NORTHRIM BANCORP, INC.

(NRIM)
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NORTHRIM BANCORP : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-K)

03/06/2020 | 03:19pm EDT
This discussion highlights key information as determined by management but may
not contain all of the information that is important to you. For a more complete
understanding, the following should be read in conjunction with the Company's
audited consolidated financial statements and the notes thereto as of December
31, 2019, 2018 and 2017 included in Item 8 of this report. Discussions of 2017
items and year-to-year comparisons between 2018 and 2017 that are not included
in this Form 10-K can be found in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in Part II, Item 7 of our Annual
Report on Form 10-K for fiscal year ended December 31, 2018.
This annual report contains forward-looking statements that involve risks and
uncertainties. Our actual results may differ materially from those indicated in
forward-looking statements. See "Cautionary Note Regarding Forward-Looking
Statements."

Executive Overview
Net income attributable to the Company increased 3% to $20.7 million or $3.04
per diluted share for the year ended December 31, 2019, from $20.0 million, or
$2.86 per diluted share, for the year ended December 31, 2018. Significant items
contributing to the increase in 2019 compared to 2018 were:

• an increase in mortgage banking income due to increased mortgage production;


•      an increase in net interest income resulting from higher average net
       interest-earning asset balances and higher average rates;

• an increase in the gain on marketable equity securities from changes in

       fair value; and


•      a benefit in the provision for loan losses primarily resulting from
       improvements in credit quality and recoveries.


Highlights for the year ended December 31, 2019 are as follows: • Total revenues, which include net interest income plus other operating

income, increased 9% to $101.8 million in 2019 from $93.4 million in 2018.

This increase mainly reflects increases in net interest income, mortgage

banking income, changes in the fair value of marketable equity securities,

       and higher interest rate swap income. These increases were partially
       offset by a decrease in commercial servicing revenue.


•      The net interest margin increased to 4.65% in 2019 from 4.55% in 2018
       mostly due to an increase in average loans to $1.01 billion in 2019
       compared to $971.5 million in 2018, as well as increases in average
       interest rates.


•      The provision for loan losses decreased in 2019 to a benefit of $1.2
       million from a benefit of $500,000 in 2018. Our nonperforming loans, net
       of government guarantees, decreased to $14.0 million at the end of 2019
       compared to $14.7 million at the end of 2018, while total adversely
       classified loans, net of government guarantees at December 31, 2019
       decreased to $22.3 million from $27.2 million at December 31, 2018. The

allowance for loan losses ("Allowance") totaled 1.83% of total portfolio

loans at December 31, 2019, compared to 1.98% at December 31, 2018. The

Allowance compared to nonperforming loans, net of government guarantees,

was 137% at December 31, 2019 compared to 133% at the end of 2018.

• Return on average assets was 1.33% in 2019 compared to 1.34% in 2018.

• The Company continued to maintain strong capital ratios with Tier 1

Capital to Risk Adjusted Assets of 14.38% at December 31, 2019 as compared

to 15.47% at December 31, 2018.

• The aggregate cash dividends paid by the Company in 2019 rose 21% to $8.5

       million from $7.1 million paid in 2018.


•      The Company repurchased 347,676 shares of its common stock in 2019 at an
       average price of $36.15 per share.



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Critical Accounting Policies
The SEC defines "critical accounting policies" as those that require application
of management's most difficult, subjective or complex judgments, often as a
result of the need to make estimates about the effect of matters that are
inherently uncertain and may change in future periods. Our significant
accounting policies are described in Note 1 in the Notes to Consolidated
Financial Statements in Item 8 of this report. Not all of these significant
accounting policies require management to make difficult, subjective or complex
judgments or estimates. Management believes that the following accounting
policies would be considered critical under the SEC's definition.
Allowance for loan losses:  The Company maintains an Allowance to reflect
inherent losses in its loan portfolio as of the balance sheet date. The Company
performs regular credit reviews of the loan portfolio to determine the credit
quality and adherence to underwriting standards. When loans are originated, they
are assigned a risk rating that is reassessed periodically during the term of
the loan through the credit review process. The Company's risk rating
methodology assigns risk ratings ranging from 1 to 10, where a higher rating
represents higher risk. These risk ratings are then consolidated into five
classes, which include pass, special mention, substandard, doubtful and loss.
These classes are a primary factor in determining an appropriate amount for the
allowance for loan losses. Each class is assessed an inherent credit loss factor
that determines an amount of allowance for loan losses provided for that group
of loans. This allowance is then adjusted for qualitative factors, by segment
and class. Qualitative factors are based on management's assessment of current
trends that may cause losses inherent in the current loan portfolio to differ
significantly from historical losses. Some factors that management considers in
determining the qualitative adjustment to the general reserve include loan
quality trends in our own portfolio, the degree of concentrations of large
borrowers in our loan portfolio, national and local economic trends, business
conditions, underwriting policies and standards, trends in local real estate
markets, effects of various political activities, peer group data, and internal
factors such as underwriting policies and expertise of the Company's employees.
Regular credit reviews of the portfolio also identify loans that are considered
potentially impaired. A loan is considered impaired when based on current
information and events, we determine that we will probably not be able to
collect all amounts due according to the loan contract, including scheduled
interest payments. When we identify a loan as impaired, we measure the
impairment using discounted cash flows, except when the sole remaining source of
the repayment for the loan is the liquidation of the collateral. In these cases,
we use the current fair value of the collateral, less selling costs, instead of
discounted cash flows. The analysis of collateral dependent loans includes
appraisals on loans secured by real property, management's assessment of the
current market, recent payment history and an evaluation of other sources of
repayment. The Company obtains appraisals on real and personal property that
secure its loans during the loan origination process in accordance with
regulatory guidance and its loan policy. The Company obtains updated appraisals
on loans secured by real or personal property based upon its assessment of
changes in the current market or particular projects or properties, information
from other current appraisals and other sources of information. The Company uses
the information provided in these updated appraisals along with its evaluation
of all other information available on a particular property as it assesses the
collateral coverage on its performing and nonperforming loans and the impact
that may have on the adequacy of its Allowance.
If we determine that the value of the impaired loan is less than the recorded
investment in the loan, we either recognize an impairment reserve as a specific
component to be provided for in the Allowance or charge-off the impaired balance
on collateral dependent loans if it is determined that such amount represents a
confirmed loss. The combination of the risk rating-based allowance component and
the impairment reserve allowance component lead to an allocated allowance for
loan losses.
Finally, the Company assesses the overall adequacy of the Allowance based on
several factors including the level of the Allowance as compared to total loans
and nonperforming loans in light of current economic conditions. This portion of
the Allowance is deemed "unallocated" because it is not allocated to any segment
or class of the loan portfolio. This portion of the Allowance provides for
coverage of credit losses inherent in the loan portfolio but not captured in the
credit loss factors that are utilized in the risk rating-based component or in
the specific impairment component of the Allowance and acknowledges the inherent
imprecision of all loss prediction models.
The unallocated portion of the Allowance is based upon management's evaluation
of various factors that are not directly measured in the determination of the
allocated portions of the Allowance. Such factors include uncertainties in
identifying triggering events that directly correlate to subsequent loss rates,
uncertainties in economic conditions, risk factors that have not yet manifested
themselves in loss allocation factors, and historical loss experience data that
may not precisely correspond to the current portfolio. In addition, the
unallocated reserve may fluctuate based upon the direction of various risk
indicators. Examples of such factors include the risk as to current and
prospective economic conditions, the level and trend of charge offs or
recoveries, and the risk of heightened imprecision or inconsistency of
appraisals used in estimating real estate values. Although this allocation
process may not accurately predict credit losses by loan type or in aggregate,
the total allowance for credit losses is available to absorb losses that may
arise from any loan type or category. Due to the subjectivity involved in the
determination of the unallocated portion of the Allowance, the relationship of
the unallocated component to the total Allowance may fluctuate from period to
period.

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Based on our methodology and its components, management believes the resulting
Allowance is adequate and appropriate for the risk identified in the Company's
loan portfolio. Given current processes employed by the Company, management
believes the segments, classes, and estimated loss rates currently assigned are
appropriate. It is possible that others, given the same information, may at any
point in time reach different reasonable conclusions that could be material to
the Company's financial statements. In addition, current loan classes and fair
value estimates of collateral are subject to change as we continue to review
loans within our portfolio and as our borrowers are impacted by economic trends
within their market areas. Although we have established an Allowance that we
consider adequate, there can be no assurance that the established Allowance will
be sufficient to offset losses on loans in the future. In addition, a
substantial percentage of our loan portfolio is secured by real estate; as a
result, a significant decline in real estate market values may require an
increase in the Allowance.
Valuation of goodwill and other intangibles: Goodwill and other intangible
assets with indefinite lives are not amortized but instead are periodically
tested for impairment. Management performs an impairment analysis for the
intangible assets with indefinite lives on an annual basis as of December 31.
Additionally, goodwill and other intangible assets with indefinite lives are
evaluated on an interim basis when events or circumstances indicate impairment
potentially exists. The impairment analysis requires management to make
subjective judgments. Events and factors that may significantly affect the
estimates include, among others, competitive forces, customer behaviors and
attrition, changes in revenue growth trends, cost structures, technology,
changes in discount rates and specific industry and market conditions. There can
be no assurance that changes in circumstances, estimates or assumptions may
result in additional impairment of all, or some portion of, goodwill or other
intangible assets. The Company performed its annual goodwill impairment testing
at December 31, 2019 and 2018 in accordance with the policy described in Note 1
to the financial statements included with this report. At December 31, 2019, the
Company performed its annual impairment test by performing a qualitative
assessment. Significant positive inputs to the qualitative assessment included
the Company's increasing net income as compared to historical trends, the
Company's stable budget-to-actual results of operations; results of regulatory
examinations; peer comparisons of the Company's net interest margin; trends in
the Company's cash flows; improvements in the Alaskan economy in 2019; increases
in the volume of mortgage originations in Alaska; and increases in the Company's
stock price. Significant negative inputs to the qualitative assessment included
the continued lower level of oil prices and the muted pace of growth in the
Alaska economy. We believe that the positive inputs to the qualitative
assessment noted above outweigh the negative inputs for both of the Company's
operating segments, and we therefore concluded that it is more likely than not
that the fair value of the Company exceeds its carrying value at December 31,
2019 and that no potential impairment existed at that time.
Valuation of OREO: OREO represents properties acquired through foreclosure or
its equivalent. Prior to foreclosure, the carrying value is adjusted to the fair
value, less cost to sell, of the real estate to be acquired by an adjustment to
the allowance for loan loss. The amount by which the fair value less cost to
sell is greater than the carrying amount of the loan plus amounts previously
charged off is recognized in earnings. Any subsequent reduction in the carrying
value is charged against earnings. Management's evaluation of fair value is
based on appraisals or discounted cash flows of anticipated sales. The amounts
ultimately recovered from the sale of OREO may differ from the carrying value of
the assets because of market factors beyond the Company's control or due to
changes in the Company's strategies for recovering the investment.
Servicing rights: The Company measures mortgage servicing rights ("MSRs") and
commercial servicing rights ("CSRs") at fair value on a recurring basis with
changes in fair value going through earnings in the period in which the change
occurs. Changes in the fair value of MSRs are recorded in mortgage banking
income, and changes in the fair value of CSRs are recorded in commercial
servicing revenue. Fair value adjustments encompass market-driven valuation
changes and the decrease in value that occurs from the passage of time, which
are separately reported. Retained servicing rights are measured at fair value as
of the date of sale. Initial and subsequent fair value measurements are
determined using a discounted cash flow model. In order to determine the fair
value of servicing rights, the present value of expected net future cash flows
is estimated. Assumptions used include market discount rates, anticipated
prepayment speeds, escrow calculations, delinquency rates and ancillary fee
income net of servicing costs. The model assumptions for MSRs are also compared
to publicly filed information from several large MSR holders, as available.
Fair Value:  A hierarchical disclosure framework associated with the level of
pricing observability is utilized in measuring financial instruments at fair
value. The degree of judgment utilized in measuring the fair value of financial
instruments generally correlates to the level of pricing observability.
Financial instruments with readily available active quoted prices or for which
fair value can be measured from actively quoted prices generally will have a
higher degree of pricing observability and a lesser degree of judgment utilized
in measuring fair value. Conversely, financial instruments rarely traded or not
quoted will generally have little or no pricing observability and a higher
degree of judgment utilized in measuring fair value. Pricing observability is
impacted by a number of factors, including the type of financial instrument,
whether the financial instrument is new to the market and not yet established
and the characteristics specific to the transaction.



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Impact of accounting pronouncements to be implemented in future periods
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses
("ASU 2016-13"). ASU 2016-13 is intended to improve financial reporting by
requiring timelier recording of credit losses on loans and other financial
instruments held by financial institutions and other organizations. Financial
institutions and other organizations will now use forward-looking information to
better inform their credit loss estimates, but will continue to use judgment to
determine which loss estimation method is appropriate for their circumstances.
ASU 2016-13 is effective for the Company for fiscal years, and interim periods
within those fiscal years, beginning on or after December 15, 2019, and must be
applied prospectively. However, on October 16, 2019 the FASB voted to delay ASU
2016-13 for Smaller Reporting Companies. The Company has elected Small Reporting
Company status, which changes the effective date for ASU 2016-13 for the Company
to fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2022.
Our implementation process includes loss forecasting model development,
evaluation of technical accounting topics, updates to our allowance
documentation, reporting processes and related internal controls, and overall
operational readiness for our adoption of the ASU 2016-13, which will continue
until adoption, including parallel runs for CECL alongside our current allowance
process.
We are in the process of developing, validating, and implementing models used to
estimate credit losses under CECL. We have completed substantially all of our
loss forecasting models, and we expect to complete the validation process for
our loan models during 2020. Our current planned approach for estimating
expected life-time credit losses for loans includes the following key
components:
•      An initial loss forecast period of one year for all loan portfolio

segments and classes of financing receivables and off-balance-sheet credit

exposures. This period reflects management's expectation of losses based

on forward-looking economic scenarios over that time.

• A historical loss forecast period covering the remaining contractual life,

adjusted for prepayments, by segment and class of financing receivables

       based on the change in key historical economic variables during
       representative historical expansionary and recessionary periods.

• A reversion period of up to two years connecting the initial loss forecast

       to the historical loss forecast based on economic conditions at the
       measurement date.

• Utilization of discounted cash flow ("DCF") methods to measure credit

impairment for loans modified in a troubled debt restructuring, unless

they are collateral dependent and measured at the fair value of

collateral. The DCF methods would obtain estimated life-time credit losses

using the conceptual components described above.



As a Smaller Reporting Company, the Company is not required to adopt CECL before
January 1, 2023, and we have elected not to early adopt as of January 1, 2020.
However, we have the option to early adopt CECL as of either January 1, 2021, or
January 1, 2022. Based on our loan portfolio composition at December 31, 2019,
and the Company's current economic forecast, had we elected to early adopt CECL
as of January 1, 2020, we estimate the impact of adoption to be an overall
decrease in our allowance for credit losses ("ACL") for loans between $7.5
million and $9 million. The reduction reflects an expected decrease for all loan
segments given their short contractual maturities. The Company does not hold a
material amount of residential mortgage loans with long or indeterminate
maturities as of December 31, 2019. In most instances the Company believes that
the ACL for these types of loans would lead to an increase in the ACL. We will
continue to evaluate and refine the results of our loss estimates until adoption
of ASU 2016-13.
The ultimate effect of CECL on our ACL will depend on the size and composition
of our loan portfolio, the loan portfolio's credit quality and economic
conditions at the time of adoption, as well as any refinements to our models,
methodology and other key assumptions. At adoption, we will have a
cumulative-effect adjustment to retained earnings for our change in the ACL. We
currently estimate an overall decrease in our ACL, which will result in an
increase to our retained earnings and regulatory capital amounts and ratios.



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RESULTS OF OPERATIONS
Income Statement
Net Income
Our results of operations are dependent to a large degree on our net interest
income. We also generate other income primarily through mortgage banking income,
purchased receivables products, sales of employee benefit plans (through August
of 2017, when we sold our interest in the assets of NBG), service charges and
fees, and bankcard fees. Our operating expenses consist in large part of
salaries and other personnel costs, occupancy, data processing, marketing, and
professional services expenses. Interest income and cost of funds, or interest
expense, are affected significantly by general economic conditions, particularly
changes in market interest rates, by government policies and the actions of
regulatory authorities, and by competition in our markets.
We earned net income attributable to the Company of $20.7 million in 2019,
compared to net income of $20.0 million in 2018. During these periods, net
income per diluted share was $3.04 and $2.86, respectively. The increase in net
income in 2019 compared to 2018 was primarily due to increases in other
operating income, net interest income, and the benefit for loan losses.
Net Interest Income / Net Interest Margin
Net interest income is the difference between interest income from loan and
investment securities portfolios and interest expense on customer deposits and
borrowings. Changes in net interest income result from changes in volume and
spread, which in turn affect our margin. For this purpose, volume refers to the
average dollar level of interest-earning assets and interest-bearing
liabilities, spread refers to the difference between the average yield on
interest-earning assets and the average cost of interest-bearing liabilities,
and margin refers to net interest income divided by average interest-earning
assets. Changes in net interest income are influenced by yields and the level
and relative mix of interest-earning assets and interest-bearing liabilities.
Net interest income in 2019 was $64.4 million, compared to $61.2 million in
2018. The increase in 2019 as compared to 2018 was the result of higher net
average interest-earning asset balances as well as higher average interest
rates. During 2019 and 2018, net interest margins were 4.65% and 4.55%,
respectively. The increase in net interest margin in 2019 as compared to 2018 is
the result of increases in the spread between the average yield on
interest-earning assets and the average cost of interest-bearing liabilities.

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The following table sets forth for the periods indicated information with regard
to average balances of assets and liabilities, as well as the total dollar
amounts of interest income from interest-earning assets and interest expense on
interest-bearing liabilities. Average yields or costs, net interest income, and
net interest margin are also presented:
Years ended December 31,                      2019                                     2018                                     2017
                                Average      Interest     Average        Average      Interest     Average        Average      Interest     Average
                              outstanding    income /     Yield /     

outstanding income / Yield / outstanding income / Yield / (In Thousands)

                  balance       expense      Cost          

balance expense Cost balance expense Cost Loans (1),(2)

                  $1,010,098     $59,919     5.93 %          

$971,548 $55,526 5.72 % $981,001 $53,301 5.43 % Loans held for sale

                56,344       2,231     3.96 %            46,089       2,016     4.37 %            44,047       1,740     3.95 %

Long-term Investments(3) 273,711 7,011 2.56 % 286,426 5,829 2.04 %

           305,211       4,634     1.52 %
Short-term investments(4)          46,404         922     1.99 %            42,386         806     1.90 %            36,944         433     1.17 %
Total interest-earning
assets                         $1,386,557     $70,083     5.05 %        $1,346,449     $64,177     4.77 %        $1,367,203     $60,108     4.40 %
Noninterest-earning assets        169,150                                  146,936                                  143,849
Total                          $1,555,707                               $1,493,385                               $1,511,052

Interest-bearing deposits $850,202 $4,961 0.58 % $809,808 $2,307 0.28 % $829,918 $1,707 0.21 % Borrowings

                         33,730         680     2.02 %            47,570         662     1.37 %            50,523         723     1.43 %

Total

interest-bearing liabilities     $883,932      $5,641     0.64 %          $857,378      $2,969     0.35 %          $880,441      $2,430     0.28 %
Noninterest-bearing demand
deposits                          426,205                                  417,464                                  418,415
Other liabilities                  36,968                                   17,521                                   19,067
Equity                            208,602                                  201,022                                  193,129
Total                          $1,555,707                               $1,493,385                               $1,511,052
Net interest income                           $64,442                                  $61,208                                  $57,678
Net interest margin                                       4.65 %                                   4.55 %                                   4.22 %
Average portfolio loans to
average-earnings assets             72.85 %                                  72.16 %                                  71.75 %
Average portfolio loans to
average total deposits              79.14 %                                  79.16 %                                  78.58 %
Average non-interest
deposits to average total
deposits                            33.39 %                                  34.02 %                                  33.52 %
Average interest-earning
assets to average
interest-bearing liabilities       156.86 %                                 157.04 %                                 155.29 %


1Interest income includes loan fees. Loan fees recognized during the period and
included in the yield calculation totaled $3.3 million, $3.0 million and $3.2
million for 2019, 2018 and 2017, respectively.

2Nonaccrual loans are included with a zero effective yield. Average nonaccrual
loans included in the computation of the average loans were $16.9 million, $17.5
million, and $18.1 million in 2019, 2018 and 2017, respectively.

3Consists of investment securities available for sale, investment securities
held to maturity, marketable equity securities, and investment in Federal Home
Loan Bank stock.
4Consists of interest bearing deposits in other banks and domestic CDs.

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The following table sets forth the changes in consolidated net interest income
attributable to changes in volume and to changes in interest rates. Changes
attributable to the combined effect of volume and interest rate have been
allocated proportionately to the changes due to volume and the changes due to
interest rate:
                                      2019 compared to 2018                      2018 compared to 2017
                                    Increase (decrease) due to                Increase (decrease) due to
(In Thousands)                  Volume          Rate          Total       Volume          Rate          Total
Interest Income:
Loans                            $2,246           $2,147      $4,393        ($508 )         $2,733      $2,225
Loans held for sale                 374             (159 )       215           83              193         276
Long-term investments              (245 )          1,427       1,182         (264 )          1,459       1,195
Short term investments               79               37         116           71              302         373
Total interest income            $2,454           $3,452      $5,906        ($618 )         $4,687      $4,069
Interest Expense:
Interest-bearing deposits          $120           $2,534      $2,654         ($40 )           $640        $600
Borrowings                          (29 )             47          18          (35 )            (26 )       (61 )
Total interest expense              $91           $2,581      $2,672         ($75 )           $614        $539




Provision for Loan Losses
We recorded a benefit for loan losses in 2019 of $1.2 million, compared to a
benefit for loan losses of $500,000 in 2018. The loan loss provision decreased
in 2019 compared to 2018 primarily due to an improvement in credit quality as
nonperforming loans and adversely classified loans decreased, the Alaskan
economy improved, and the Company recorded net recoveries for the year. See the
"Allowance for Loan Losses" section under "Financial Condition" and Note 6 of
the Notes to Consolidated Financial Statements included in Item 8 of this report
for further discussion of these decreases and changes in the Company's
Allowance.
Other Operating Income
The following table details the major components of other operating income for
the years ended December 31:
(In Thousands)                  2019      $ Change  % Change     2018      $ Change    % Change     2017
Other Operating Income
Mortgage banking income        $24,201     $3,357       16  %   $20,844     ($2,443 )     (10 )%   $23,287
Purchased receivable income      3,271         16        -  %     3,255         280         9  %     2,975
Bankcard fees                    2,976        165        6  %     2,811         214         8  %     2,597
Service charges on deposit
accounts                         1,557         49        3  %     1,508        (106 )      (7 )%     1,614
Interest rate swap income          964        880    1,048  %        84          58       223  %        26
Gain (loss) on marketable
equity securities                  911      1,536      246  %      (625 )      (625 )    (100 )%         -
Commercial servicing revenue       624       (798 )    (56 )%     1,422       1,050       282  %       372
Rental income                      497       (195 )    (28 )%       692         160        30  %       532
Other loan fees                    269         77       40  %       192          (2 )      (1 )%       194
Gain on loans acquired - APB        30       (227 )    (88 )%       257          68        36  %       189
Gain (loss) on sale of
securities                          23         23      100  %         -         (11 )    (100 )%        11
Gain on sale of Northrim
Benefits Group                       -          -        -  %         -      (4,445 )    (100 )%     4,445
Employee benefit plan income         -          -        -  %         -      (2,506 )    (100 )%     2,506
Other income                     2,023        296       17  %     1,727     

1 - % 1,726

   Total other operating
income                         $37,346     $5,179       16  %   $32,167     ($8,307 )     (21 )%   $40,474




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2019 Compared to 2018
The most significant changes in other operating income in 2019 were increases in
mortgage banking income and gains on marketable equity securities, as well as
higher interest rate swap income. Mortgage banking income consists of gross
income from the origination and sale of mortgages as well as mortgage loan
servicing fees and is the largest component of other operating income at 65% of
total other operating income in 2019. Mortgage banking income increased in 2019
compared to 2018 mainly due to an increase in mortgage loans originated and sold
as this volume increased to $684 million in 2019 from $528 million in 2018. The
overall increase in mortgage originations is primarily the result of the
decrease in interest rates during the year. The Company recognized $964,000 in
interest rate swap income in 2019 on the execution of five interest rate swaps
which totaled $40.6 million in notional value compared to the execution of two
interest rate swaps with a total notional value of $2.8 million in 2018. These
interest rate swaps are related to the Company's commercial lending operations.
Lastly, commercial servicing revenue decreased in 2019 because in 2018 the
Company recorded for the first time in other operating income the fair value of
its commercial loan servicing portfolio of $1.0 million. In 2019, only changes
in the fair value of the Company's commercial loan servicing portfolio are
reflected in other operating income, which comprised a portion of the decrease
in other income in 2019 as compared to 2018.
Other Operating Expense
The following table details the major components of other operating expense for
the years ended December 31:
(In Thousands)                     2019      $ Change  % Change     2018      $ Change   % Change     2017
Other Operating Expense
Salaries and other personnel
expense                           $51,317     $6,667       15  %   $44,650        ($71 )      -  %   $44,721
Data processing expense             7,128      1,093       18  %     6,035         486        9  %     5,549
Occupancy expense                   6,607        471        8  %     6,136        (616 )     (9 )%     6,752
Professional and outside
services                            2,531         78        3  %     2,453          88        4  %     2,365
Marketing expense                   2,373         55        2  %     2,318        (248 )    (10 )%     2,566
Insurance expense                     557       (305 )    (35 )%       862        (299 )    (26 )%     1,161
Compensation expense - RML
acquisition payments                  468        468      100  %         -        (130 )   (100 )%       130
Intangible asset amortization          60        (10 )    (14 )%        70         (30 )    (30 )%       100
Loss on sale of premise and
equipment                               -         (2 )   (100 )%         2          (1 )    (33 )%         3
OREO (income) expense, net rental income and gains on sale:
  OREO operating expense              693       (109 )    (14 )%       802         382       91  %       420
  Impairment on OREO                    -          -        -  %         -        (904 )   (100 )%       904
  Rental income on OREO              (506 )       35        6  %      (541 )      (425 )   (366 )%      (116 )
  Gains on sale of OREO              (380 )     (377 )     NM           (3 )       368       99  %      (371 )
     Subtotal                        (193 )     (451 )   (175 )%       258        (579 )    (69 )%       837
Other expenses                      5,990     (1,026 )    (15 )%     7,016 

47 1 % 6,969

   Total other operating
expense                           $76,838     $7,038       10  %   $69,800     ($1,353 )     (2 )%   $71,153




                                       38
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2019 Compared to 2018
Other operating expense increased in 2019 as compared to the prior year
primarily due to increases in salaries and other personnel expense, data
processing expense, occupancy expense, and compensation expense related to RML
acquisition payments. These increases were only partially offset by a decrease
in other expenses. The fourth quarter of 2019 marked the end of the five-year
period following the acquisition of RML during which the Company was required to
make additional payments to the former owners of RML when profitability hit
certain targets. Per the terms of the purchase agreement, no further payments
are scheduled, and therefore no additional expense for RML acquisition payments
will be recorded in the future. The $6.7 million increase in salaries and other
personnel expense is the result of the following items. Salaries increased $2.2
million, or approximately 8% in 2019 compared to 2018 due to salary increases as
total FTE remained consistent from 2018 to 2019. Profit sharing expense
increased $1.5 million, or 112%, in 2019 as compared to 2018. While a portion of
this increase is due to improvement in the Company's financial results in 2019,
the majority of the increase is due to a redesign of the profit sharing plan
that results in a higher payout to employees when the Company's financial
results are higher. Commission expense for mortgage originations increased $1.4
million, or 27%, as a result of higher mortgage production in 2019. Lastly,
group medical expense increased $1.1 million, or 23%, due to higher claims in
the Company's self-insured medical benefit plan in 2019 compared to 2018. Data
processing expense increased $1.1 million in 2019 as compared to 2018 due to
costs associated with the addition of two new branches in 2019, costs for
improved functionality for digital products and services, and the addition of
various software applications related to our lending activities. Occupancy
expense increased in 2019 as compared to 2018 primarily due to a one-time
technical correction that decreased depreciation expense by $670,000 in 2018.
The reserve for purchased receivable losses decreased $87,000 and employee
recruitment expense decreased $76,000 in 2019 as compared to 2018.
Income Taxes
The provision for income taxes increased $1.4 million or 33%, to $5.4 million in
2019 as compared to 2018. The increase in 2019 is primarily due to higher pretax
income, less tax exempt income, and fewer low income housing tax credits as a
percentage of pre-tax income as compared to 2018. Additionally, in 2018 the
Company finalized its valuation of net deferred tax assets related to the
decrease in the federal tax rate after completing a fixed asset cost segregation
study for tax planning purposes which resulted in a $470,000 decrease in tax
expense that was not repeated in 2019. The Company's effective tax rates were
21% and 17% in 2019 and 2018, respectively. The changes in the Company's
effective tax rates for 2019 and 2018 are primarily due to the items discussed
regarding the changes in tax expense for these periods.

FINANCIAL CONDITION
Investment Securities
The composition of our investment securities portfolio, which includes
securities available for sale and marketable equity securities, reflects
management's investment strategy of maintaining an appropriate level of
liquidity while providing a relatively stable source of interest income. The
investment securities portfolio also mitigates interest rate and credit risk
inherent in the loan portfolio, while providing a vehicle for the investment of
available funds, a source of liquidity (by pledging as collateral or through
repurchase agreements), and collateral for certain public funds
deposits. Investment securities designated as available for sale comprised 97%
of the portfolio as of December 31, 2019 and are available to meet liquidity
requirements.
Our investment portfolio consists primarily of government sponsored entity
securities, corporate securities, collateralized loan obligations, and municipal
securities.  Investment securities at December 31, 2019 increased $5.2 million,
or 2%, to $284.1 million from $278.9 million at December 31, 2018. The increase
at December 31, 2019 as compared to December 31, 2018 is primarily due to
investment of funds received as deposit balances increased, as well as proceeds
from sales, maturities, and security calls being reinvested as of December 31,
2019. The average maturity of the investment portfolio was approximately one and
a half years at December 31, 2019.
Investment securities may be pledged as collateral to secure public deposits or
borrowings. At December 31, 2019 and 2018, $30.6 million and $58.4 million in
securities were pledged for deposits and borrowings, respectively. Pledged
securities decreased at December 31, 2019 as compared to December 31, 2018
because the Company had decreased balances in securities sold under agreements
to repurchase accounts at December 31, 2019.

                                       39
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The following tables set forth the composition of our investment portfolio at
December 31 for the years indicated:
(In Thousands)                                     Amortized Cost     Fair 

Value

Securities Available for Sale:
2019:
  U.S. Treasury and government sponsored entities        $210,756       $211,852
  Municipal Securities                                      3,288          3,297
  Corporate Bonds                                          34,764         35,066
  Collateralized Loan Obligations                          25,980         

25,923

      Total                                              $274,788       

$276,138

2018:

  U.S. Treasury and government sponsored entities        $209,908       $208,860
  Municipal Securities                                      9,089          9,084
  Corporate Bonds                                          40,139         39,780
  Collateralized Loan Obligations                          13,990         

13,886

       Total                                             $273,126       

$271,610

2017:

  U.S. Treasury and government sponsored entities        $250,794       $249,461
  Municipal Securities                                     14,395         14,421
  Corporate Bonds                                          36,654         37,132
  Collateralized Loan Obligations                           6,000          6,005
  Preferred Stock                                           5,422          5,731
       Total                                             $313,265       $312,750
Marketable Equity Securities:
2019:
  Preferred Stock                                          $7,349         $7,945
       Total                                               $7,349         $7,945
  2018:
  Preferred Stock                                          $7,580         $7,265
       Total                                               $7,580         $7,265





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The following table sets forth the market value, maturities, and weighted average pretax yields of our investment portfolio as of December 31, 2019:

                                                                Maturity
                                       Within                                 Over
(In Thousands)                         1 Year     1-5 Years    5-10 Years   10 Years      Total
Securities Available for Sale:
  U.S. Treasury and government
sponsored entities
     Balance                           $52,668     $159,184           $-          $-     $211,852
     Weighted average yield               2.30 %       2.07 %          - %         - %       2.13 %
  Municipal securities
     Balance                              $994       $2,303           $-          $-       $3,297
     Weighted average yield               2.15 %       3.97 %          - %         - %       3.42 %
  Corporate bonds
     Balance                           $12,027      $17,975       $5,064          $-      $35,066
     Weighted average yield               2.74 %       2.95 %       2.91 %         - %       2.87 %

Collateralized loan obligations

     Balance                                $-           $-       $5,999     $19,924      $25,923
     Weighted average yield                  - %          - %       3.88 %      3.64 %       3.70 %
  Total
     Balance                           $65,689     $179,462      $11,063     $19,924     $276,138
     Weighted average yield               2.38 %       2.18 %       3.44 %      3.64 %       2.38 %
Marketable Equity Securities
  Preferred Stock
     Balance                                $-           $-           $-      $7,945       $7,945
     Weighted average yield                  - %          - %          - %      4.70 %       4.70 %



The Company's investment in marketable equity securities does not have a
maturity date but it has been included in the over 10 years column above. At
December 31, 2019, we held no securities of any single issuer (other than
government sponsored entities) that exceeded 10% of our shareholders' equity.
Loans
Our loan products include short and medium-term commercial loans, commercial
credit lines, construction and real estate loans, and consumer loans. To a
lesser extent, through our wholly-owned subsidiary RML, we also originate
mortgage loans which we sell to the secondary market. We retain servicing rights
on mortgage loans originated by RML and sold to the Alaska Housing Finance
Corporation ("AHFC"). We emphasize providing financial services to small and
medium-sized businesses and to individuals. From our inception, we have
emphasized commercial, land development and home construction, and commercial
real estate lending. These types of lending have provided us with needed market
opportunities and generally provide higher net interest margins compared to
other types of lending such as consumer lending. However, they also involve
greater risks, including greater exposure to changes in local economic
conditions.
All of our loans and credit lines are subject to approval procedures and amount
limitations. These limitations apply to the borrower's total outstanding
indebtedness and commitments to us, including the indebtedness of any
guarantor. Generally, we are permitted to make loans to one borrower of up to
15% of the unimpaired capital and surplus of the Bank. The loan-to-one-borrower
limitation for the Bank was $27.8 million at December 31, 2019. At December 31,
2019, the Company had two relationships whose total direct and indirect
commitments exceeded $27.8 million; however, no individual direct relationship
exceeded the loans-to-one borrower limitation. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Provision for Loan
Losses" for further discussion of the Company's concentration of loans to large
borrowers.
Our lending operations are guided by loan policies, which outline the basic
policies and procedures by which lending operations are conducted. Generally,
the policies address our desired loan types, target markets, underwriting and
collateral requirements, terms, interest rate and yield considerations, and
compliance with laws and regulations. The policies are reviewed and approved
annually by the board of directors of the Bank. Our Quality Assurance Department
provides a detailed financial

                                       41
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analysis of our largest, most complex loans. In addition, the Quality Assurance
Department, along with the Chief Credit Officer of the Bank, have developed
processes to analyze and manage various concentrations of credit within the
overall loan portfolio. The Credit Administration Department monitors the
procedures and processes for both the analysis and reporting of problem loans,
and also develops strategies to resolve problem loans based on the facts and
circumstances for each loan. Finally, our Internal Audit Department also
performs an independent review of each loan portfolio for compliance with loan
policy as well as a review of credit quality.  The Internal Audit review follows
the FDIC sampling guidelines, and a review of each portfolio is performed on an
annual basis.
The following table sets forth the composition of our loan portfolio by loan
segment:
                                     December 31, 2019             December 31, 2018             December 31, 2017             December 31, 2016             December 31, 2015
                                                 Percent of                    Percent of                    Percent of                    Percent of                    Percent of
(In Thousands)                   Dollar Amount     Total      Dollar Amount      Total      Dollar Amount      Total      Dollar Amount      Total      Dollar Amount      Total
Commercial                           $412,690    39.5  %           $342,420    34.8  %           $313,514    32.8  %           $277,802    28.5  %           $271,946    27.8  %
Real estate construction
one-to-four family                     38,818     3.7  %             37,111     3.8  %             31,201     3.3  %             26,061     2.7  %             44,488     4.5  %
Real estate construction other         61,808     5.9  %             72,256     7.3  %             80,093     8.4  %             72,159     7.4  %             74,956     7.7  %
Real estate term owner occupied       138,891    13.3  %            126,414    12.8  %            132,042    13.8  %            152,112    15.6  %            143,667    14.7  %
Real estate term non-owner
occupied                              312,960    30.0  %            325,720    33.1  %            319,313    33.4  %            356,411    36.6  %            347,284    35.4  %
Real estate term other                 42,506     4.1  %             42,039     4.3  %             40,411     4.2  %             45,402     4.7  %             46,672     4.8  %
Consumer secured by 1st deeds
of trust                               16,198     1.6  %             19,228     2.0  %             22,616     2.4  %             23,280     2.4  %             26,369     2.7  %
Consumer other                         24,585     2.4  %             23,645     2.4  %             19,919     2.1  %             25,281     2.6  %             28,912     3.0  %
Subtotal                           $1,048,456                      $988,833                      $959,109                      $978,508                      $984,294
Less: Unearned origination fee,
net of origination costs               (5,085 )  (0.5 )%             (4,487 )  (0.5 )%             (4,156 )  (0.4 )%             (4,434 )  (0.5 )%             (4,612 )  (0.5 )%
Total portfolio loans              $1,043,371                      $984,346                      $954,953                      $974,074                      $979,682



Commercial Loans: Our commercial loan portfolio includes both secured and
unsecured loans for working capital and expansion. Short-term working capital
loans generally are secured by accounts receivable, inventory, or equipment. We
also make longer-term commercial loans secured by equipment and real estate. We
also make commercial loans that are guaranteed in large part by the Small
Business Administration or the Bureau of Indian Affairs and to a lesser extent
guaranteed by the United States Department of Agriculture, as well as commercial
real estate loans that are purchased by the Alaska Industrial Development and
Export Authority ("AIDEA"). Commercial loans increased to $412.7 million at
December 31, 2019 from $342.4 million at December 31, 2018 and represented
approximately 39% and 35% of our total loans outstanding as of December 31, 2019
and December 31, 2018, respectively. Commercial loans reprice more frequently
than other types of loans, such as real estate loans. More frequent repricing
means that interest cash flows from commercial loans are more sensitive to
changes in interest rates. In a rising interest rate environment, our philosophy
is to emphasize the pricing of loans on a floating rate basis, which allows
these loans to reprice more frequently and to contribute positively to our net
interest margin.
Commercial Real Estate: We are an active lender in the commercial real estate
market. At December 31, 2019, commercial real estate loans increased slightly to
$494.4 million from $494.2 million at December 31, 2018, and represented
approximately 47% and 50% of our loan portfolio as of December 31, 2019 and
December 31, 2018, respectively. These loans are typically secured by office
buildings, apartment complexes or warehouses. Loan amortization periods range
from 10 to 25 years and generally have a maximum maturity of 10 years.
We may sell all or a portion of a commercial real estate loan to two State of
Alaska entities, AIDEA and AHFC, which were both established to provide
long-term financing in the State of Alaska. The loans that AIDEA purchases
typically feature a maturity twice that of the loans retained by us and bear a
lower interest rate. The blend of our and AIDEA's loan terms allows us to
provide competitive long-term financing to our customers, while reducing the
risk inherent in this type of lending. We also originate and sell to AHFC loans
secured by multifamily residential units. Typically, 100% of these loans are
sold to AHFC and we provide ongoing servicing of the loans for a fee. AIDEA and
AHFC make it possible for us to originate these commercial real estate loans and
enhance fee income while reducing our exposure to interest rate risk.
Construction Loans:   We provide construction lending for commercial real estate
projects. Such loans generally are made only when the Company has also committed
to finance the completed project with a commercial real estate loan, or if there
is a firm take-out commitment upon completion of the project by a third party
lender. Additionally, we provide land development and residential subdivision
construction loans. We also originate one-to-four-family residential and
condominium construction loans

                                       42
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to builders for construction of homes. The Company's construction loans
decreased in 2019 to $100.6 million, down from $109.4 million in 2018, and
represented approximately 10% and 11% of our loan portfolio in December 31, 2019
and December 31, 2018, respectively. As of December 31, 2019, approximately
$24.0 million or 24%, of the Company's construction loans were for low income
housing tax credit projects as compared to $43.1 million or 39% as of December
31, 2018.
Consumer Loans: We provide personal loans for automobiles, recreational
vehicles, boats, and other larger consumer purchases. We provide both secured
and unsecured consumer credit lines to accommodate the needs of our individual
customers, with home equity lines of credit serving as the major product in this
area.
Loans Directly Exposed to the Oil and Gas Industry: The Company defines "direct
exposure" to the oil and gas industry as companies that it has identified as
significantly reliant upon activity related to the oil and gas industry, such as
oil producers or drilling and exploration companies, and companies who provide
oilfield services, lodging, equipment rental, transportation, and other logistic
services specific to the industry. The Company estimates that $79.2 million, or
approximately 8% of loans as of December 31, 2019 have direct exposure to the
oil and gas industry as compared to $62.3 million, or approximately 6% of loans
as of December 31, 2018. The Company has no loans to oil producers or drilling
and exploration companies as of the end of 2019 or 2018, but the $79.2 million
outstanding as of December 31, 2019 noted above does include $14.2 million
related to the construction of an oil rig. The Company's unfunded commitments to
borrowers that have direct exposure to the oil and gas industry were $31.1
million and $32.5 million at December 31, 2019 and 2018, respectively. The
portion of the Company's allowance for loan losses that related to the loans
with direct exposure to the oil and gas industry was estimated at $1.6 million
and $1.4 million as of December 31, 2019 and 2018, respectively.
The following table details loan balances by loan segment asset quality rating
("AQR") and class of financing receivable for loans with direct oil and gas
exposure as of the dates indicated:
                                                                                         Real estate
                                 Real estate                               Real estate       term                         Consumer
(In                             construction            Real estate        term owner     non-owner     Real estate    secured by 1st     Consumer
Thousands)   Commercial      one-to-four family      construction other     occupied       occupied      term other    deeds of trust      other          Total
December
31, 2019
AQR Pass        $62,345                      $-                     $-        $4,153             $-             $-               $-           $361       $66,859
AQR Special
Mention             450                       -                      -         1,900          6,916              -                -              -         9,266
AQR
Substandard       3,070                       -                      -             -              -              -                -              -         3,070
    Total
loans           $65,865                      $-                     $-        $6,053         $6,916             $-               $-           $361       $79,195
December
31, 2018
AQR Pass        $44,512                      $-                     $-        $5,216             $-             $-               $-           $399       $50,127
AQR Special
Mention             857                       -                      -         2,242          7,364              -                -              -        10,463
AQR
Substandard      $1,723                      $-                     $-            $-             $-             $-               $-             $-        $1,723
    Total
loans           $47,092                      $-                     $-        $7,458         $7,364             $-               $-           $399       $62,313



                                       43
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Maturities and Sensitivities of Loans to Change in Interest Rates: The following table presents the aggregate maturity data of our loan portfolio, excluding loans held for sale, at December 31, 2019:

                                                              Maturity
(In Thousands)                               Within 1 Year    1-5 Years    Over 5 Years       Total
Commercial                                        $133,784     $117,941        $160,965       $412,690
Real estate construction one-to-four family         36,153        2,665               -         38,818
Real estate construction other                      40,331       10,300          11,177         61,808
Real estate term owner occupied                      7,469       37,064          94,358        138,891
Real estate term non-owner occupied                 18,657       88,581         205,722        312,960
Real estate term other                               3,993       14,622          23,891         42,506
Consumer secured by 1st deeds of trust                 119        1,269          14,810         16,198
Consumer other                                         819        5,676          18,090         24,585
Total                                             $241,325     $278,118        $529,013     $1,048,456
Fixed interest rate                                $89,162     $118,274         $88,693       $296,129
Floating interest rate                             152,163      159,844         440,320        752,327
Total                                             $241,325     $278,118        $529,013     $1,048,456



   At December 31, 2019, 57% of the portfolio was scheduled to mature or reprice
in 2020 with 39% scheduled to mature or reprice between 2021 and 2024.
As of December 31, 2019, approximately 73% of commercial loans are variable rate
loans, of which 66% reprice within one year. The majority of these loans reprice
to an index based upon the prime rate of interest or the respective Federal Home
Loan Bank of Boston (the "Boston FHLB") rate. The Company also uses floors in
its commercial loan pricing as loans are originated or renewed during the year.
At December 31, 2019, the interest rates for approximately 81% of commercial
real estate loans are variable, of which 46% reset within one year.
Approximately 40% of commercial real estate variable rate loans reprice in
greater than one year but within three years. The indices for these loans
include the prime rate of interest or the respective Treasury or FHLB-Boston
rate. The Company also uses floors in its commercial real estate loan pricing as
loans are originated or renewed during the year.
Loans Held for Sale and Mortgage Servicing Rights:   The Company originates
residential mortgage loans and sells them in the secondary market through our
wholly-owned subsidiary, RML. All residential mortgage loans originated and sold
in 2019 and 2018 were newly originated loans that did not affect nonperforming
loans. The Company also has a mortgage servicing portfolio which is comprised of
1-4 family loans serviced for Freddie Mac Home Loan Corporation ("FHLMC") and
AHFC. The Company retains servicing rights on all mortgage loans originated by
RML and sold to AHFC. Mortgages originated by RML and sold to AHFC represent
approximately 23% and 32% of the mortgages originated by RML in 2019 and 2018,
respectively. MSRs are adjusted to fair value quarterly with the change recorded
in mortgage banking income. The value of MSRs at December 31, 2019 and 2018 were
$11.9 million and $10.8 million, respectively. The value of MSRs is impacted by
market rates for mortgage loans primarily due to how changes in interest rates
affect prepayments of mortgage loans. To the extent loans are prepaid sooner
than estimated at the time servicing assets are originally recorded, it is
possible that certain residential MSR assets may decrease in value. Generally,
the fair value of our residential MSRs are expected to increase as market rates
for mortgage loans rise and decrease if market rates fall.


                                       44
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Credit Quality and Nonperforming Assets
Nonperforming assets consist of nonaccrual loans, accruing loans that are 90
days or more past due, repossessed assets and OREO. The following table sets
forth information regarding our nonperforming loans and total nonperforming
assets:
(In Thousands)                                  2019        2018        2017        2016        2015
Nonperforming loans
Nonaccrual loans                               $15,356     $15,210     $21,626     $13,893      $3,686
Loans 90 days past due and accruing                  -           -         252         456           -

Government guarantees on nonperforming loans (1,405 ) (516 ) (467 ) (1,413 ) (1,561 ) Net nonperforming loans

                        $13,951     $14,694     $21,411     $12,936      $2,125
Other real estate owned                          7,043       7,962       8,651       6,574       3,053
Repossessed assets                                 231       1,242           -           -           -
Other real estate owned guaranteed by
government                                      (1,279 )    (1,279 )    (1,333 )      (195 )         -
Net nonperforming assets                       $19,946     $22,619     

$28,729 $19,315 $5,178


Nonperforming loans, net of government
guarantees
to portfolio loans                                1.34 %      1.49 %      2.24 %      1.33 %      0.22 %
Nonperforming assets, net of government
guarantees to total assets                        1.21 %      1.50 %      1.89 %      1.27 %      0.35 %
Performing restructured loans                   $1,448      $3,413      $7,668      $6,131     $11,804
Nonperforming loans plus performing
restructured loans, net of government
guarantees                                     $15,399     $18,107     $29,079     $19,067     $13,929
Nonperforming loans plus performing
restructured loans to portfolio loans, net
of government guarantees                          1.48 %      1.84 %      3.05 %      1.96 %      1.42 %
Nonperforming assets plus performing
restructured loans to total assets, net of
government guarantees                             1.30 %      1.73 %      2.40 %      1.67 %      1.13 %
Adversely classified loans, net of
government guarantees                          $22,330     $27,217     $33,845     $35,634     $30,825
Loans 30-89 days past due and accruing, net
of government guarantees to portfolio loans       0.15 %      0.36 %      0.22 %      0.22 %      0.12 %
Allowance for loan losses to portfolio loans      1.83 %      1.98 %      2.25 %      2.02 %      1.85 %
Allowance for loan losses to nonperforming
loans, net of government guarantees                137 %       133 %       

100 % 152 % 854 %




The Company's nonperforming loans, net of government guarantees decreased in
2019 to $14.0 million as compared to $14.7 million in 2018. This decrease was
mostly due to a large nonaccrual loan payoff, as well as principal paydowns and
charge-offs on nonaccrual loans in 2019. There was interest income of $301,000
and $159,000 recognized in net income for 2019 and 2018, respectively, related
to interest collected on nonaccrual loans whose principal has been paid down to
zero. The Company had three relationships that represented more than 10% of
nonaccrual loans as of December 31, 2019.
 The Company had $1.4 million and $3.4 million in loans classified as troubled
debt restructuring loans ("TDRs") that were performing as of December 31, 2019
and 2018, respectively. Additionally, there were $8.7 million and $11.4 million
in TDRs included in nonaccrual loans at December 31, 2019 and 2018 for total
TDRs of $10.1 million and $14.8 million at December 31, 2019 and 2018,
respectively. The decrease in TDRs at December 31, 2019 as compared to 2018 was
primarily due to payoffs and paydowns on loans classified as TDRs that were only
partially offset by additions to TDRs in 2019. See Note 5 of the Notes to
Consolidated Financial Statements included in Item 8 of this report for further
discussion of TDRs.
At December 31, 2019, management had identified potential problem loans of $9.0
million as compared to potential problem loans of $17.1 million at December 31,
2018. Potential problem loans are loans which are currently performing that have
developed negative indications that the borrower may not be able to comply with
present payment terms and which may later be included in nonaccrual, past due,
or impaired loans. The $8.1 million decrease in potential problem loans at
December 31, 2019 from December 31, 2018 was primarily due to the transfer of
eight relationships totaling $7.0 million to nonaccrual loans, the payoff of two
relationships totaling $3.8 million and $1.7 million of other loan
paydowns. These decreases were partially offset by the addition of several
relationships totaling $3.5 million in 2019.

                                       45
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The Company acquired other assets consisting of aircraft totaling $1.2 million
in the fourth quarter of 2018 through foreclosure proceedings related to one
lending relationship. These assets were sold in the third quarter of 2019. The
Company acquired a vessel totaling $231,000 in the third quarter of 2019 through
foreclosure proceedings related to one lending relationship.
The following summarizes OREO activity for the periods indicated:
(In Thousands)                                       2019      2018      

2017

Balance, beginning of the year                      $7,962    $8,651    

$6,574

Transfers from loans                                     -       686     

5,912

Investment in other real estate owned                    -       144        

-

Proceeds from the sale of other real estate owned (1,299 ) (1,522 ) (3,302 ) Gain on sale of other real estate owned, net

           380         3       

371

Impairment on other real estate owned                    -         -      (904 )
Balance, end of year                                 7,043     7,962     8,651
Government guarantees                               (1,279 )  (1,279 ) 

(1,333 ) Balance, end of year, net of government guarantees $5,764 $6,683 $7,318




At December 31, 2019 and 2018 the Company held $5.8 million and $6.7 million,
respectively, of OREO assets, net of government guarantees. At December 31,
2019, OREO consists of $1.4 million in residential lots in various stages of
development and a $5.6 million commercial building. All OREO property is located
in Alaska. The Bank initiates foreclosure proceedings to recover and sell
collateral pledged by a debtor to secure a loan based on various events of
default and circumstances related to loans that are secured by either commercial
or residential real property. These events and circumstances include
delinquencies, the Company's relationship with the borrower, and the borrower's
ability to repay the loan via a source other than the collateral. If the loan
has not yet matured, the debtors may cure the events of default up to the time
of sale to retain their interest in the collateral. Failure to cure the defaults
will result in the debtor losing ownership interest in the property, which is
taken by the creditor, or high bidder at a foreclosure sale.
During 2019, the Company had no additions to OREO. During 2019, the Company
received approximately $1.3 million in proceeds from the sale of OREO which
included $1.1 million from the sale of lots and land and $214,000 from the sale
of single-family residences. The Company recognized $380,000 and $144,000 in
gains and $0 and $141,000 in losses on the sale of OREO properties in 2019 and
2018, respectively, for net gains of $380,000 and $3,000 in 2019 and 2018,
respectively.  The Company had remaining accumulated deferred gains on the sale
of OREO properties of $231,000 and $262,000 at December 31, 2019 and 2018,
respectively.
The Company did not make any loans to facilitate the sale of OREO in 2019 or
2018. Our underwriting policies and procedures for loans to facilitate the sale
of OREO are no different than our standard loan policies and procedures.
The Company recognized impairments of zero in both 2019 and 2018 due to
adjustments to the Company's estimate of the fair value of certain properties
based on changes in estimated costs to complete the projects, decrease in
expected sales prices, and changes in the Anchorage and the Southeastern Alaska
real estate markets.
Allowance for Loan Losses
The Company maintains an Allowance to reflect management's assessment of
probable, estimable losses inherent in the loan portfolio. The Allowance is
increased by provisions for loan losses and loan recoveries and decreased by
loan charge-offs. The size of the Allowance is determined through quarterly
assessments of probable estimated losses in the loan portfolio. Our methodology
for making such assessments and determining the adequacy of the Allowance
includes the following key elements:
•         A specific allocation for impaired loans. Management determines the

fair value of the majority of these loans based on the underlying

collateral values. This analysis is based upon a specific analysis for

each impaired loan, including external appraisals on loans secured by

          real property, management's assessment of the current market, recent
          payment history, and an evaluation of other sources of
          repayment. In-house evaluations of fair value are used in the
          impairment analysis in some situations. Inputs to the in-house
          evaluation process include information about sales of comparable
          properties in the appropriate markets and changes in tax assessed
          values. The Company obtains appraisals on real and personal property

that secure its loans during the loan origination process in accordance

          with regulatory guidance and its loan policy. The Company obtains
          updated appraisals on loans secured by real or personal property based



                                       46
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upon its assessment of changes in the current market or particular projects or
properties, information from other current appraisals, and other sources of
information. Appraisals may be adjusted downward by the Company based on its
evaluation of the facts and circumstances on a case by case basis. External
appraisals may be discounted when management believes that the absorption period
used in the appraisal is unrealistic, when expected liquidation costs exceed
those included in the appraisal, or when management's evaluation of
deteriorating market conditions warrants an adjustment. Additionally, the
Company may also adjust appraisals in the above circumstances between appraisal
dates. The Company uses the information provided in these updated appraisals
along with its evaluation of all other information available on a particular
property as it assesses the collateral coverage on its performing and
nonperforming loans and the impact that may have on the adequacy of its
Allowance. The specific allowance for impaired loans, as well as the overall
Allowance, may increase based on the Company's assessment of updated
appraisals. See Note 26 of the Notes to Consolidated Financial Statements
included in Item 8 of this report for further discussion of the Company's
estimation of impaired loans measured at fair value.
When the Company determines that a loss has occurred on an impaired loan, a
charge-off equal to the difference between carrying value and fair value is
recorded. If a specific allowance is deemed necessary for a loan, and then that
loan is partially charged off, the loan remains classified as a nonperforming
loan after the charge-off is recognized.

•         A general allocation - The Company has identified segments and classes
          of loans not considered impaired for purposes of establishing the
          general allocation allowance. The Company disaggregates the loan
          portfolio into segments and classes based on its assessment of how

different pools of loans with like characteristics in the portfolio

behave over time. This determination is based on historical experience

and management's assessment of how current facts and circumstances are

expected to affect the loan portfolio.



The Company first disaggregates the loan portfolio into the following eight
segments: commercial, real estate construction one-to-four family, real estate
construction other, real estate term owner occupied, real estate term non-owner
occupied, real estate term other, consumer secured by 1st deeds of trust, and
other consumer loans.

After division of the loan portfolio into segments, the Company then further
disaggregates each of the segments into classes. The Company has a total of five
classes, which are based off of the Company's loan risk grading system known as
the Asset Quality Rating ("AQR") system. The risk ratings are discussed in Note
5 to the Consolidated Financial Statements included in Item 8 of this
report. There are five loan classes: pass (pass AQR grades, which are grades 1 -
6), special mention, substandard, doubtful, and loss. There have been no changes
to these loan classes in 2019.

After the portfolio has been disaggregated into segments and classes, the
Company calculates a general reserve for each segment and class based on the
average loss history for each segment and class. The Company utilizes a
look-back period of five years in the calculation of average historical loss
rates.

After the Company calculates a general allocation using our loss history, the
general reserve is then adjusted for qualitative factors by segment and
class. Qualitative factors are based on management's assessment of current
trends that may cause losses inherent in the current loan portfolio to differ
significantly from historical losses. Some factors that management considers in
determining the qualitative adjustment to the general reserve include our
concentration of large borrowers; national and local economic trends; general
business conditions; trends in local real estate markets; economic, political,
and industry specific factors that affect resource development in Alaska;
effects of various political activities; peer group data; and internal factors
such as underwriting policies and expertise of the Company's employees.

• An unallocated reserve - The unallocated portion of the Allowance

provides for other credit losses inherent in our loan portfolio that

may not have been contemplated in the specific and general components

of the Allowance, and it acknowledges the inherent imprecision of all

loss prediction models. The unallocated component is reviewed

periodically based on trends in credit losses and overall economic

conditions. At December 31, 2019 and 2018, the unallocated allowance

as a percentage of the total Allowance was 11% and 13%, respectively.




                                       47
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The following table shows the allocation of the Allowance for the years
indicated:
                                      2019                        2018                        2017                        2016                        2015

(In Thousands)               Amount     % of Loans(1)    Amount     % of Loans(1)    Amount     % of Loans(1)    Amount     % of Loans(1)    Amount     % of Loans(1)
Commercial                    $6,604           39 %       $5,660           35 %       $6,172           34 %       $5,535           28 %       $5,906           28 %
Real estate construction
one-to-four family               643            4 %          675            4 %          629            3 %          550            3 %          854            4 %
Real estate construction
other                          1,017            6 %        1,275            7 %        1,566            8 %        1,465            7 %        1,439            8 %
Real estate term owner
occupied                       2,188           13 %        2,027           13 %        2,194           14 %        2,358           16 %        1,657           15 %
Real estate term non-owner
occupied                       5,180           30 %        5,799           33 %        6,043           33 %        6,853           37 %        5,515           35 %
Real estate term other           671            4 %          716            4 %          725            4 %          819            5 %          628            4 %
Consumer secured by 1st
deeds of trust                   270            2 %          306            2 %          315            2 %          313            2 %          264            3 %
Consumer other                   436            2 %          426            2 %          307            2 %          408            2 %          397            3 %
Unallocated                    2,079            - %        2,635            - %        3,510            - %        1,396            - %        1,493            - %
Total                        $19,088          100 %      $19,519          100 %      $21,461          100 %      $19,697          100 %      $18,153          100 %

1Represents percentage of this category of loans to total portfolio loans.


The following table sets forth information regarding changes in our Allowance
for the years indicated:
(In Thousands)                           2019          2018          2017          2016          2015
Balance at beginning of year           $19,519        $21,461       $19,697       $18,153       $16,723
Charge-offs:
Commercial                                (195 )       (1,716 )      (1,611 )        (903 )        (616 )
Real estate construction one-to-four
family                                       -              -             -          (535 )           -
Real estate term other                       -            (28 )          (5 )           -           (81 )
Consumer secured by 1st deeds of
trust                                       (4 )         (143 )         (85 )         (36 )         (28 )
Consumer other                             (18 )          (39 )         (43 )          (8 )        (101 )
Total charge-offs                         (217 )       (1,926 )      (1,744 )      (1,482 )        (826 )
Recoveries:
Commercial                                 908            442           293           699           379
Real estate term other                      28              3             2             -           107
Consumer secured by 1st deeds of
trust                                        -             12             2             -             3
Consumer other                              25             27            11            29            13
Total recoveries                           961            484           308           728           502
Net, recoveries (charge-offs)              744         (1,442 )      (1,436 )        (754 )        (324 )
Provision (benefit) for loan losses     (1,175 )         (500 )       3,200         2,298         1,754
Balance at end of year                 $19,088        $19,519       $21,461       $19,697       $18,153
Ratio of net (recoveries)
charge-offs to average loans
outstanding during the period            (0.07 )%        0.15 %        0.15 

% 0.08 % 0.03 %




In accordance with GAAP, loans acquired in connection with our acquisition of
Alaska Pacific on April 1, 2014 were recorded at their fair value at the
acquisition date. Credit discounts were included in the determination of fair
value; therefore, an allowance for loan losses was not recorded at the
acquisition date. Purchased credit impaired loans were evaluated on a loan by
loan basis and the valuation allowance for these loans was netted against the
carrying value. Loans acquired from Alaska Pacific have been classified as
impaired loans and evaluated for specific impairment using the same methodology
as all other loans since April 1, 2014. A general allowance for loans acquired
from Alaska Pacific was established if there was deterioration in credit quality
of the acquired loans subsequent to acquisition from April 1, 2014 through
December 31, 2017. As of December 31, 2019 and 2018, loans acquired from Alaska
Pacific are included in the Company's general allowance using the same
methodology as all other loans as described above due to the amount of time that
has passed since the loans were purchased. There was no specific

                                       48
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impairment on acquired loans at December 31, 2019 or 2018. The purchase discount
related to acquired credit impaired loans was $345,000 and $375,000 as of
December 31, 2019 and 2018, respectively.
The provision for loan losses in 2019 as compared to 2018 decreased $675,000 to
a benefit of $1.2 million compared to a benefit of $500,000 in 2018. This
decrease is primarily due to net recoveries on loans and a decrease in
qualitative factors mostly due to strengthening in the Alaska economy in 2019.
The Company determined that an Allowance of $19.1 million, or 1.83% of portfolio
loans, is appropriate as of December 31, 2019 based on our analysis of the
current credit quality of the portfolio and current economic conditions. The
provision for loan losses in 2018 as compared to 2017 decreased $3.7 million to
a benefit of $500,000 compared to a provision of $3.2 million in 2017. This
decrease is primarily due to a decrease in nonperforming loans and the portion
of the Allowance specific to impaired loans. The provision for loan losses in
2017 as compared to 2016 increased $902,000 to $3.2 million compared to $2.3
million in 2016. This increase was primarily due to an increase in nonperforming
loans and the portion of the Allowance specific to impaired loans. The provision
for loan losses in 2016 as compared to 2015 increased $544,000 to $2.3 million
compared to $1.8 million in 2015. This increase was primarily due to an increase
in nonperforming loans in 2016 compared to the prior year as well as an increase
in qualitative factors mostly due to softening in the Alaska economy in 2016.
While management believes that it uses the best information available to
determine the Allowance, unforeseen market conditions and other events could
result in an adjustment to the Allowance, and net income could be significantly
affected if circumstances differed substantially from the assumptions used in
making the final determination of the Allowance.

Purchased Receivables
We purchase accounts receivable from our business customers and provide them
with short-term working capital. We provide this service to our customers in
Alaska, Washington, Oregon, and some other states through NFS.
   Our purchased receivable activity is guided by policies that outline risk
management, documentation, and approval limits. The policies are reviewed and
approved annually by the Company's Board of Directors. Purchased receivables are
recorded on the balance sheet net of a reserve for purchased receivable losses.
Purchased receivable balances increased at December 31, 2019 to $24.4 million
from $14.4 million at December 31, 2018, and year-to-date average purchased
receivable balances were $18.8 million and $17.4 million in 2019 and 2018,
respectively. Purchased receivable income was $3.3 million in both 2019 and
2018. Purchased receivable income in 2019 remained consistent with 2018 despite
an increase in average balances due to a decrease in average yield which varies
depending on the makeup of the purchased receivable portfolio.
The following table sets forth information regarding changes in the purchased
receivable reserve for the years indicated:
(In Thousands)                                               2019      2018      2017
Balance at beginning of year                                  $190      $200      $171
  Charge-offs                                                    -         -         -
  Recoveries                                                     -         -         -
Net recoveries (charge-offs)                                     -         -         -
Reserve for (recovery from) purchased receivables              (96 )     (10 )      29
Balance at end of year                                         $94      

$190 $200 Ratio of net charge-offs (recoveries) to average purchased receivables during the period

                                    - %       - %       - %


Deposits

Deposits are our primary source of funds. Total deposits increased 12% to $1.372 billion at December 31, 2019 from $1.228 billion at December 31, 2018. Our deposits generally are expected to fluctuate according to the level of our market share, economic conditions, and normal seasonal trends. The following table sets forth the average balances outstanding and average interest rates for each major category of our deposits, for the periods indicated:

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                                                 2019                             2018                             2017
                                                         Average                          Average                          Average
(In Thousands)                       Average balance    rate paid    

Average balance rate paid Average balance rate paid Interest-bearing demand accounts

            $272,895     0.17 %              $243,000     0.07 %              $220,449     0.03 %
Money market accounts                        209,245     0.55 %               225,014     0.31 %               238,830     0.17 %
Savings accounts                             233,057     0.46 %               241,807     0.31 %               249,641     0.21 %
Certificates of deposit                      135,005     1.67 %                99,987     0.70 %               120,998     0.57 %
Total interest-bearing accounts              850,202     0.58 %               809,808     0.28 %               829,918     0.21 %
Noninterest-bearing demand accounts          426,205                          417,464                          418,415
Total average deposits                    $1,276,407                       $1,227,272                       $1,248,333



Certificates of Deposit: The only deposit category with stated maturity dates is
certificates of deposit. At December 31, 2019, we had $164.5 million in
certificates of deposit, of which $90.5 million, or 55%, are scheduled to mature
in 2020. The Company's certificates of deposit increased to $164.5 million
during 2019 as compared to $113.3 million at December 31, 2018. The aggregate
amount of certificates of deposit in amounts of $100,000 or more at December 31,
2019 and 2018, was $118.9 million and $70.7 million, respectively. The following
table sets forth the amount outstanding of certificates of deposits in amounts
of $100,000 or more by time remaining until maturity and percentage of total
deposits as of December 31, 2019:
                                      Time Certificates of Deposits
                                           of $100,000 or More


(In Thousands)                     Amount              Percent of Total Deposits
Amounts maturing in:
Three months or less                        $14,779                    12 %
Over 3 through 6 months                       4,631                     4 %
Over 6 through 12 months                     41,545                    35 %
Over 12 months                               57,940                    49 %
Total                                      $118,895                   100 %



The Company offers the Certificate of Deposit Account Registry Service® (CDARS®)
as a member of Promontory Interfinancial Network, LLCSM (Network). When a
Network member places a deposit using CDARS, that certificate of deposit is
divided into amounts under the standard FDIC insurance maximum ($250,000) and is
allocated among member banks, making the large deposit eligible for FDIC
insurance. The Company had $1.2 million CDARS certificates of deposits at
December 31, 2019 and no CDARS certificates of deposits at December 31, 2018.

Borrowings

FHLB: The Bank is a member of the Federal Home Loan Bank of Des Moines (the
"FHLB"). As a member, the Bank is eligible to obtain advances from the FHLB.
FHLB advances are dependent on the availability of acceptable collateral such as
marketable securities or real estate loans, although all FHLB advances are
secured by a blanket pledge of the Company's assets. At December 31, 2019, our
maximum borrowing line from the FHLB was $734.0 million, approximately 45% of
the Bank's assets, subject to the FHLB's collateral requirements. The Company
has outstanding advances of $8.9 million as of December 31, 2019 which were
originated to match fund low income housing projects that qualify for long term
fixed interest rates. The first advance is a $1.9 million FHLB Community
Investment Program advance which was originated on March 22, 2013. It has an
eighteen year term with a 30 year amortization period, which mirrors the term of
the term real estate loan made to the borrower, and a fixed rate of 3.12%. The
second advance is a $2.1 million FHLB Community Investment Cash Advance Program
advance that was originated in the second quarter of 2016. This advance has a 20
year term with a 30 year amortization period, which mirrors the term of the term
real estate loan made to the borrower, and a fixed interest rate of 2.61%. The
third advance is a $3.0 million FHLB Community Investment Cash Advance Program
advance that was originated in the third quarter of 2017. This advance has a 20
year term with a 30 year amortization period and a fixed interest rate of 3.25%,
which mirrors the term of the loan made to the borrower. The fourth advance

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is a $1.0 million FHLB Community Investment Cash Advance Program advance that
was originated in the third quarter of 2019. This advance has a 20 year term
with a 30 year amortization period and a fixed interest rate of 2.69%, which
mirrors the term of the loan made to the borrower. The last advance is a
$769,000 FHLB Community Investment Cash Advance Program advance that was
originated in the third quarter of 2019. This advance has a 20 year term with a
30 year amortization period and a fixed interest rate of 2.69%, which mirrors
the term of the loan made to the borrower. All of these FHLB advances are
included in borrowings.
Federal Reserve Bank:  The Federal Reserve Bank of San Francisco (the "Federal
Reserve Bank") is holding $79.5 million of loans as collateral to secure
advances made through the discount window as of December 31, 2019. There were no
discount window advances outstanding at December 31, 2019 or 2018.
Other Short-term Borrowings:  Securities sold under agreements to repurchase
were zero and $34.3 million, as of December 31, 2019 and 2018, respectively. The
average balance outstanding of securities sold under agreements to repurchase
during 2019 and 2018 was $15.2 million and $29.9 million, respectively, and the
maximum outstanding at any month-end was $36.6 million and $36.5 million,
respectively, during the same time periods. The securities sold under agreements
to repurchase are held by the FHLB under the Company's control.
The Company is subject to provisions under Alaska state law which generally
limit the amount of outstanding debt to 15% of total assets or $244.7 million
and $222.6 million at December 31, 2019 and 2018, respectively.
Long-term Borrowings:    The Company had no long-term borrowings outstanding
other than the FHLB advances noted above as of December 31, 2019 or 2018.
Contractual Obligations
The following table references contractual obligations of the Company for the
periods indicated. This table does not include interest payments:
                                                                     Payments Due by Period

(In Thousands)                            Within 1 Year      1-3 Years      3-5 Years      Over 5 Years        Total
December 31, 2019:
Certificates of deposit                         $90,554        $70,734         $1,390            $1,794       $164,472
Short-term borrowings                                 -              -              -                 -              -
Long-term borrowings                                187            444            471             7,789          8,891
Junior subordinated debentures                        -              -              -            10,310         10,310
Operating lease obligations                       2,665          4,718          3,592             6,453         17,428
Other long-term liabilities(1)                    2,937          9,484          1,341             4,001         17,763
Capital commitments                               1,389              -              -                 -          1,389
Total                                           $97,732        $85,380         $6,794           $30,347       $220,253
December 31, 2018:
Certificates of deposit                         $57,451        $52,529         $1,494            $1,799       $113,273
Short-term borrowings                            34,278              -              -                 -         34,278
Long-term borrowings                                167            351            373             6,350          7,241
Junior subordinated debentures                        -              -              -            10,310         10,310
Operating lease obligations                       2,668          4,908          3,750             8,121         19,447
Other long-term liabilities                       1,010          1,703          1,453             3,196          7,362
Capital commitments                                  57              -              -                 -             57
Total                                           $95,631        $59,491         $7,070           $29,776       $191,968



(1) Includes principal payments related to employee benefit plans. If a benefit
payment schedule is established, payments are recorded in the corresponding
dates listed in the table above. Unscheduled payments for all remaining benefits
are recorded "Over 5 Years". Additional information about employee benefit plans
is provided in Note 19 of the Notes to the Consolidated Financial Statements in
Item 8 below.


                                       51
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  Short and long-term borrowings included in the table above are described in
the "Borrowings" section above. Junior subordinated debentures include $10.3
million that was originated on December 16, 2005, matures on March 15, 2036, and
bears interest at a rate of 90-day LIBOR plus 1.37%, adjusted quarterly. The
Company entered into an interest rate swap in the third quarter of 2017 to hedge
the variability in cash flows arising out of its junior subordinated debentures,
by swapping the cash flows with an interest rate swap which receives floating
and pays fixed. The Company has designated this interest rate swap as a hedging
instrument. The interest rate swap effectively fixes the Company's interest
payments on the $10 million of junior subordinated debentures held under
Northrim Statutory Trust 2 ("NST2") at 3.72% through its maturity date.
Operating lease obligations are more fully described in Note 12 of the Company's
Consolidated Financial Statements included in Item 8 of this report. Other
long-term liabilities consist of amounts that the Company owes for its
investments in Delaware limited partnerships that develop low-income housing
projects throughout the United States. Additional information about these
partnerships is included at Note 8. The Company purchased a $10.7 million
interest in R4 Frontier Housing Partners L.P., Coronado Park Senior Village L.P.
("R4-Coronado") in March 2013. The investment in R4-Coronado was 95% funded at
the end of 2019 and is expected to be fully funded in 2029. The Company
purchased an $8.5 million interest in R4 Frontier Housing Partners L.P.,
Mountain View Village V L.P. ("R4-MVV") in May 2014. The investment in R4-MVV
was 97% funded at the end of 2019 and is expected to be fully funded in 2030.
The Company purchased a $6.8 million interest in R4 Frontier Housing Partners
L.P., PJ33 L.P. ("R4-PJ33") in June 2016. The investment in R4-PJ33 was 94%
funded at the end of 2019 and is expected to be fully funded in 2032. The
Company purchased a $7.3 million interest in R4 Frontier Housing Partners L.P.,
Parkscape L.P. ("R4-Coronado II") in June 2019. The investment in R4-Coronado II
was 5% funded at the end of 2019 and is expected to be fully funded in 2035. The
Company also purchased a $4.0 million interest in R4 Frontier Housing Partners
L.P., Duke Apartments L.P. ("R4-Duke") in November 2019. The investment in
R4-Duke was 9% funded at the end of 2019 and is expected to be fully funded in
2035.
Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance sheet
risk. Among the off-balance sheet items entered into in the ordinary course of
business are commitments to extend credit, commitments to originate loans held
for sale and the issuance of letters of credit. These instruments involve, to
varying degrees, elements of credit and interest rate risk in excess of the
amounts recognized on the balance sheet. Certain commitments are
collateralized. We apply the same credit standards to these commitments as in
all of our lending activities and include these commitments in our lending risk
evaluations.
As of December 31, 2019, we had commitments to extend credit of $301.9 million,
which were not reflected on our balance sheet, compared to $260.6 million as of
December 31, 2018. Commitments to extend credit are agreements to lend to
customers. These commitments have specified interest rates and generally have
fixed expiration dates but may be terminated by the Company if certain
conditions of the contract are violated. Collateral held relating to these
commitments varies, but generally includes real estate, inventory, accounts
receivable, and equipment. Our exposure to credit loss under commitments to
extend credit is represented by the amount of these commitments. Since many of
the commitments are expected to expire without being drawn upon, these total
commitment amounts do not necessarily represent future cash requirements.

As of December 31, 2019, we had commitments to originate loans held for sale of
$48.8 million, which were not reflected in the balance sheet compared to $45.0
million as of December 31, 2018. Mortgage loans sold to investors may be sold
with servicing rights released, for which the Company makes only standard legal
representations and warranties as to meeting certain underwriting and collateral
documentation standards. In the past two years, the Company has had to
repurchase one loan due to deficiencies in underwriting or loan documentation
and has not realized significant losses related to this repurchase. Management
currently believes that any liabilities that may result from such recourse
provisions are not significant.

As of December 31, 2019, we had standby letters of credit of $2.0 million, which
were not reflected on our balance sheet compared to $3.2 million as of December
31, 2018. Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party. Credit risk
arises in these transactions from the possibility that a customer may not be
able to repay the Company upon default of performance. Collateral held for
standby letters of credit is based on an individual evaluation of each
customer's creditworthiness.

Our total unfunded lending commitments at December 31, 2019, which includes
commitments to extend credit, commitments to originate loans held for sale and
standby letters of credit, were $352.7 million, compared to $308.8 million as of
December 31, 2018. We do not expect that all of these commitments are likely to
be fully drawn upon at any one time. The Company has established reserves of
$152,000 and $130,000 at December 31, 2019 and 2018, respectively, for estimated
losses related to these commitments that are recorded in other liabilities on
the consolidated balance sheet.

Additional information regarding Off-Balance Sheet Arrangements is included in
Notes 20 and 21 of the Notes to Consolidated Financial Statements included in
Item 8 of this report.

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Liquidity and Capital Resources
Our shareholders' equity at December 31, 2019, was $207.1 million, as compared
to $205.9 million at December 31, 2018. The Company earned net income of $20.7
million, issued 23,269 shares of common stock through the exercise of stock
options, and repurchased 347,676 shares during 2019. At December 31, 2019, the
Company had approximately 6.6 million shares of its common stock outstanding.
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, including the conservation buffer that is now in full effect, the
Company expects to continue to receive dividends from the Bank during 2020.
The Bank manages its liquidity through its Asset and Liability Committee. Our
primary sources of funds are customer deposits and advances from the FHLB. These
funds, together with loan repayments, loan sales, other borrowed funds, retained
earnings, and equity are used to make loans, to acquire securities and other
assets, and to fund deposit flows and continuing operations. The primary sources
of demands on our liquidity are customer demands for withdrawal of deposits and
borrowers' demands that we advance funds against unfunded lending
commitments. Our total unfunded commitments to fund loans, loans held for sale,
and letters of credit at December 31, 2019, were $352.7 million. We do not
expect that all of these loans are likely to be fully drawn upon at any one
time. Additionally, as noted above, our total deposits at December 31, 2019,
were $1.4 billion.
As shown in the Consolidated Statements of Cash Flows, net cash used by
operating activities was $821,000 in 2019 and net cash provided by operating
activities was $25.2 million in 2018.  The primary source of cash provided by
operating activities for all periods presented was positive net income; however,
in 2019 the origination of loans held for sale exceeded proceeds from the sale
of loans held for sale which is the primary reason that operating cash flow is
negative in 2019. Net cash used by investing activities was $71.9 million in
2019 and primarily due to the fact that purchases of investment securities and
net investment in loans and purchased receivables exceeded proceeds from sales
and maturities of securities available for sale. Net cash provided by investing
activities was $5.6 million in 2018 as the Company's proceeds from sales and
maturities of securities available for sale were greater than funds used to
purchase additional investment securities in those years. Financing activities
provided cash of $90.6 million in 2019 and used cash of $31.1 million in 2018.
Financing activities provided cash in 2019 due to an increase in deposits that
was only partially offset by a decrease in securities sold under repurchase
agreements, repurchase of 347,676 shares of the Company's common stock for $12.6
million, and the payment of cash dividends to shareholders. Financing activities
used net cash in 2018 primarily as a result of a decrease in deposit balances
and payment of cash dividends to shareholders.
The sources by which we meet the liquidity needs of our customers are current
assets and borrowings available through our correspondent banking relationships
and our credit lines with the Federal Reserve Bank and the FHLB. At December 31,
2019, our current assets were $431.3 million and our funds available for
borrowing under our existing lines of credit were $800.7 million. Given these
sources of liquidity and our expectations for customer demands for cash and for
our operating cash needs, we believe our sources of liquidity to be sufficient
in the foreseeable future.
During 2019, the Company's Board of Directors approved a quarterly cash dividend
of $0.30 per common share for the first and second quarters and $0.33 per common
share for the third and fourth quarters. These dividends were made pursuant to
our existing dividend policy and in consideration of, among other things,
earnings, regulatory capital levels, liquidity, asset quality, and the overall
payout ratio. We expect that dividend payments will be reassessed on a quarterly
basis by the Board of Directors in accordance with the dividend policy. The
payment of cash dividends is subject to regulatory limitations as described
under the Supervision and Regulation section of Part I of this report. There is
no assurance that future cash dividends on common shares will be declared or
increased.
On February 27, 2020, the Board of Directors approved payment of a $0.34 per
share dividend on March 20, 2020, to shareholders of record on March 12,
2020. This dividend is $0.01, or 3%, higher than the Company's dividend of $0.33
that was paid in the fourth quarter of 2019.
In September 2002, our Board of Directors approved a plan whereby we would
periodically repurchase for cash up to approximately 5% of our shares of common
stock in the open market. We purchased an aggregate of 688,442 shares of our
common stock under this program through December 31, 2009 at a total cost of
$14.2 million at an average price of $20.65 per share, which left a balance of
227,242 shares available under the stock repurchase program. The Company did not
repurchase any of its shares in 2010 through 2016. In 2017, we purchased an
aggregate of 58,341 shares at an average price of $27.56 per share. In 2018, we
purchased an aggregate of 15,468 shares at an average price of $31.90 per share.
In April 2019, the Company's Board of Directors

                                       53
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approved a plan whereby it would periodically repurchase for cash up to
approximately 5% of its shares of common stock in the open market where 340,000
shares were available for repurchase. In 2019 we purchased an aggregate of
347,676 shares at an average price of $36.15 per share. At December, 31, 2019,
there were zero shares available under the stock repurchase program. However, on
January 27, 2020, the Board authorized the repurchase of up to an additional
327,000 shares of common stock. We intend to continue to repurchase our stock
from time-to-time depending upon market conditions, but we can make no
assurances that we will continue this program or that we will authorize
additional shares for repurchase. The table below shows this effect on diluted
earnings per share.
              Diluted
               EPS as
Years Ending: Reported   Diluted EPS without Stock Repurchase
2019           $3.04                    $2.59
2018           $2.86                    $2.56
2017           $1.88                    $1.69
2016           $2.06                    $1.87
2015           $2.56                    $2.31



On May 8, 2003, the Company's subsidiary, NCT1, issued trust preferred
securities in the principal amount of $8 million. These securities carried an
interest rate of 90-day LIBOR plus 3.15% per annum that was initially set at
4.45% adjusted quarterly. The securities had a maturity date of May 15, 2033,
and were callable by the Company on or after May 15, 2008. These securities were
treated as Tier 1 capital by the Company's regulators for capital adequacy
calculations. The Company redeemed these trust preferred securities on August
15, 2017.
On December 16, 2005, the Company's subsidiary, NST2, issued trust preferred
securities in the principal amount of $10 million. These securities carry an
interest rate of 90-day LIBOR plus 1.37% per annum that was initially set at
5.86% adjusted quarterly. The securities have a maturity date of March 15, 2036,
and are callable by the Company on or after March 15, 2011. These securities are
treated as Tier 1 capital by the Company's regulators for capital adequacy
calculations. The interest cost to the Company of these securities was $398,000
in 2019. At December 31, 2019, the securities had an interest rate of 3.26%. The
Company entered into an interest rate swap in the third quarter of 2017 to hedge
the variability in cash flows arising out of its junior subordinated debentures,
by swapping the cash flows with an interest rate swap which receives floating
and pays fixed. The Company has designated this interest rate swap as a hedging
instrument. The interest rate swap effectively fixes the Company's interest
payments on the $10 million of junior subordinated debentures held under NST2 at
3.72% through its maturity date. Net of the impact of the interest rate swap,
interest expense on these securities was $389,000 in 2019 and 2018.
We are subject to minimum capital requirements. Federal banking agencies have
adopted regulations establishing minimum requirements for the capital adequacy
of banks and bank holding companies. The requirements address both risk-based
capital and leverage capital. We believe as of December 31, 2019, 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 in 2019 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 2020, exceeding the FDIC's new 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 that the
Company completed in the fourth quarter of 2005 is included in the Company's
capital for regulatory purposes, although they are accounted for as a long-term
debt in our financial statements. The trust preferred securities are not
accounted for on the Bank's financial statements nor are they included in its
capital. As a result, the Company has $10 million more in regulatory capital
than the Bank at December 31, 2019 and 2018, respectively, which explains most
of the difference in the capital ratios for the two entities.
                      Minimum                                    Actual
                     Required                                    Ratio             Actual
December 31, 2019    Capital           Well-Capitalized         Company          Ratio Bank
Total risk-based
capital               8.00%                10.00%                15.63%            13.24%
Tier 1 risk-based
capital               6.00%                 8.00%                14.38%            11.98%
Common equity tier
1 capital             4.50%                 6.50%                13.69%            11.98%
Leverage ratio        4.00%                 5.00%                12.41%            10.36%



                                       54

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See Note 24 of the Consolidated Financial Statements for a detailed discussion
of the capital ratios. The requirements for "well-capitalized" come from the
Prompt Correction Action rules. See Item 1 Supervision and Regulation. These
rules apply to the Bank but not to the Company. Under the rules of the Federal
Reserve Bank, a bank holding company such as the Company is generally defined to
be "well capitalized" if its Tier 1 risk-based capital ratio is 8.0% or more and
its total risk-based capital ratio is 10.0% or more.

Effects of Inflation and Changing Prices:  The primary impact of inflation on
our operations is increased operating costs. Unlike most industrial companies,
virtually all of the assets and liabilities of a financial institution are
monetary in nature. As a result, interest rates generally have a more
significant impact on a financial institution's performance than the effects of
general levels of inflation. Although interest rates do not necessarily move in
the same direction or to the same extent as the prices of goods and services,
increases in inflation generally have resulted in increased interest rates,
which could affect the degree and timing of the repricing of our assets and
liabilities. In addition, inflation has an impact on our customers' ability to
repay their loans. See additional discussion below in Item 7A regarding how
various market risks affect the Company.

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