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 wars in Ukraine and the Middle East; 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 reported that Alaska’s seasonally adjusted unemployment rate in August of 2023 was 3.9% compared to the U.S. rate of 3.8%. The total number of payroll jobs in Alaska, not including uniformed military, increased 1.4% or 4,800 jobs between August of 2022 and August of 2023. According to the DOL, Leisure and Hospitality had the largest growth in new jobs through August compared to the prior year. The sector added 2,000 positions for a year over year growth rate of 4.8% in August of 2023. The Oil & Gas sector grew the quickest as a percentage of growth at 5.7% or 400 new jobs. Construction added 600 jobs for a 3.2% growth rate and Health Care grew 2.3% or 900 jobs between August of 2022 and August of 2023. Manufacturing decreased 2.2% or 400 jobs due to a decline in seafood processing. The Information and Financial Activities sectors both declined by 100 jobs year over year in August of 2023. 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 an annualized rate 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 aided 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. The monthly average price of Alaska North Slope (“ANS”) crude oil has been in a range between $75.64 and $95.05 in the first nine months of 2023. The Alaska Department of Revenue (“DOR”) calculated ANS crude oil production was 480 thousand barrels per day (“bpd”) in Alaska’s fiscal year ending June 30, 2023. The DOR has forecast production to increase to 504 thousand bpd in Alaska’s fiscal year 2024. That number is projected to grow by the DOR 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 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 nine months of 2023, the average sales price in Anchorage continued to increase 5.4% to $481,360. Average sales prices for single family homes in the Matanuska Susitna Borough rose 9.9% in 2022 to $382,439, continuing a trend of average price increases for more than a decade. In the first nine months of 2023, the average sales price in the Matanuska Susitna Borough has increased 5.3% to $402,799. These two markets represent where the vast majority of the residential lending activity of Northrim Bank (the “Bank”) occurs. The Alaska Multiple Listing Services reported there were 1,616 housing units sold in Anchorage in the first nine months of 2023, compared to 2,274 through September of 2022 for a decline of 28.9%. Anchorage home sales also declined by 21.2% in 2022 compared to 2021. For the first nine months of 2023 there were 1,258 homes sales in the Matanuska Susitna Borough, compared to 1,670 through September of 2022 for a decrease of 24.7%. Matanuska Susitna Borough home sales also declined 11.9% in 2022 compared to the prior year. 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 5.25%-5.50% as of September 30, 2023. Similarly, the prime rate of interest has increased from 7.50% as of December 31, 2022 to 8.50% as of September 30, 2023. 39 Highlights and Summary of Performance - Third Quarter of 2023 The Company reported net income and earnings per diluted share of $8.4 million and $1.48, respectively, for the third quarter of 2023 compared to net income and earnings per diluted share of $10.1 million and $1.76, respectively, for the third quarter of 2022. The Company reported net income and earnings per diluted share of $18.8 million and $3.30, respectively, for the first nine months of 2023 compared to net income and earnings per diluted share of $22.1 million and $3.79, respectively, for the first nine months of 2022. The decrease in net income for the three-month period ending September 30, 2023 compared to the same period last year is primarily attributable to a higher provision for credit losses due to loan growth, a decrease in net income in the Home Mortgage Lending segment as a result of decreased production and yields on sold loans, and an increase in salaries and other personnel expense that was only partially offset by a gain on an Other Real Estate Owned (“OREO”) sale. The decrease in net income for the nine-month period ending September 30, 2023 compared to the same period last year is primarily the result of decreased mortgage banking income, a higher provision for credit losses, and an increase in salaries and other personnel expense. These changes were only partially offset by increased net interest income, purchased receivable income, unrealized gains on marketable securities and the gain on the OREO sale. 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 nine months of 2023 as compared to the same period a year ago. • Net interest income in the third quarter of 2023 increased slightly to $26.4 million compared to $26.3 million in the third quarter of 2022. Net interest income in the first nine months of 2023 increased 13% to $76.5 million compared to $67.8 million in the first nine months of 2022. • Net interest margin was 4.15% for the third quarter of 2023, a 7 basis point decrease from the third quarter of 2022. Net interest margin was 4.17% for the first nine months of 2023, a 48 basis point increase from the first nine months of 2022. The decrease in the third quarter of 2023 compared to the same period in 2022 was primarily due to lower recoveries of interest income on nonaccrual loans and lower fee income on Paycheck Protection Program loans. These decreases were only partially offset by higher yields on interest-earning assets, net of higher costs on interest-bearing deposits. The increase in the first nine months of 2023 compared to the same period 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 third quarter of 2023 was 7.39% compared to 5.83% in the third quarter a year ago. • Loans were $1.72 billion at September 30, 2023, up 14% from December 31, 2022 primarily as a result of commercial and consumer mortgage loan growth. At September 30, 2023, approximately 74% of loans are variable and 18% of earning assets are subject to rate increases in the fourth quarter of 2023 when prime or other rate indices increase. • Total deposits were $2.43 billion at September 30, 2023, up 2% from December 31, 2022. Demand deposits decreased 4% at September 30, 2023 from December 31, 2022 and currently represent 31% of total deposits. • The average cost of interest-bearing deposits for the quarter was 1.75% at September 30, 2023, up from 0.28% at September 30, 2022. • Total liquid assets and investments and loans maturing within one year were $517.8 million and our funds available for borrowing under our existing lines of credit were $717.2 million at September 30, 2023. Other financial measures are shown in the table below: Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Return on average assets, annualized 1.22 % 1.52 % 0.95 % 1.13 % Return on average shareholders' equity, annualized 14.67 % 18.18 % 11.11 % 13.02 % Dividend payout ratio 40.40 % 28.23 % 54.62 % 34.74 % 40 Nonperforming assets: Nonperforming assets, net of government guarantees were $5.2 million at September 30, 2023 and $6.4 million at December 31, 2022. OREO, net of government guarantees, increased to $150,000 at September 30, 2023, from zero at December 31, 2022. Nonperforming loans, net of government guarantees decreased $1.3 million, or 20% to $5.1 million as of September 30, 2023 from $6.4 million as of December 31, 2022, primarily due to payoffs and pay downs in the first nine months of 2023 that were only partially offset by the transfer of two lending relationships to nonaccrual status. $3.8 million, or 73% of nonperforming loans, net of government guarantees at September 30, 2023, are nonaccrual loans related to three commercial relationships. The following table summarizes nonperforming asset activity for the three-month periods ending September 30, 2023 and 2022. Writedowns Transfers to (In Thousands) Balance at June 30, 2023 Additions this quarter Payments this quarter /Charge-offs this quarter Transfers to OREO Performing Status this quarter Sales this quarter Balance at September 30, 2023 Nonperforming loans $7,723 $291 ($1,403) ($91) $— $— $— $6,520 Nonperforming loans guaranteed by government (2,374) — 919 — — — — (1,455) Nonperforming loans, net 5,349 291 (484) (91) — — — 5,065 Other real estate owned 273 — — (123) — — — 150 Total nonperforming assets, net of government guarantees $5,622 $291 ($484) ($214) $— $— $— $5,215 Writedowns Transfers to (In Thousands) Balance at June 30, 2022 Additions this quarter Payments this quarter /Charge-offs this quarter Transfers to OREO Performing Status this quarter Sales this quarter Balance at September 30, 2022 Nonperforming loans $8,001 $298 ($1,159) ($48) $— $— $— $7,092 Nonperforming loans guaranteed by government (683) — 64 — — — — (619) Nonperforming loans, net 7,318 298 (1,095) (48) — — — 6,473 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 $11,677 $298 ($1,095) ($48) $— $— $— $10,832 Potential problem assets: Potential problem loans are loans which are currently performing in accordance with contractual terms but that have developed negative indications that the borrower may not be able to comply with present payment terms and which may later be included in nonaccrual, past due, or impaired loans. These loans are closely monitored and their performance is reviewed by management on a regular basis. At September 30, 2023, management had identified $2.2 million potential problem loans as compared to potential problem loans of $1.6 million at December 31, 2022. The increase in potential problem loans from December 31, 2022 to September 30, 2023 is primarily the result of increased line of credit usage on one loan balance and two new potential problem loans which were only partially offset by various loan paydowns and the movement of one potential problem loan to nonaccrual in the first nine months of 2023. Additionally, the Company has $1.0 million in adversely classified purchased receivables. As of September 30, 2023, management believes that these receivables are collectible and no Allowance for Credit Losses (“ACL”) is considered necessary at this time; however, negative indications may require an ACL in the future. 41 RESULTS OF OPERATIONS Income Statement Net Income Net income for the third quarter of 2023 decreased $1.8 million to $8.4 million as compared to $10.1 million for the same period in 2022. The decrease in net income in the third quarter of 2023 as compared to the same quarter a year ago is largely attributable to a $1.5 million increase in the provision for credit losses due to loan growth, a $1.3 million decrease in mortgage banking income and $1.1 million increase in salaries and other personnel expense that was only partially offset by a gain on OREO sale and lower marketing expenses. Net income for the first nine months of 2023 decreased $3.4 million to $18.8 million as compared to $22.1 million for the same period in 2022. The decrease in net income in the first nine 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 nine-month period ended September 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 third quarter of 2023 increased slightly by $39,000, to $26.4 million as compared to $26.3 million for the third quarter of 2022. The net interest margin decreased 7 basis points to 4.15% in the third quarter of 2023 as compared to 4.22% in the third quarter of 2022. Net interest income for the first nine months of 2023 increased $8.7 million, or 13%, to $76.5 million as compared to $67.8 million for the first nine months of 2022. The net interest margin increased 48 basis points to 4.17% in the first nine months of 2023 as compared to 3.69% in the first nine months of 2022. The increase in net interest income in the third quarter and first nine 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 decrease in net interest margin in the third quarter as compared to the same period of 2022 was primarily due to a decrease in recoveries of interest income on nonaccrual loans which was only partially offset by a favorable change in the mix of earning-assets towards higher loan balances as a percentage of earning-assets. The increase in net interest margin in the first nine months of 2023 as compared to the same period of 2022 was primarily the result of higher yields on earning-assets that was only partially offset by increases in interest expense on borrowings and deposits. Changes in net interest margin in the three and nine-month periods ended September 30, 2023 as compared to the same periods in the prior year are detailed below: Three Months Ended September 30, 2023 vs. September 30, 2022 Nonaccrual interest adjustments (0.16) % Impact of SBA Paycheck Protection Program loans (0.08) % Interest rates on loans and liabilities and loan fees, all other loans 0.01 % Volume and mix of other interest-earning assets and liabilities 0.16 % Change in net interest margin (0.07) % Nine Months Ended September 30, 2023 vs. September 30, 2022 Nonaccrual interest adjustments (0.09) % Impact of SBA Paycheck Protection Program loans (0.13) % Interest rates on loans and liabilities and loan fees, all other loans 0.62 % Volume and mix of other interest-earning assets and liabilities 0.08 % Change in net interest margin 0.48 % 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 September 30, 2023 and 2022. Average yields or costs are calculated on a tax-equivalent basis. (Dollars in Thousands) Three Months Ended September 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 $42,273 $324,280 ($282,007) (87) % $584 $1,899 ($1,315) (69) % 5.39 % 2.29 % 3.10 % Taxable long-term investments 2 715,767 678,609 37,158 5 % 4,727 3,530 1,197 34 % 2.43 % 1.98 % 0.45 % Loans held for sale 62,350 53,769 8,581 16 % 988 656 332 51 % 6.34 % 4.88 % 1.46 % Loans 3,4 1,695,736 1,414,982 280,754 20 % 28,109 21,474 6,635 31 % 6.61 % 6.05 % 0.56 % Interest-earning assets 5 2,516,126 2,471,640 44,486 2 % 34,408 27,559 6,849 25 % 5.48 % 4.47 % 1.01 % Nonearning assets 205,770 174,182 31,588 18 % Total $2,721,896 $2,645,822 $76,074 3 % Interest-bearing demand $828,854 $688,566 $140,288 20 % $3,614 $562 $3,052 543 % 1.73 % 0.32 % 1.41 % Savings deposits 270,945 346,306 (75,361) (22) % 322 130 192 148 % 0.47 % 0.15 % 0.32 % Money market deposits 232,054 315,049 (82,995) (26) % 766 158 608 385 % 1.31 % 0.20 % 1.11 % Time deposits 287,625 167,112 120,513 72 % 2,436 214 2,222 1,038 % 3.36 % 0.51 % 2.85 % Total interest-bearing deposits 1,619,478 1,517,033 102,445 7 % 7,138 1,064 6,074 571 % 1.75 % 0.28 % 1.47 % Borrowings 76,681 24,573 52,108 212 % 920 184 736 400 % 4.73 % 2.92 % 1.81 % Total interest-bearing liabilities 1,696,159 1,541,606 154,553 10 % 8,058 1,248 6,810 546 % 1.88 % 0.32 % 1.56 % Non-interest bearing demand deposits 747,147 846,764 (99,617) (12) % Other liabilities 52,078 36,446 15,632 43 % Equity 226,512 221,006 5,506 2 % Total $2,721,896 $2,645,822 $76,074 3 % Net interest income $26,350 $26,311 $39 — % Net interest margin 4.15 % 4.22 % (0.07) % Average loans to average interest-earning assets 67.39 % 57.25 % Average loans to average total deposits 71.65 % 59.86 % Average non-interest deposits to average total deposits 31.57 % 35.82 % Average interest-earning assets to average interest-bearing liabilities 148.34 % 160.33 % 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 $881,000 and $2.0 million in the third 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 $7.2 million and $7.7 million in the third 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 September 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 September 30, 2023 and 2022. (In Thousands) Three Months Ended September 30, 2023 vs. 2022 Increase (decrease) due to Volume Rate Total Interest Income: Short-term investments ($2,497) $1,182 ($1,315) Taxable long-term investments 231 966 1,197 Loans held for sale 72 260 332 Loans 4,065 2,570 6,635 Total interest income $1,871 $4,978 $6,849 Interest Expense: Interest-bearing demand $90 $2,962 $3,052 Savings deposits (34) 226 192 Money market deposits (53) 661 608 Time deposits 27 2,195 2,222 Interest-bearing deposits 30 6,044 6,074 Borrowings 724 12 736 Total interest expense $754 $6,056 $6,810 44 The following table compares average balances and rates as well as margins on earning assets for the nine-month periods ended September 30, 2023 and 2022. Average yields or costs are calculated on a tax-equivalent basis. (Dollars in Thousands) Nine Months Ended September 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 $79,362 $414,159 ($334,797) (81) % $2,901 $2,907 ($6) — % 4.82 % 0.93 % 3.89 % Taxable long-term investments 2 723,693 587,084 136,609 23 % 14,018 7,497 6,521 87 % 2.41 % 1.64 % 0.77 % Loans held for sale 40,433 55,363 (14,930) (27) % 1,837 1,682 155 9 % 6.06 % 4.05 % 2.01 % Loans 3,4 1,608,293 1,397,789 210,504 15 % 77,267 58,523 18,744 32 % 6.46 % 5.62 % 0.84 % Interest-earning assets 5 2,451,781 2,454,395 (2,614) 0 % 96,023 70,609 25,414 36 % 5.30 % 3.88 % 1.42 % Nonearning assets 192,430 167,835 24,595 15 % Total $2,644,211 $2,622,230 $21,981 1 % Interest-bearing demand $771,504 $678,043 $93,461 14 % $8,490 $844 $7,646 906 % 1.47 % 0.17 % 1.30 % Savings deposits 284,841 349,301 (64,460) (18) % 989 376 613 163 % 0.46 % 0.14 % 0.32 % Money market deposits 256,937 319,379 (62,442) (20) % 2,361 363 1,998 550 % 1.23 % 0.15 % 1.08 % Time deposits 264,026 172,274 91,752 53 % 5,995 655 5,340 815 % 3.04 % 0.51 % 2.53 % Total interest-bearing deposits 1,577,308 1,518,997 58,311 4 % 17,835 2,238 15,597 697 % 1.51 % 0.20 % 1.31 % Borrowings 52,075 24,674 27,401 111 % 1,664 544 1,120 206 % 4.23 % 2.91 % 1.32 % Total interest-bearing liabilities 1,629,383 1,543,671 85,712 6 % 19,499 2,782 16,717 601 % 1.60 % 0.24 % 1.36 % Non-interest bearing demand deposits 746,251 816,741 (70,490) (9) % Other liabilities 42,596 34,451 8,145 24 % Equity 225,981 227,367 (1,386) (1) % Total $2,644,211 $2,622,230 $21,981 1 % Net interest income $76,524 $67,827 $8,697 13 % Net interest margin 4.17 % 3.69 % 0.48 % Average loans to average interest-earning assets 65.60 % 56.95 % Average loans to average total deposits 69.22 % 59.84 % Average non-interest deposits to average total deposits 32.12 % 34.97 % Average interest-earning assets to average interest-bearing liabilities 150.47 % 159.00 % 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 $3.2 million and $7.3 million in the first nine 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 $7.4 million and $9.2 million in the first nine 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 nine-month periods ending September 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 nine-month periods ending September 30, 2023 and 2022. (In Thousands) Nine Months Ended September 30, 2023 vs. 2022 Increase (decrease) due to Volume Rate Total Interest Income: Short-term investments ($3,888) $3,882 ($6) Taxable long-term investments 2,165 4,356 6,521 Loans held for sale (531) 686 155 Loans 7,514 11,230 18,744 Total interest income $5,260 $20,154 $25,414 Interest Expense: Interest-bearing demand $100 $7,546 $7,646 Savings deposits (81) 694 613 Money market deposits (85) 2,083 1,998 Time deposits 141 5,199 5,340 Interest-bearing deposits 75 15,522 15,597 Borrowings 1,069 51 1,120 Total interest expense $1,144 $15,573 $16,717 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 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 September 30, Nine Months Ended September 30, (In Thousands) 2023 2022 2023 2022 Credit loss expense on loans held for investment $750 ($903) $2,519 ($797) Credit loss expense on unfunded commitments 440 550 438 757 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 $1,190 ($353) $2,957 ($40) The increase in the ACL for the three and nine-month periods ending September 30, 2023 as compared to the same periods in 2022 is primarily the result of increased loan and unfunded commitment 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. 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 September 30, 2023 decreased $670,000, or 8%, to $8.0 million as compared to $8.7 million for the same period in 2022, primarily due to a $1.3 million decrease in mortgage banking income in the third quarter of 2023 compared to the same quarter a year ago, which was only partially offset by a $619,000 increase in purchased receivable income. The decrease in mortgage banking income in the three-month period ended September 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 nine-month period ended September 30, 2023 decreased $7.4 million, or 27%, to $19.9 million as compared to $27.3 million for the same period in 2022, primarily due to a $8.3 million decrease in mortgage banking income in the first nine months of 2023 compared to the same period a year ago, which was only partially offset by a $1.6 million increase in purchased receivable income and a $754,000 increase in the fair market value of marketable securities. The decrease in mortgage banking income in the nine-month period ended September 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 nine-month period ended September 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 third quarter of 2023 increased $610,000, or 3%, to $22.9 million as compared to $22.3 million for the same period in 2022 is primarily due to increased salaries and other personnel expense which was only partially offset by a decrease in OREO expense due to subsequent proceeds received in the third quarter of 2023 that are related to a government guarantee on an OREO property sold in December 2022. Other operating expense for the first nine months of 2023 increased $3.6 million, or 5%, to $70.2 million as compared to $66.6 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 third quarter and first nine 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 third quarter of 2023, Northrim recorded $1.9 million in state and federal income tax expense, for an effective tax rate of 18.43% compared to $2.9 million and 22.41% for the same period in 2022. In the first nine months of 2023, Northrim recorded $4.5 million in state and federal income tax expense, for an effective tax rate of 19.29% compared to $6.4 million and 22.41% 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 September 30, 2023 decreased 3% to $699.5 million from $724.5 million at December 31, 2022 mostly due to maturities and calls of available for sale securities during the first nine months of 2023. The table below details portfolio investment balances by portfolio investment type: September 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 $578,635 82.7 % $595,161 82.2 % Municipal securities 809 0.1 % 795 0.1 % Corporate bonds 50,228 7.2 % 60,394 8.3 % Collateralized loan obligations 59,228 8.5 % 57,429 7.9 % Preferred stock 10,615 1.5 % 10,740 1.5 % Total portfolio investments $699,515 $724,519 The average estimated duration of the investment portfolio at September 30, 2023, was approximately 2.8 years. As of September 30, 2023, $87.7 million available for sale securities are scheduled to mature in the next six months, $47.4 million are scheduled to mature in six months to one year, and $173.9 million are scheduled to mature in the following year, a total of $308.9 million or 12% of earning assets at September 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: September 30, 2023 December 31, 2022 Dollar Amount Percent of Total Dollar Amount Percent of Total (In Thousands) Commercial & industrial loans $415,898 24.2 % $358,128 23.8 % Commercial real estate: Owner occupied properties 357,455 20.8 % 349,973 23.3 % Non-owner occupied and multifamily properties 506,256 29.3 % 482,270 32.2 % Residential real estate: 1-4 family residential properties secured by first liens 180,849 10.5 % 73,381 4.9 % 1-4 family residential properties secured by junior liens and revolving secured by 1-4 family first liens 27,535 1.6 % 20,259 1.3 % 1-4 family residential construction loans 32,185 1.9 % 44,000 2.9 % Other construction, land development and raw land loans 119,716 7.0 % 99,182 6.6 % Obligations of states and political subdivisions in the US 30,463 1.8 % 32,539 2.2 % Agricultural production, including commercial fishing 40,923 2.4 % 34,099 2.3 % Consumer loans 5,986 0.3 % 4,335 0.3 % Other loans 2,825 0.2 % 3,619 0.2 % Total loans $1,720,091 $1,501,785 Loans increased by $218.3 million, or 15%, to $1.720 billion at September 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 $100.3 million, or approximately 6% of loans as of September 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 $34.9 million and $51.8 million at September 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 $920,000 as of September 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) September 30, 2023 December 31, 2022 Commercial & industrial loans $81,713 $66,864 Commercial real estate: Owner occupied properties 11,661 9,108 Non-owner occupied and multifamily properties 5,582 6,013 Other loans 1,379 1,431 Total $100,335 $83,416 The Company monitors other concentrations within the loan portfolio depending on trends in the current and future estimated economic conditions. At September 30, 2023, the Company had $124.3 million, or 7% of portfolio loans, in the Healthcare sector, $103.0 million, or 6% of portfolio loans, in the Tourism sector, $79.6 million, or 5% of portfolio loans, in the Accommodations sector, $78.3 million, or 5% of portfolio loans, in the Fishing sector, $71.8 million, or 4% of portfolio loans, in the Retail sector, $62.5 million, or 4% of portfolio loans, in the Aviation (non-tourism) sector, and $48.4 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 September 30, 2023: (In Thousands) Tourism Aviation (non-tourism) Healthcare Retail Fishing Restaurant Accommodations Total ACL $588 $560 $1,015 $596 $503 $365 $653 $4,280 The following table sets forth information regarding changes in the ACL for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, (In Thousands) 2023 2022 2023 2022 Balance at beginning of period $15,645 $11,537 $13,838 $11,739 Commercial & industrial loans (91) (45) (140) (506) Consumer loans — (3) (14) (3) Total charge-offs (91) (48) (154) (509) Recoveries: Commercial & industrial loans 181 1,325 267 1,441 Residential real estate: 1-4 family residential properties secured by junior liens and revolving secured by 1-4 family first liens 5 9 17 30 Agricultural production, including commercial fishing — — — 15 Consumer loans 1 2 4 3 Total recoveries 187 1,396 288 1,549 Net, recoveries 96 1,348 134 1,040 Provision (benefit) for credit losses 750 (903) 2,519 (797) Balance at end of period $16,491 $11,982 $16,491 $11,982 The following table sets forth information regarding changes in the ACL for unfunded commitments for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, (In Thousands) 2023 2022 2023 2022 Balance at beginning of period $1,968 $1,303 $1,970 $1,096 Provision for credit losses 440 550 438 757 Balance at end of period $2,408 $1,853 $2,408 $1,853 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 increased $40.7 million, or 2%, to $2.428 billion as of September 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: September 30, 2023 December 31, 2022 (In thousands) Balance % of total Balance % of total Demand deposits $764,647 31 % $797,434 34 % Interest-bearing demand 875,814 36 % 767,686 32 % Savings deposits 265,799 11 % 320,917 13 % Money market deposits 230,814 10 % 308,317 13 % Time deposits 290,856 12 % 192,857 8 % Total deposits $2,427,930 $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 September 30, 2023 and 92% of total deposits at December 31, 2022. The only deposit category with stated maturity dates is certificates of deposit. At September 30, 2023, the Company had $290.9 million in certificates of deposit as compared to certificates of deposit of $192.9 million at December 31, 2022. At September 30, 2023, $182.0 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 September 30, 2023 and December 31, 2022, was $121.1 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 September 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 $30,550 25 % Over 3 through 6 months 16,919 14 % Over 6 through 12 months 22,309 18 % Over 12 months 51,281 43 % Total $121,059 100 % At September 30, 2023, 71% of total deposits were held in business accounts and 29% of deposit balances were held in consumer accounts. Northrim had approximately 33,000 deposit customers with an average balance of $73,000 as of September 30, 2023. Northrim had 16 customers with balances over $10 million as of September 30, 2023 which accounted for $370.6 million, or 15%, of total deposits. Uninsured deposits totaled $999.5 million or 41% of total deposits as of September 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 nine months of 2023, Northrim has taken a proactive, targeted approach to increase deposit rates. There was no unusual deposit activity during the first nine 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 September 30, 2023, our maximum borrowing line from the FHLB was $1.248 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 September 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 September 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 $60.0 million of securities as collateral to secure the Company's ability to take advances through the discount window on September 30, 2023. There were no discount window advances outstanding at either September 30, 2023 or December 31, 2022. The Federal Reserve Bank is holding $20.0 million of securities as collateral to secure the Company's ability to take advances through the Federal Reserve Bank's Bank Term Funding Program (“BTFP”) on September 30, 2023. There were no BTFP advances outstanding at September 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 $970.5 million at September 30, 2023 and $930.1 million at December 31, 2022. At September 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 September 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 September 30, 2023, the Company has 10.0 million authorized shares of common stock, of which 5.5 million are issued and outstanding, leaving 4.5 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 $111.2 million, or 4% of total assets at September 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. The Company had other comprehensive income, net of tax, of $1.4 million for the nine-month period ending September 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 $26.5 million as of September 30, 2023. Accumulated unrealized losses, net of income taxes on held to maturity securities, which are not recorded in shareholders' equity, are $3.2 million as of September 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 September 30, 2023, the weighted average maturity of available for sale securities is 2.8 years compared to 3.3 years at December 31, 2022 and 4.1 years at December 31, 2021. At September 30, 2023, $135.1 million available for sale securities mature within one year, $173.9 million mature within one to two years, and $186.8 million mature within two to three years. Our total unfunded commitments to fund loans and letters of credit at September 30, 2023 were $460.3 million. We do not expect that all of these loans are likely to be fully drawn upon at any one time. At September 30, 2023, certificates of deposit totaling $182.0 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 September 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 September 30, 2023, are not material to the Company's liquidity position as of September 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 September 30, 2023, our liquid assets, which include investments and loans maturing within a year, were $517.8 million. Our funds available for borrowing under our existing lines of credit based on loans currently pledged and investments available to be pledged as collateral were $717.2 million. 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 $11.1 million for the first nine 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 $210.7 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 provided by financing activities in the same period was $73.7 million, primarily due to increases in deposits and borrowings, which were only partially offset by cash dividends paid to shareholder and repurchases of 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 Company repurchased 152,887 shares of its common stock under the Company's previously announced repurchase programs in the first nine months of 2023. At September 30, 2023, there are 132,113 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 September 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 September 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 September 30, 2023 Total risk-based capital 8.00% 10.00% 12.58% 10.97% Tier 1 risk-based capital 6.00% 8.00% 11.67% 10.06% Common equity tier 1 capital 4.50% 6.50% 11.21% 10.07% Leverage ratio 4.00% 5.00% 9.02% 7.76% 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 September 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