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, 2022. 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, and the strength of the local economy. All statements, other than statements of historical fact, regarding our financial position, business strategy, management’s plans and objectives for future operations are forward-looking statements. 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 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: potential further increases in interest rates; the value of securities held in our investment portfolio; the impact of the results of government initiatives on the regulatory landscape, natural resource extraction industries, and capital markets; the impact of declines in the value of commercial and residential real estate markets, high unemployment rates, inflationary pressures and slowdowns in economic growth; changes in banking regulation or actions by bank regulators; inflation, supply-chain constraints, and potential geopolitical instability, including the war in Ukraine; financial stress on borrowers (consumers and businesses) as a result of higher rates or an uncertain economic environment; the general condition of, and changes in, the Alaska economy; our ability to maintain or expand our market share or net interest margin; the sufficiency of our provision for credit losses and the accuracy of the assumptions or estimates used in preparing our financial statements, including those related to current expected credit losses accounting guidance; our ability to maintain asset quality; our ability to implement our marketing and growth strategies; our ability to identify and address cyber-security risks, including security breaches, “denial of service attacks,” “hacking,” and identity theft; disease outbreaks, such as the COVID-19 pandemic, or similar health threats and measures implemented to combat them; 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. In addition, there are risks inherent in the banking industry relating to collectability of loans and changes in interest rates. 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, 2022, 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. 38 Update on Economic Conditions The Alaska Department of Labor ("DOL") has released preliminary jobs data through May of 2023. The DOL reported Alaska’s seasonally adjusted unemployment rate for May of 2023 decreased to 3.6%, which is now lower than the U.S. rate, which rose to 3.7%. The DOL reports total payroll jobs in Alaska increased 1.8% or 5,800 jobs compared to May of 2022. According to the DOL, Leisure and Hospitality had the largest growth of 7.2% year over year in May 2023. The 2,600 job increase over the prior 12 months brings the sector to 38,700 jobs, which is higher than the pre-pandemic level. Professional and Business Services added 800 jobs and Health Care increased by 600 jobs over the same 12 month period. The Oil and Gas sector has benefited from higher energy prices and new exploration activity, resulting in an increase of 300 jobs or 4.3% since May of 2022. Transportation, Warehousing and Utilities added 400 jobs and Retail also increased by 400 jobs year over year compared to May of 2022. Manufacturing, which is primarily seafood processing, declined 500 jobs and Information decreased 100 jobs for the same 12 month period. Alaska’s Gross State Product (“GSP”) in the first quarter of 2023, was estimated to be $63.8 billion in current dollars, according to the Federal Bureau of Economic Analysis ("BEA"). Alaska’s inflation adjusted “real” GSP grew 1.6% at annualized rates in the first quarter of 2023, compared to the average U.S. rate of 2%. Alaska’s real GSP improvement in the first quarter of 2023 was most positively impacted by gains in the Construction and Health Care sectors. The BEA also calculated Alaska’s seasonally adjusted personal income at $52.1 billion in the first quarter of 2023. This was an annualized improvement of 7.2% for Alaska and larger than the national average of 5.1%. Alaskans had annualized wage earnings growth of 6.6%, compared to a U.S. average of 4.6% in the first quarter of 2023 as compared to a year ago. The monthly average price of Alaska North Slope (“ANS”) crude oil has been in a stable range between $75.81 and $82.83 in the first six months of 2023. The Alaska Department of Revenue (“DOR”) calculated ANS crude oil production was 486 thousand barrels per day (“bpd”) in Alaska’s fiscal year ending June 30, 2022. The DOR has forecast production to increase to 494 thousand bpd in Alaska’s fiscal year 2023 and 504 thousand bpd in 2024. That number is projected by the DOR to grow to 556 thousand bpd in 2028. This is primarily a result of new production coming on line in the NPR-A region west of Prudhoe Bay. According to the Mortgage Bankers Association, Alaska’s home mortgage delinquency rate in the first quarter of 2023 improved to 2.7% compared to 2.9% in the fourth quarter of 2022. Alaska’s delinquency rate of 2.7% compares to the national average rate of 3.3% for the first quarter of 2023. The Mortgage Bankers Association survey reported that the mortgage foreclosure inventory in Alaska in the first quarter of 2023 was 0.54% and the national average was 0.57%. According to the Alaska Multiple Listing Services, the average sales price of a single family home in Anchorage rose 7.6% in 2022 to $456,544. This was the fifth consecutive year of price increases, following growth of 6.9% in 2021 and 5.8% in 2020. In the first six months of 2023, the average sales price in Anchorage continued to increase 3.7% to $473,330. Average sales prices for single family homes in the Matanuska Susitna Borough rose 9.9% in 2022 to $382,504, continuing a trend of average price increases for more than a decade. Average home prices in the Matanuska Susitna Borough increased 15.6% in 2021 and 9.9% in 2020. In the first six months of 2023, the average sales price in the Matanuska Susitna Borough has increased 3.5% to $395,952. These two markets represent the regions where the vast majority of the residential lending activity of Northrim Bank (the “Bank”) occurs. The Alaska Multiple Listing Services reported there were 934 housing units sold in Anchorage in the first six months of 2023, compared to 1,298 in the first half of 2022 for a decline of 33.2%. Anchorage home sales also declined by 21.2% in 2022 compared to 2021. A lack of inventory due to a reduction in the supply of new homes being constructed and a lower churn of existing homes being listed on the market are the primary reasons for the decline in sales. The limited supply of homes is not keeping up with demand and therefore price increases are continuing, despite the higher interest rate environment. The Matanuska Susitna Borough also experienced a lower volume of home sales in the last 18 months. For the first six months of 2023 there were 761 homes sales in the Matanuska Susitna Borough, compared to 1,077 in the first half of 2022 for a decrease of 29.3%. Matanuska Susitna Borough home sales also declined 11.9% in 2022 compared to the prior year according to the Alaska Multiple Listing Services. The Board of Governors of the Federal Reserve System increased its benchmark interest rate target from 4.25%-4.50% as of December 31, 2022 to 5.00%-5.25% as of June 30, 2023. Similarly, the prime rate of interest has increased from 7.50% as of December 31, 2022 to 8.25% as of June 30, 2023. 39 Highlights and Summary of Performance - Second Quarter of 2023 The Company reported net income and earnings per diluted share of $5.6 million and $0.98, respectively, for the second quarter of 2023 compared to net income and earnings per diluted share of $4.8 million and $0.83, respectively, for the second quarter of 2022. The Company reported net income and earnings per diluted share of $10.4 million and $1.82, respectively, for the first six months of 2023 compared to net income and earnings per diluted share of $12.0 million and $2.03, respectively, for the first six months of 2022. The increase in net income for the three-month period ending June 30, 2023 compared to the same period last year is primarily attributable to an increase in net interest income, which was only partially offset by a higher provision for credit losses and a decrease in net income in the Home Mortgage Lending segment as a result of decreased production and yields on sold loans. The decrease in net income for the six-month period ending June 30, 2023 compared to the same period last year is primarily the result of decreased mortgage banking income and a higher provision for credit losses which was only partially offset by increased net interest income. The first quarter of 2022 also included $2.0 million in keyman insurance proceeds. Increases in interest rates drove the decrease in production in the Home Mortgage Lending segment and the increase in net interest income in the first six months of 2023 as compared to the same period a year ago. • Net interest income in the second quarter of 2023 increased 13% to $25.1 million compared to $22.2 million in the second quarter of 2022. Net interest income in the first six months of 2023 increased 21% to $50.2 million compared to $41.5 million in the first six months of 2022. • Net interest margin was 4.14% for the second quarter of 2023, a 47 basis point increase from the second quarter of 2022. Net interest margin was 4.18% for the first six months of 2023, a 76 basis point increase from the first six months of 2022. The increase in both periods compared to the same periods in 2022 was primarily due to higher yields on all interest-earning asset categories, which were only partially offset by higher costs on interest-bearing deposits. • The weighted average interest rate for new loans booked in the second quarter of 2023 was 6.93% compared to 5.07% in the second quarter a year ago. • Loans were $1.66 billion at June 30, 2023, up 10% from December 31, 2022 primarily as a result of commercial and consumer mortgage loan growth. At June 30, 2023, approximately 74% of loans are variable and 15% of earning assets are subject to rate increases in the third quarter of 2023 when prime or other rate indices increase. • Total deposits were $2.30 billion at June 30, 2023, down 4% from December 31, 2022. Demand deposits decreased 11% at June 30, 2023 from December 31, 2022 and currently represent 31% of total deposits. • The average cost of interest-bearing deposits for the quarter was 1.56% at June 30, 2023, up from 0.16% at June 30, 2022. • Total liquid assets and investments and loans maturing within one year were $442.9 million and our funds available for borrowing under our existing lines of credit were $1.224 billion at June 30, 2023. Other financial measures are shown in the table below: Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Return on average assets, annualized 0.85 % 0.74 % 0.81 % 0.93 % Return on average shareholders' equity, annualized 9.85 % 8.58 % 9.30 % 10.51 % Dividend payout ratio 61.54 % 49.30 % 66.07 % 40.22 % 40 Nonperforming assets: Nonperforming assets, net of government guarantees were $5.6 million at June 30, 2023 and $6.4 million at December 31, 2022. Other Real Estate Owned ("OREO"), net of government guarantees, increased to $272,000 at June 30, 2023, from zero at December 31, 2022. Nonperforming loans, net of government guarantees decreased $1.1 million, or 17% to $5.3 million as of June 30, 2023 from $6.4 million as of December 31, 2022, primarily due to payoffs and pay downs in the first six months of 2023 that were only partially offset by the transfer of one lending relationship to nonaccrual status. $3.9 million, or 70% of nonperforming loans, net of government guarantees at June 30, 2023, are nonaccrual loans related to three commercial relationships. The following table summarizes nonperforming asset activity for the three-month periods ending June 30, 2023 and 2022. Writedowns Transfers to (In Thousands) Balance at March 31, 2023 Additions this quarter Payments this quarter /Charge-offs this quarter Transfers to OREO Performing Status this quarter Sales this quarter Balance at June 30, 2023 Nonperforming loans $8,775 $— ($1,003) ($49) $— $— $— $7,723 Nonperforming loans guaranteed by government (2,692) — 269 49 — — — (2,374) Nonperforming loans, net 6,083 — (734) — — — — 5,349 Other real estate owned 273 — — — — — — 273 Total nonperforming assets, net of government guarantees $6,356 $— ($734) $— $— $— $— $5,622 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 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, 2023, management had identified potential problem loans of $1.7 million as compared to potential problem loans of $1.6 million at December 31, 2022. The slight increase in potential problem loans from December 31, 2022 to June 30, 2023 is primarily the result of increased loan balances which were only partially offset by various loan paydowns in the first six months of 2023. RESULTS OF OPERATIONS Income Statement Net Income Net income for the second quarter of 2023 increased $782,000 to $5.6 million as compared to $4.8 million for the 41 same period in 2022. The increase in net income in the second quarter of 2023 as compared to the same quarter a year ago is mostly attributable to a $2.9 million increase in net interest income, which was only partially offset by a $2.0 million decrease in mortgage banking income and an increase in the provision for credit losses. Net income for the first half of 2023 decreased $1.6 million to $10.4 million as compared to $12.0 million for the same period in 2022. The decrease in net income in the first six months of 2023 as compared to the same period a year ago is primarily due to a decrease in mortgage banking income, due to lower production volume, as well as an increase in the provision for credit losses which was only partially offset by an increase in net interest income. Additionally, the Company received $2.0 million in life insurance proceeds in the six-month period ended June 30, 2022 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. Net Interest Income/Net Interest Margin Net interest income for the second quarter of 2023 increased $2.9 million, or 13%, to $25.1 million as compared to $22.2 million for the second quarter of 2022. The net interest margin increased 47 basis points to 4.14% in the second quarter of 2023 as compared to 3.67% in the second quarter of 2022. Net interest income for the first six months of 2023 increased $8.7 million, or 21%, to $50.2 million as compared to $41.5 million for the first six months of 2022. The net interest margin increased 76 basis points to 4.18% in the first six months of 2023 as compared to 3.42% in the first six months of 2022. The increase in net interest income in the second quarter and first six months of 2023 compared to the same periods in 2022 was primarily the result of increased interest on loans, investments, and interest bearing deposits in other banks which was only partially offset by an increase in interest expense on interest-bearing deposits and borrowings. The increase in net interest margin in the second quarter and first six months of 2023 as compared to the same periods of 2022 was primarily the result of higher yields on earning-assets. Changes in net interest margin in the three and six-month period ended June 30, 2023 as compared to the same period in the prior year are detailed below: Three Months Ended June 30, 2023 vs. June 30, 2022 Nonaccrual interest adjustments (0.11) % Impact of SBA Paycheck Protection Program loans (0.17) % Interest rates on loans and liabilities and loan fees, all other loans 0.68 % Volume and mix of other interest-earning assets and liabilities 0.07 % Change in net interest margin 0.47 % Six Months Ended June 30, 2023 vs. June 30, 2022 Nonaccrual interest adjustments (0.05) % Impact of SBA Paycheck Protection Program loans (0.20) % Interest rates on loans and liabilities and loan fees, all other loans 0.96 % Volume and mix of other interest-earning assets and liabilities 0.05 % Change in net interest margin 0.76 % 42 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, 2023 and 2022. Average yields or costs are calculated on a tax-equivalent basis. (Dollars in Thousands) Three Months Ended June 30, Interest income/ Average Tax Equivalent Average Balances Change expense Change Yields/Costs 6 2023 2022 $ % 2023 2022 $ % 2023 2022 Change Interest-bearing deposits in other banks 1 $66,058 $382,015 ($315,957) (83) % $828 $766 $62 8 % 4.96 % 0.79 % 4.17 % Taxable long-term investments 2 727,833 589,553 138,280 23 % 4,679 2,419 2,260 93 % 2.40 % 1.59 % 0.81 % Loans held for sale 37,594 59,677 (22,083) (37) % 559 620 (61) (10) % 5.96 % 4.16 % 1.80 % Loans 3,4 1,603,126 1,398,149 204,977 15 % 25,754 19,187 6,567 34 % 6.48 % 5.52 % 0.96 % Interest-earning assets 5 2,434,611 2,429,394 5,217 0 % 31,820 22,992 8,828 38 % 5.31 % 3.83 % 1.48 % Nonearning assets 185,342 172,655 12,687 7 % Total $2,619,953 $2,602,049 $17,904 1 % Interest-bearing demand $765,984 $669,848 $96,136 14 % $2,849 $167 $2,682 1,606 % 1.49 % 0.10 % 1.39 % Savings deposits 282,579 349,108 (66,529) (19) % 326 118 208 176 % 0.46 % 0.14 % 0.32 % Money market deposits 245,790 322,384 (76,594) (24) % 813 103 710 689 % 1.33 % 0.13 % 1.20 % Time deposits 273,820 172,617 101,203 59 % 2,126 211 1,915 908 % 3.11 % 0.49 % 2.62 % Total interest-bearing deposits 1,568,173 1,513,957 54,216 4 % 6,114 599 5,515 921 % 1.56 % 0.16 % 1.40 % Borrowings 54,602 24,675 29,927 121 % 564 181 383 212 % 4.11 % 2.92 % 1.19 % Total interest-bearing liabilities 1,622,775 1,538,632 84,143 5 % 6,678 780 5,898 756 % 1.65 % 0.20 % 1.45 % Non-interest bearing demand deposits 735,615 808,186 (72,571) (9) % Other liabilities 34,514 31,064 3,450 11 % Equity 227,049 224,167 2,882 1 % Total $2,619,953 $2,602,049 $17,904 1 % Net interest income $25,142 $22,212 $2,930 13 % Net interest margin 4.14 % 3.67 % 0.47 % Average loans to average interest-earning assets 65.85 % 57.55 % Average loans to average total deposits 69.59 % 60.21 % Average non-interest deposits to average total deposits 31.93 % 34.80 % Average interest-earning assets to average interest-bearing liabilities 150.03 % 157.89 % 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. 3 Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled $1.1 million and $2.3 in the second quarter of 2023 and 2022, respectively. 4 Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loan balances were $8.3 million and $8.8 million in the second quarter of 2023 and 2022, 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. 6 Tax-equivalent yields/costs assume a federal tax rate of 21% and state tax rate of 7.43% for a combined tax rate of 28.43%. 43 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, 2023 and 2022. 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, 2023 and 2022. (In Thousands) Three Months Ended June 30, 2023 vs. 2022 Increase (decrease) due to Volume Rate Total Interest Income: Short-term investments ($12) $74 $62 Taxable long-term investments 704 1,556 2,260 Loans held for sale (275) 214 (61) Loans 2,297 4,270 6,567 Total interest income $2,714 $6,114 $8,828 Interest Expense: Interest-bearing demand $21 $2,661 $2,682 Savings deposits (27) 235 208 Money market deposits (31) 741 710 Time deposits 42 1,873 1,915 Interest-bearing deposits 5 5,510 5,515 Borrowings 356 27 383 Total interest expense $361 $5,537 $5,898 44 The following table compares average balances and rates as well as margins on earning assets for the six-month periods ended June 30, 2023 and 2022. Average yields or costs are calculated on a tax-equivalent basis. (Dollars in Thousands) Six Months Ended June 30, Interest income/ Average Tax Equivalent Average Balances Change expense Change Yields/Costs 6 2023 2022 $ % 2023 2022 $ % 2023 2022 Change Interest-bearing deposits in other banks 1 $98,314 $459,843 ($361,529) (79) % $2,317 $1,008 $1,309 130 % 4.69 % 0.44 % 4.25 % Taxable long-term investments 2 727,722 540,563 187,159 35 % 9,291 3,967 5,324 134 % 2.40 % 1.43 % 0.97 % Loans held for sale 29,294 56,173 (26,879) (48) % 849 1,025 (176) (17) % 5.80 % 3.65 % 2.15 % Loans 3,4 1,563,847 1,389,050 174,797 13 % 49,158 37,050 12,108 33 % 6.39 % 5.40 % 0.99 % Interest-earning assets 5 2,419,177 2,445,629 (26,452) (1) % 61,615 43,050 18,565 43 % 5.21 % 3.58 % 1.63 % Nonearning assets 185,545 164,611 20,934 13 % Total $2,604,722 $2,610,240 ($5,518) 0 % Interest-bearing demand $742,356 $672,694 $69,662 10 % $4,876 $282 $4,594 1,629 % 1.32 % 0.08 % 1.24 % Savings deposits 291,904 350,823 (58,919) (17) % 667 246 421 171 % 0.46 % 0.14 % 0.32 % Money market deposits 269,584 321,580 (51,996) (16) % 1,595 205 1,390 678 % 1.19 % 0.13 % 1.06 % Time deposits 252,030 174,898 77,132 44 % 3,559 441 3,118 707 % 2.85 % 0.51 % 2.34 % Total interest-bearing deposits 1,555,874 1,519,995 35,879 2 % 10,697 1,174 9,523 811 % 1.39 % 0.16 % 1.23 % Borrowings 39,567 24,726 14,841 60 % 744 360 384 107 % 3.74 % 2.94 % 0.80 % Total interest-bearing liabilities 1,595,441 1,544,721 50,720 3 % 11,441 1,534 9,907 646 % 1.44 % 0.20 % 1.24 % Non-interest bearing demand deposits 745,795 801,481 (55,686) (7) % Other liabilities 37,772 33,436 4,336 13 % Equity 225,714 230,602 (4,888) (2) % Total $2,604,722 $2,610,240 ($5,518) 0 % Net interest income $50,174 $41,516 $8,658 21 % Net interest margin 4.18 % 3.42 % 0.76 % Average loans to average interest-earning assets 64.64 % 56.80 % Average loans to average total deposits 67.94 % 59.83 % Average non-interest deposits to average total deposits 32.40 % 34.52 % Average interest-earning assets to average interest-bearing liabilities 151.63 % 158.32 % 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. 3 Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled $2.3 million and $5.3 million in the first six months of 2023 and 2022, respectively. 4 Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loan balances were $7.6 million and $9.9 million in the first six months of 2023 and 2022, 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. 6 Tax-equivalent yields/costs assume a federal tax rate of 21% and state tax rate of 7.43% for a combined tax rate of 28.43%. 45 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, 2023 and 2022. 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, 2023 and 2022. (In Thousands) Six Months Ended June 30, 2023 vs. 2022 Increase (decrease) due to Volume Rate Total Interest Income: Short-term investments ($115) $1,424 $1,309 Taxable long-term investments 1,800 3,524 5,324 Loans held for sale (616) 440 (176) Loans 503 11,605 12,108 Total interest income $1,572 $16,993 $18,565 Interest Expense: Interest-bearing demand $26 $4,568 $4,594 Savings deposits (47) 468 421 Money market deposits (38) 1,428 1,390 Time deposits 99 3,019 3,118 Interest-bearing deposits 40 9,483 9,523 Borrowings 345 39 384 Total interest expense $385 $9,522 $9,907 46 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) 2023 2022 2023 2022 Credit loss expense on loans held for investment $1,510 $273 $1,769 $106 Credit loss expense on unfunded commitments (103) 190 (2) 207 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 $1,407 $463 $1,767 $313 The increase in the ACL for the three and six-month periods ending June 30, 2023 as compared to the same periods in 2022 is primarily the result of increased loan balances, as well as a decrease in management's assumptions for prepayment and curtailment speeds. These changes are only partially offset by improvement in management's forecasted economic factors and a decrease in unfunded commitment balances. 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. Other Operating Income Other operating income for the three-month period ended June 30, 2023 decreased $827,000, or 11%, to $7.0 million as compared to $7.8 million for the same period in 2022, primarily due to a $2.0 million decrease in mortgage banking income in the second quarter of 2023 compared to the same quarter a year ago. The decrease in mortgage banking income in the three-month period ended June 30, 2023 as compared to the same period in 2022 was primarily due to decreased production volume due primarily to increases in mortgage interest rates. Other operating income for the six-month period ended June 30, 2023 decreased $6.7 million, or 36%, to $11.9 million as compared to $18.6 million for the same period in 2022, primarily due to a $7.0 million decrease in mortgage banking income in the first six months of 2023 compared to the same period a year ago, which was only partially offset by a $1.0 million increase in purchased receivable income and a $775,000 increase in the fair market value of marketable securities. The decrease in mortgage banking income in the six-month period ended June 30, 2023 as compared to the same period in 2022 was primarily due to decreased production volume due largely to increases in mortgage interest rates. Additionally, the Company received $2.0 million in life insurance proceeds in the six-month period ended June 30, 2022 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. Other Operating Expense Other operating expense for the second quarter of 2023 increased $544,000, or 2%, to $23.8 million as compared to $23.2 million for the same period in 2022 primarily due to increased marketing and insurance expenses as well as an increase in other operating expenses. Other operating expense for the first six months of 2023 increased $3.0 million, or 7%, to $47.3 million as compared to $44.3 million for the same period in 2022 primarily due to an increase in salaries and other personnel expense as well as smaller increases in most other expense categories as the Company has grown and increased its number of branches and mortgage origination offices. The Company opened its 18th branch in Nome in the fourth quarter of 2022, its 19th branch in Kodiak in the first quarter of 2023, and a loan production office in Homer in the second quarter of 2023 which contributed to increased salaries and personnel expense for the Community Banking segment. 47 Income Taxes For the second quarter and first six months of 2023, Northrim recorded a lower effective tax rate as compared to the same periods in 2022 as a result of an increase in tax credits and tax exempt interest income as a percentage of pre-tax income in 2023. In the second quarter of 2023, Northrim recorded $1.4 million in state and federal income tax expense, for an effective tax rate of 19.56% compared to $1.5 million and 24.11% for the same period in 2022. In the first six months of 2023, Northrim recorded $2.6 million in state and federal income tax expense, for an effective tax rate of 19.97% compared to $3.5 million and 22.42% for the same period in 2022. 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, 2023 decreased 1% to $718.5 million from $724.5 million at December 31, 2022 mostly due to maturities and calls of available for sale securities during the first six months of 2023. The table below details portfolio investment balances by portfolio investment type: June 30, 2023 December 31, 2022 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 $597,665 83.1 % $595,161 82.2 % Municipal securities 802 0.1 % 795 0.1 % Corporate bonds 50,230 7.0 % 60,394 8.3 % Collateralized loan obligations 59,192 8.2 % 57,429 7.9 % Preferred stock 10,604 1.5 % 10,740 1.5 % Total portfolio investments $718,493 $724,519 The average estimated duration of the investment portfolio at June 30, 2023, was approximately three-years. As of June 30, 2023, $66.1 million available for sale securities are scheduled to mature in the next six months, $61.9 million are scheduled to mature in six months to one year, and $175.6 million are scheduled to mature in the following year, a total of $303.5 million or 12% of earning assets at June 30, 2023. 48 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, 2023 December 31, 2022 Dollar Amount Percent of Total Dollar Amount Percent of Total (In Thousands) Commercial & industrial loans $418,752 25.2 % $358,128 23.8 % Commercial real estate: Owner occupied properties 348,834 21.0 % 349,973 23.3 % Non-owner occupied and multifamily properties 490,821 29.7 % 482,270 32.2 % Residential real estate: 1-4 family residential properties secured by first liens 160,546 9.7 % 73,381 4.9 % 1-4 family residential properties secured by junior liens and revolving secured by 1-4 family first liens 25,156 1.5 % 20,259 1.3 % 1-4 family residential construction loans 35,349 2.1 % 44,000 2.9 % Other construction, land development and raw land loans 95,124 5.7 % 99,182 6.6 % Obligations of states and political subdivisions in the US 35,325 2.1 % 32,539 2.2 % Agricultural production, including commercial fishing 40,767 2.5 % 34,099 2.3 % Consumer loans 5,551 0.3 % 4,335 0.3 % Other loans 3,014 0.2 % 3,619 0.2 % Total loans $1,659,239 $1,501,785 Loans increased by $157.5 million, or 10%, to $1.659 billion at June 30, 2023 from $1.502 billion at December 31, 2022, primarily as a result of increased commercial and consumer mortgage loans. 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 $97.3 million, or approximately 6% of loans as of June 30, 2023 have direct exposure to the oil and gas industry as compared to $83.4 million, or approximately 6% of loans as of December 31, 2022. The Company's unfunded commitments to borrowers that have direct exposure to the oil and gas industry were $42.5 million and $51.8 million at June 30, 2023 and December 31, 2022, 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 $882,000 as of June 30, 2023 and $786,000 as of December 31, 2022. 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, 2023 December 31, 2022 Commercial & industrial loans $78,223 $66,864 Commercial real estate: Owner occupied properties 11,911 9,108 Non-owner occupied and multifamily properties 5,727 6,013 Other loans 1,394 1,431 Total $97,255 $83,416 The Company monitors other concentrations within the loan portfolio depending on trends in the current and future estimated economic conditions. At June 30, 2023, the Company had $127.6 million, or 8% of portfolio loans, in the Healthcare sector, $102.2 million, or 6% of portfolio loans, in the Tourism sector, $75.7 million, or 5% of portfolio loans, in the Accommodations sector, $72.5 million, or 4% of portfolio loans, in the Retail sector, $71.6 million, or 4% of portfolio loans, in the Fishing sector, $64.7 million, or 4% of portfolio loans, in the Aviation (non-tourism) sector, and $48.6 million, or 3% in the Restaurant sector. 49 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, 2023: (In Thousands) Tourism Aviation (non-tourism) Healthcare Retail Fishing Restaurant Accommodations Total ACL $658 $557 $1,072 $614 $445 $385 $587 $4,318 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) 2023 2022 2023 2022 Balance at beginning of period $14,157 $11,310 $13,838 $11,739 Commercial & industrial loans (49) (166) (49) (461) Consumer loans — — (14) — Total charge-offs (49) (166) (63) (461) Recoveries: Commercial & industrial loans 21 103 86 116 Residential real estate: 1-4 family residential properties secured by junior liens and revolving secured by 1-4 family first liens 5 9 12 21 Agricultural production, including commercial fishing — 7 — 15 Consumer loans 1 1 3 1 Total recoveries 27 120 101 153 Net, charge-offs (22) (46) 38 (308) Provision (benefit) for credit losses 1,510 273 1,769 106 Balance at end of period $15,645 $11,537 $15,645 $11,537 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) 2023 2022 2023 2022 Balance at beginning of period $2,071 $1,113 $1,970 $1,096 Provision for credit losses (103) 190 (2) 207 Balance at end of period $1,968 $1,303 $1,968 $1,303 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. 50 Deposits Deposits are the Company’s primary source of funds. Total deposits decreased $84.9 million, or 4%, to $2.302 billion as of June 30, 2023 compared to $2.387 billion as of December 31, 2022. The following table summarizes the Company's composition of deposits as of the periods indicated: June 30, 2023 December 31, 2022 (In thousands) Balance % of total Balance % of total Demand deposits $711,390 31 % $797,434 34 % Interest-bearing demand 795,128 35 % 767,686 32 % Savings deposits 275,602 12 % 320,917 13 % Money market deposits 232,698 10 % 308,317 13 % Time deposits 287,493 12 % 192,857 8 % Total deposits $2,302,311 $2,387,211 The Company’s mix of deposits continues to contribute to a low cost of funds with balances in transaction accounts representing 88% of total deposits at June 30, 2023 and 92% of total deposits at December 31, 2022. The only deposit category with stated maturity dates is certificates of deposit. At June 30, 2023, the Company had $287.5 million in certificates of deposit as compared to certificates of deposit of $192.9 million at December 31, 2022. At June 30, 2023, $175.9 million, or 61%, of the Company’s certificates of deposits are scheduled to mature over the next 12 months as compared to $128.4 million, or 67%, of total certificates of deposit at December 31, 2022. The aggregate amount of certificates of deposit in amounts of $250,000 and greater at June 30, 2023 and December 31, 2022, was $117.3 million and $77.5 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, 2023: Time Certificates of Deposit of $250,000 or More Percent of Total Deposits (In Thousands) Amount Amounts maturing in: Three months or less $8,585 7 % Over 3 through 6 months 31,350 27 % Over 6 through 12 months 21,190 18 % Over 12 months 56,186 48 % Total $117,311 100 % At June 30, 2023, 69% of total deposits were held in business accounts and 31% of deposit balances were held in consumer accounts. Northrim had approximately 33,000 deposit customers with an average balance of $70,000 as of June 30, 2023. Northrim had 15 customers with balances over $10 million as of June 30, 2023 which accounted for $332.6 million, or 14%, of total deposits. Uninsured deposits totaled $910.7 million or 40% of total deposits as of June 30, 2023 compared to $1.1 billion or 46% of total deposits as of December 31, 2022. As interest rates continued to increase in the first six months of 2023, Northrim has taken a proactive, targeted approach to increase deposit rates. There was no unusual deposit activity during the first six months of 2023. 51 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, 2023, our maximum borrowing line from the FHLB was $1.180 billion, approximately 45% of the Bank’s assets, subject to the FHLB’s collateral requirements. The Company has outstanding advances of $14.0 million as of June 30, 2023 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%. Additionally, the Company has a short-term $50.0 million advance from the FHLB outstanding as of June 30, 2023 at a fixed rate of 5.49% which matures on November 14, 2023. Federal Reserve Bank: The Federal Reserve Bank of San Francisco (the "Federal Reserve Bank") is holding $20.0 million of loans as collateral to secure the Company's ability to take advances through the discount window on June 30, 2023. There were no discount window advances outstanding at either June 30, 2023 or December 31, 2022. The Federal Reserve Bank is holding $60.0 million of securities as collateral to secure the Company's ability to take advances through the Federal Reserve Bank's recently created Bank Term Funding Program ("BTFP") on June 30, 2023. There were no BTFP advances outstanding at June 30, 2023. 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 $917.7 million at June 30, 2023 and $930.1 million at December 31, 2022. The Company had an overnight advance of $1.0 million outstanding at 5.75% at June 30, 2023. At June 30, 2023 and December 31, 2022, 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, 2023 or December 31, 2022. 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 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 June 30, 2023, the Company has 10.0 million authorized shares of common stock, of which 5.6 million are issued and outstanding, leaving 4.4 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. 52 The Company had cash and cash equivalents of $36.8 million, or 1% of total assets at June 30, 2023 compared to $259.4 million, or 10% of total assets as of December 31, 2022. The decrease in cash and cash equivalents since the end of 2022 is primarily due to an increase in loans and a decrease in deposits. The Company had other comprehensive income, net of tax, of $3.0 million for the six-month period ending June 30, 2023 primarily due to unrealized holding gains on available for sale securities. Accumulated unrealized losses, net of income taxes on available for sale securities, which are recorded in total shareholders' equity, are $27.5 million as of June 30, 2023. Accumulated unrealized losses, net of income taxes on held to maturity securities, which are not recorded in shareholders' equity, are $3.0 million as of June 30, 2023. Management does not believe that liquidation of these securities, which would result in realized losses, will occur prior to maturity of these securities. As of June 30, 2023, the weighted average maturity of available for sale securities is 3.0 years compared to 3.3 years at December 31, 2022 and 4.1 years at December 31, 2021. At June 30, 2023, $128.0 million available for sale securities mature within one year, $175.6 million mature within one to two years, and $167.8 million mature within two to three years. Our total unfunded commitments to fund loans and letters of credit at June 30, 2023 were $418.2 million. We do not expect that all of these loans are likely to be fully drawn upon at any one time. At June 30, 2023, certificates of deposit totaling $175.9 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. At June 30, 2023 the Company has a $50 million FHLB advance that is due in November 2023. Management believes that cash requirements to fund future non-deposit and non-borrowing liabilities, including operating lease liabilities and other liabilities, as of June 30, 2023, are not material to the Company's liquidity position as of June 30, 2023. The Company has other available sources of liquidity to fund unforeseen liquidity requirements. These include borrowings available through our correspondent banking relationships and our credit lines with the Federal Reserve Bank and the FHLB. At June 30, 2023, our liquid assets, which include investments and loans maturing within a year, were $442.9 million and our funds available for borrowing under our existing lines of credit were $1.224 billion. Additionally, the Company can obtain borrowings under the BTFP as a source of liquidity in order to help assure that banks have the ability to meet the needs of all depositors. The BTFP allows eligible depository institutions to pledge high-quality securities to obtain liquidity and eliminate the need for the financial institution to sell securities quickly in times of stress. 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 for the foreseeable future. As shown in the Consolidated Statements of Cash Flows included in Part I - Item 1 "Financial Statements" of this report, net cash used by operating activities was $22.5 million for the first six months of 2023, primarily due to cash used in connection with the origination of loans held for sale, which was only partially offset by cash provided by net income and net proceeds from the sale of loans held for sale. Net cash used by investing activities was $155.3 million for the same period, primarily due to an increase in loans which was only partially offset by maturities and calls of available for sale securities. Net cash used by financing activities in the same period was $44.8 million, primarily due to a decrease in deposits, as well as cash dividends paid to shareholder and repurchases of common stock. These decreases were only partially offset by an increase in borrowings. 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 89,887 shares of its common stock under the Company's previously announced repurchase programs in the first six months of 2023. At June 30, 2023, there are 195,113 shares remaining under the repurchase program. The Company may elect to continue to repurchase our common 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, 2023, 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 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 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 53 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 June 30, 2023, 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, 2023 Total risk-based capital 8.00% 10.00% 13.02% 11.16% Tier 1 risk-based capital 6.00% 8.00% 12.13% 10.26% Common equity tier 1 capital 4.50% 6.50% 11.64% 10.27% Leverage ratio 4.00% 5.00% 9.28% 7.83% See Note 22 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, 2022 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, 2022. 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 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, 2022. 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 mortgage servicing rights, and fair value. There have been no material changes to the valuation techniques or models, that affect our estimates during 2023. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our assessment of market risk as of June 30, 2023 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, 2022. 54