, as a result of decreased production. The increase in net income for the nine-month period ending September 30, 2021 compared to the same period last year is attributable to increased net income in the Community Banking segment mostly due to fee income from PPP loans and a reduction in the ACL. This increase in the Community Banking segment was only partially offset by a decrease in net income in the Home Mortgage Lending segment, which resulted primarily from decreased production in the second and third quarters of 2021 compared to 2020. • Total revenue in the third quarter of 2021, which includes net interest income plus other operating income, decreased 17% to $33.1 million from $39.9 million in the third quarter a year ago, primarily due to a $8.0 million decrease in mortgage banking income which was only partially offset by a $2.1 million increase in net interest income. Total revenue in the first nine months of 2021 increased 5% to $101.8 million from $97.0 million compared to the same period a year ago, primarily due to a $7.7 million increase in net interest income which was only partially offset by a $2.9 million decrease in mortgage banking income. The increases in net interest income in both periods in 2021 compared to the same periods in 2020 are mainly due to increased loan balances and fees on PPP loans. • The Company booked a benefit for credit losses of $1.1 million for the three-month period ending September 30, 2021, compared to a provision of $567,000 in the same period in 2020. For the first nine months of 2021, the Company booked a benefit for credit losses of $3.0 million compared to a provision of $3.0 million in the same period in 2020. The provisions for both periods in 2021 were recorded using the CECL accounting standard and reflect expected lifetime credit losses on loans and off-balance sheet unfunded loan commitments. The decrease in the provision for credit losses in both periods of 2021 compared to the same periods in 2020 is primarily the result of improvement in economic assumptions used to estimate lifetime credit losses, which was only partially offset by increases in loan balances, net of government guarantees. • The Company paid cash dividends of $0.38 per common share in the third quarter of 2021, up 9% from $0.35 in the third quarter of 2020. • At September 30, 2021, the capital ratios of the Company and Northrim Bank (the "Bank") were well in excess of all regulatory requirements. During the third quarter of 2021, the Company repurchased 29,613 shares of its common stock under the previously announced share repurchase program with 221,988 shares remaining of the 313,000 authorized for repurchase. Other financial measures are shown in the table below: Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Return on average assets, annualized 1.40 % 2.31 % 1.66 % 1.62 % Return on average shareholders' equity, annualized 14.47 % 22.10 % 16.57 % 14.58 % Dividend payout ratio 26.86 % 18.95 % 23.86 % 29.22 % Credit Quality Nonperforming assets: Nonperforming assets, net of government guarantees at September 30, 2021 decreased $180,000, or 1% to $16.1 million as compared to $16.3 million at December 31, 2020. OREO, net of government guarantees, decreased $1.4 million to $4.6 million at September 30, 2021 as compared to $6.0 million at December 31, 2020 due to the sale of one property in the second quarter of 2021 and one property in the third quarter of 2021, which was only partially offset by the addition of one OREO property in the first quarter of 2021. Nonperforming loans, net of government guarantees increased $1.4 million, or 14% to $11.5 million as of September 30, 2021 from $10 million as of December 31, 2020, primarily due to the addition of two relationships in the first three months of 2021 which were only partially offset by payoffs and pay downs in the second and third quarters of 2021. $9.3 million, or 82% of nonperforming assets at September 30, 2021, are nonaccrual loans related to six commercial relationships. While it is too early to determine the effect that the COVID-19 pandemic will ultimately have on our non-performing assets, significant increases may occur in subsequent quarters. 50 The following table summarizes nonperforming asset activity for the three-month periods ending September 30, 2021 and 2020. Writedowns Transfers to (In Thousands) Balance at June 30, 2021 Additions this quarter Payments this quarter /Charge-offs this quarter Transfers to OREO Performing Status this quarter Sales this quarter Balance at September 30, 2021 Nonperforming loans $13,104 $— ($611) $— $— $— $— $12,493 Nonperforming loans guaranteed by government (1,096) — 79 — — — — (1,017) Nonperforming loans, net 12,008 — (532) — — — — 11,476 Other real estate owned 7,073 — — — — — (1,161) 5,912 Other real estate owned guaranteed by government (1,279) — — — — — — (1,279) Total nonperforming assets, net of government guarantees $17,802 $— ($532) $— $— $— ($1,161) $16,109 Writedowns Transfers to (In Thousands) Balance at June 30, 2020 Additions this quarter Payments this quarter /Charge-offs this quarter Transfers to OREO/REPO Performing Status this quarter Sales this quarter Balance at September 30, 2020 Nonperforming loans $14,365 $386 ($1,963) ($141) $— $— $— $12,647 Nonperforming loans guaranteed by government (1,635) — 35 — — — — (1,600) Nonperforming loans, net 12,730 386 (1,928) (141) — — — 11,047 Other real estate owned 7,205 — — — — — (243) 6,962 Repossessed assets 919 — — (140) — — — 779 Nonperforming purchased receivables 1,226 — (816) — — — — 410 Other real estate owned guaranteed by government (1,279) — — — — — — (1,279) Total nonperforming assets, net of government guarantees $20,801 $386 ($2,744) ($281) $— $— ($243) $17,919 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 September 30, 2021, management had identified potential problem loans of $4.7 million as compared to potential problem loans of $6.1 million at December 31, 2020. The decrease in potential problem loans from December 31, 2020 to September 30, 2021 is primarily the result of one $3.9 million relationship moving to nonaccrual as well as pay downs and credit risk upgrades to existing potential problem loans in the first nine months of 2021 which were only partially offset by additions to potential problem loans in the first nine months of 2021. 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 $2.4 million in loans classified as TDRs that were performing and $4.7 million in TDRs included in nonaccrual loans at September 30, 2021 for a total of approximately $7.0 million. There are $2.4 million in government guarantees associated with TDRs, resulting in total TDRs, net of government guarantees, of $4.6 million at September 30, 2021. At December 31, 2020 there were $832,000 in loans classified as TDRs, net of government guarantees that were performing and $4.5 million in TDRs included in nonaccrual loans for a total of $5.3 million. See Note 4 of the Notes to Consolidated Financial Statements included in Item 1 of this report for further discussion of TDRs. 51 RESULTS OF OPERATIONS Income Statement Net Income Net income for the third quarter of 2021 decreased $3.0 million to $8.9 million as compared to $11.9 million for the same period in 2020. The decrease in net income is attributable to a $4.9 million decrease in net income in the Home Mortgage Lending segment, which is primarily due to lower production that was only partially offset by a $1.9 million increase in net income in the Community Banking segment. The increase in net income in the Community Banking segment in the three months ended September 30, 2021, as compared to the same period a year ago is primarily due an increase in net interest income from PPP fees and a decrease in the provision for credit losses, and these changes were only partially offset by an increase in the provision for income taxes. Net income for the nine months of 2021 increased $6.6 million to $29.4 million as compared to $22.8 million for the same period in 2020. The increase in net income is attributable to a $8.9 million increase in net income in the Community Banking segment due an increase in net interest income from PPP fees and a decrease in the provision for credit losses, and similar to the third quarter comparison discussed above, these changes were only partially offset by an increase in the provision for income taxes. Net income in the Home Mortgage Lending segment decreased $2.3 million in the first nine months of 2021 as compared to the same period in 2020, primarily due to a decrease in production. Net Interest Income/Net Interest Margin Net interest income for the third quarter of 2021 increased $2.1 million, or 12%, to $20.4 million as compared to $18.3 million for the third quarter of 2020. Net interest margin decreased 45 basis points to 3.45% in the third quarter of 2021 as compared to 3.90% in the third quarter of 2020. Net interest income for the first nine months of 2021 increased $7.7 million, or 15%, to $59.1 million as compared to $51.4 million for the first nine months of 2020. Net interest margin decreased 45 basis points to 3.60% in the first nine months of 2021 as compared to 4.05% in the same period in 2020. The increase in net interest income in the third quarter and first nine-months of 2021 compared to the same periods of 2020 was primarily the result of higher average earning asset balances, an increase in loan fee income due in large part to full recognition of the deferred PPP loan fees upon loan forgiveness through the SBA, and reduced interest expense. During the three and nine-month periods ending September 30, 2021, Northrim received $102.4 million and $339.4 million, respectively, in loan forgiveness through the SBA compared to none in the same periods in 2020. Total net PPP fee income including accretion and full fee recognition upon loan forgiveness was $3.0 million and $8.9 million during the three and nine-month periods ending September 30, 2021, respectively, compared to $1.4 million and $2.7 million in the three and nine-month periods ending September 30, 2020. PPP fee income for 2020 included only fee accretion. As of September 30, 2021, there was $197,000 of net PPP fee income from round one remaining and $7.9 million remaining from round two for total net deferred fees on PPP loans of $8.1 million. The decrease in net interest margin in the third quarter and first nine months of 2021 as compared to the same periods a year ago was primarily the result of lower interest rates and a less favorable mix of earning assets due to significant increases in short-term investments, which is the lowest yielding type of earning asset for the Company. Changes in net interest margin in the three and nine-month periods ended September 30, 2021 as compared to the same period in the prior year are detailed below: Three Months Ended September 30, 2021 vs. September 30, 2020 Nonaccrual interest adjustments (0.07) % Impact of SBA Paycheck Protection Program loans 0.61 % Interest rates and loan fees (0.18) % Volume and mix of interest-earning assets (0.81) % Change in net interest margin (0.45) % 52 Nine Months Ended September 30, 2021 vs. September 30, 2020 Nonaccrual interest adjustments (0.01) % Impact of SBA Paycheck Protection Program loans 0.19 % Interest rates and loan fees (0.33) % Volume and mix of interest-earning assets (0.30) % Change in net interest margin (0.45) % 53 Components of Net Interest Margin The following table compares average balances and rates as well as margins on earning assets for the three-month periods ended September 30, 2021 and 2020: (Dollars in Thousands) Three Months Ended September 30, Interest income/ Average Balances Change expense Change Average Yields/Costs 2021 2020 $ % 2021 2020 $ % 2021 2020 Change Loans 1,2 $1,469,072 $1,465,839 $3,233 — % $19,173 $17,734 $1,439 8 % 5.18 % 4.81 % 0.37 % Loans held for sale 99,716 122,994 (23,278) (19) % 727 957 (230) (24) % 2.89 % 3.10 % (0.21) % Short-term investments 3 390,004 60,504 329,500 545 % 149 17 132 776 % 0.15 % 0.11 % 0.04 % Long-term investments 4 389,631 217,599 172,032 79 % 1,233 1,086 147 14 % 1.26 % 1.99 % (0.73) % Total investments 779,635 278,103 501,532 180 % 1,382 1,103 279 25 % 0.70 % 1.58 % (0.88) % Interest-earning assets 2,348,423 1,866,936 481,487 26 % 21,282 19,794 1,488 8 % 3.60 % 4.22 % (0.62) % Nonearning assets 170,317 172,853 (2,536) (1) % Total $2,518,740 $2,039,789 $478,951 23 % Interest-bearing demand $609,718 $409,758 $199,960 49 % $117 $156 ($39) (25) % 0.08 % 0.15 % (0.07) % Savings deposits 326,733 266,588 60,145 23 % 122 168 (46) (27) % 0.15 % 0.25 % (0.10) % Money market deposits 267,723 218,965 48,758 22 % 97 153 (56) (37) % 0.14 % 0.28 % (0.14) % Time deposits 176,287 181,882 (5,595) (3) % 331 843 (512) (61) % 0.74 % 1.84 % (1.10) % Total interest-bearing deposits 1,380,461 1,077,193 303,268 28 % 667 1,320 (653) (49) % 0.19 % 0.49 % (0.30) % Borrowings 24,962 23,574 1,388 6 % 183 180 3 2 % 2.91 % 3.04 % (0.13) % Total interest-bearing liabilities 1,405,423 1,100,767 304,656 28 % 850 1,500 (650) (43) % 0.24 % 0.54 % (0.30) % Demand deposits and other noninterest-bearing liabilities 869,864 725,585 144,279 20 % Equity 243,453 213,437 30,016 14 % Total $2,518,740 $2,039,789 $478,951 23 % Net interest income $20,432 $18,294 $2,138 12 % Net interest margin 3.45 % 3.90 % (0.45) % Average loans to average interest-earning assets 62.56 % 78.52 % Average loans to average total deposits 66.55 % 83.75 % Average non-interest deposits to average total deposits 37.46 % 38.45 % Average interest-earning assets to average interest-bearing liabilities 167.10 % 169.60 % 1 Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled $3.9 million and $2.2 million in the third quarter of 2021 and 2020, respectively. 2 Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loan balances were $12.7 million and $13.9 million in the third quarter of 2021 and 2020, respectively . 3 Consists of interest bearing deposits in other banks. 4 Consists of investment in debt securities available for sale, equity securities, investment securities held to maturity, and investment in Federal Home Loan Bank stock. 54 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 September 30, 2021 and 2020. 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 September 30, 2021 vs. 2020 Increase (decrease) due to Volume Rate Total Interest Income: Loans $513 $926 $1,439 Loans held for sale (172) (58) (230) Short-term investments 128 4 132 Long-term investments 737 (590) 147 Total interest income $1,206 $282 $1,488 Interest Expense: Interest-bearing deposits $302 ($955) ($653) Borrowings 10 (7) 3 Total interest expense $312 ($962) ($650) 55 The following table compares average balances and rates as well as margins on earning assets for the nine-month periods ended September 30, 2021 and 2020: (Dollars in Thousands) Nine Months Ended September 30, Interest income/ Average Balances Change expense Change Average Yields/Costs 2021 2020 $ % 2021 2020 $ % 2021 2020 Change Loans 1,2 $1,501,139 $1,289,838 $211,301 16 % $56,015 $49,237 $6,778 14 % 4.99 % 5.10 % (0.11) % Loans held for sale 108,455 95,050 13,405 14 % 2,272 2,267 5 — % 2.80 % 3.19 % (0.39) % Short-term investments 3 240,635 60,011 180,624 301 % 248 284 (36) (13) % 0.14 % 0.63 % (0.49) % Long-term investments 4 347,888 252,594 95,294 38 % 3,596 4,349 (753) (17) % 1.38 % 2.30 % (0.92) % Total investments 588,523 312,605 275,918 88 % 3,844 4,633 (789) (17) % 0.87 % 1.98 % (1.11) % Interest-earning assets 2,198,117 1,697,493 500,624 29 % 62,131 56,137 5,994 11 % 3.78 % 4.42 % (0.64) % Nonearning assets 171,350 177,811 (6,461) (4) % Total $2,369,467 $1,875,304 $494,163 26 % Interest-bearing demand $547,734 $370,270 $177,464 48 % $362 $476 ($114) (24) % 0.09 % 0.17 % (0.08) % Savings deposits 318,761 247,605 71,156 29 % 377 581 (204) (35) % 0.16 % 0.31 % (0.15) % Money market deposits 256,729 213,201 43,528 20 % 323 574 (251) (44) % 0.17 % 0.36 % (0.19) % Time deposits 178,601 176,046 2,555 1 % 1,433 2,504 (1,071) (43) % 1.07 % 1.90 % (0.83) % Total interest-bearing deposits 1,301,825 1,007,122 294,703 29 % 2,495 4,135 (1,640) (40) % 0.26 % 0.55 % (0.29) % Borrowings 25,031 39,645 (14,614) (37) % 519 561 (42) (7) % 2.77 % 1.89 % 0.88 % Total interest-bearing liabilities 1,326,856 1,046,767 280,089 27 % 3,014 4,696 (1,682) (36) % 0.30 % 0.60 % (0.30) % Demand deposits and other noninterest-bearing liabilities 805,343 619,772 185,571 30 % Equity 237,268 208,765 28,503 14 % Total $2,369,467 $1,875,304 $494,163 26 % Net interest income $59,117 $51,441 $7,676 15 % Net interest margin 3.60 % 4.05 % (0.45) % Average loans to average interest-earning assets 68.29 % 75.98 % Average loans to average total deposits 72.77 % 81.79 % Average non-interest deposits to average total deposits 36.89 % 36.14 % Average interest-earning assets to average interest-bearing liabilities 165.66 % 162.17 % 1 Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled $11.5 million and $5.1 million in the first nine months of 2021 and 2020, respectively. 2 Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loan balances were $12.3 million and $14.4 million in the first nine months of 2021 and 2020, respectively . 3 Consists of interest bearing deposits in other banks. 4 Consists of investment in debt securities available for sale, equity securities, investment securities held to maturity, and investment in Federal Home Loan Bank stock. 56 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 nine-month periods ending September 30, 2021 and 2020. 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) Nine Months Ended September 30, 2021 vs. 2020 Increase (decrease) due to Volume Rate Total Interest Income: Loans $7,603 ($825) $6,778 Loans held for sale 35 (30) 5 Short-term investments 317 (353) (36) Long-term investments 1,554 (2,307) (753) Total interest income $9,509 ($3,515) $5,994 Interest Expense: Interest-bearing deposits $979 ($2,619) ($1,640) Borrowings (248) 206 (42) Total interest expense $731 ($2,413) ($1,682) Provision for Credit Losses The Company adopted ASU 2016-13 effective January 1, 2021. The provision for credit loss expense is the amount of expense that, based on our judgment, is required to maintain the ACL at an appropriate level under CECL. The determination of the amount of the ACL is complex and involves a high degree of judgment and subjectivity. Refer to Note 1 of the notes to Consolidated Financial Statements included in Item 1 of this report for detailed discussion regarding ACL methodologies for loans, available for sale debt securities, held to maturity securities, loans held for investment, unfunded commitments, and purchased receivables. The following table presents the major categories of credit loss expense: Three Months Ended September 30, Nine Months Ended September 30, (In Thousands) 2021 2020 2021 2020 Credit loss expense on loans held for investment ($762) $567 ($2,828) $3,031 Credit loss expense on unfunded commitments (344) — (193) — Credit loss expense on available for sale debt securities — — — — Credit loss expense on held to maturity securities — — — — Credit loss expense on purchased receivables — — — — Total credit loss expense ($1,106) $567 ($3,021) $3,031 As noted above, the provision for credit losses was recorded in accordance with CECL in 2021. The provision for credit losses in 2020, prior to adoption of CECL, was recorded under the incurred loss model. Despite the fact that a different methodology was used in the calculation of the provision for credit losses in 2021 versus 2020, in general the decrease in the provision for credit losses on loans for the three and nine-month periods ending September 30, 2021 as compared to the same periods in 2020 is primarily the result of improvement in economic assumptions used to estimate credit losses. The ongoing impacts of the CECL methodology will be dependent upon changes in economic conditions and forecasts, as well as loan portfolio composition, quality, and duration. 57 Other Operating Income Other operating income for the three-month period ended September 30, 2021, decreased $9.0 million, or 41%, to $12.7 million as compared to $21.6 million for the same period in 2020, primarily due to an $8.0 million decrease in mortgage banking income in the third quarter of 2021 compared to the same quarter in 2020. The decrease in mortgage banking income in the three-month period ended September 30, 2021 as compared to the same period in 2020 was primarily due to decreased refinance activity due to changes in the mortgage interest rates and decreased mortgages for home purchases. Additionally, there was a decrease in interest rate swap income and unrealized gain on marketable securities. These decreases were only partially offset by an increase in bankcard fees due to lower transaction volume in the third quarter of 2020 resulting from quarantine restrictions related to the COVID-19 pandemic and an increase in service charges on deposits due to customer accommodations related to the impacts of COVID-19 that lowered service changes on deposits in the third quarter of 2020. Other operating income for the nine-month period ended September 30, 2021, decreased $2.9 million, or 6%, to $42.7 million as compared to $45.6 million for the same period in 2020, primarily due to a $2.9 million decrease in mortgage banking income in the first nine months of 2021 compared to the same period in 2020. The decrease in mortgage banking income in the nine-month period ended September 30, 2021 as compared to the same period in 2020 was primarily due to decreased refinance activity due to changes in the mortgage interest rates that was only partially offset by increased mortgages for home purchases. Additionally, there was a decrease in interest rate swap income due to fewer of these transactions and purchased receivable income decreased due to customers reportedly using PPP funds instead of selling receivables. These decreases were only partially offset by increases in bankcard fees and service charges on deposits due to the cessation of COVID-19 quarantine restrictions and higher transaction volume as compared to the same period in 2020, as well as an increase in unrealized gain on marketable securities in the first nine months of 2021 compared to 2020. Other Operating Expense Other operating expense for the third quarter of 2021 decreased $972,000, or 4%, to $22.5 million as compared to $23.5 million for the same period in 2020 primarily due to lower salaries and other personnel expense related to mortgage banking operations, which fluctuate with production volumes. OREO expense, net of renal income and gains on sale also decreased in the third quarter of 2021 as compared to 2020 due to a gain on the sale of one OREO property in the third quarter of 2021. These decreases were only partially offset by an increase in data processing expense primarily related to increased customer and transaction volume. Other operating expense for the first nine months of 2021 increased $1.2 million, or 2%, to $66.2 million from $65.0 million for the same period in 2020 primarily due to higher salaries and other personnel expense in the Community Banking segment due to salary increases and a higher accrual for profit sharing expense. Additionally, data processing and occupancy expenses increased in the first nine months of 2021 as compared to 2020 due to increased customer and transaction volume, miscellaneous repairs and maintenance, and tenant improvements at several of the Company's locations. These increases were only partially offset by lower salary and other personnel expense related to mortgage banking operations, which fluctuate with production volumes, and a decrease in OREO expense, net of renal income and gains on sale due to a gain on the sale of one OREO property noted above that occurred in the third quarter of 2021. Income Taxes For the first nine months of 2021, Northrim recorded $9.2 million in state and federal income tax expense, for an effective tax rate of 23.9% compared to $6.3 million and 21.5% for the same period in 2020. Northrim recorded a higher effective tax rate for the first nine months of 2021 as compared to the same period in 2020 as a result of a decrease in tax credits and tax exempt interest income as a percentage of pre-tax income in 2021, as well as the reversal of a $454,000 accrual of tax expense in the second quarter of 2020. In the third quarter of 2021, Northrim recorded $2.8 million in state and federal income tax expense for an effective tax rate of 23.9%, compared to $4.0 million, or 25.2% in the third quarter of 2020. Northrim recorded a lower effective tax rate for the third quarter of 2021 as compared to the same period in 2020 as a result of an increase in tax credits and tax exempt interest income as a percentage of pre-tax income in 2021 as compared to 2020. 58 FINANCIAL CONDITION Balance Sheet Overview Portfolio Investments Portfolio investments, which include investment securities available for sale, investment securities held to maturity, and marketable equity securities, at September 30, 2021 increased 53%, or $141.0 million, to $407.7 million from $266.7 million at December 31, 2020 as proceeds from an increase in deposits that were not lent out were invested in the first nine months of 2021. The table below details portfolio investment balances by portfolio investment type: September 30, 2021 December 31, 2020 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 $299,824 73.5 % $174,601 65.5 % Municipal securities 850 0.2 % 856 0.3 % Corporate bonds 55,411 13.6 % 40,492 15.2 % Collateralized loan obligations 43,037 10.6 % 41,684 15.6 % Preferred stock 8,551 2.1 % 9,052 3.4 % Total portfolio investments $407,673 $266,685 Loans and Lending Activities The following table presents the concentration distribution of the loan portfolio, net of deferred fees and costs, as of the dates indicated: September 30, 2021 December 31, 2020 Dollar Amount Percent of Total Dollar Amount Percent of Total (In Thousands) Commercial & industrial loans $504,305 34.7 % $612,254 42.2 % Commercial real estate: Owner occupied properties 292,021 20.1 % 233,320 16.2 % Non-owner occupied and multifamily properties 443,258 30.7 % 392,452 27.2 % Residential real estate: 1-4 family residential properties secured by first liens 29,548 2.0 % 33,415 2.3 % 1-4 family residential properties secured by junior liens and revolving secured by 1-4 family first liens 18,749 1.3 % 18,236 1.3 % 1-4 family residential construction loans 36,386 2.5 % 32,500 2.3 % Other construction, land development and raw land loans 73,313 5.1 % 83,463 5.8 % Obligations of states and political subdivisions in the US 17,470 1.2 % 15,318 1.1 % Agricultural production, including commercial fishing 27,573 1.9 % 12,968 0.9 % Consumer loans 5,014 0.3 % 5,734 0.4 % Other loans 3,020 0.2 % 4,390 0.3 % Total loans $1,450,657 $1,444,050 59 Loans increased by $6.6 million, or 0.5%, to $1.451 billion at September 30, 2021 from $1.444 billion at December 31, 2020, primarily as a result of increased commercial real estate loans. Commercial real estate loans increased $109.5 million, or 17% during the nine-month period ending September 30, 2021 as compared to December 31, 2020. As shown in the table above, 1-4 family residential construction loans, obligations of states and political subdivisions, and agriculture production, including commercial fishing also increased in the first nine months of 2021 while the remaining loan segments decreased slightly, as compared to year end 2020. Management believes that the significant outreach that the Company has done throughout the SBA PPP lending cycle to both existing customers and new PPP loan customers has contributed to growth in our market share for non-PPP lending relationships. PPP loans are included in commercial and industrial loans in the table above and totaled $203.4 million at September 30, 2021 and $304.6 million at December 31, 2020. 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 $61.6 million, or approximately 4% of loans as of September 30, 2021 have direct exposure to the oil and gas industry as compared to $65.1 million, or approximately 4% of loans as of December 31, 2020. The Company's exposure as a percent of the total loan portfolio excluding SBA PPP loans as of September 30, 2021 was 5% and as of December 31, 2020 was 6%. The Company has no loans to oil producers or exploration companies as of September 30, 2021 or December 31, 2020, but the totals noted include a loan related to construction of an oil drilling rig. The balance of this loan was $3.9 million and $3.0 million at September 30, 2021 and December 31, 2020, 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 $70.5 million and $63.5 million at September 30, 2021 and December 31, 2020, respectively. The portion of the Company's ACL that related to the loans with direct exposure to the oil and gas industry was estimated at $1.3 million as of September 30, 2021 and $1.2 million as of December 31, 2020. 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) September 30, 2021 December 31, 2020 Commercial & industrial loans $42,201 $41,016 Commercial real estate: Owner occupied properties 11,178 11,296 Non-owner occupied and multifamily properties 6,696 6,606 Consumer loans — 2,256 Other loans 1,480 3,948 Total $61,555 $65,122 Supplemental information about significant COVID-19 exposure on directly impacted industries At September 30, 2021, the Company had $99.8 million, or 7% of portfolio loans, in the healthcare sector, $83.4 million, or 6% of portfolio loans, in the tourism sector, $59.5 million, or 4% of portfolio loans, in the aviation (non-tourism) sector, $42.0 million, or 3% in the restaurant sector, $64.2 million, or 4% of portfolio loans, in the fishing sector, $40.2 million, or 3% of portfolio loans, in the retail sector, and $52.9 million, or 4% of portfolio loans, in the accommodations sector. At September 30, 2021, the Company had $99.8 million, or 8% of total loans excluding SBA PPP loans, in the healthcare sector, $83.4 million, or 7% of portfolio loans excluding SBA PPP loans, in the tourism sector, $59.5 million, or 5% of portfolio loans excluding SBA PPP loans, in the aviation (non-tourism) sector, $42.0 million, or 3% of total loans excluding SBA PPP loans in the restaurant sector, $64.2 million, or 5% of total loans excluding SBA PPP loans, in the fishing sector, $52.9 million, or 4% of 60 total loans excluding SBA PPP loans in the accommodations sector, and $40.2 million, or 3% of total loans excluding SBA PPP loans, in retail loans. The portion of the Company's ACL that related to the loans with exposure to these industries is estimated at the following amounts as of September 30, 2021: (In Thousands) Tourism Aviation (non-tourism) Healthcare Retail Fishing Restaurant Accommodations Total ACL $897 $532 $1,084 $500 $576 $474 $568 $4,631 The following table sets forth information regarding changes in the ACL for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, (In Thousands) 2021 2020 2021 2020 Balance at beginning of period $14,539 $20,653 $21,136 $19,088 Cumulative effect of adoption of ASU 2016-13 — — (4,511) — Charge-offs: Commercial & industrial loans — 56 273 1,011 Commercial real estate: Owner occupied properties — 85 — 85 Other loans — — — 14 Total charge-offs — 141 273 1,110 Recoveries: Commercial & industrial loans 23 600 235 629 Commercial real estate: Owner occupied properties 2 — 6 — 1-4 family residential properties secured by junior liens and revolving secured by 1-4 family first liens 9 3 29 23 Agricultural production, including commercial fishing 5 — 20 — Consumer loans — 1 2 16 Other loans — — — 6 Total recoveries 39 604 292 674 Net, charge-offs (39) (463) (19) 436 (Benefit) provision for credit losses (762) 567 (2,828) 3,031 Balance at end of period $13,816 $21,683 $13,816 $21,683 The following table sets forth information regarding changes in the ACL for unfunded commitments for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, (In Thousands) 2021 2020 2021 2020 Balance at beginning of period $1,567 $167 $187 $152 Cumulative effect of adoption of ASU 2016-13 — — 1,229 — Adjusted balance, beginning of period 1,567 167 1,416 152 (Benefit) provision for credit losses (344) 12 (193) 27 Balance at end of period $1,223 $179 $1,223 $179 While management believes that it uses the best information available to determine the ACL, unforeseen market conditions and other events could result in adjustment to the ACL, and net income could be significantly affected if 61 circumstances differed substantially from the assumptions used in making the final determination of the ACL. Moreover, bank regulators frequently monitor banks' loan loss allowances, and if regulators were to determine that the Company’s ACL is inadequate, they may require the Company to increase the ACL, 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 $471.6 million, or 26%, to $2.297 billion as of September 30, 2021 compared to $1.825 billion as of December 31, 2020. This increase is primarily due to funding PPP loans, but is also due to new customer relationships as a result of the Company's significant PPP efforts during the first nine months of 2021 and the last nine months of 2020. The following table summarizes the Company's composition of deposits as of the periods indicated: September 30, 2021 December 31, 2020 (In thousands) Balance % of total Balance % of total Demand deposits $868,810 38 % $643,825 35 % Interest-bearing demand 644,035 28 % 459,095 25 % Savings deposits 330,465 14 % 308,725 17 % Money market deposits 278,529 12 % 237,705 13 % Time deposits 174,702 8 % 175,631 10 % Total deposits $2,296,541 $1,824,981 The Company’s mix of deposits continues to contribute to a low cost of funds with balances in transaction accounts representing 92% of total deposits at September 30, 2021 and 90% of total deposits at December 31, 2020. The only deposit category with stated maturity dates is certificates of deposit. At September 30, 2021, the Company had $174.7 million in certificates of deposit as compared to certificates of deposit of $175.6 million at December 31, 2020. At September 30, 2021, $101.2 million, or 58%, of the Company’s certificates of deposits are scheduled to mature over the next 12 months as compared to $175.6 million, or 73%, of total certificates of deposit at December 31, 2020. The aggregate amount of certificates of deposit in amounts of $100,000 and greater at September 30, 2021 and December 31, 2020, was $135.9 million and $133.3 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 September 30, 2021: Time Certificates of Deposit of $100,000 or More Percent of Total Deposits (In Thousands) Amount Amounts maturing in: Three months or less $22,111 16 % Over 3 through 6 months 20,202 15 % Over 6 through 12 months 37,551 28 % Over 12 months 56,075 41 % Total $135,939 100 % There were no depositors with deposits representing 10% or more of total deposits at September 30, 2021 or December 31, 2020. 62 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 September 30, 2021, our maximum borrowing line from the FHLB was $1.167 billion, approximately 45% of the Bank’s assets, subject to the FHLB’s collateral requirements. The Company has outstanding advances of $14.6 million as of September 30, 2021 which were originated to match fund low income housing projects that qualify for long term fixed interest rates. 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: The Federal Reserve Bank of San Francisco (the "Federal Reserve Bank") is holding $60.4 million of loans as collateral to secure advances made through the discount window on September 30, 2021. There were no discount window advances outstanding at September 30, 2021 or December 31, 2020, respectively. Other Short-term Borrowings: The Company is subject to provisions under Alaska state law, which generally limit the amount of outstanding debt to 35% of total assets or $907.6 million at September 30, 2021 and $736.0 million at December 31, 2020. At September 30, 2021 and December 31, 2020, 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 September 30, 2021 or December 31, 2020. 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 2021. 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 September 30, 2021 were $371.9 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 September 30, 2021 were $2.297 billion. As shown in the Consolidated Statements of Cash Flows included in Part I - Item 1 "Financial Statements" of this report, net cash provided by operating activities was $75.3 million for the first nine months of 2021, primarily due to cash provided by proceeds from the sale of loans held for sale, which were only partially offset by cash used in connection with the origination of loans held for sale. Net cash used by investing activities was $160.0 million for the same period, primarily due to purchases of available for sale and held to maturity securities and increases in loans and purchased receivables. This use of cash was only partially offset by proceeds from the maturities and calls of securities available for sale. Net cash provided by financing activities in the same period was $461.0 million, primarily due to increases in deposits largely due to funding PPP loans that was done via deposit into customer accounts. 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 September 30, 2021, our funds available for borrowing under our existing lines of credit were $1.219 billion. 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. 63 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 17,308 shares of its common stock in the first nine months of 2021 and repurchased 91,012 shares of its common stock under the Company's previously announced repurchase program. The Company repurchased 29,613 shares of its common stock in the third quarter of 2021. At September 30, 2021, the Company had 6,177,300 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 September 30, 2021, that the Company and the Bank met all applicable capital adequacy requirements for a “well-capitalized” institution by regulatory standards. 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 2021, 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 September 30, 2021 and December 31, 2020, 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 September 30, 2021 Total risk-based capital 8.00% 10.00% 15.00% 12.18% Tier 1 risk-based capital 6.00% 8.00% 14.17% 11.34% Common equity tier 1 capital 4.50% 6.50% 13.59% 11.36% Leverage ratio 4.00% 5.00% 9.48% 7.57% December 31, 2020 Total risk-based capital 8.00% 10.00% 15.46% 13.13% Tier 1 risk-based capital 6.00% 8.00% 14.20% 11.88% Common equity tier 1 capital 4.50% 6.50% 13.57% 11.89% Leverage ratio 4.00% 5.00% 10.25% 8.55% See Note 24 of the Consolidated Financial Statements in Part II. Item 8 of the Company's Annual Report on Form 10-K for the year ended December 31, 2020 for a detailed discussion of the capital ratios. The requirements for "well- capitalized" come from the Prompt Corrective Action rules. See Part I. Item 1 - Business - Supervision and Regulation in the Company's Annual Report on Form 10-K for the year ended December 31, 2020. 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. 64 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 September 30, 2021 and December 31, 2020, the Company’s commitments to extend credit and to provide letters of credit which are not reflected on its balance sheet amounted to $371.9 million and $377.4 million, respectively. Additionally, the Company had commitments to originate loans held for sale of $169.4 million and $150.3 million, as of September 30, 2021 and December 31, 2020, 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 $1.2 million and $187,000 at September 30, 2021 and December 31, 2020 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 a branch remodel in Anchorage. At September 30, 2021 the Company considers these commitments to be immaterial. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our assessment of market risk as of September 30, 2021 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, 2020.