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, 2021. 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 government initiatives 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, including the ware in Ukraine; 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, 2021, 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. 39 Update on Economic Conditions The Alaska economy has seen continued job growth and personal income gains. A strong rebound in tourism activity, coupled with high oil prices has benefited the state. Management believes that the national focus on supply chain issues and the desire for more domestic production should improve the demand for Alaska’s vast natural resources. Like the rest of the nation, Alaska’s housing market saw large price increases over the last year. However, we expect the rapidly rising interest rate environment to temper the Alaska housing market in the second half of 2022. The Alaska Department of Labor ("DOL") has released data through May of 2022. The DOL reports total payroll jobs in Alaska increased 2.9% or 8,900 jobs compared to May of 2021. The Leisure and Hospitality sector showed the fastest year over year increase of 12.4%. Tourism related jobs were the hardest hit from the pandemic travel restrictions, but were also the quickest to rebound. The Oil and Gas sector has benefited from high energy prices and added 600 jobs since May of 2021, a 9.1% increase. Other sectors showing improvement over the last 12 months include Trade, Warehousing, and Utilities (+6.8%), Other Services (+4.8%); Financial Activities (+2.8%), and Professional and Business Services (+2.6%). The only private sectors to decline year over year were Manufacturing (-2.9%) and Information (-2.1%). The Government sector was up slightly by 0.6%, an increase of 500 jobs through May 2022 year-over-year. Alaska’s Gross State Product (“GSP”), was estimated to be $58 billion at the end of 2021 by the Federal Bureau of Economic Analysis ("BEA"). This was a 0.3% increase in 2021 over 2020 figures. The BEA also calculated Alaska’s seasonally adjusted personal income was $49 billion in 2021, an improvement of 5.9% over 2020. This was largely a result of COVID related government transfer payments and an improvement in employment leading to higher wage income last year. The price of Alaska North Slope crude oil began 2021 averaging $55.56 a barrel in January and climbed steadily throughout the year due to rising global demand to a monthly average high of $84.36 in October 2021. 2022 began with a monthly average of $86.50 a barrel in January and surpassed $100 in March after the war in Ukraine began. Prices increased in the second quarter of 2022, reaching a monthly average of $120.17 a barrel in June. Alaska’s home mortgage delinquency level continues to be better than most of the nation. According to the Mortgage Bankers Association, Alaska’s delinquency rate in the first quarter of 2022 was 3.49% compared to the national average rate of 3.84%. The Mortgage Bankers Association survey reported that the mortgage foreclosure rate in Alaska in the first quarter of 2022 was identical to the national average rate of 0.53%. According to the Alaska Multiple Listing Services, the average sales price of a single family home in Anchorage rose 6.9% in 2021 to $424,148. In the first six months of 2022 prices climbed another 7.5% to $456,052. Average sales prices in the Matanuska Susitna Borough rose 15.6% in 2021 and another 11% in the first six months of 2022 to $386,429. These two markets represent where the vast majority of the Bank’s residential lending activity occurs. Prices also increased 13.9% in the Fairbanks North Star Borough, 13.4% in the Kenai Peninsula Borough, and 13.8% in the Kodiak Island Borough in 2021. The number of housing units sold in Anchorage was up significantly in 2021 by 11.2%, following an increase of 19.5% in 2020, as reported by the Alaska Multiple Listing Services. The Matanuska Susitna Borough also had strong sales activity, up 11.7% in 2021 and 9.7% in 2020. The Board of Governors of the Federal Reserve System increased its benchmark interest rate target from near zero as of December 31, 2021 to 2.25%-2.50% as of July 31, 2022. Similarly, the Prime rate of interest has increased from 3.25% as of December 31, 2022 to 5.50% as of July 31, 2022. The two and ten year Treasury rates were 2.89% and 2.67% as of July 31, 2022, up from 0.73% and 1.52% as of December 31, 2021, respectively. Management agrees with sentiment from industry experts that rates will continue to rise through the end of 2022 and into the first half of 2023. 40 Highlights and Summary of Performance - Second Quarter of 2022 The Company reported net income and diluted earnings per share of $4.8 million and $0.83, respectively, for the second quarter of 2022 compared to net income and diluted earnings per share of $8.3 million and $1.33, respectively, for the second quarter of 2021. The Company reported net income and diluted earnings per share of $12.0 million and $2.03, respectively, for the first six months of 2022 compared to net income and diluted earnings per share of $20.5 million and $3.27, respectively, for the first six months of 2021. The decrease in net income for the three and six-month periods ending June 30, 2022 compared to the same periods last year is primarily attributable to a decrease in net income in the Home Mortgage Lending segment as a result of decreased production and yields on sold loans, as well as a higher provision for credit losses and higher other operating expenses in the Community Banking segment that were only partially offset by higher net interest income. Increases in interest rates drove the decrease in production in the Home Mortgage Lending segment and the increase in net interest income. • Total revenue in the second quarter of 2022, which includes net interest income plus other operating income, decreased 10% to $30.0 million from $33.3 million in the second quarter a year ago, primarily due to a $5.5 million decrease in mortgage banking income and a $988.0 thousand increase in unrealized loss on marketable equity securities. These decreases were only partially offset by a $3.0 million increase in net interest income. Total revenue in the six-months ending June 30, 2022 decreased 12% to $60.1 million from $68.7 million in the same period a year ago, primarily due to a $12.1 million decrease in mortgage banking income and a $1.3 million increase in unrealized loss on marketable securities. • Net interest income in the second quarter of 2022 increased 16% to $22.2 million compared to $19.2 million in the second quarter of 2021. Net interest income excluding PPP interest and fees in the second quarter of 2022 increased 33% to $20.8 million, compared to $15.6 million in the second quarter of 2021. Net interest income in the six-months ending June 30, 2022 increased 7% to $41.5 million compared to $38.7 million in the same period a year ago. Net interest income excluding PPP interest and fees in the six-months ending June 30, 2022 increased 22% to $37.8 million compared to $30.9 million in the same period a year ago. • Net interest margin was 3.67% for the second quarter of 2022, a 19 basis point increase from the second quarter of 2021 primarily due to the higher yields on portfolio loans and investments and on interest bearing deposits in other banks. Net interest margin was 3.42% for the six-months ending June 30, 2022, a 26 basis point decrease from the same period a year ago primarily due to the a change in the mix of earning assets that was only partially offset by higher yields. Average interest bearing deposits in other banks increased to 19% of average interest-earning assets in the six-months ending June 30, 2022, compared to 8% in the same period a year ago. • Loans were $1.41 billion at June 30, 2022, down 1% from December 31, 2021 primarily as a result of PPP forgiveness which was only partially offset by core loan growth. Loans excluding the impact from PPP, were $1.37 billion at June 30, 2022, up 6% from $1.30 billion at December 31, 2021. As of June 30, 2022, 76% of core portfolio loans are adjustable rate and are subject to rate increases as the prime rate and other indices increase. • The Company booked a provision for credit losses of $463,000 and $313,000 for the three- and six-month periods ending June 30, 2022, respectively, compared to a benefit of $427,000 and a benefit of $1.9 million in the same periods in 2021. The increase in the provision for credit losses in both periods in 2022 compared to the same periods in the prior year are primarily the result of core loan growth. • The Company paid cash dividends of $0.41 per common share in the second quarter of 2022, up 11% from $0.37 in the second quarter of 2021. • At June 30, 2022, the capital ratios of the Company and Northrim Bank (the "Bank") were well in excess of all regulatory requirements. • During the second quarter of 2022, the Company repurchased 200,619 shares of its common stock under the previously announced share repurchase program at an average price of $41.04 per share. There are no shares remaining of the 300,000 previously authorized for repurchase. 41 Other financial measures are shown in the table below: Three Months Ended June 30, Six Months Ended June 30, 2022 2021 2022 2021 Return on average assets, annualized 0.74 % 1.40 % 0.93 % 1.80 % Return on average shareholders' equity, annualized 8.58 % 14.10 % 10.51 % 17.68 % Dividend payout ratio 49.30 % 27.80 % 40.22 % 22.57 % Growth and Paycheck Protection Program: • In 2020 and 2021, Northrim funded a total of nearly 5,800 PPP loans totaling $612.6 million to both existing and new customers. Management estimates that we funded approximately 24% of the number and 32% of the value of all Alaska PPP second round loans. • As of June 30, 2022, PPP has resulted in 2,344 new customers totaling $69.7 million in non-PPP loans, and $132.4 million in new deposit balances. • As of June 30, 2022, Northrim customers had received forgiveness through the U.S, Small Business Administration ("SBA") on 5,407 PPP loans totaling $582.0 million, of which 417 PPP loans totaling $33.7 million were forgiven in the second quarter of 2022, 537 PPP loans totaling $56.9 million were forgiven in the first quarter of 2022, and 4,451 PPP loans totaling $491.4 million were forgiven in 2021. Of the PPP loans forgiven in the second quarter of 2022, 414 loans totaling $33.4 million related to PPP round two. As of June 30, 2022, approximately 99% of the number of PPP round one loans funded and 88% of the number of PPP round two loans funded have been forgiven. Credit Quality • Customer Accommodations: The Company implemented several forms of assistance to help our customers in the event that they experienced financial hardship as a result of COVID-19 in addition to our participation in PPP lending. As of June 30, 2022, remaining accommodations include interest only and deferral options on loan payments. The total 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 June 30, 2022 (Dollars in thousands) Interest Only Full Payment Deferral Total Portfolio loans $23,573 $— $23,573 Number of modifications 5 — 5 Number of relationships 2 — 2 Loan Modifications due to COVID-19 as of December 31, 2021 (Dollars in thousands) Interest Only Full Payment Deferral Total Portfolio loans $49,219 $— $49,219 Number of modifications 16 — 16 Number of relationships 6 — 6 The $23.6 million in COVID-19 loan accommodations as of June 30, 2022 are scheduled to return to normal principal and interest payments in 2022. Nonperforming assets: Nonperforming assets, net of government guarantees at June 30, 2022 decreased 22%, or $3.3 million to $11.7 million as compared to $15.0 million at December 31, 2021. Other Real Estate Owned ("OREO"), net of government guarantees, remained at $4.4 million at June 30, 2022 as compared to December 31, 2021. Nonperforming loans, net of government guarantees decreased $3.4 million, or 32% to $7.3 million as of June 30, 2022 from $10.7 million as of December 31, 2021, primarily due to the transfer of one relationship back to accrual status in the first six months of 2022 as well as payoffs and pay downs in the first half of 2022. $5.9 million, or 74% of nonperforming assets at June 30, 2022, are nonaccrual loans related to five commercial relationships. The following table summarizes nonperforming asset activity for the three-month periods ending June 30, 2022 and 2021. 42 Writedowns Transfers to (In Thousands) Balance at March 31, 2022 Additions this quarter Payments this quarter /Charge-offs this quarter Transfers to OREO Performing Status this quarter Sales this quarter Balance at June 30, 2022 Nonperforming loans $9,609 $22 ($1,464) ($166) $— $— $— $8,001 Nonperforming loans guaranteed by government (907) — 224 — — — — (683) Nonperforming loans, net 8,702 22 (1,240) (166) — — — 7,318 Other real estate owned 5,638 — — — — — — 5,638 Other real estate owned guaranteed by government (1,279) — — — — — — (1,279) Total nonperforming assets, net of government guarantees $13,061 $22 ($1,240) ($166) $— $— $— $11,677 Writedowns Transfers to (In Thousands) Balance at March 31, 2021 Additions this quarter Payments this quarter /Charge-offs this quarter Transfers to OREO/REPO Performing Status this quarter Sales this quarter Balance at June 30, 2021 Nonperforming loans $14,463 $173 ($1,422) ($110) $— $— $— $13,104 Nonperforming loans guaranteed by government (1,382) — 286 — — — — (1,096) Nonperforming loans, net 13,081 173 (1,136) (110) — — — 12,008 Other real estate owned 7,563 — — — — — (490) 7,073 Repossessed assets 225 — — — — — (225) — Other real estate owned guaranteed by government (1,279) — — — — — — (1,279) Total nonperforming assets, net of government guarantees $19,590 $173 ($1,136) ($110) $— $— ($715) $17,802 Potential problem loans: Potential problem loans are loans which are currently performing in accordance with contractual terms but that have developed negative indications that the borrower may not be able to comply with present payment terms and which may later be included in nonaccrual, past due, or impaired loans. These loans are closely monitored and their performance is reviewed by management on a regular basis. At June 30, 2022, management had identified potential problem loans of $1.4 million as compared to potential problem loans of $2.1 million at December 31, 2021. The decrease in potential problem loans from December 31, 2021 to June 30, 2022 is primarily the result of one relationship payoff in the first half of 2022 which was only partially offset by the addition of one relationship in the first six months of 2022. 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 $3.0 million in loans classified as TDRs that were performing and $5.8 million in TDRs included in nonaccrual loans at June 30, 2022 for a total of approximately $8.9 million. There are $3.1 million in government guarantees associated with TDRs, resulting in total TDRs, net of government guarantees, of $5.8 million at June 30, 2022. At December 31, 2021 there were $773,000 in loans classified as TDRs, net of government guarantees that were performing and $6.5 million in TDRs included in nonaccrual loans for a total of $7.3 million. See Note 3 of the Notes to Consolidated Financial Statements included in Item 1 of this report for further discussion of TDRs. 43 RESULTS OF OPERATIONS Income Statement Net Income Net income for the second quarter of 2022 decreased $3.6 million to $4.8 million as compared to $8.3 million for the same period in 2021. The decrease in net income is mostly attributable to a $3.3 million decrease in net income in the Home Mortgage Lending segment, which is primarily due to lower production and a $239,000 decrease in net income in the Community Banking segment. The decrease in net income in the Community Banking segment in the three months ended June 30, 2022, as compared to the same period a year ago is primarily due to an increase in the provision for credit losses and other operating expenses which were only partially offset by increased net interest income. Net income for the first half of 2022 decreased $8.5 million to $12.0 million as compared to $20.5 million for the same period in 2021. The decrease in net income is mostly attributable to a $7.3 million decrease in net income in the Home Mortgage Lending segment, which is primarily due to lower production and a $1.2 million decrease in net income in the Community Banking segment. The decrease in net income in the Community Banking segment in the six-month period ended June 30, 2022, as compared to the same period a year ago is primarily due to an increase in the provision for credit losses and other operating expenses. These decreases were only partially offset by a $2.8 million increase in net interest income and $2.0 million in life insurance proceeds received in connection with the death of the Company’s former Executive Vice President, General Counsel and Corporate Secretary who passed away on November 11, 2021. 44 Net Interest Income/Net Interest Margin Net interest income for the second quarter of 2022 increased $3.0 million, or 16%, to $22.2 million as compared to $19.2 million for the second quarter of 2021. Net interest margin increased 19 basis points to 3.67% in the second quarter of 2022 as compared to 3.48% in the second quarter of 2021. Net interest income for the first half of 2022 increased $2.8 million, or 7%, to $41.5 million as compared to $38.7 million for the first half of 2021. Net interest margin decreased 26 basis points to 3.42% in the first half of 2022 as compared to 3.68% in the first half of 2021. The increase in net interest income in the second quarter and first six-months of 2022 compared to the same periods in 2021 was primarily the result of increased interest on loans, investments, and interest bearing deposits in other banks and decreased interest expense which was only partially offset by a decrease in loan fee income due in large part to decreased recognition of the deferred PPP loan fees upon loan forgiveness through the SBA. During the three and six-month periods ending June 30, 2022, Northrim received $33.7 million and $90.6 million, respectively, in PPP loan forgiveness through the SBA, compared to $133.0 million and $238.0 million, respectively, in the same periods in 2021. Total net PPP fee income including accretion and full fee recognition upon loan forgiveness was $1.3 million and $2.6 million during the three-month periods ending June 30, 2022 and 2021, respectively, and $3.4 million and $5.9 million during the six-month periods ending June 30, 2022 and 2021, respectively. As of June 30, 2022, there was $1.1 million of net deferred fees remaining on PPP loans mostly from the second round of PPP loan originations. The increase in net interest margin in the second quarter of 2022 as compared to the same period a year ago was primarily the result of higher yields on earning-assets which was only partially offset by 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. The decrease in the net interest margin in the first half of 2022 compared to the same period a year ago is primarily due to the less favorable mix of earning assets, which was only partially offset by higher yields. Changes in net interest margin in the three and six-month periods ended June 30, 2022 as compared to the same periods in the prior year are detailed below: Three Months Ended June 30, 2022 vs. June 30, 2021 Nonaccrual interest adjustments (0.04) % Impact of SBA Paycheck Protection Program loans 0.11 % Interest rates and loan fees 0.35 % Volume and mix of interest-earning assets (0.23) % Change in net interest margin 0.19 % Six Months Ended June 30, 2022 vs. June 30, 2021 Nonaccrual interest adjustments 0.05 % Impact of SBA Paycheck Protection Program loans 0.09 % Interest rates and loan fees 0.07 % Volume and mix of interest-earning assets (0.47) % Change in net interest margin (0.26) % 45 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 June 30, 2022 and 2021. Average yields or costs are not calculated on a tax-equivalent basis. (Dollars in Thousands) Three Months Ended June 30, Interest income/ Average Balances Change expense Change Average Yields/Costs 2022 2021 $ % 2022 2021 $ % 2022 2021 Change Interest-bearing deposits in other banks 1 $382,015 $208,067 $173,948 84 % $766 $61 $705 1,156 % 0.80 % 0.12 % 0.68 % Taxable long-term investments 2 588,741 353,404 235,337 67 % 2,415 1,225 1,190 97 % 1.65 % 1.39 % 0.26 % Non-taxable long-term investments 2 812 856 (44) (5) % 4 4 — — % 1.98 % 1.87 % 0.11 % Loans held for sale 59,677 111,228 (51,551) (46) % 620 763 (143) (19) % 4.17 % 2.75 % 1.42 % Loans 3,4 1,398,149 1,541,701 (143,552) (9) % 19,187 18,200 987 5 % 5.50 % 4.74 % 0.76 % Interest-earning assets 5 2,429,394 2,215,256 214,138 10 % 22,992 20,253 2,739 14 % 3.80 % 3.67 % 0.13 % Nonearning assets 172,655 173,164 (509) — % Total $2,602,049 $2,388,420 $213,629 9 % Interest-bearing demand $669,848 $561,570 $108,278 19 % $167 $128 $39 30 % 0.10 % 0.09 % 0.01 % Savings deposits 349,108 311,929 37,179 12 % 118 126 (8) (6) % 0.14 % 0.16 % (0.02) % Money market deposits 322,384 256,215 66,169 26 % 103 112 (9) (8) % 0.13 % 0.18 % (0.05) % Time deposits 172,617 186,315 (13,698) (7) % 211 513 (302) (59) % 0.49 % 1.10 % (0.61) % Total interest-bearing deposits 1,513,957 1,316,029 197,928 15 % 599 879 (280) (32) % 0.16 % 0.27 % (0.11) % Borrowings 24,675 25,032 (357) (1) % 181 182 (1) (1) % 2.94 % 2.92 % 0.02 % Total interest-bearing liabilities 1,538,632 1,341,061 197,571 15 % 780 1,061 (281) (26) % 0.20 % 0.32 % (0.12) % Non-interest bearing demand deposits 808,186 766,954 41,232 5 % Other liabilities 839,250 809,971 (11,953) (28) % Equity 224,167 237,388 (13,221) (6) % Total $2,602,049 $2,388,420 $213,629 9 % Net interest income $22,212 $19,192 $3,020 16 % Net interest margin 3.67 % 3.48 % 0.19 % Average loans to average interest-earning assets 57.55 % 69.59 % Average loans to average total deposits 60.21 % 74.01 % Average non-interest deposits to average total deposits 34.80 % 36.82 % Average interest-earning assets to average interest-bearing liabilities 157.89 % 165.19 % 1 Consists of interest bearing deposits in other banks and domestic CDs. 2 Consists of investment securities available for sale, investment securities held to maturity, marketable equity securities, and investment in Federal Home Loan Bank stock. Taxable long-term investments consist of U.S. treasury and government sponsored entities, corporate bonds, collateral loan obligations, marketable equity securities, and Federal Home Loan Bank stock. Non-taxable long-term investments consist of municipal securities. 3 Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled $2.3 million and $3.4 million in the second quarter of 2022 and 2021, respectively. 4 Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loan balances were $8.8 million and $13.8 million in the second quarter of 2022 and 2021, respectively . 5 The Company does not have any fed funds sold or securities purchased with agreements to resell to disclose as part of its total interest-earning assets in the periods presented. 46 The following tables set forth the changes in consolidated net interest income attributable to changes in volume and to changes in interest rates for the three-month periods ending June 30, 2022 and 2021. 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. The Company did not have any fed funds sold or securities purchased with agreements to resell for the three-month periods ending June 30, 2022 and 2021. (In Thousands) Three Months Ended June 30, 2022 vs. 2021 Increase (decrease) due to Volume Rate Total Interest Income: Short-term investments $91 $614 $705 Taxable long-term investments 1,039 151 1,190 Nontaxable long-term investments — — — Loans held for sale (439) 296 (143) Loans (1,299) 2,286 987 Total interest income ($608) $3,347 $2,739 Interest Expense: Interest-bearing demand $26 $13 $39 Savings deposits 14 (22) (8) Money market deposits 25 (34) (9) Time deposits (41) (261) (302) Interest-bearing deposits 24 (304) (280) Borrowings (2) 1 (1) Total interest expense $22 ($303) ($281) 47 The following table compares average balances and rates as well as margins on earning assets for the six-month periods ended June 30, 2022 and 2021. Average yields or costs are not calculated on a tax-equivalent basis. (Dollars in Thousands) Six Months Ended June 30, Interest income/ Average Balances Change expense Change Average Yields/Costs 2022 2021 $ % 2022 2021 $ % 2022 2021 Change Interest-bearing deposits in other banks 1 $459,843 $164,712 $295,131 179 % $1,008 $99 $909 918 % 0.44 % 0.12 % 0.32 % Taxable long-term investments 2 56,173 112,897 (56,724) (50) % 1,025 1,545 (520) (34) % 3.68 % 2.76 % 0.92 % Non-taxable long-term investments 2 539,741 325,815 213,926 66 % 3,958 2,354 1,604 68 % 1.48 % 1.46 % 0.02 % Loans held for sale 822 856 (34) (4) % 9 9 — — % 2.21 % 2.12 % 0.09 % Loans 3,4 1,389,050 1,517,438 (128,388) (8) % 37,050 36,842 208 1 % 5.38 % 4.90 % 0.48 % Interest-earning assets 5 2,445,629 2,121,718 323,911 15 % 43,050 40,849 2,201 5 % 3.55 % 3.88 % (0.33) % Nonearning assets 164,611 171,870 (7,259) (4) % Total $2,610,240 $2,293,588 $316,652 14 % Interest-bearing demand $672,694 $516,228 $156,466 30 % $282 $246 $36 15 % 0.08 % 0.10 % (0.02) % Savings deposits 350,823 314,709 36,114 11 % 246 255 (9) (4) % 0.14 % 0.16 % (0.02) % Money market deposits 321,580 251,140 70,440 28 % 205 225 (20) (9) % 0.13 % 0.18 % (0.05) % Time deposits 174,898 179,778 (4,880) (3) % 441 1,102 (661) (60) % 0.51 % 1.24 % (0.73) % Total interest-bearing deposits 1,519,995 1,261,855 258,140 20 % 1,174 1,828 (654) (36) % 0.16 % 0.29 % (0.13) % Borrowings 24,726 25,066 (340) (1) % 360 336 24 7 % 2.94 % 2.70 % 0.24 % Total interest-bearing liabilities 1,544,721 1,286,921 257,800 20 % 1,534 2,164 (630) (29) % 0.20 % 0.34 % (0.14) % Non-interest bearing demand deposits 801,481 727,589 73,892 10 % Other liabilities 33,436 44,959 (11,523) (26) % Equity 230,602 234,119 (3,517) (2) % Total $2,610,240 $2,293,588 $316,652 14 % Net interest income $41,516 $38,685 $2,831 7 % Net interest margin 3.42 % 3.68 % (0.26) % Average loans to average interest-earning assets 56.80 % 71.52 % Average loans to average total deposits 59.83 % 76.27 % Average non-interest deposits to average total deposits 34.52 % 36.57 % Average interest-earning assets to average interest-bearing liabilities 158.32 % 164.87 % 1 Consists of interest bearing deposits in other banks and domestic CDs. 2 Consists of investment securities available for sale, investment securities held to maturity, marketable equity securities, and investment in Federal Home Loan Bank stock. Taxable long-term investments consist of U.S. treasury and government sponsored entities, corporate bonds, collateral loan obligations, marketable equity securities, and Federal Home Loan Bank stock. Non-taxable long-term investments consist of municipal securities. 3 Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled $5.3 million and $16.2 million in the first six months of 2022 and 2021, respectively. 4 Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loan balances were $9.9 million and $12.2 million in the first six months of 2022 and 2021, respectively . 5 The Company does not have any fed funds sold or securities purchased with agreements to resell to disclose as part of its total interest-earning assets in the periods presented. 48 The following tables set forth the changes in consolidated net interest income attributable to changes in volume and to changes in interest rates for the six-month periods ending June 30, 2022 and 2021. 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. The Company did not have any fed funds sold or securities purchased with agreements to resell for the six-month periods ending June 30, 2022 and 2021. (In Thousands) Six Months Ended June 30, 2022 vs. 2021 Increase (decrease) due to Volume Rate Total Interest Income: Short-term investments $367 $542 $909 Taxable long-term investments 1,354 250 1,604 Nontaxable long-term investments — — — Loans held for sale (1,549) 1,029 (520) Loans (6,666) 6,874 208 Total interest income ($6,494) $8,695 $2,201 Interest Expense: Interest-bearing demand $68 ($32) $36 Savings deposits 27 (36) (9) Money market deposits 54 (74) (20) Time deposits (31) (630) (661) Interest-bearing deposits 118 (772) (654) Borrowings (5) 29 24 Total interest expense $113 ($743) ($630) Provision for Credit Losses The provision for credit loss expense is the amount of expense that, based on our judgment, is required to maintain the Allowance for Credit Losses ("ACL") at an appropriate level under the Current Expected Credit Losses ("CECL") model. The determination of the amount of the ACL is complex and involves a high degree of judgment and subjectivity. The following table presents the major categories of credit loss expense: Three Months Ended June 30, Six Months Ended June 30, (In Thousands) 2022 2021 2022 2021 Credit loss expense on loans held for investment $273 ($161) $106 ($2,066) Credit loss expense on unfunded commitments 190 (266) 207 151 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 (benefit) expense $463 ($427) $313 ($1,915) The increase in the provision for credit losses on loans for the three and six-month periods ending June 30, 2022 as compared to the same periods in 2021 is primarily the result of increased unguaranteed loan balances in the three and six-month periods ending June 30, 2022 as compared to the same periods in 2021 that were only partially offset by a decrease in the estimated loss rates due to lower forecasted unemployment rates. During the same periods in 2021, decreases in estimated loss rates were higher than the decreases in 2022 due to larger decreases in the forecasted unemployment rates. 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. 49 Other Operating Income Other operating income for the three-month period ended June 30, 2022, decreased $6.3 million, or 45%, to $7.8 million as compared to $14.1 million for the same period in 2021, primarily due to a $5.5 million decrease in mortgage banking income in the second quarter of 2022 compared to the same quarter in 2021. The decrease in mortgage banking income in the three-month period ended June 30, 2022 as compared to the same period in 2021 was primarily due to decreased production volume due to decreased refinance activity resulting from increases in the mortgage interest rates. Additionally, there was a $988.0 thousand increase in unrealized loss on marketable securities. These decreases were only partially offset by small increases in bankcard fees and service charges on deposit accounts due to an increase in customers. Other operating income for the six-month period ended June 30, 2022, decreased $11.4 million, or 38%, to $18.6 million as compared to $30.0 million for the same period in 2021, primarily due to a $12.1 million decrease in mortgage banking income in the first half of 2022 compared to the same period in 2021 for the same reason outlined above. Additionally, there was a $1.3 million increase in unrealized loss on marketable securities. These decreases were only partially offset by $2.0 million in life insurance proceeds received in connection with the death of the Company’s former Executive Vice President, General Counsel and Corporate Secretary who passed away on November 11, 2021, as well as small increases in bankcard fees and service charges on deposit accounts due to an increase in customers. Other Operating Expense Other operating expense for the second quarter of 2022 increased $902,000, or 4%, to $23.2 million as compared to $22.3 million for the same period in 2021 primarily due to higher salaries and other personnel expense related to the community banking segment that was only partially offset by a decrease in salaries and other personnel expense related to mortgage banking operations, which fluctuate with production volumes. Additionally, insurance expense increased in the second quarter of 2022 as compared to the second quarter of 2021 due to higher FDIC insurance premiums primarily due to growth in the Company's balance sheet. Other operating expense for the first half of 2022 increased $676,000, or 2%, to $44.3 million as compared to $43.7 million for the same period in 2021 primarily due to higher insurance expense due to higher FDIC insurance premiums primarily due to growth in the Company's balance sheet. Additionally, marketing expense and professional fees increased in the first half of 2022 as compared to 2021 due to timing differences of advertising and sponsorships and increased investment management fees attributable to the growth in our investment portfolio. Income Taxes For the second quarter and first half of 2022, Northrim recorded a lower effective tax rate as compared to the same periods in 2021 as a result of an increase in tax credits and tax exempt interest income as a percentage of pre-tax income in 2022. In the second quarter of 2022, Northrim recorded $1.5 million in state and federal income tax expense, for an effective tax rate of 24.11% compared to $3.1 million and 26.89% for the same period in 2021. For the first half of 2022, Northrim recorded $3.5 million in state and federal income tax expense, for an effective tax rate of 22.42% compared to $6.4 million in state and federal income tax expense, for an effective tax rate of 23.88% for the same period in 2021. 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 June 30, 2022 increased 43%, or $195.8 million, to $650.9 million from $455.1 million at December 31, 2021 as proceeds from an increase in deposits that were not lent out were invested in the first six months of 2022. 50 The table below details portfolio investment balances by portfolio investment type: June 30, 2022 December 31, 2021 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 $521,338 80.1 % $341,480 75.0 % Municipal securities 807 0.1 % 840 0.2 % Corporate bonds 61,753 9.5 % 52,946 11.6 % Collateralized loan obligations 57,878 8.9 % 51,418 11.3 % Preferred stock 9,122 1.4 % 8,420 1.9 % Total portfolio investments $650,898 $455,104 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: June 30, 2022 December 31, 2021 Dollar Amount Percent of Total Dollar Amount Percent of Total (In Thousands) Commercial & industrial loans $394,841 28.1 % $448,338 31.7 % Commercial real estate: Owner occupied properties 313,174 22.3 % 300,200 21.2 % Non-owner occupied and multifamily properties 446,592 31.7 % 435,311 30.8 % Residential real estate: 1-4 family residential properties secured by first liens 37,298 2.7 % 32,542 2.3 % 1-4 family residential properties secured by junior liens and revolving secured by 1-4 family first liens 21,953 1.6 % 19,610 1.4 % 1-4 family residential construction loans 43,915 3.1 % 36,222 2.6 % Other construction, land development and raw land loans 87,163 6.2 % 88,094 6.2 % Obligations of states and political subdivisions in the US 24,005 1.7 % 16,403 1.2 % Agricultural production, including commercial fishing 29,482 2.1 % 27,959 2.0 % Consumer loans 4,092 0.3 % 4,801 0.3 % Other loans 3,194 0.2 % 4,406 0.3 % Total loans $1,405,709 $1,413,886 Loans decreased by $8.2 million, or 1%, to $1.406 billion at June 30, 2022 from $1.414 billion at December 31, 2021, primarily as a result of decreased SBA PPP loans. Loans excluding PPP loans increased $78.2 million, or 6% to $1.374 billion at June 30, 2022 from $1.296 billion at December 31, 2021. 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 $31.9 million at June 30, 2022 and $118.2 million at December 31, 2021. Information about loan concentrations 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 $59.2 million, or approximately 4% of loans as of June 30, 2022 have direct exposure to the oil and gas industry as compared to $63.6 million, or approximately 5% of loans as of December 31, 2021. The Company's unfunded commitments to borrowers that have direct exposure to the oil and gas industry were $68.1 million and $66.4 million at June 30, 2022 and December 31, 2021, respectively. The portion of the Company's 51 ACL that related to the loans with direct exposure to the oil and gas industry was estimated at $466,000 as of June 30, 2022 and $684,000 as of December 31, 2021. 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) June 30, 2022 December 31, 2021 Commercial & industrial loans $41,370 $45,338 Commercial real estate: Owner occupied properties 10,066 10,244 Non-owner occupied and multifamily properties 6,296 6,564 Other loans 1,465 1,495 Total $59,197 $63,641 The Company monitors other concentrations within the loan portfolio depending on trends in the current and future estimated economic conditions. At June 30, 2022, the Company had $121.3 million, or 9% of portfolio loans, in the Healthcare sector, $96.6 million, or 7% of portfolio loans, in the Tourism sector, $63.1 million, or 4% of portfolio loans, in the Retail sector, $59.9 million, or 4% of portfolio loans, in the Accommodations sector, $58.5 million, or 4% of portfolio loans, in the Fishing sector, $51.1 million, or 4% in the Restaurant sector, and $50.0 million, or 4% of portfolio loans, in the Aviation (non-tourism) sector. 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 June 30, 2022: (In Thousands) Tourism Aviation (non-tourism) Healthcare Retail Fishing Restaurant Accommodations Total ACL $683 $325 $945 $529 $365 $406 $459 $3,712 52 The following table sets forth information regarding changes in the ACL for the periods indicated: Three Months Ended June 30, Six Months Ended June 30, (In Thousands) 2022 2021 2022 2021 Balance at beginning of period $11,310 $14,764 $11,739 $21,136 Cumulative effect of adoption of ASU 2016-13 — — — (4,511) Charge-offs: Commercial & industrial loans (166) (110) (461) (273) Total charge-offs (166) (110) (461) (273) Recoveries: Commercial & industrial loans 103 27 116 212 Commercial real estate: Owner occupied properties — 2 — 4 1-4 family residential properties secured by junior liens and revolving secured by 1-4 family first liens 9 10 21 20 Agricultural production, including commercial fishing 7 7 15 15 Consumer loans 1 — 1 2 Total recoveries 120 46 153 253 Net, charge-offs (46) (64) (308) (20) (Benefit) provision for credit losses 273 (161) 106 (2,066) Balance at end of period $11,537 $14,539 $11,537 $14,539 The following table sets forth information regarding changes in the ACL for unfunded commitments for the periods indicated: Three Months Ended June 30, Six Months Ended June 30, (In Thousands) 2022 2021 2022 2021 Balance at beginning of period $1,113 $1,833 $1,096 $187 Cumulative effect of adoption of ASU 2016-13 — — — 1,229 Adjusted balance, beginning of period 1,113 1,833 1,096 1,416 (Benefit) provision for credit losses 190 (266) 207 151 Balance at end of period $1,303 $1,567 $1,303 $1,567 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 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. 53 Deposits Deposits are the Company’s primary source of funds. Total deposits decreased $86.2 million, or 4%, to $2.335 billion as of June 30, 2022 compared to $2.422 billion as of December 31, 2021, primarily due to the drawdown of a large temporary deposit in the first quarter of 2022. The following table summarizes the Company's composition of deposits as of the periods indicated: June 30, 2022 December 31, 2021 (In thousands) Balance % of total Balance % of total Demand deposits $830,156 35 % $887,824 37 % Interest-bearing demand 666,283 29 % 692,683 29 % Savings deposits 349,208 15 % 348,164 14 % Money market deposits 319,843 14 % 314,996 13 % Time deposits 169,900 7 % 177,964 7 % Total deposits $2,335,390 $2,421,631 The Company’s mix of deposits continues to contribute to a low cost of funds with balances in transaction accounts representing 93% of total deposits at June 30, 2022 and 93% of total deposits at December 31, 2021. The only deposit category with stated maturity dates is certificates of deposit. At June 30, 2022, the Company had $169.9 million in certificates of deposit as compared to certificates of deposit of $178.0 million at December 31, 2021. At June 30, 2022, $133.1 million, or 78%, of the Company’s certificates of deposits are scheduled to mature over the next 12 months as compared to $118.5 million, or 67%, of total certificates of deposit at December 31, 2021. The aggregate amount of certificates of deposit in amounts of $250,000 and greater at June 30, 2022 and December 31, 2021, was $73.3 million and $77.1 million, respectively. The following table sets forth the amount outstanding of deposits in amounts of $250,000 and greater by time remaining until maturity and percentage of total deposits as of June 30, 2022: Time Certificates of Deposit of $250,000 or More Percent of Total Deposits (In Thousands) Amount Amounts maturing in: Three months or less $11,681 16 % Over 3 through 6 months 14,653 20 % Over 6 through 12 months 29,479 40 % Over 12 months 17,457 24 % Total $73,270 100 % Borrowings FHLB: The Bank is a member of the Federal Home Loan Bank of Des Moines (the "FHLB"). As a member, the Bank is eligible to obtain advances from the FHLB. FHLB advances are dependent on the availability of acceptable collateral such as marketable securities or real estate loans, although all FHLB advances are secured by a blanket pledge of the Bank’s assets. At June 30, 2022, our maximum borrowing line from the FHLB was $1.169 billion, approximately 45% of the Bank’s assets, subject to the FHLB’s collateral requirements. The Company has outstanding advances of $14.3 million as of June 30, 2022 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 $50.5 million of loans as collateral to secure advances made through the discount window on June 30, 2022. There were no discount window advances outstanding at either June 30, 2022 or December 31, 2021. 54 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 $909.4 million at June 30, 2022 and $948.0 million at December 31, 2021. At June 30, 2022 and December 31, 2021, the Company had no short-term (original maturity of one year or less) borrowings that exceeded 30% of shareholders’ equity. Long-term Borrowings. The Company had no long-term borrowing outstanding other than the FHLB advances noted above as of June 30, 2022 or December 31, 2021. 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 2022. Other available sources of liquidity for the bank holding company include the issuance of debt and the issuance of common or preferred stock. As of June 30, 2022, the Company has 10.0 million authorized shares of common stock, of which 5.7 million are issued and outstanding, leaving 4.3 million shares available for issuance. Additionally, the Company has 2.5 million authorized shares of preferred stock available for issuance. The Bank manages its liquidity through its Asset and Liability Committee. The Bank's primary source of funds are customer deposits. These funds, together with loan repayments, loan sales, maturity of investment securities, borrowed funds, and retained earnings 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. The Company had cash and cash equivalents of $336.9 million, or 13% of total assets at June 30, 2022 compared to $645.8 million, or 24% of total assets as of December 31, 2021. The decrease in cash and cash equivalents is primarily due to an increase in available for sale securities and a decrease in deposits, but is still elevated as compared to historical norms. The Company had other comprehensive losses, net of tax, of $4.9 million and $15.9 million for the three and six-month periods ending June 30, 2022 primarily due to unrealized holding losses on available for sale securities due to increases in interest rates. Management does not believe that liquidation of these securities, which would result in realized losses, will occur prior to maturity of these securities. Furthermore, management expects that the Company's elevated level of liquidity will continue through 2022 and potentially into subsequent years. Accordingly, management has invested in slightly longer term investment securities as compared to the last several years. As of June 30, 2022, the weighted average maturity of available for sale securities is 3.6 years compared to 4.1 years at December 31, 2021 and 2.6 years at December 31, 2020. At June 30, 2022, no available for sale securities mature within one year, $137.0 million mature within one to two years, and $178.4 million mature within two to three years. Our total unfunded commitments to fund loans and letters of credit at June 30, 2022 were $415.8 million. We do not expect that all of these loans are likely to be fully drawn upon at any one time. At June 30, 2022, certificates of deposit totaling $133.1 million are scheduled to mature over the next 12 months and may be withdrawn from the Bank. Similar to loans, we do not expect that these maturing certificates of deposit, or other non-maturity deposits, to be withdrawn from the Bank in a manner that will strain liquidity; however, unforeseen future circumstances or events may cause higher than anticipated withdrawal of deposits or draws of unfunded commitments to fund new loans. Management believes that cash requirements to fund future non-deposit liabilities, including operating lease liabilities, other liabilities, or borrowings as of June 30, 2022, are not material to the Company's liquidity position as of June 30, 2022. The Company has other available sources of liquidity to fund unforeseen liquidity needs. These include borrowings available through our correspondent banking relationships and our credit lines with the Federal Reserve Bank and the FHLB. At June 30, 2022, our liquid assets were $578.8 million and our funds available for borrowing under our existing lines of credit were $1.224 billion. 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. 55 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 $15.3 million for the first six months of 2022, 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 $218.8 million for the same period, primarily due to purchases of available for sale and held to maturity securities as well as an increase in purchased receivables. This use of cash was only partially offset by a decrease in loans, mostly attributable to SBA PPP forgiveness. Net cash used by financing activities in the same period was $105.4 million, primarily due to a decrease in deposits. Throughout our history, the Company has periodically repurchased for cash a portion of its shares of common stock in the open market. The Company repurchased 333,724 shares of its common stock under the Company's previously announced repurchase programs in the first six months of 2022. At June 30, 2022, there are no shares remaining of the shares previously authorized for repurchase. The Company may elect 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. Capital Requirements and Ratios We are subject to minimum capital requirements. Federal banking agencies have adopted regulations establishing minimum requirements for the capital adequacy of banks and bank holding companies. The requirements address both risk-based capital and leverage capital. We believe as of June 30, 2022, 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 2022, exceeding the FDIC’s requirements for the “well-capitalized” classification. The capital ratios for the Company exceed those for the Bank primarily because the $10 million trust preferred securities offering completed in the fourth quarter of 2005 is included in the Company’s capital for regulatory purposes, although they are accounted for as a long-term debt in our financial statements. The trust preferred securities are not accounted for on the Bank’s financial statements nor are they included in its capital. As a result, the Company has $10 million more in regulatory capital than the Bank at both June 30, 2022 and December 31, 2021, which explains most of the difference in the capital ratios for the two entities. Minimum Required Capital Well-Capitalized Actual Ratio Company Actual Ratio Bank June 30, 2022 Total risk-based capital 8.00% 10.00% 13.45% 11.46% Tier 1 risk-based capital 6.00% 8.00% 12.74% 10.74% Common equity tier 1 capital 4.50% 6.50% 12.20% 10.76% Leverage ratio 4.00% 5.00% 8.84% 7.44% See Note 23 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, 2021 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, 2021. 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. 56 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, 2021. The SEC defines "critical accounting policies" as those that require application of management's most difficult, subjective or complex judgments as a result of the need to make "critical accounting estimates", which are estimates that involve estimation uncertainty that has had or is reasonably likely to have a material impact on the Company's financial condition or results of operations. The Company's critical accounting policies include allowance for credit losses, valuation of goodwill and other intangible assets, the valuation of OREO, the valuation of mortgage servicing rights, and fair value. There have been no material changes to the valuation techniques or models, that affect our estimates during 2022 except as noted below. Allowance for Credit Losses Policy: For loan pools that utilize the discounted cash flow ("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. 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. As of December 31, 2021, management utilized and forecasted Alaska unemployment as a loss driver for all of the loan pools that utilized the DCF method. Management also utilized and forecasted 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 correlated to expected future losses. Additionally, the Company's regression models for PD as of December 31, 2021 utilized the Company's actual historical loan level default data. As of January 1, 2022, management utilizes and forecasts U.S. unemployment as the sole loss driver for all of the loan pools that utilize the DCF method. The Company's regression models for PD as of January 1, 2022 utilize peer historical loan level default data. Peers for this purpose include banks in the United States with total assets between $1 billion and $5 billion whose loan portfolios share certain characteristics with the Company's loan portfolio. Peers differ by loan segment; a bank is included in the peer group for each loan segment under the following circumstances: • The percentage the balance of the loan segment compared to total loans over a five year look back period is within 1.5 standard deviations of the Company's data, and • The percentage of total charge offs for the loan segment over a five year look back period is within 1 standard deviation of the Company's data; and • The percentage of total charge offs for the loan segment during the recessionary period from the fourth quarter of 2008 to the fourth quarter of 2012 is within 1 standard deviation of the Company's data. No other changes have been made to the Company's Allowance for Credit Losses Policy since December 31, 2021. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our assessment of market risk as of June 30, 2022 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, 2021. 57