NORTHRIM BANCORP INC 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We have prepared this Management's Discussion and Analysis as an aid to understanding our financial results. It highlights key information as determined by management but may not contain all of the information that is important to you. It should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto included in Part II. Item 8 of this report. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II. Item 7 of our Annual Report on Form 10-K for fiscal year ended December 31, 2021. This annual report contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those indicated in forward-looking statements. See “Cautionary Note Regarding Forward-Looking Statements.” Executive Overview Net income decreased 18% to $30.7 million or $5.27 per diluted share for the year ended December 31, 2022, from $37.5 million, or $6.00 per diluted share, for the year ended December 31, 2021. The decrease in net income is primarily the result of a $11.2 million decrease in net income in the Home Mortgage Lending segment, which was only partially offset by an $4.5 million increase in net income in the Community Banking segment. Highlights for the year ended December 31, 2022 are as follows: • Net income in the Home Mortgage Lending segment decreased 109%, or $11.2 million, to a loss of $897,000 in 2022 from $10.3 million in 2021 driven by a decrease in production volume to $585.5 million in 2022 from $1.118 billion in 2021 largely due to the significant increase in interest rates in 2022. • Net income in the Community Banking segment increased 16% or $4.5 million, to $31.6 million in 2022 as compared to 2021. This increase was primarily the result of the following: ◦ Net interest income increased $14.8 million to $92.9 million in 2022 from $78.1 million in 2021 despite a decrease of $10.7 million in PPP interest and fee income primarily due to the increase in interest rates in 2022, and due to growth in core loans (excluding PPP loans) and higher average balances in long-term investments and interest-bearing deposits in other banks. ◦ The provision for credit losses increased in 2022 to a provision of $1.8 million from a benefit of $4.1 million in 2021. In 2022, the provision for credit losses included a provision for growth in both unguaranteed loan balances and unfunded commitments, and a provision for a slight increase in projected loss rates. These increases were only partially offset by net recoveries for the year. In 2021, there was a reversal of the provision for credit losses due to a decrease in projected loss rates that was only partially offset by growth in unguaranteed loan and unfunded commitment balances and net charge offs for the year. • The net interest margin increased to 3.85% in 2022 from 3.58% in 2021 mostly due to an increase in average yields on interest earning assets to 4.06% in 2022 compared to 3.74% in 2021 as a result of higher interest rates. • In 2020 and 2021, Northrim funded approximately 5,800 PPP loans totaling approximately $612.6 million to both existing and new customers. Management estimates that Northrim funded approximately 24% of the number and 32% of the value of all Alaska PPP second round loans. • As of December 31, 2022, Northrim's PPP efforts have resulted in approximately 2,300 new customers totaling $135.9 million in new deposit balances and contributed to the growth in core portfolio loans. 33 • The Company implemented assistance to help its customers experiencing financial challenges as a result of COVID-19. The total outstanding principal balance of loan modifications due to the impacts of COVID-19 as of December 31, 2022 was $1.0 million, down from $8.4 million as of September 30, 2022 and $49.2 million as of December 31, 2021. The $1.0 million of remaining COVID-19 loan accommodations are scheduled to return to normal principal and interest payments in the first quarter of 2023. • Nonperforming loans, net of government guarantees, decreased to $6.4 million at the end of 2022 compared to $10.7 million at the end of 2021, while total adversely classified loans, net of government guarantees at December 31, 2022 decreased to $7.6 million from $13.7 million at December 31, 2021. The Allowance for Credit Losses ("ACL") totaled 0.92% of total portfolio loans at December 31, 2022, compared to 0.83% at December 31, 2021. This increase is primarily due to a decrease in government loan guarantees resulting from a decrease in PPP loans as a percentage of the Company's loan portfolio. The ACL as a percentage of total portfolio loans, net of government guarantees was 0.99% at December 31, 2022 compared to 0.93% at December 31, 2021. • The aggregate cash dividends paid by the Company in 2022 rose 13% to $10.6 million from $9.4 million paid in 2021. • The Company repurchased 333,724 shares of its common stock in 2022 at an average price of $42.42 per share. • Total shareholders' equity was $218.6 million as of December 31, 2022, up 4% from the preceding quarter, and down 8% from $237.8 million a year ago. Shareholders' equity was negatively impacted by the fair value of the available for sales securities portfolio which decreased $27.4 million in 2022 and, to a lesser extent the share repurchases totaling $14.2 million. The Company continued to maintain strong regulatory capital ratios with Tier 1 Capital to Risk Adjusted Assets of 12.81% at December 31, 2022. 34 Trends in Miscellaneous Financial Data (1) Years Ended December 31, (In thousands, except per share data and shares outstanding amounts) 2022 2021 2020 2019 2018 2017 Five Year Compound Growth Rate (Unaudited) Net interest income $95,115 $80,827 $70,665 $64,442 $61,208 $57,678 11 % Provision (benefit) for credit losses 1,846 (4,099) 2,432 (1,175) (500) 3,200 (10) % Other operating income 34,077 52,263 63,328 37,346 32,167 40,474 (3) % Compensation expense, RML acquisition payments — — — 468 — 130 (100) % Other operating expense 88,852 89,196 89,114 76,370 69,800 71,023 5 % Income before provision for income taxes $38,494 $47,993 $42,447 $26,125 $24,075 $23,799 10 % Provision for income taxes 7,753 10,476 9,559 5,434 4,071 10,321 (6) % Net Income 30,741 37,517 32,888 20,691 20,004 13,478 18 % Less: Net income attributable to noncontrolling interest — — — — — 327 (100) % Net income attributable to Northrim Bancorp, Inc. $30,741 $37,517 $32,888 $20,691 $20,004 $13,151 19 % Year End Balance Sheet Assets $2,674,318 $2,724,719 $2,121,798 $1,643,996 $1,502,988 $1,518,596 12 % Loans 1,501,785 1,413,886 1,444,050 1,043,371 984,346 954,953 9 % Deposits 2,387,211 2,421,631 1,824,981 1,372,351 1,228,088 1,258,283 14 % Shareholders' equity 218,629 237,817 221,575 207,117 205,947 192,802 3 % Common shares outstanding 5,700,728 6,014,813 6,251,004 6,558,809 6,883,216 6,871,963 (4) % Average Balance Sheet Assets $2,641,008 $2,432,599 $1,936,047 $1,555,707 $1,493,385 $1,511,052 12 % Earning assets 2,469,383 2,260,778 1,758,839 1,386,557 1,346,449 1,367,203 13 % Loans 1,415,125 1,478,318 1,339,908 1,010,098 971,548 981,001 8 % Deposits 2,354,881 2,125,080 1,638,216 1,276,407 1,227,272 1,248,333 14 % Shareholders' equity 224,773 239,214 211,721 208,602 201,022 193,129 3 % Basic common shares outstanding 5,765,088 6,180,801 6,354,687 6,708,622 6,877,573 6,889,621 (4) % Diluted common shares outstanding 5,829,412 6,249,313 6,431,367 6,808,209 6,981,557 6,977,910 (4) % Per Common Share Data Basic earnings $5.33 $6.07 $5.18 $3.08 $2.91 $1.91 23 % Diluted earnings $5.27 $6.00 $5.11 $3.04 $2.86 $1.88 23 % Book value per share $38.35 $39.54 $35.45 $31.58 $29.92 $28.06 6 % Tangible book value per share (2) $35.55 $36.88 $32.88 $29.12 $27.57 $25.70 7 % Cash dividends per share $1.82 $1.50 $1.38 $1.26 $1.02 $0.86 16 % 35 Years Ended December 31, 2022 2021 2020 2019 2018 2017 Five Year Compound Growth Rate (Unaudited) Performance Ratios Return on average assets 1.16 % 1.54 % 1.70 % 1.33 % 1.34 % 0.87 % 6 % Return on average equity 13.68 % 15.68 % 15.53 % 9.92 % 9.95 % 6.81 % 15 % Equity/assets 8.18 % 8.73 % 10.44 % 12.60 % 13.70 % 12.70 % (8) % Tangible common equity/tangible assets (3) 7.62 % 8.19 % 9.76 % 11.73 % 12.76 % 11.75 % (8) % Net interest margin 3.85 % 3.58 % 4.02 % 4.65 % 4.55 % 4.22 % (2) % Net interest margin (tax equivalent) (4) 3.89 % 3.60 % 4.05 % 4.70 % 4.60 % 4.28 % (2) % Non-interest income/total revenue 26.38 % 39.27 % 47.26 % 36.69 % 34.45 % 41.24 % (9) % Efficiency ratio (5) 68.76 % 66.99 % 66.47 % 75.43 % 74.68 % 72.39 % (1) % Dividend payout ratio 34.17 % 25.02 % 26.66 % 40.79 % 35.08 % 45.44 % (6) % Asset Quality Nonperforming loans, net of government guarantees $6,430 $10,672 $10,048 $13,951 $14,694 $21,411 (21) % Nonperforming assets, net of government guarantees 6,430 15,031 16,289 19,946 22,619 28,729 (26) % Nonperforming loans, net of government guarantees/portfolio loans 0.43 % 0.75 % 0.70 % 1.34 % 1.49 % 2.24 % (28) % Net charge-offs (recoveries)/average loans (0.08) % 0.07 % 0.03 % (0.07) % 0.15 % 0.15 % NM Allowance for credit losses/portfolio loans 0.92 % 0.83 % 1.46 % 1.83 % 1.98 % 2.25 % (16) % Nonperforming assets, net of government guarantees/assets 0.24 % 0.55 % 0.77 % 1.21 % 1.50 % 1.89 % (34) % Other Data Effective tax rate (6) 20 % 22 % 23 % 21 % 17 % 43 % (14) % Number of banking offices (7) 19 18 17 16 16 14 6 % Number of employees (FTE) (8) 469 451 438 431 430 429 2 % 1 These unaudited schedules provide selected financial information concerning the Company that should be read in conjunction with Part II Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report. 2 Tangible book value per share is a non-GAAP ratio defined as shareholders’ equity, less intangible assets, divided by common shares outstanding. Management believes that tangible book value is a useful measurement of the value of the Company’s equity because it excludes the effect of intangible assets on the Company’s equity. See reconciliation to book value per share, the most comparable GAAP measurement below. 3 Tangible common equity to tangible assets is a non-GAAP ratio that represents total equity less goodwill and intangible assets divided by total assets less goodwill and intangible assets. Management believes this ratio is important as it has received more attention over the past several years from stock analysts and regulators. The most comparable GAAP measure of shareholders' equity to total assets is calculated by dividing total shareholders' equity by total assets. See reconciliation to shareholders' equity to total assets below. 4 Tax-equivalent net interest margin is a non-GAAP performance measurement in which interest income on non-taxable investments and loans is presented on a tax-equivalent basis using a combined federal and state statutory rate of 28.43% in 2018 through 2022 and 41.11% in 2017. Management believes that tax-equivalent net interest margin is a useful financial measure because it enables investors to evaluate net interest margin excluding tax expense in order to monitor our effectiveness in growing higher interest yielding assets and managing our costs of 36 interest bearing liabilities over time on a fully tax equivalent basis. See reconciliation to net interest margin, the comparable GAAP measurement below. 5 In managing our business, we review the efficiency ratio exclusive of intangible asset amortization, which is a non-GAAP performance measurement. Management believes that this is a useful financial measurement because we believe this presentation provides investors with a more accurate picture of our operating efficiency. The efficiency ratio is calculated by dividing other operating expense, exclusive of intangible asset amortization, by the sum of net interest income and other operating income. Other companies may define or calculate this data differently. For additional information see the "Other Operating Expense" section in Part II. Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report. See reconciliation to comparable GAAP measurement below. 6 The Company’s 2017 results included the impact of the enactment of the Tax Cuts and Jobs Act, which was signed into law on December 22, 2017. The law includes significant changes to the U.S. corporate tax system, including a Federal corporate rate reduction from 35% to 21%. In 2017, the Company applied the newly enacted corporate federal income tax rate of 21%, reducing the value of the Company's net deferred tax asset, resulting in approximately a $2.7 million increase in tax expense. In 2018, the Company finalized changes related to the reduction in the federal tax rate which resulted in a $470,000 reduction in tax expense. 7 Number of banking offices does not include RML locations. 2022 number of banking offices includes 18 full service branches and 1 loan production office. 2021 number of banking offices includes 17 full service branches and 1 loan production office. 2020 number of banking offices includes 16 full service branches and 1 loan production office. 2018 number of banking offices includes 15 full service branches and 1 loan production office. 8 FTE includes 336, 321, 312, 311, 320, and 314 Community Banking employees in 2022, 2021, 2020, 2019, 2018 and 2017, respectively. FTE includes 133, 130, 126, 120, 110, and 115 Home Mortgage Lending employees in 2022, 2021, 2020, 2019, 2018 and 2017, respectively. Reconciliation of Selected Non-GAAP Financial Data to GAAP Financial Measures These unaudited schedules provide selected financial information concerning the Company that should be read in conjunction with "Part II. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report. 37 Reconciliation of total shareholders' equity to tangible common shareholders’ equity (Non-GAAP) and total assets to tangible assets: (In Thousands) 2022 2021 2020 2019 2018 2017 Total shareholders' equity $218,629 $237,817 $221,575 $207,117 $205,947 $192,802 Total assets 2,674,318 2,724,719 2,121,798 1,643,996 1,502,988 1,518,596 Total shareholders' equity to total assets ratio 8.18 % 8.73 % 10.44 % 12.60 % 13.70 % 12.70 % (In Thousands) 2022 2021 2020 2019 2018 2017 Total shareholders' equity $218,629 $237,817 $221,575 $207,117 $205,947 $192,802 Less: goodwill and other intangible assets, net 15,984 16,009 16,046 16,094 16,154 16,224 Tangible common shareholders' equity $202,645 $221,808 $205,529 $191,023 $189,793 $176,578 Total assets $2,674,318 $2,724,719 $2,121,798 $1,643,996 $1,502,988 $1,518,596 Less: goodwill and other intangible assets, net 15,984 16,009 16,046 16,094 16,154 16,224 Tangible assets $2,658,334 $2,708,710 $2,105,752 $1,627,902 $1,486,834 $1,502,372 Tangible common equity to tangible assets ratio 7.62 % 8.19 % 9.76 % 11.73 % 12.76 % 11.75 % Reconciliation of tangible book value per share (Non-GAAP) to book value per share (In thousands, except per share data) 2022 2021 2020 2019 2018 2017 Total shareholders' equity $218,629 $237,817 $221,575 $207,117 $205,947 $192,802 Divided by common shares outstanding 5,700,728 6,014,813 6,251,004 6,558,809 6,883,216 6,871,963 Book value per share $38.35 $39.54 $35.45 $31.58 $29.92 $28.06 (In thousands, except per share data) 2022 2021 2020 2019 2018 2017 Total shareholders' equity $218,629 $237,817 $221,575 $207,117 $205,947 $192,802 Less: goodwill and intangible assets, net 15,984 16,009 16,046 16,094 16,154 16,224 Tangible book value $202,645 $221,808 $205,529 $191,023 $189,793 $176,578 Divided by common shares outstanding 5,700,728 6,014,813 6,251,004 6,558,809 6,883,216 6,871,963 Tangible book value per share $35.55 $36.88 $32.88 $29.12 $27.57 $25.70 38 Reconciliation of tax-equivalent net interest margin (Non-GAAP) to net interest margin (In Thousands) 2022 2021 2020 2019 2018 2017 Net interest income (9) $95,115 $80,827 $70,665 $64,442 $61,208 $57,678 Divided by average interest-bearing assets 2,469,383 2,260,778 1,758,839 1,386,557 1,346,449 1,367,203 Net interest margin 3.85 % 3.58 % 4.02 % 4.65 % 4.55 % 4.22 % (In Thousands) 2022 2021 2020 2019 2018 2017 Net interest income (9) $95,115 $80,827 $70,665 $64,442 $61,208 $57,678 Plus: reduction in tax expense related to tax-exempt interest income 939 489 613 722 726 872 $96,054 $81,316 $71,278 $65,164 $61,934 $58,550 Divided by average interest-bearing assets 2,469,383 2,260,778 1,758,839 1,386,557 1,346,449 1,367,203 Tax-equivalent net interest margin 3.89 % 3.60 % 4.05 % 4.70 % 4.60 % 4.28 % Calculation of efficiency ratio (In Thousands) 2022 2021 2020 2019 2018 2017 Net interest income (9) $95,115 $80,827 $70,665 $64,442 $61,208 $57,678 Other operating income 34,077 52,263 63,328 37,346 32,167 40,474 Total revenue 129,192 133,090 133,993 101,788 93,375 98,152 Other operating expense 88,852 89,196 89,114 76,838 69,800 71,153 Less intangible asset amortization 25 37 48 60 70 100 Adjusted other operating expense $88,827 $89,159 $89,066 $76,778 $69,730 $71,053 Efficiency ratio 68.76 % 66.99 % 66.47 % 75.43 % 74.68 % 72.39 % 9 Amount represents net interest income before provision for loan losses. Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although we believe these non-GAAP financial measures are frequently used by stakeholders in the evaluation of the Company, they have limitations as analytical tools and should not be considered in isolation or as a substitute for analysis of results as reported under GAAP. RESULTS OF OPERATIONS Income Statement Net Income Our results of operations are dependent to a large degree on our net interest income. We also generate other income primarily through mortgage banking income, purchased receivables products, service charges and fees, and bankcard fees. Our operating expenses consist in large part of salaries and other personnel costs, data processing, occupancy, marketing, and professional services expenses. Interest income and cost of funds, or interest expense, and mortgage banking income are affected significantly by general economic conditions, particularly changes in market interest rates, by government policies and the actions of regulatory authorities, and by competition in our markets. We earned net income of $30.7 million in 2022, compared to net income of $37.5 million in 2021. During these periods, net income per diluted share was $5.27 and $6.00, respectively. The following sections present discussion of the components that make up net income. 39 Net Interest Income / Net Interest Margin Net interest income is the difference between interest income from loan and investment securities portfolios and interest expense on customer deposits and borrowings. Changes in net interest income result from changes in volume and spread, which in turn affect our margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Changes in net interest income are influenced by yields and the level and relative mix of interest-earning assets and interest-bearing liabilities. Net interest income in 2022 was $95.1 million, compared to $80.8 million in 2021. The increase in 2022 as compared to 2021 was primarily the result of increased interest on core loans (excluding PPP loans), investments, and interest bearing deposits in other banks which was only partially offset by a decrease in loan interest and fee income from PPP loans. Interest income on PPP loans was $405,000 and $2.9 million in 2022 and 2021, respectively. Loan fee income on PPP loans was $4.3 million and $12.5 million in 2022 and 2021, respectively. Loan fee income on PPP loans is largely made up of fees fully recognized upon loan forgiveness from the SBA. Loan fee income decreased due to decreased recognition of the deferred PPP loan fees upon forgiveness through the SBA in 2022 compared to 2021. Interest income on core loans increased $26.5 million in 2022 as compared to 2021 due to an increase in interest rates and higher net average interest-earning asset balances. Interest expense increased $1.4 million as a result of higher interest rates and average higher interest-bearing deposit balances. During 2022 and 2021, net interest margins were 3.85% and 3.58%, respectively. The increase in net interest margin in 2022 as compared to 2021 is primarily the result of higher yields on earning-assets and higher average core portfolio loan balances and long-term and short-term investment balances. 40 The following table sets forth for the periods indicated information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities. Average yields or costs, net interest income, and net interest margin are also presented. Average yields or costs are not calculated on a tax-equivalent basis: Years ended December 31, 2022 2021 2020 Average outstanding balance Interest income / expense Average Yield / Cost Average outstanding balance Interest income / expense Average Yield / Cost Average outstanding balance Interest income / expense Average Yield / Cost (In Thousands) Loans (1),(2) $1,415,125 $80,549 5.69 % $1,478,318 $76,392 5.17 % $1,339,908 $67,876 5.07 % Loans held for sale 51,537 2,236 4.34 % 101,752 2,849 2.80 % 105,287 3,215 3.05 % Taxable long-term investments (3) 617,972 11,860 1.92 % 368,319 4,900 1.33 % 245,148 5,234 2.14 % Non-taxable long-term investments (3) 810 18 2.22 % 853 18 2.11 % 2,236 82 3.67 % Interest-bearing deposits in other banks (4) 383,939 5,665 1.48 % 311,536 447 0.14 % 66,260 309 0.47 % Total interest-earning assets (5) 2,469,383 100,328 4.06 % 2,260,778 84,606 3.74 % 1,758,839 76,716 4.36 % Noninterest-earning assets 171,625 171,821 177,208 Total $2,641,008 $2,432,599 $1,936,047 Interest-bearing demand $701,679 $2,091 0.30 % $575,298 $484 0.08 % $387,417 $622 0.16 % Savings deposits 344,349 563 0.16 % 323,131 499 0.15 % 257,292 717 0.28 % Money market deposits 318,375 785 0.25 % 264,344 418 0.16 % 219,024 708 0.32 % Time deposits 169,931 1,046 0.62 % 178,215 1,676 0.94 % 176,873 3,232 1.83 % Total interest-bearing deposits 1,534,334 4,485 0.29 % 1,340,988 3,077 0.23 % 1,040,606 5,279 0.51 % Borrowings 24,623 728 2.96 % 24,993 702 2.81 % 35,918 772 2.15 % Total interest-bearing liabilities 1,558,957 5,213 0.33 % 1,365,981 3,779 0.28 % 1,076,524 6,051 0.56 % Noninterest-bearing demand deposits 820,547 784,092 597,610 Other liabilities 36,731 43,312 50,192 Equity 224,773 239,214 211,721 Total $2,641,008 $2,432,599 $1,936,047 Net interest income $95,115 $80,827 $70,665 Net interest margin 3.85 % 3.58 % 4.02 % Average portfolio loans to average-earnings assets 57.31 % 65.39 % 76.18 % Average portfolio loans to average total deposits 60.09 % 69.57 % 81.79 % Average non-interest deposits to average total deposits 34.84 % 36.90 % 36.48 % Average interest-earning assets to average interest-bearing liabilities 158.40 % 165.51 % 163.38 % 1 Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled $8.5 million, $16.2 million and $8.9 million for 2022, 2021 and 2020, respectively. 2 Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loans were $8.6 million, $12.3 million, and $13.8 million in 2022, 2021 and 2020, respectively. 3 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. 4 Consists of interest bearing deposits in other banks and domestic CDs. 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. 41 The following table sets forth the changes in consolidated net interest income attributable to changes in volume and to changes in interest rates. Changes attributable to the combined effect of volume and interest rate have been allocated proportionately to the changes due to volume and the changes due to interest rate: 2022 compared to 2021 2021 compared to 2020 Increase (decrease) due to Increase (decrease) due to (In Thousands) Volume Rate Total Volume Rate Total Interest Income: Loans ($3,363) $7,520 $4,157 $7,186 $1,330 $8,516 Loans held for sale (1,772) 1,159 (613) (105) (261) (366) Taxable long-term investments 4,210 2,750 6,960 2,064 (2,398) (334) Non-taxable long-term investments (1) 1 — (38) (26) (64) Interest-bearing deposits in other banks 128 5,090 5,218 170 (32) 138 Total interest income ($798) $16,520 $15,722 $9,277 ($1,387) $7,890 Interest Expense: Interest-bearing demand $80 $1,527 $1,607 $229 ($367) ($138) Savings deposits 50 14 64 154 (372) (218) Money market deposits 58 309 367 125 (415) (290) Time deposits (75) (555) (630) 25 (1,581) (1,556) Interest-bearing deposits 309 1,099 1,408 1,236 (3,438) (2,202) Borrowings (10) 36 26 29 (99) (70) Total interest expense $299 $1,135 $1,434 $1,265 ($3,537) ($2,272) 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 the current expected credit loss methodology ("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 Part II. Item 8 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 for the periods presented: (In Thousands) 2022 2021 Credit loss expense on loans held for investment $972 ($3,779) Credit loss expense on unfunded commitments 874 (320) 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 $1,846 ($4,099) As noted above, the provision for credit losses was recorded in accordance with CECL in 2022 and 2021. In general the increase in the provision for credit losses in 2022 as compared to 2021 is primarily the result of increased portfolio loan and unfunded commitment balances, and, to a lesser extent, an increase in projected loss rates. In 2021, there was a reversal of the provision primarily due to a decrease in projected loss rates following the uncertainty of the impacts of the COVID-19 pandemic in 2020 and the first half of 2021. 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. 42 See the “Loans and Lending Activity” section under “Financial Condition” and Note 5 of the Notes to Consolidated Financial Statements included in Part II. Item 8 of this report for further discussion of these decreases and changes in the Company’s ACL. Other Operating Income The following table details the major components of other operating income for the years ended December 31: (In Thousands) 2022 $ Change % Change 2021 $ Change % Change 2020 Other Operating Income Mortgage banking income $21,572 ($20,572) (49) % $42,144 ($10,491) (20) % $52,635 Bankcard fees 3,697 308 9 % 3,389 552 19 % 2,837 Purchased receivable income 2,002 (257) (11) % 2,259 (391) (15) % 2,650 Keyman insurance proceeds 2,002 2,002 NM — — NM — Commercial servicing revenue 1,628 1,322 432 % 306 (221) (42) % 527 Service charges on deposit accounts 1,611 314 24 % 1,297 195 18 % 1,102 Interest rate swap income 157 (295) (65) % 452 (497) (52) % 949 Gain (loss) on sale of securities — (67) (100) % 67 (31) 100 % 98 (Loss) gain on marketable equity securities (1,119) (1,018) (1,008) % (101) (162) 266 % 61 Other income 2,527 77 3 % 2,450 (19) (1) % 2,469 Total other operating income $34,077 ($18,186) (35) % $52,263 ($11,065) (17) % $63,328 2022 Compared to 2021 The most significant decreases in other operating income in 2022 was a decrease in mortgage banking income, followed by a decrease in the fair market value of marketable equity securities, a decrease in interest rate swap income, and a decrease in purchased receivable income. These decreases were partially offset by life insurance proceeds received in connections 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 increases in commercial servicing revenue, service charges on deposit accounts, and bankcard fees. Mortgage banking income consists of gross income from the origination and sale of mortgages as well as mortgage loan servicing fees and is the largest component of other operating income at 63% of total other operating income in 2022 and 81% in 2021. Mortgage banking income decreased in 2022 compared to 2021 mainly due to a decrease in mortgage loans originated and sold as this volume decreased to $585.5 million in 2022 from $1.12 billion in 2021. The overall decrease in mortgage originations in 2022 as compared to the prior year is primarily the result of the changes in interest rates during the year that led to decreased activity. Interest rate swap income decreased in 2022 as compared to 2021 due to a decrease in the origination of new swap contracts with commercial loan customers. The Company executed new customer swap contracts with a notional value of $11.7 million in 2022 as compared to new customer swap contracts with a notional value of $15.7 million in 2021. Purchased receivable income decreased in 2022 as compared to 2021 due to customers reportedly using PPP funds instead of selling receivables to fund their operating cash needs. Commercial servicing revenue increased in 2022 as compared to 2021 primarily resulting from an increase in the fair value of our commercial servicing rights, which generally increase when interest rates rise causing the expected life of the servicing asset, and the resulting cash flow to the Company, to increase. Bankcard fees and service charges on deposit accounts increased in 2022 due an increase in the number of the Company's deposit customers, as well as due to the cessation of COVID-19 quarantine restrictions, which both led to higher transaction volume as compared to 2021. 43 Other Operating Expense The following table details the major components of other operating expense for the years ended December 31: (In Thousands) 2022 $ Change % Change 2021 $ Change % Change 2020 Other Operating Expense Salaries and other personnel expense $58,172 ($2,240) (4) % $60,412 ($725) (1) % $61,137 Data processing expense 8,926 359 4 % 8,567 899 12 % 7,668 Occupancy expense 6,915 (163) (2) % 7,078 454 7 % 6,624 Professional and outside services 2,993 192 7 % 2,801 (356) (11) % 3,157 Marketing expense 2,747 6 — % 2,741 421 18 % 2,320 Insurance expense 2,054 461 29 % 1,593 365 30 % 1,228 Intangible asset amortization 25 (12) (32) % 37 (11) (23) % 48 OREO (income) expense, net rental income and gains on sale: OREO operating expense 634 (143) (18) % 777 119 18 % 658 Rental income on OREO (548) (24) (5) % (524) (15) (3) % (509) Losses (gains) on sale of OREO 414 1,099 160 % (685) (294) NM (391) Subtotal 500 932 216 % (432) (190) 79 % (242) Other expenses 6,520 121 2 % 6,399 (775) (11) % 7,174 Total other operating expense $88,852 ($344) — % $89,196 $82 — % $89,114 2022 Compared to 2021 Other operating expense decreased by less than 1% in 2022 as compared to 2021. The largest decrease was in salaries and other personnel expense primarily related to mortgage banking operations, which fluctuate with production volumes. Occupancy expense and intangible asset expense also decreased slightly in 2022 compared to 2021 due to lower repairs and maintenance costs. These decreases were mostly offset by increases in OREO expense, insurance expense, data processing expense, and professional and outside services. OREO expense increased in 2022 primarily due to increased losses on sale of OREO properties as compared to 2021. Insurance expense, data processing expense, and professional and outside services increased in 2022 as compared to 2021 due to increased FDIC insurance costs associated with asset growth, increased customer and transaction volume, and increased investment management fees attributable to the growth in our investment portfolio. Income Taxes The provision for income taxes decreased $2.7 million or 26%, to $7.8 million in 2022 as compared to 2021. The decrease in 2022 is primarily due to lower pretax income. The Company's effective tax rate decreased to 20.1% in 2022 from 21.8% in 2021, primarily due to an increase in tax exempt income and low income housing tax credits as a percentage of pre-tax income in 2022 compared to 2021. FINANCIAL CONDITION Investment Securities The composition of our investment securities portfolio, which includes securities available for sale, held-to-maturity investments, and marketable equity securities, reflects management’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of interest income. The investment securities portfolio also mitigates interest rate and credit risk inherent in the loan portfolio, while providing a vehicle for the investment of available funds, a source of liquidity (by pledging as collateral or through repurchase agreements), and collateral for certain public funds deposits. Investment securities designated as available for sale comprised 93% of the portfolio as of December 31, 2022 and are available to meet liquidity requirements in a contingency situation. 44 Our investment portfolio consists primarily of government sponsored entity securities, corporate securities, collateralized loan obligations, and municipal securities. Investment securities at December 31, 2022 increased $269.4 million, or 59%, to $724.5 million from $455.1 million at December 31, 2021. The increase at December 31, 2022 as compared to December 31, 2021 came from the investment of short-term funds included in interest bearing deposits in other banks. The average maturity of the investment portfolio was approximately three and a quarter years at December 31, 2022. Investment securities may be pledged as collateral to secure public deposits or borrowings. At December 31, 2022 and 2021, $59.3 million and $59.5 million in securities were pledged for deposits and borrowings, respectively. 45 The following tables set forth the composition of our investment portfolio at December 31 for the years indicated: (In Thousands) Amortized Cost Fair Value Securities Available for Sale: 2022: U.S. Treasury and government sponsored entities $634,582 $595,161 Municipal Securities 820 795 Corporate Bonds 24,281 23,644 Collateralized Loan Obligations 59,434 57,429 Total $719,117 $677,029 2021: U.S. Treasury and government sponsored entities $345,514 $341,480 Municipal Securities 820 840 Corporate Bonds 32,721 32,946 Collateralized Loan Obligations 51,431 51,418 Total $430,486 $426,684 2020: U.S. Treasury and government sponsored entities $173,318 $174,601 Municipal Securities 820 856 Corporate Bonds 29,951 30,492 Collateralized Loan Obligations 41,782 41,684 Total $245,871 $247,633 Marketable Equity Securities: 2022: Preferred Stock $11,303 $10,740 Total $11,303 $10,740 2021: Preferred Stock $7,865 $8,420 Total $7,865 $8,420 2020: Preferred Stock $8,395 $9,052 Total $8,395 $9,052 Securities Held to Maturity: 2022: Corporate Bonds $36,750 $32,639 Total $36,750 $32,639 2021: Corporate Bonds $20,000 $19,164 Total $20,000 $19,164 2020: Corporate Bonds $10,000 $10,000 Total $10,000 $10,000 46 The following table sets forth the market value, maturities, and weighted average pretax yields of our investment portfolio as of December 31, 2022: Maturity Within Over (In Thousands) 1 Year 1-5 Years 5-10 Years 10 Years Total Securities Available for Sale: U.S. Treasury and government sponsored entities Balance $65,541 $529,620 $— $— $595,161 Weighted average yield (1) 2.68 % 2.91 % — % — % 2.89 % Municipal securities Balance $— $795 $— $— $795 Weighted average yield (1) — % 2.14 % — % — % 2.14 % Corporate bonds Balance $— $23,644 $— $— $23,644 Weighted average yield (1) — % 4.43 % — % — % 4.43 % Collateralized loan obligations Balance $4,751 $— $26,401 $26,277 $57,429 Weighted average yield (1) 5.86 % — % 5.40 % 5.39 % 5.43 % Total Balance $70,292 $554,059 $26,401 $26,277 $677,029 Weighted average yield (1) 2.90 % 2.97 % 5.40 % 5.39 % 3.15 % Securities Held to Maturity Corporate bonds Balance $— $8,870 $23,769 $— $32,639 Weighted average yield (1) — % 5.50 % 5.01 % — % 5.15 % Marketable Equity Securities Preferred Stock Balance $— $— $— $10,740 $10,740 Weighted average yield (1) — % — % — % 5.88 % — % (1) Weighted average yields have been calculated on an amortized cost basis and not on a tax-equivalent basis. The Company’s investment in marketable equity securities does not have a maturity date but it has been included in the over 10 years column above. Loans and Lending Activities All of our loans and credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness and commitments to us, including the indebtedness of any guarantor. Generally, we are permitted to make loans to one borrower of up to 15% of the unimpaired capital and surplus of the Bank. The legal lending limit for the Bank was $32.1 million at December 31, 2022. At December 31, 2022, the Company had two relationships whose total direct and indirect commitments exceeded $32.1 million; however, no individual direct relationship exceeded the loans-to-one borrower limitation. The Company's loans have grown significantly in recent history, in part due to PPP loans, but over the last 3 years, core loans have also increased significantly. Management attributes higher growth in core loans in 2022 and 2021 to our ability to attract new customers through our outreach to the community. The Company's "Land and Expand" program was designed to increase both loans and deposits as we attract a broader customer base and convert new PPP customers into full banking relationships. 47 The following table presents growth information for loans and loans excluding PPP loans: Years Ended December 31, (In Thousands) 2022 2021 2020 2019 2018 2017 Five Year Compound Growth Rate Loans $1,501,785 $1,413,886 $1,444,050 $1,043,371 $984,346 $954,953 9 % Less: PPP loans 7,110 118,229 304,587 — — — NM Loans, excluding PPP loans $1,494,675 $1,295,657 $1,139,463 $1,043,371 $984,346 $954,953 9 % Percent change, Loans excluding PPP loans 15 % 14 % 9 % 6 % 3 % The following table sets forth the composition of our loan portfolio by loan segment as of the dates indicated: December 31, 2022 December 31, 2021 Dollar Amount Percent of Total Dollar Amount Percent of Total (In Thousands) Commercial & industrial loans $358,128 23.8 % $448,338 31.7 % Commercial real estate: Owner occupied properties 349,973 23.3 % 300,200 21.2 % Non-owner occupied and multifamily properties 482,270 32.2 % 435,311 30.8 % Residential real estate: 1-4 family residential properties secured by first liens 73,381 4.9 % 32,542 2.3 % 1-4 family residential properties secured by junior liens and revolving secured by 1-4 family first liens 20,259 1.3 % 19,610 1.4 % 1-4 family residential construction loans 44,000 2.9 % 36,222 2.6 % Other construction, land development and raw land loans 99,182 6.6 % 88,094 6.2 % Obligations of states and political subdivisions in the US 32,539 2.2 % 16,403 1.2 % Agricultural production, including commercial fishing 34,099 2.3 % 27,959 2.0 % Consumer loans 4,335 0.3 % 4,801 0.3 % Other loans 3,619 0.2 % 4,406 0.3 % Total portfolio loans $1,501,785 $1,413,886 The following table presents the maturity distribution of our loan portfolio and the rate sensitivity of these loans to changes in interest rates as of December 31, 2022: By Maturity Loans Over One Year By Rate Sensitivity (In Thousands) Within 1 Year 1-5 Years 5-15 Years Over 15 Years Total Fixed Interest Rate Variable Interest Rate Commercial & industrial loans $74,235 $147,790 $136,103 $— $358,128 $134,161 $149,732 Commercial real estate 31,783 133,758 581,802 84,900 832,243 232,824 567,636 Residential real estate 42,702 6,862 26,071 62,077 137,712 39,413 55,597 Other construction 39,121 22,110 35,169 2,710 99,110 21,132 38,857 Consumer and other 4,760 5,882 63,941 9 74,592 41,774 28,058 Total $192,601 $316,402 $843,086 $149,696 $1,501,785 $469,304 $839,880 48 Information about industry concentrations: Management utilizes the loan segments included in the tables above within the Company's CECL methodology to assess credit risk. These segments are largely determined by type of loan collateral. The Company also separately monitors concentrations in the loan portfolio based on industries, and these industry concentration are discussed below. 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 oil producers or drilling and exploration companies, and companies who provide oilfield services, lodging, equipment rental, transportation, and other logistic services specific to the industry. The Company estimates that $83.4 million, or approximately 6% of loans as of December 31, 2022 have direct exposure to the oil and gas industry as compared to $63.6 million, or approximately 4% 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 $51.8 million and $66.4 million at December 31, 2022 and 2021, 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 $786,000 and $684,000 as of December 31, 2022 and 2021, respectively. 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) December 31, 2022 December 31, 2021 Commercial & industrial loans $66,864 $45,338 Commercial real estate: Owner occupied properties 9,108 10,244 Non-owner occupied and multifamily properties 6,013 6,564 Other loans 1,431 1,495 Total loans $83,416 $63,641 The Company monitors other concentrations within the loan portfolio depending on trends in the current and future estimated economic conditions. At December 31, 2022, the Company had $126.5 million, or 8% of total portfolio loans, in the Healthcare sector; $96.3 million, or 6% of portfolio loans, in the Tourism sector; $70.8 million, or 5% in the Fishing sector; $65.1 million, or 4% in the Accommodations sector; $54.8 million, or 4% in Retail loans; $50.8 million, or 3% of portfolio loans, in the Aviation (non-tourism) sector; and $46.9 million, or 3% in the Restaurants and Breweries 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 December 31, 2022: (In Thousands) Tourism Aviation (non-tourism) Healthcare Retail Fishing Restaurants and Breweries Accommodations Total ACL $570 $397 $1,096 $525 $503 $388 $569 $4,048 49 Credit Quality and Nonperforming Assets The following table sets forth information regarding our nonperforming loans and total nonperforming assets: December 31, December 31, (In Thousands) 2022 2021 Nonaccrual loans $7,076 $11,650 Loans 90 days past due and accruing — — Total nonperforming loans $7,076 $11,650 Nonperforming loans guaranteed by government ($646) ($978) Net nonperforming loans $6,430 $10,672 Other real estate owned — $5,638 Other real estate owned guaranteed by government — ($1,279) Net nonperforming assets $6,430 $15,031 Nonperforming loans, net of government guarantees / portfolio loans 0.43 % 0.75 % Nonperforming loans, net of government guarantees / portfolio loans, net of government guarantees 0.46 % 0.88 % Nonperforming assets, net of government guarantees / total assets 0.24 % 0.55 % Nonperforming assets, net of government guarantees / total assets net of government guarantees 0.25 % 0.60 % Performing restructured loans $291 $2,355 Performing restructured loans guaranteed by government — ($2,518) Net performing restructured loans $291 $773 Nonperforming loans plus performing restructured loans, net of government guarantees $6,721 $11,445 Nonperforming loans plus performing restructured loans, net of government guarantees / portfolio loans 0.45 % 0.81 % Nonperforming loans plus performing restructured loans, net of government guarantees / portfolio loans, net of government guarantees 0.48 % 0.94 % Nonperforming assets plus performing restructured loans, net of government guarantees / total assets 0.25 % 0.58 % Nonperforming assets plus performing restructured loans, net of government guarantees / total assets, net of government guarantees 0.26 % 0.63 % Adversely classified loans, net of government guarantees $7,581 $13,739 Special mention loans, net of government guarantees $4,760 $22,110 Loans 30-89 days past due and accruing, net of government guarantees /portfolio loans 0.01 % — % Loans 30-89 days past due and accruing, net of government guarantees / portfolio loans, net of government guarantees 0.01 % — % Allowance for credit losses / portfolio loans 0.92 % 0.83 % Allowance for credit losses / portfolio loans, net of government guarantees 0.99 % 0.97 % Allowance for credit losses / nonperforming loans, net of government guarantees 215 % 110 % Gross loan charge-offs for the quarter $— $1,179 Gross loan recoveries for the quarter ($87) ($53) Net loan (recoveries) charge-offs for the quarter ($87) $1,126 Net loan (recoveries) charge-offs year-to-date ($1,127) $1,107 Net loan (recoveries) charge-offs for the quarter / average loans, for the quarter (0.01) % 0.08 % Net loan (recoveries) charge-offs year-to-date / average loans, year-to-date annualized (0.08) % 0.07 % The Company’s nonperforming assets, net of government guarantees decreased to $6.4 million at December 31, 2022 as compared to $15.0 million at December 31, 2021. This decrease was mostly due to principal paydowns on nonaccrual loans 50 which were only partially offset by additions to nonaccrual loans in 2022. There was interest income of $2.2 million and $1.6 million recognized in net income for 2022 and 2021, respectively, related to interest collected on nonaccrual loans whose principal had been paid down to zero. Additionally, the sale of the only OREO property held by the Company for all of 2022 reduced OREO to zero as of December 31, 2022 from $4.4 million, net of government guarantees, at December 31, 2021. The Company holds a government guarantee related to the OREO property that was sold in December 2022; however, the value of this guarantee has not been included in the Company's financial statements in 2022 due to uncertainty as to the total amount that will be received from the guarantee. For the fourth quarter of 2022, a loss from the sale of OREO of $414,000 is included in OREO expense, net of rental income in the income statement. We expect to receive proceeds related to this government guarantee in 2023. The Company had $291,000 and $773,000 in loans classified as TDRs, net of government guarantees that were performing as of December 31, 2022 and 2021, respectively. Additionally, there were $4.8 million and $6.5 million in TDRs included in nonaccrual loans at December 31, 2022 and 2021, respectively, for total TDRs, net of government guarantees of $5.1 million and $7.3 million at December 31, 2022 and 2021, respectively. The decrease in TDRs at December 31, 2022 as compared to 2021 was primarily due to payoffs and paydowns on loans classified as TDRs in 2022. See Note 5 of the Notes to Consolidated Financial Statements included in Part II. Item 8 of this report for further discussion of TDRs. At December 31, 2022, management had identified potential problem loans of $1.6 million as compared to potential problem loans of $2.1 million at December 31, 2021. Potential problem loans are loans which are currently performing that have developed negative indications that the borrower may not be able to comply with present payment terms and which may later be included in nonaccrual, past due, or impaired loans. The decrease in potential problem loans at December 31, 2022 from December 31, 2021 was primarily due to paydowns and credit risk upgrades to existing potential problem loans that were partially offset by the addition of new potential problem loans in 2022. The Company acquired a vessel totaling $231,000 in the third quarter of 2019 through foreclosure proceedings related to one lending relationship that was sold in the second quarter of 2021. The following summarizes OREO activity for the periods indicated: (In Thousands) 2022 2021 2020 Balance, beginning of the year $5,638 $7,289 $7,043 Transfers from loans — 274 652 Proceeds from the sale of other real estate owned (5,224) (2,610) (797) (Loss) Gain on sale of other real estate owned, net (414) 685 391 Balance, end of year — 5,638 7,289 Government guarantees — (1,279) (1,279) Balance, end of year, net of government guarantees $— $4,359 $6,010 The Company made a $1.0 million loan in 2021 to facilitate the sale of OREO in 2021, but did not make any loans to facilitate the sale of OREO in 2022. Our underwriting policies and procedures for loans to facilitate the sale of OREO are no different than our standard loan policies and procedures. Allowance for Credit Losses The Company adopted ASU 2016-13 effective January 1, 2021. 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 51 Statements included in Part II. Item 8 of this report for detailed discussion regarding the ACL methodology for loans and unfunded commitments. The following tables show the allocation of the ACL and the percent of loans in each category to total loans and the ratio of net loan charge-offs to average loans outstanding by loan segment for the years indicated: 2022 % of Loans (1) Net loan charge-offs (recoveries) to average loans (In Thousands) Amount Commercial & industrial loans $2,914 25 % (0.26) % Commercial real estate: Owner occupied properties 3,094 23 % (0.02) % Non-owner occupied and multifamily properties 3,615 32 % — % Residential real estate: 1-4 family residential properties secured by first liens 1,413 5 % (0.01) % 1-4 family residential properties secured by junior liens and revolving secured by 1-4 family first liens 389 1 % (0.19) % 1-4 family residential construction loans 312 3 % — % Other construction, land development and raw land loans 1,803 7 % — % Obligations of states and political subdivisions in the US 79 2 % — % Agricultural production, including commercial fishing 145 2 % (0.05) % Consumer loans 68 — % (0.02) % Other loans 6 — % — % Total $13,838 100 % (0.08) % 1 Represents percentage of this category of loans to total portfolio loans. 2021 % of Loans (1) Net loan charge-offs (recoveries) to average loans (In Thousands) Amount Commercial & industrial loans $3,027 33 % 0.21 % Commercial real estate: Owner occupied properties 3,176 21 % — % Non-owner occupied and multifamily properties 2,930 31 % — % Residential real estate: 1-4 family residential properties secured by first liens 439 2 % — % 1-4 family residential properties secured by junior liens and revolving secured by 1-4 family first liens 215 1 % (0.21) % 1-4 family residential construction loans 120 3 % — % Other construction, land development and raw land loans 1,635 6 % — % Obligations of states and political subdivisions in the US 32 1 % — % Agricultural production, including commercial fishing 91 2 % (0.15) % Consumer loans 67 — % (0.27) % Other loans 7 — % — % Total $11,739 100 % 0.07 % 1 Represents percentage of this category of loans to total portfolio loans. The ACL for loans increased to $13.8 million at December 31, 2022 compared to $11.7 million at December 31, 2021 primarily due to an increase in loan balances, net of guarantees, as well as a slight increase in expected future loss rates. The Company determined that an ACL of $13.8 million, or 0.92% of portfolio loans, is appropriate as of December 31, 2022 based on our analysis of the current credit quality of the portfolio and forecasted economic conditions. 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. 52 The following table sets forth information regarding changes in the ACL for unfunded commitments for the years indicated: (In Thousands) 2022 2021 Balance at beginning of period $1,096 $187 Impact of adopting ASC 326 — 1,229 Adjusted balance, beginning of period 1,096 1,416 (Benefit) provision for credit losses 874 (320) Balance at end of period $1,970 $1,096 While management believes that it uses the best information available to determine the ACL, unforeseen market conditions and other events could result in an 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. Purchased Receivables Purchased receivable balances increased at December 31, 2022 to $20.0 million from $7.0 million at December 31, 2021, and year-to-date average purchased receivable balances were $7.0 million and $12.4 million in 2022 and 2021, respectively. Purchased receivable income was $2.0 million and $2.3 million in 2022 and 2021, respectively. Purchased receivable income in 2022 decreased from 2021 due to customers reportedly using PPP loans to fund liquidity needs instead of selling receivables. The following table sets forth information regarding changes in the purchased receivable ACL for the years indicated: (In Thousands) 2022 2021 2020 Balance at beginning of year $— $73 $94 Cumulative effect of adopting ASU 2016-13 — (73) — Charge-offs — — — Recoveries — — — Charge-offs net of recoveries — — — Reserve for (recovery from) purchased receivables — — (21) Balance at end of year $— $— $73 Ratio of net charge-offs (recoveries) to average purchased receivables during the period — % — % — % Deposits Deposits are our primary source of funds. Total deposits decreased 1% to $2.39 billion at December 31, 2022 from $2.42 billion at December 31, 2021. Our deposits generally are expected to fluctuate according to the level of our market share, economic conditions, and normal seasonal trends. The following table sets forth the average balances outstanding and average interest rates for each major category of our deposits, for the periods indicated: 2022 2021 2020 Average balance Average rate paid Average balance Average rate paid Average balance Average rate paid (In Thousands) Interest-bearing demand accounts $701,679 0.30 % $575,298 0.08 % $387,416 0.16 % Money market accounts 318,375 0.25 % 264,344 0.16 % 219,025 0.32 % Savings accounts 344,349 0.16 % 323,131 0.15 % 257,292 0.28 % Certificates of deposit 169,931 0.62 % 178,215 0.94 % 176,873 1.83 % Total interest-bearing accounts 1,534,334 0.29 % 1,340,988 0.23 % 1,040,606 0.51 % Noninterest-bearing demand accounts 820,547 784,092 597,610 Total average deposits $2,354,881 $2,125,080 $1,638,216 53 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 December 31, 2022 and 93% at December 31, 2021. The only deposit category with stated maturity dates is certificates of deposit. At December 31, 2022, we had $192.9 million in certificates of deposit, of which $128.4 million, or 67%, are scheduled to mature in 2023. The Company’s certificates of deposit increased to $192.9 million during 2022 as compared to $178.0 million at December 31, 2021. The aggregate amount of certificates of deposit in amounts of $250,000 or more at December 31, 2022 and 2021, was $77.5 million and $77.1 million, respectively. The following table sets forth the amount outstanding of certificates of deposits in amounts of $250,000 or more by time remaining until maturity and percentage of total deposits as of December 31, 2022: Time Certificates of Deposits of $250,000 or More Percent of Total Deposits (In Thousands) Amount Amounts maturing in: Three months or less $20,964 27 % Over 3 through 6 months 6,613 9 % Over 6 through 12 months 20,321 26 % Over 12 months 29,629 38 % Total $77,527 100 % The Company offers the Certificate of Deposit Account Registry Service® (CDARS®) as a member of Promontory Interfinancial Network, LLCSM (Network). When a Network member places a deposit using CDARS, that certificate of deposit is divided into amounts under the standard FDIC insurance maximum ($250,000) and is allocated among member banks, making the large deposit eligible for FDIC insurance. The Company had $30.2 million CDARS certificates of deposits at December 31, 2022 and $24.0 million CDARS certificates of deposits at December 31, 2021. 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 Company’s assets. At December 31, 2022, our maximum borrowing line from the FHLB was $1.195 billion, approximately 45% of the Bank’s assets, subject to the FHLB’s collateral requirements. The Company has outstanding advances of $14.1 million as of December 31, 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 $44.3 million of loans as collateral to secure advances made through the discount window as of December 31, 2022. There were no discount window advances outstanding at December 31, 2022 or 2021. The Company paid less than $1,000 in interest in 2022 and 2021 on this agreement. Other Short and Long-term Borrowings: The Company had no short or long-term borrowings outstanding other than the FHLB advances noted above as of December 31, 2022 or 2021. The Company is subject to provisions under Alaska state law which generally limits the amount of outstanding debt to 35% of total assets or $929.3 million at December 31, 2021 and 35% of total assets or $948.0 million at December 31, 2021. 54 Junior Subordinated Debentures On December 16, 2005, the Company’s subsidiary, NST2, issued trust preferred securities in the principal amount of $10 million. These securities carry an interest rate of 90-day LIBOR plus 1.37% per annum that was initially set at 5.86% adjusted quarterly. The securities have a maturity date of March 15, 2036, and are callable by the Company on or after March 15, 2011. These securities are treated as Tier 1 capital by the Company’s regulators for capital adequacy calculations. The interest cost to the Company of these securities was $326,000 in 2022. At December 31, 2022, the securities had an interest rate of 6.14%. The Company entered into an interest rate swap in the third quarter of 2017 to hedge the variability in cash flows arising out of its junior subordinated debentures, by swapping the cash flows with an interest rate swap which receives floating and pays fixed. The Company has designated this interest rate swap as a hedging instrument. The interest rate swap effectively fixes the Company's interest payments on the $10 million of junior subordinated debentures held under NST2 at 3.72% through its maturity date. Net of the impact of the interest rate swap, interest expense on these securities was $387,000 in 2022 and $382,000 in 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 2023. 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 December 31, 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 $259.4 million, or 10% of total assets at December 31, 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 increases in investment securities and loans. While down from December 31, 2021, this level of cash and cash equivalents is still elevated as compared to historical norms both in balance and as a percentage of total assets. The Company had cumulative other comprehensive losses, net of tax, of $29.1 million in 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 into 2023 and potentially into subsequent years. Accordingly, management has invested in slightly longer term investment securities in 2021 and 2022 as compared to the last several years. As of December 31, 2022, the weighted average maturity of available for sale securities is 3.3 years compared to 4.1 years at December 31, 2021 and 2.6 years at December 31, 2020. At December 31, 2022, $70.3 million available for sale securities mature within one year, $167.8 million mature in 2024, and $138.6 million mature in 2025. Our total unfunded commitments to fund loans and letters of credit at December 31, 2022 were $497.7 million. We do not expect that all of these loans are likely to be fully drawn upon at any one time. At December 31, 2022, certificates of deposit totaling $128.4 million and $52.1 million, respectively, contractually mature in 2023 and 2024, 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 December 31, 2022, are not material to the Company's liquidity position as of December 31, 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 December 31, 2022, our liquid assets were $570.7 million and our funds available for borrowing under our existing lines of credit were $1.24 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 II. Item 8 of this report, net cash provided by operating activities was $78.1 million in 2022 and $112.0 million in 2021, respectively. The primary source of cash provided by operating activities for both periods was proceeds from the sale of loans held for sale net of proceeds used in originations, as well as positive net income. In 2022, proceeds from the sale of loans held for sale net of proceeds used in originations decreased as compared to 2021 as refinance and purchase activity slowed. Net cash used by investing activities was $405.6 million in 2022 primarily due to purchases of available for sale and held to maturity securities and to a lesser extent, increases in loans and purchased receivables. Net cash used by investing activities was $159.1 million in 2021 primarily due to purchases of available for sale and held to maturity securities, net of proceeds from the maturity of available for sale securities. Financing activities used cash of $59.0 million in 2022 and provided cash of $577.0 million in 2021. Financing activities used cash in 2022 due to a decrease in deposits as wells as payment of cash dividends to shareholders and the repurchase of shares of the Company's common stock. Financing activities provided cash in 2021 due to increases in deposits that were only partially offset by the payment of cash dividends to shareholders and the repurchase of shares of the Company's common stock. Throughout our history, the Company has periodically repurchased for cash a portion of its shares of common stock in the open market. The following table presents the amount of common shares repurchased and the weighted average price paid per share for the periods indicated: Years Ending: Common Shares Repurchased Weighted Average Price 2022 333,724 $42.42 2021 279,276 $41.30 2020 327,000 $30.51 2019 347,676 $36.15 2018 15,468 $31.90 At December, 31, 2022, there were no shares available under the previously announced stock repurchase program. However, on January 27, 2023 the Company announced that its Board of Directors authorized the repurchase of up to an additional 285,000 shares of common stock. The Company intends 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. The table below shows the cumulative effect the repurchase of common shares since the inception of the Company on diluted earnings per share: Years Ending: Diluted EPS as Reported Diluted EPS without Stock Repurchase 2022 $5.27 $3.92 2021 $6.00 $4.79 2020 $5.11 $4.22 2019 $3.04 $2.59 2018 $2.86 $2.56 Regulatory Capital Requirements: 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 December 31, 2022, that the Company and the Bank met all applicable capital adequacy requirements for a “well-capitalized” institution by regulatory standards. 56 The table below illustrates the capital requirements in effect in 2022 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 2023 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 is included in the Company’s capital for regulatory purposes, although they are accounted for as a long-term debt in our consolidated financial statements. The trust preferred securities are not accounted for on the Bank’s financial statements nor are they included in its capital. As a result, the Company has $10 million more in regulatory capital than the Bank at December 31, 2022 and 2021, respectively, which explains most of the difference in the capital ratios for the two entities. Minimum Required Capital Well-Capitalized Actual Ratio Company Actual Ratio Bank December 31, 2022 Total risk-based capital 8.00% 10.00% 13.64% 11.42% Tier 1 risk-based capital 6.00% 8.00% 12.81% 10.58% Common equity tier 1 capital 4.50% 6.50% 12.29% 10.59% Leverage ratio 4.00% 5.00% 9.01% 7.42% See Note 22 of the Consolidated Financial Statements included in Part II. Item 8 of this report for a detailed discussion of the capital ratios. The requirements for "well-capitalized" come from the Prompt Correction Action rules. See Part I. Item 1 Supervision and Regulation. 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. Critical Accounting Policies 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. Our significant accounting policies are described in Note 1 in the Notes to Consolidated Financial Statements in Part II. Item 8 of this report. Not all of these significant accounting policies require management to make critical accounting estimates. Management believes that the following accounting policies would be considered critical under the SEC's definition. The following discussion is intended to supplement, but not duplicate, information provided in Note 1 in the Notes to Consolidated Financial Statements in Part II. Item 8 of this report for these policies. Allowance for Credit Losses Policy : The Company adopted CECL on January 1, 2021. The Company's Executive Loan Management Committee and Asset Liability Committee are both involved in monitoring various aspects of the Company's 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. The Company uses a DCF method for 8 of its 11 loan pools, which represent 95% of the amortized cost basis of total loan pools at December 31, 2022. The weighted average remaining life method is used for the remaining 3 loan pools primarily because loan level data constraints preclude the use of the DCF model. 57 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. As of December 31, 2021, management utilized and forecasted Alaska unemployment as a loss driver for all of the loans pools that utilize 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 correlates to expected future losses. Other internal and external indicators of economic forecasts are also considered by management when developing the forecast metrics. 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; • 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. For all periods presented, 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 has identified the following pools of financial assets with similar risk characteristics for measuring expected credit losses under CECL as adopted by the Company on January 1, 2021, which are unchanged as of December 31, 2022: Commercial & industrial - Commercial loans are loans for commercial, corporate and business purposes. The Company’s commercial business loan portfolio is comprised of loans for a variety of purposes and across a variety of industries. These loans include general commercial and industrial loans, loans to purchase capital equipment, and other business loans for working capital and operational purposes. Commercial loans are generally secured by accounts receivable, inventory and other business assets. Also included in commercial loans are our PPP loans originated during 2020 and 2021. The Company utilizes the DCF method to quantitatively estimate credit losses for this pool. Commercial real estate - This category of loans consists of the following loan types: Owner occupied - This category includes non-farm, non-residential real estate loans for a variety of commercial property types and purposes, including owner occupied commercial real estate loans primarily secured by commercial office or industrial buildings, warehouses or retail buildings where the owner of the building occupies the property. Repayment terms vary considerably, interest rates are fixed or variable, and are structured for full, partial, or no amortization of principal. The Company utilizes the DCF method to quantitatively estimate credit losses for this pool. Non-owner occupied and multifamily - This category includes non-farm, non-residential real estate loans for a variety of commercial property types and purposes, including investment real estate loans that are primarily secured by office and 58 industrial buildings, warehouses or retail buildings where the owner of the building does not occupy the property, non-owner occupied apartment or multifamily residential buildings, and various special purpose properties. Repayment terms vary considerably, interest rates are fixed or variable, and are structured for full, partial, or no amortization of principal. Generally, these types of loans are thought to involve a greater degree of credit risk than owner occupied commercial real estate as they are more sensitive to adverse economic conditions. The Company utilizes the DCF method to quantitatively estimate credit losses for this pool. Residential real estate - This category of loans consists of the following loan types: 1-4 family residential properties secured by first liens - This category of loans includes term loans secured by first liens on residential real estate. The Company utilizes the DCF method to quantitatively estimate credit losses for this pool. 1-4 family residential properties secured by junior liens and revolving credit lines secured by 1-4 family first liens - This category of loans includes term loans primarily secured by junior liens on residential real estate and revolving credit lines that are secured by first liens on residential real estate. Home equity revolving lines of credit and home equity term loans are included in this group of loans. The Company utilizes the DCF method to quantitatively estimate credit losses for this pool. 1-4 family residential construction - This category of loans consists of loans to finance the ground up construction, improvement and/or carrying for sale after the completion of construction of 1-4 family residential properties which will secure the loan. These loans may also be secured by tracts or individual parcels of land on which 1-4 family residential properties are being constructed. The repayment of construction loans is generally dependent upon the successful completion of the improvements by the builder for the end user, or sale of the property to a third-party. The Company utilizes the DCF method to quantitatively estimate credit losses for this pool. Other construction, land development, and raw land - This category of loans consists of loans to finance the ground up construction, improvement and/or carrying for sale after the completion of construction of owner occupied and non-owner occupied commercial properties, and loans secured by raw or improved land. The repayment of construction loans is generally dependent upon the successful completion of the improvements by the builder for the end user, or sale of the property to a third-party. Repayment of land secured loans are dependent upon the successful development and sale of the property, the sale of the land as is, or the outside cash flow of the owners to support the retirement of the debt. The Company utilizes the DCF method to quantitatively estimate credit losses for this pool. Agricultural production, including commercial fishing - These loans are for the purpose of financing agricultural production, including growing and storing of crops, and for the purpose of financing fisheries and forestries, including loans to commercial fishermen. These loans may be secured or unsecured, but any loans for these purposes that are secured by real estate are included in a real estate category. The Company utilizes the weighted average remaining life method to quantitatively estimate credit losses for this pool. Consumer - Loans used for personal use, which may be secured or unsecured, and customer overdrafts. The Company utilizes the DCF method to quantitatively estimate credit losses for this pool. Obligations of states and political subdivisions in the US - This category of loans includes all loans made to states, counties municipalities, school districts, drainage and sewer districts, and Indian tribes in the U.S. These loans maybe be secured by any type of collateral, including real estate. The Company utilizes the weighted average remaining life method to quantitatively estimate credit losses for this pool. Other - This category of loans includes all other loans that cannot properly be reported in one of the preceding categories. The Company utilizes the weighted average remaining life method to quantitatively estimate credit losses for this pool. 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; 59 • Inflation and monetary policy in the United States; • 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. Valuation of goodwill and other intangibles: Management performs an impairment analysis for the intangible assets with indefinite lives on an annual basis as of December 31. Additionally, goodwill and other intangible assets with indefinite lives are evaluated on an interim basis when events or circumstances indicate impairment potentially exists. The impairment analysis requires management to make subjective judgments. Events and factors that may significantly affect the estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures, technology, changes in discount rates and specific industry and market conditions. There can be no assurance that changes in circumstances, estimates or assumptions may result in additional impairment of all, or some portion of, goodwill or other intangible assets. The Company performed its annual goodwill impairment testing at December 31, 2022 and 2021 in accordance with the policy described in Note 1 to the financial statements included in Part II. Item 8 of this report. At December 31, 2022, the Company performed its annual impairment test by performing a qualitative assessment. Significant positive inputs to the qualitative assessment included the Company’s increasing net income as compared to historical trends; the Company's increasing market share for deposits in our markets; results of regulatory examinations; peer comparisons of the Company's net interest margin; trends in the Company’s cash flows; improvements in the Alaskan economy in 2022; increases in the Company's market share of mortgage originations; and increases in the Company's stock price. Significant negative inputs to the qualitative assessment included the muted pace of growth in the Alaska economy and a decline in home mortgage originations. We believe that the positive inputs to the qualitative assessment noted above outweigh the negative inputs for both of the Company's operating segments, and we therefore concluded that it is more likely than not that the fair value of the Company exceeds its carrying value at December 31, 2022 and that no potential impairment existed at that time. Servicing rights: The Company measures mortgage servicing rights ("MSRs") and commercial servicing rights ("CSRs") at fair value on a recurring basis with changes in fair value going through earnings in the period in which the change occurs. Changes in the fair value of MSRs are recorded in mortgage banking income, and changes in the fair value of CSRs are recorded in commercial servicing revenue. Fair value adjustments encompass market-driven valuation changes and the decrease in value that occurs from the passage of time, which are separately reported. Retained servicing rights are measured at fair value as of the date of sale. Initial and subsequent fair value measurements are determined using a discounted cash flow model. In order to determine the fair value of servicing rights, the present value of expected net future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, escrow calculations, delinquency rates and ancillary fee income net of servicing costs. The model assumptions for MSRs are also compared to publicly filed information from several large MSR holders, as available. Fair Value: A hierarchical disclosure framework associated with the level of pricing observability is utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no pricing observability and a higher degree of judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction.