NORTHRIM BANCORP, INC. This discussion should be read in conjunction with the unaudited consolidated financial statements ofNorthrim BanCorp, Inc. (the "Company") and the notes thereto presented elsewhere in this report and with the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 . Except as otherwise noted, references to "we", "our", "us" or "the Company" refer toNorthrim BanCorp, Inc. and its subsidiaries that are consolidated for financial reporting purposes. Note Regarding Forward Looking-Statements This quarterly report on Form 10-Q includes "forward-looking statements," as that term is defined for purposes of Section 21E of the Securities Exchange Act of 1934, as amended, which are not historical facts. These forward-looking statements describe management's expectations about future events and developments such as future operating results, growth in loans and deposits, continued success of the Company's style of banking, the strength of the local economy, and statements related to the expected or potential impact of the novel coronavirus ("COVID-19") pandemic and related responses of the government. All statements other than statements of historical fact, including statements regarding industry prospects, future results of operations or financial position and the expected or potential impact of COVID-19 and related responses of the government, made in this report are forward-looking. We use words such as "anticipate," "believe," "expect," "intend" and similar expressions in part to help identify forward-looking statements. Forward-looking statements reflect management's current plans and expectations and are inherently uncertain. Our actual results may differ significantly from management's expectations, and those variations may be both material and adverse. Forward-looking statements, whether concerning COVID-19 and the government response related thereto or otherwise, are subject to various risks and uncertainties that may cause our actual results to differ materially and adversely from our expectations as indicated in the forward-looking statements. These risks and uncertainties include: the uncertainties relating to the impact of COVID-19 on the Company's credit quality, business, operations and employees; the availability and terms of funding from government sources related to COVID-19; the timing of Paycheck Protection Program ("PPP") loan forgiveness; the general condition of, and changes in, theAlaska economy; our ability to maintain or expand our market share or net interest margin; our ability to maintain asset quality; our ability to implement our marketing and growth strategies; and our ability to execute our business plan. Further, actual results may be affected by competition on price and other factors with other financial institutions; customer acceptance of new products and services; the regulatory environment in which we operate; and general trends in the local, regional and national banking industry and economy. Many of these risks, as well as other risks that may have a material adverse impact on our operations and business, are identified in Part II. Item 1A Risk Factors of this report and Item 1A in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , as well as in our other filings with theSecurities and Exchange Commission . However, you should be aware that these factors are not an exhaustive list, and you should not assume these are the only factors that may cause our actual results to differ from our expectations. In addition, you should note that forward looking statements are made only as of the date of this report and that we do not intend to update any of the forward-looking statements or the uncertainties that may adversely impact those statements, other than as required by law.
Critical Accounting Policies
The preparation of the consolidated financial statements requires us to make a
number of estimates and assumptions that affect the reported amounts and
disclosures in the consolidated financial statements. On an ongoing basis, we
evaluate our estimates and assumptions based upon historical experience and
various other factors and circumstances. We believe that our estimates and
assumptions are reasonable; however, actual results may differ significantly
from these estimates and assumptions which could have a material impact on the
carrying value of assets and liabilities at the balance sheet dates and on our
results of operations for the reporting periods.
The accounting policies that involve significant estimates and assumptions by
management, which have a material impact on the carrying value of certain assets
and liabilities, are considered critical accounting policies. The Company's
critical accounting policies include those that address the accounting for the
allowance for loan losses ("Allowance"), valuation of goodwill and other
intangible assets, the valuation of other real estate owned ("OREO"), and the
valuation of mortgage servicing rights. These critical accounting policies are
further described in Item 7, Management's Discussion and Analysis, and in Note
1, Summary of Significant Accounting Policies, of the Notes to Consolidated
Financial Statements in the Company's Annual Report on Form 10-K for the year
ended December 31, 2019 . Management has applied its critical accounting policies
and estimation methods consistently in all periods presented in these
consolidated financial statements.
44
--------------------------------------------------------------------------------Impact of accounting pronouncements to be implemented in future periods
InJune 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 afterDecember 15, 2019 , and must be applied prospectively. However, onOctober 16, 2019 the FASB voted to delay ASU 2016-13 for Smaller Reporting Companies. In addition, onMarch 27, 2020 , the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was signed by the President ofthe United States that included an option for entities to delay the implementation of ASU 2016-13 until the earlier of the termination date of the national emergency declaration by the President orDecember 31, 2020 . The Company has electedSmall 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 afterDecember 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 current expected credit losses ("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 offbalance- 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 aSmaller Reporting Company , the Company is not required to adopt CECL beforeJanuary 1, 2023 , and we have elected not to early adopt as ofJanuary 1, 2020 . However, we have the option to early adopt CECL as of eitherJanuary 1, 2021 , orJanuary 1, 2022 . Based on our loan portfolio composition atSeptember 30, 2020 , and the Company's current economic forecast, had we elected to early adopt CECL as ofSeptember 30, 2020 , we estimate the impact of adoption to be an overall decrease in our allowance for credit losses ("ACL") for loans between approximately$2.0 million and$3.0 million . The estimated 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 ofSeptember 30, 2020 . 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 we adopt 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. 45 --------------------------------------------------------------------------------
Update on Economic Conditions
When 2020 began, it appeared thatAlaska's economy was on track for a solid year of growth. A three year mild recession starting in 2016 ended in the 4th quarter of 2018. For the next 18 consecutive months,Alaska's total number of jobs grew month over month compared to the prior year according to theState Department of Labor ("DOL"). That came to an abrupt end in April of 2020 when the full force of the COVID pandemic shocked the global economy.Alaska faced unemployment rates as high as 13.5% in April after being as low as 5.2% in March of 2020. The DOL has reported that unemployment rates have moderated each of the last four months since the high in April. The seasonally adjusted unemployment rate improved from 11.6% in July to 7.4% in August. In August of 2020,Alaska had approximately 37,000 fewer payroll jobs than August of 2019. Oil prices have been fluctuating significantly in 2020 as the global economy reacts to the COVID-19 pandemic. Average monthly Alaska North Slope ("ANS") crude oil prices began the year averaging$65.48 for the month of January. The virus concerns began to have an effect when monthly ANS prices declined to$54.48 in February and$33.21 in March. In the second quarter, ANS prices hit a monthly average low of$16.54 in April and increased to$28.21 in May. The ANS price has firmed up in the$40 range for the last four months. ANS averaged$41.78 in June,$43.56 in July,$43.36 in August and$40.42 in September. Despite the serious economic challenges of COVID, there has been extensive government spending to offset the negative impacts of shutdown mandates in the interest of public health. ForAlaska this has meant approximately$5.6 billion in total direct aid to date. To put that in perspective, the Gross State Product ("GSP") of all annual economic activity inAlaska was measured at$45.6 billion in the second quarter of 2020. So that is equivalent to 12% or 1/8th ofAlaska's entire GSP. The stimulus is most easily seen in the personal income data.The Federal Bureau of Economic Analysis ("BEA") reported personal income forAlaska rose by$2.6 billion or 24% in the second quarter of 2020 as compared to the first quarter of 2020. This was largely a result of a$4.9 billion increase in government transfer payments. There was a$2.2 billion reduction in wage income and a$139 million decrease in investment and rental income. In other words, the increase in government transfer payments was more than double the loss in wages and decrease in dividends, interest and rental income combined. Inflation is still very low in theU.S. and even negative inAlaska . TheU.S. inflation rate is up 1.3% over the last 12 months according to theBureau of Labor Statistics ("BLS"). This has been consistently below theFederal Reserve's target rate of 2%. The BLS reported the consumer price index forAnchorage has actually been a negative 1.5% over the last 12 months. Notable declines in prices include gasoline -17.3% and clothing -10.1%. As always it is a mixed bag. Food and beverage prices have risen by 5.2% and health care costs are up 7.7% according to the BLS. The housing market has been remarkably stable and even positive inAlaska in 2020. Prices have increased on average 4.3% inAnchorage , 7.5% in the Mat-Su, 4% inFairbanks , 7.2% on theKenai Peninsula and 11% inKodiak according to theMultiple Listing Service ("MLS"). The number of homes sold is also higher in all these markets exceptKenai , which is down just slightly from last year.Alaska's delinquency and foreclosure levels continue to be better than most of the nation. According to theMortgage Bankers Association ,Alaska's foreclosure rate was 0.60% at the end of the first quarter 2020 and it declined to 0.54% in the second quarter. That compares to 0.73% and 0.68% at the end of the first and second quarter of 2020 for theU.S. TheMortgage Bankers Association national survey reported that the percentage of delinquent mortgage loans inAlaska was 3.23% in the first quarter of 2020 and rose to 7.69% in the second quarter. The comparableU.S. rate was 4% in the first quarter of 2020 and 7.97% in the second quarter. Borrowers who took advantage of three month forbearance programs to delay payments show up as technically delinquent until they are approved for a formal restructure of their missed loan payments or until they catch up on the three months of missed payments. 46 --------------------------------------------------------------------------------
COVID-19 Issues:
•Industry Exposure: Northrim has identified various industries that may be adversely impacted by the COVID-19 pandemic and the significant decline in oil prices. Though the industries affected may change through the progression of the pandemic, the following sectors for which the Company has exposure, as a percent of the total loan portfolio as ofSeptember 30, 2020 are being impacted: Tourism (4%), Oil and Gas (4%), Aviation (non-tourism) (4%), Healthcare (6%), Accommodations (3%), Retail (2%) and Restaurants (2%). The Company's exposure as a percent of the total loan portfolio excluding SBA PPP loans as ofSeptember 30, 2020 are: Tourism (6%), Oil and Gas (6%), Aviation (non-tourism) (5%), Healthcare (7%), Accommodations (3%), Retail (2%) and Restaurants (2%). •Customer Accommodations: The Company has implemented several forms of assistance to help our customers in the event that they experience financial hardship as a result of COVID-19 in addition to our participation in PPP lending. The provisions of the CARES Act included an election to not apply the guidance on accounting for certain troubled debt restructurings related to COVID-19 and allow certain accommodations to borrowers. These accommodations include interest only and deferral options on loan payments, as well as the waiver of various fees related to loans, deposits and other services. The Company has elected to adopt these provisions of the CARES Act. The outstanding principal balance of loan modifications due to the impacts of COVID-19 were as follows: Loan Modifications due to COVID-19 as of September 30, 2020 (Dollars in thousands) Interest Only Full Payment Deferral Total Portfolio loans$46,056 $74,337 $120,393 Number of modifications 16 59 75 Loan Modifications due to COVID-19 as of June 30, 2020 (Dollars in thousands) Interest Only Full Payment Deferral Total Portfolio loans$64,298 $293,224 $357,522 Number of modifications 76 403 479 Consumer loans represent 1% of total loan modifications identified above. Of the$120 million and 75 loan modifications as ofSeptember 30, 2020 , approximately$11.4 million and 12 loans have entered into a second modification. •Loan Loss Reserve: The Company booked a loan loss provision of$567,000 for the quarter endedSeptember 30, 2020 . This compares to a provision for loan losses of$404,000 during the previous quarter and a$2.1 million benefit for loan loss provision in the third quarter a year ago. •Credit Quality: Net adversely classified loans improved to$14.5 million atSeptember 30, 2020 , as compared to$22.3 million atDecember 31, 2019 . Net loan recoveries were$463,000 in the third quarter of 2020, compared to net loan recoveries of$694,000 in the third quarter of 2019.
•Branch Operations: All branches are fully operational, while a number of customer and employee safety measure continue to be implemented.
•Remote Workers: As ofSeptember 30, 2020 , approximately 50% of the Company's employees are working remotely either on a full- or part-time basis directly due to the pandemic caused by COVID-19. These employees primarily hold non-customer facing positions within the Company. Prior to the pandemic, less than 8% of the Company's employees worked remotely. The increase in the number of employees that work remotely has had no material impact on the Company's operations. •Growth and Paycheck Protection Program: •The Company's asset base increased during the third quarter endedSeptember 30, 2020 , due primarily to commercial and PPP loan originations. •During the third quarter of 2020, Northrim funded an additional 426 PPP loans totaling$22.7 million to both existing and new customers, bringing the PPP portfolio to approximately 2,888 loans totaling$375.6 million atSeptember 30, 2020 . •According to the SBA, the Company originated more SBA PPP loans in theState of Alaska than any other financial institution, funding 23% of the number and 28% of the value of all Alaska PPP loans for the period endingJune 30, 2020 . 47 -------------------------------------------------------------------------------- •As ofSeptember 30, 2020 Northrim has submitted 17 PPP loans totaling$9.2 million for forgiveness through the SBA. •The Company initially utilized theFederal Reserve Bank's Paycheck Protection Program Liquidity Facility (the "PPPLF") to fund PPP loans, but has since paid back those funds in full and has funded the SBA PPP loans through core deposits and maturity of long-term investments. •Capital Management: AtSeptember 30, 2020 , the capital ofNorthrim Bank (the "Bank") was well in excess of all regulatory requirements. The Company resumed its stock repurchase program at the end of August and repurchased 89,000 shares of its common stock in the third quarter of 2020 at an average price of$26.66 , leaving 45,549 shares available under the previously announced repurchase authorization. Highlights and Summary of Performance - Third Quarter of 2020 The Company reported net income and diluted earnings per share of$11.9 million and$1.84 , respectively, for the third quarter of 2020 compared to net income and diluted earnings per share of$7.5 million and$1.11 , respectively, for the third quarter of 2019. The Company reported net income and diluted earnings per share of$22.8 million and$3.52 , respectively, for the first nine months of 2020 compared to net income and diluted earnings per share of$16.1 million and$2.35 , respectively, for the same period in 2019. The increase in net income for the three and nine month periods endingSeptember 30, 2020 compared to the same periods last year is primarily due to an increase in net income in the Home Mortgage Lending segment as a result of increased production. •Total revenue in the third quarter of 2020, which includes net interest income plus other operating income, increased 49% to$39.9 million from$26.8 million in the third quarter a year ago, primarily due to a$10.4 million increase in mortgage banking income. Similarly, total revenue in the first nine months of 2020 increased 28% to$97.0 million from$75.6 million in the first nine months of 2019, primarily due to a$20.0 million increase in mortgage banking income. •Net interest income increased 12% to$18.3 million in the third quarter of 2020 and increased 7% to$51.4 million in the first nine months of 2020 compared to the same periods in 2019 mainly due to increased loans and loans held for sale balances. •Net interest margin decreased to 3.90% in the third quarter of 2020 as compared to 4.60% in the third quarter a year ago and decreased to 4.05% for the first nine months of 2020 compared to 4.71% for the first nine months of 2019 primarily due to lower interest rates. •The provision for loan losses increased to$567,000 and$3.0 million for the three and nine-month periods endingSeptember 30, 2020 , compared to a benefit of$2.1 million and a benefit of$1.0 million in the same periods in 2019. While credit quality has continued to improve as nonperforming loans and adversely classified loans have decreased in 2020, the increase in the provision for loan losses for both periods is the result of management's assessment of risk associated with the COVID-19 pandemic, the reduction in oil prices and a slowingAlaska economy, as well as growth in the unguaranteed portion of the loan portfolio. •The Company paid cash dividends of$0.35 per common share in the third quarter of 2020, up 6% from$0.33 in the third quarter of 2019. 48 --------------------------------------------------------------------------------
Other financial measures are shown in the table below:
Three Months Ended
2020 2019 2020 2019
Return on average assets, annualized 2.31 % 1.90 % 1.62 % 1.41 %
Return on average shareholders' equity,
annualized 22.10 % 14.45 % 14.58 % 10.32 %
Dividend payout ratio 18.95 % 29.17 % 29.22 % 39.40 %
Credit Quality
Nonperforming assets: Nonperforming assets, net of government guarantees at
September 30, 2020 decreased $2.1 million , or 10% to $17.9 million as compared
to $19.9 million at December 31, 2019 . OREO, net of government guarantees,
decreased $81,000 to $5.7 million at September 30, 2020 as compared to $5.8
million at December 31, 2019 due to the sale of one OREO property in the third
quarter of 2020 which was only partially offset by the transfer of one loan to
OREO during the second quarter of 2020. Nonperforming loans, net of government
guarantees decreased $2.9 million during the first nine months of 2020 as
compared to December 31, 2019 , as paydowns and chargeoffs exceeded additions in
the first nine months of 2020. $7.8 million , or 44% of nonperforming assets are
nonaccrual loans and nonperforming purchased receivables related to five
commercial relationships. Two of these relationships, which totaled $3.3 million
at the end of the third quarter of 2020, are businesses in the medical industry.
While it is too early to determine the effect that the COVID-19 pandemic will
ultimately have on our non-performing assets, significant increases may occur in
subsequent quarters.
49
--------------------------------------------------------------------------------
The following table summarizes nonperforming asset activity for the
three-month periods ending
Writedowns Transfers to
/Charge-offs Performing Status Balance at September 30 ,
(In Thousands) Balance at June 30, 2020 Additionsthis quarter Payments this quarter this quarter Transfers to OREO this quarter Sales this quarter
2020
Commercial loans $8,362 $386 ($1,861 ) ($56 ) $- $- $- $6,831
Commercial real estate 5,123 - (98) (85) - - - 4,940
Construction loans 702 - - - - - - 702
Consumer loans 178 - (4) - - - - 174
Nonperforming loans guaranteed by
government (1,635) - 35 - - - - (1,600)
Total nonperforming loans 12,730 386 (1,928) (141) - - - 11,047
Other real estate owned 7,205 - - - - - (243) 6,962
Repossessed assets 919 - - (140) - - - 779
Nonperforming purchased
receivables 1,226 - (816) - - - - 410
Other real estate owned guaranteed
by government (1,279) - - - - - - (1,279)
Total nonperforming assets,
net of government guarantees$20,801 $386 ($2,744 ) ($281 ) $- $- ($243 )$17,919 Writedowns Transfers to /Charge-offs Performing Status Balance at (In Thousands) Balance at June 30, 2019 Additions
this quarter Payments this quarter this quarter Transfers to OREO/REPO this quarter Sales this quarter
$11,207 $1,328 ($1,414 ) ($22 ) ($231 ) $- $-$10,868 Commercial real estate 5,041 - (67) - - - - 4,974 Construction loans 1,492 - (19) - - - - 1,473 Consumer loans 340 7 (213) (7) - - - 127 Nonperforming loans guaranteed by government (1,139) (797) 1 - - - - (1,935) Total nonperforming loans 16,941 538 (1,712) (29) (231) - - 15,507 Other real estate owned 7,043 - - - - - - 7,043 Repossessed assets 1,182 231 - - - - (1,182) 231 Other real estate owned guaranteed by government (1,279) - - - - - - (1,279)
Total nonperforming assets,
net of government guarantees$23,887 $769 ($1,712 ) ($29 ) ($231 ) $- ($1,182 )$21,502 Potential problem loans: Potential problem loans are loans which are currently performing in accordance with contractual terms but that have developed negative indications that the borrower may not be able to comply with present payment terms and which may later be included in nonaccrual, past due, or impaired loans. These loans are closely monitored and their performance is reviewed by management on a regular basis. AtSeptember 30, 2020 , management had identified potential problem loans of$7.6 million as compared to potential problem loans of$9.0 million atDecember 31, 2019 . The decrease in potential problem loans fromDecember 31, 2019 toSeptember 30, 2020 is primarily the result of$3.2 million in paydowns and the addition of a government guarantee on one loan totaling$1.4 million . Three commercial relationships totaling$1.1 million as ofDecember 31, 2019 , net of government guarantees, were transferred to nonaccrual status, and there were four new potential problem loans during the first nine months of 2020 totaling$4.3 million , net of government guarantees. Troubled debt restructurings ("TDRs"): TDRs are those loans for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower, have been granted due to the borrower's weakened financial condition. Interest on TDRs will be accrued at the restructured rates when it is anticipated that no loss of original principal will occur, and the interest can be collected, which is generally after a period of six months. The Company had$2.4 million in loans 50 -------------------------------------------------------------------------------- classified as TDRs that were performing and$6.1 million in TDRs included in nonaccrual loans atSeptember 30, 2020 for a total of approximately$8.5 million . There are$2.5 million in government guarantees associated with TDRs, so total TDRs, net of government guarantees, are$5.9 million atSeptember 30, 2020 . AtDecember 31, 2019 there were$1.4 million in loans classified as TDRs that were performing and$8.7 million in TDRs included in nonaccrual loans for a total of$10.1 million . See Note 4 of the Notes to Consolidated Financial Statements included in Item 1 of this report for further discussion of TDRs. RESULTS OF OPERATIONS Income Statement Net Income Net income for the third quarter of 2020 increased$4.3 million , or 57%, to$11.9 million as compared to$7.5 million for the same period in 2019. Net income for the first nine months of 2020 increased$6.7 million , or 41%, to$22.8 million compared to$16.1 million for the first nine months of 2019. The increase in net income in both periods is primarily due to an increase in net income in the Home Mortgage Lending segment as a result of increased production.
Net Interest Income/Net Interest Margin
Net interest income for the third quarter of 2020 increased$2.0 million , or 12%, to$18.3 million as compared to$16.3 million for the third quarter of 2019. Net interest margin decreased 70 basis points to 3.90% in the third quarter of 2020 as compared to 4.60% in the third quarter of 2019. Net interest income for the first nine months of 2020 increased$3.4 million , or 7%, to$51.4 million as compared to$48.0 million for the first nine months of 2019. Net interest margin decreased 66 basis points to 4.05% in the first nine months of 2020 as compared to 4.71% in the first nine months of 2019. The increase in net interest income in the third quarter and first nine months of 2020 compared to the same periods of 2019 was primarily the result of higher interest income on loans and loans held for sale due to increased balances. The decrease in net interest margin in the third quarter and the first nine months of 2020 as compared to the same periods a year ago was primarily the result of the reduction in short-term interest rates in 2020 and the impact of the SBA PPP loans on the resulting yields in the loan portfolio. Changes in net interest margin in the three and nine months endedSeptember 30, 2020 as compared to the same period in the prior year are detailed below: Three
Months Ended
2020 vs. September 30, 2019
Nonaccrual interest adjustments 0.19 %
Impact of SBA Paycheck Protection Program loans (0.33) %
Interest rates and loan fees (0.61) %
Volume and mix of interest-earning assets 0.05 %
Change in net interest margin (0.70) %
Nine Months Ended September 30,
2020 vs. September 30, 2019
Nonaccrual interest adjustments 0.08 %
Impact of SBA Paycheck Protection Program loans (0.18) %
Interest rates and loan fees (0.53) %
Volume and mix of interest-earning assets (0.03) %
Change in net interest margin (0.66) %
51-------------------------------------------------------------------------------- Components of Net Interest Margin The following table compares average balances and rates as well as margins on earning assets for the three-month periods endedSeptember 30, 2020 and 2019: (Dollars in Thousands) Three Months Ended September 30, Interest income/ Average Balances Change expense Change Average Yields/Costs 2020 2019 $ % 2020 2019 $ % 2020 2019 Change Loans1,2$1,465,839 $1,020,186 $445,653 44 %$17,734 $15,154 $2,580 17 % 4.81 % 5.89 % (1.08) % Loans held for sale 122,994 74,181 48,813 66 % 957 709 248 35 % 3.10 % 3.79 % (0.69) % Short-term investments3 60,504 58,754 1,750 3 % 17 313 (296) (95) % 0.11 % 2.11 % (2.00) % Long-term investments4 217,599 253,364 (35,765) (14) % 1,086 1,661 (575) (35) % 1.99 % 2.60 % (0.61) % Total investments 278,103 312,118 (34,015) (11) % 1,103 1,974 (871) (44) % 1.58 % 2.51 % (0.93) % Interest-earning assets 1,866,936 1,406,485 460,451 33 % 19,794 17,837 1,957 11 % 4.22 % 5.03 % (0.81) % Nonearning assets 172,853 169,907 2,946 2 % Total$2,039,789 $1,576,392 $463,397 29 % Interest-bearing demand$409,758 $288,781 $120,977 42 %$156 $167 ($11 ) (7) % 0.15 % 0.23 % (0.08) % Savings deposits 266,588 234,130 32,458 14 % 168 285 (117) (41) % 0.25 % 0.48 % (0.23) % Money market deposits 218,965 209,147 9,818 5 % 153 303 (150) (50) % 0.28 % 0.57 % (0.29) % Time deposits 181,882 138,311 43,571 32 % 843 610 233 38 % 1.84 % 1.75 % 0.09 % Total interest-bearing deposits 1,077,193 870,369 206,824 24 % 1,320 1,365 (45) (3) % 0.49 % 0.62 % (0.13) % Borrowings 23,574 19,749 3,825 19 % 180 166 14 8 % 3.04 % 3.33 % (0.29) % Total interest-bearing liabilities 1,100,767 890,118 210,649 24 % 1,500 1,531 (31) (2) % 0.54 % 0.68 % (0.14) % Demand deposits and other noninterest-bearing liabilities 725,585 479,372 246,213 51 % Equity 213,437 206,902 6,535 3 % Total$2,039,789 $1,576,392 $463,397 29 % Net interest income$18,294 $16,306 $1,988 12 % Net interest margin 3.90 % 4.60 % (0.70) % Average loans to average interest-earning assets 78.52 % 72.53 % Average loans to average total deposits 83.75 % 78.01 % Average non-interest deposits to average total deposits 38.45 % 33.45 % Average interest-earning assets to average interest-bearing liabilities 169.60 %
158.01 %
1Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled$2.2 million and$841,000 in the third quarter of 2020 and 2019, respectively. 2Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loan balances were$13.9 million and$17.8 million in the third quarter of 2020 and 2019, respectively. 3Consists of interest bearing deposits in other banks. 4Consists of investment debt securities available for sale, equity securities, investment securities held to maturity, and investment inFederal Home Loan Bank stock. 52 -------------------------------------------------------------------------------- The following tables set forth the changes in consolidated net interest income attributable to changes in volume and to changes in interest rates for the three-month periods endingSeptember 30, 2020 and 2019. Changes attributable to the combined effect of volume and interest rate have been allocated proportionately to the changes due to volume and the changes due to interest rates: (In Thousands) Three Months Ended September 30, 2020 vs. 2019 Increase (decrease) due to Volume Rate Total Interest Income: Loans$2,658 ($78 )$2,580 Loans held for sale 342 (94) 248 Short-term investments 9 (305) (296) Long-term investments (219) (356) (575) Total interest income$2,790 ($833 )$1,957 Interest Expense: Interest-bearing deposits$282 ($327 ) ($45 ) Borrowings 28 (14) 14 Total interest expense$310 ($341 ) ($31 ) 53
-------------------------------------------------------------------------------- The following table compares average balances and rates as well as margins on earning assets for the nine-month periods endedSeptember 30, 2020 and 2019: (Dollars in Thousands) Nine Months Ended September 30, Interest income/ Average Balances Change expense Change Average Yields/Costs 2020 2019 $ % 2020 2019 $ % 2020 2019 Change Loans1,2$1,289,838 $1,004,157 $285,681 28 %$49,237 $44,607 $4,630 10 % 5.10 % 5.94 % (0.84) % Loans held for sale 95,050 52,379 42,671 81 % 2,267 1,586 681 43 % 3.19 % 4.05 % (0.86) % Short-term investments3 60,011 35,394 24,617 70 % 284 591 (307) (52) % 0.63 % 2.23 % (1.60) % Long-term investments4 252,594 271,645 (19,051) (7) % 4,349 5,237 (888) (17) % 2.30 % 2.58 % (0.28) % Total investments 312,605 307,039 5,566 2 % 4,633 5,828 (1,195) (21) % 1.98 % 2.54 % (0.56) % Interest-earning assets 1,697,493 1,363,575 333,918 24 % 56,137 52,021 4,116 8 % 4.42 % 5.10 % (0.68) % Nonearning assets 177,811 166,548 11,263 7 % Total$1,875,304 $1,530,123 $345,181 23 % Interest-bearing demand$370,270 $261,295 $108,975 42 %$476 $313 $163 52 % 0.17 % 0.16 % 0.01 % Savings deposits 247,605 234,177 13,428 6 % 581 830 (249) (30) % 0.31 % 0.47 % (0.16) % Money market deposits 213,201 207,350 5,851 3 % 574 846 (272) (32) % 0.36 % 0.55 % (0.19) % Time deposits 176,046 127,094 48,952 39 % 2,504 1,488 1,016 68 % 1.90 % 1.57 % 0.33 % Total interest-bearing deposits 1,007,122 829,916 177,206 21 % 4,135 3,477 658 19 % 0.55 % 0.56 % (0.01) % Borrowings 39,645 38,618 1,027 3 % 561 512 49 10 % 1.89 % 1.77 % 0.12 % Total interest-bearing liabilities 1,046,767 868,534 178,233 21 % 4,696 3,989 707 18 % 0.60 % 0.61 % (0.01) % Demand deposits and other noninterest-bearing liabilities 619,772 452,772 167,000 37 % Equity 208,765 208,817 (52) - % Total$1,875,304 $1,530,123 $345,181 23 %
Net interest income$51,441 $48,032 $3,409 7 % Net interest margin 4.05 % 4.71 % (0.66) % Average loans to average interest-earning assets 75.98 % 73.64 % Average loans to average total deposits 81.79 % 80.48 % Average non-interest deposits to average total deposits 36.14 % 33.48 % Average interest-earning assets to average interest-bearing liabilities 162.17 %
157.00 %
1Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled$5.1 million and$2.4 million in the first nine months of 2020 and 2019, respectively. 2Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loan balances were$14.4 million and$17.2 million in the first six months of 2020 and 2019, respectively. 3Consists of interest bearing deposits in other banks. 4Consists of investment debt securities available for sale, equity securities, investment securities held to maturity, and investment inFederal Home Loan Bank stock. 54 -------------------------------------------------------------------------------- The following tables set forth the changes in consolidated net interest income attributable to changes in volume and to changes in interest rates for the nine-month periods endingSeptember 30, 2020 and 2019. Changes attributable to the combined effect of volume and interest rate have been allocated proportionately to the changes due to volume and the changes due to interest rates: (In Thousands) Nine Months Ended September 30, 2020 vs. 2019 Increase (decrease) due to Volume Rate Total Interest Income: Loans$4,751 ($122 )$4,629 Loans held for sale 925 (243) 682 Short-term investments 123 (430) (307) Long-term investments (363) (525) (888) Total interest income$5,436 ($1,320 )
Interest Expense:
Interest-bearing deposits $785 ($20 ) $765
Borrowings 13 36 49
Total interest expense $798 $16 $814 Provision for Loan Losses
The provision for loan losses increased to$567,000 for the third quarter of 2020 and$3.0 million for the first nine months of 2020 compared to a benefit for loan losses of$2.1 million in the third quarter of 2019 and a benefit for loan losses of$1.0 million for the first nine months of 2019. While credit quality has continued to improve as nonperforming loans and adversely classified loans have decreased in 2020 as compared to the prior year, the increase in the provision for loan losses for both periods is the result of management's assessment of risk associated with the COVID-19 pandemic, the reduction in oil prices and a slowingAlaska economy, as well as growth in the unguaranteed portion of the loan portfolio. The ratio of the Allowance to total nonperforming loans, net of government guarantees was 196% atSeptember 30, 2020 and 137% atDecember 31, 2019 .
See "Analysis of Allowance for Loan Losses" under the "Financial Condition-Balance Sheet Overview" and Note 5 of the Notes to Consolidated Financial Statements included in Item 1 of this report for more information on changes in the Company's Allowance.
Other Operating Income
Other operating income for the three-month period endedSeptember 30, 2020 , increased$11.1 million , or 105%, to$21.6 million as compared to$10.5 million for the same period in 2019, primarily due to the$10.4 million increase in mortgage banking income in the third quarter of 2020 compared to the same quarter in 2019. This increase in mortgage banking income in the three months endedSeptember 30, 2020 as compared to the same period in 2019 was primarily due to increased refinance activity and home purchases due to changes in the mortgage interest rates. Additionally, the Company recognized$726,000 in interest rate swap fee income in the third quarter of 2020. This increase was only partially offset by a decrease in purchased receivable income due to customers reportedly using PPP funds instead of selling receivables, and a decrease in service charges on deposit accounts due to customer accommodations related to the impacts of COVID19 as compared to the third quarter of 2019. 55 -------------------------------------------------------------------------------- Other operating income for the first nine months of 2020 increased$18.0 million , or 65%, to$45.6 million as compared to$27.6 million for the same period in 2019, primarily due to a$20.0 million increase in mortgage banking income. Similar to the third quarter, this increase in mortgage banking income was primarily due to increased refinance activity and home purchases due to changes in the mortgage interest rates. This increase in the first nine months of 2020 was only partially offset by decreases in purchased receivable income, due to customers reportedly using PPP funds instead of selling receivables, a decrease in service charges on deposit accounts due to customer accommodations related to the impacts of COVID19 as compared to the first nine months of 2019, and the recognition of a$347,000 unrealized loss on marketable securities in the first nine months of 2020 compared to a$782,000 unrealized gain on marketable securities for the same period in 2019.
Other Operating Expense
Other operating expense for the third quarter of 2020 increased$4.2 million , or 22%, to$23.5 million as compared to the same period in 2019 primarily due to higher salaries and other personnel expense and other miscellaneous operating expenses related to mortgage banking operations, which fluctuate with production volumes. Other operating expense for the first nine months of 2020 increased$8.7 million , or 16%, to$65.0 million from$56.2 million in the same period in 2019 primarily due to higher salaries and other personnel expense and other miscellaneous operating expenses related to mortgage banking operations, which fluctuate with production volumes. Additionally, data processing costs in the Community Banking segment were higher due to charges for additional products and services, and insurance expense in the Community Banking segment increased because of higherFDIC insurance due to the increase in total assets.
Income Taxes
The provision for income taxes for the third quarter of 2020 increased$2.0 million , or 97%, as compared to the same period in 2019. The provision for income taxes in the first nine months of 2020 increased$1.9 million , or 44%, as compared to the first nine months of 2019. The increase in the three-month period endingSeptember 30, 2020 as compared to the same period in 2019 was primarily due to the increase in pretax income. The effective tax rate increased to 25% in the three-month period endingSeptember 30, 2020 as compared to 21% in the same period in 2019, and the effective tax rate increased to 22% in the nine-month period endingSeptember 30, 2020 as compared to 21% in the same period in 2019. The increased rate in both the three and nine-month periods endingSeptember 30, 2020 was primarily due to decreased tax credits and tax exempt interest income as a percentage of net income which was only partially offset by the reversal of a$454,000 accrual for a potential increase in tax expense related to an audit that was performed in 2018 by theState of Alaska for tax years 2014-2016. The Company has appealed theState of Alaska's decision on this matter and reversed this accrual in the second quarter of 2020 because the Company believes that it is more likely than not that the court will rule in the Company's favor.
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