NORTHRIM BANCORP, INC. 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 ofDecember 31, 2020 , 2019 and 2018 included in Part II. Item 8 of this report. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 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 endedDecember 31, 2019 . 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 59% to$32.9 million or$5.11 per diluted share for the year endedDecember 31, 2020 , from$20.7 million , or$3.04 per diluted share, for the year endedDecember 31, 2019 . Significant items contributing to the increase in 2020 compared to 2019 were: •an increase in mortgage banking income due to increased mortgage production and refinance activity; and •an increase in net interest income resulting from higher average net interest-earning asset balances. Highlights for the year endedDecember 31, 2020 are as follows: •Total revenues, which include net interest income plus other operating income, increased 32% to$134.0 million in 2020 from$101.8 million in 2019. This increase mainly reflects increases in net interest income and mortgage banking income. These increases were partially offset by a decreases in purchased receivable income and unrealized gains on marketable equity securities. •The net interest margin decreased to 4.02% in 2020 from 4.65% in 2019 mostly due to a decrease in average yields on interest earning assets to 4.36% in 2020 compared to 5.05% in 2019 as a result of lower interest rates. Additionally, the mix of earning assets, specifically the addition of lower yielding PPP loans, also contributed to the decrease in the net interest margin in 2020 as compared to the prior year. •The provision for loan losses increased in 2020 to a provision of$2.4 million from a benefit of$1.2 million in 2019 primarily due to management's assessment of risks associated with the COVID-19 pandemic, which were only partially offset by improvement in the overall credit quality of the loan portfolio. Our nonperforming loans, net of government guarantees, decreased to$10.0 million at the end of 2020 compared to$14.0 million at the end of 2019, while total adversely classified loans, net of government guarantees atDecember 31, 2020 decreased to$12.8 million from$22.3 million atDecember 31, 2019 . The allowance for loan losses ("Allowance") totaled 1.46% of total portfolio loans atDecember 31, 2020 , compared to 1.83% atDecember 31, 2019 . The Allowance compared to nonperforming loans, net of government guarantees, was 210% atDecember 31, 2020 compared to 137% at the end of 2019. •Return on average assets was 1.70% in 2020 compared to 1.33% in 2019. •The Company continued to maintain strong capital ratios with Tier 1 Capital to Risk Adjusted Assets of 14.20% atDecember 31, 2020 as compared to 14.38% atDecember 31, 2019 . •The aggregate cash dividends paid by the Company in 2020 rose 4% to$8.8 million from$8.5 million paid in 2019. •The Company repurchased 327,000 shares of its common stock in 2020 at an average price of$30.51 per share. 37 -------------------------------------------------------------------------------- COVID-19 Issues: •Industry Exposure: Northrim has identified various industries that may be adversely impacted by the COVID-19 pandemic and the decline in oil prices that occurred in 2020. 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 ofDecember 31, 2020 are being impacted: Tourism (5%), Oil and Gas (4%), Aviation (non-tourism) (4%), Healthcare (7%), Accommodations (3%), Retail (1%) and Restaurants (2%). The Company's exposure as a percent of the total loan portfolio excluding PPP loans as ofDecember 31, 2020 are: Tourism (7%), Oil and Gas (6%), Aviation (non-tourism) (5%), Healthcare (8%), Accommodations (3%), Retail (2%) and Restaurants (3%). •Customer Accommodations: The Company has implemented several forms of assistance to help customers experiencing financial challenges 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 economic impacts of COVID-19 for the periods below were as follows: Loan Modifications due to COVID-19 as of December 31, 2020 (Dollars in thousands) Interest Only Full Payment Deferral Total Portfolio loans$43,379 $22,165 $65,544 Number of modifications 23 11 34 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 less than 1% of total loan modifications identified above. Of the$65.5 million and 34 loan modifications as ofDecember 31, 2020 , approximately$53.9 million and 31 loans have entered into a second modification. •Loan Loss Reserve: The Company booked a loan loss provision of$2.4 million in 2020 compared to a benefit for loan loss provisions of$1.2 million in 2019.
•Credit Quality: Net adversely classified loans were
•Branch Operations: All branches are fully operational, while a number of customer and employee safety measure continue to be implemented.
•Growth and Paycheck Protection Program: •Northrim funded 2,888 PPP loans totaling$375.6 million to both existing and new customers in 2020. •According to the SBA, the Company originated more 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 endingSeptember 30, 2020 . •As ofDecember 31, 2020 , Northrim customers had received forgiveness through the SBA on 537 PPP loans totaling$65.1 million . •The Company initially utilized theFederal Reserve Bank's Paycheck Protection Program Liquidity Facility (the "PPPLF") to fund PPP loans, but paid those funds back in full during the second quarter and has since funded the PPP loans through core deposits and maturity of long-term investments. 38 --------------------------------------------------------------------------------
•Capital Management: At
Critical Accounting Policies
TheSEC 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 theSEC'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 economic conditions, the level and trend of charge offs or 39 -------------------------------------------------------------------------------- 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. 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 ofDecember 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 atDecember 31, 2020 and 2019 in accordance with the policy described in Note 1 to the financial statements included with this report. AtDecember 31, 2020 , the Company performed its annual impairment test by performing a quantitative assessment. The Company estimated the fair value of the Company using two valuation methodologies including a control premium approach and a discounted cash flow approach. We then compared the estimated fair value of each segment to the carrying value and concluded that no potential impairment existed at ofDecember 31, 2020 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. 40 --------------------------------------------------------------------------------
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" or "CECL"). 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. 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 . Early application was permitted for specified periods. The Company early adopted ASU 2016-13 onJanuary 1, 2021 after finalizing data and model validation and our internal governance framework. The guidance was applied on a modified retrospective basis with the cumulative effect of initially applying the amendments recognized in retained earnings atJanuary 1, 2021 . However, certain provisions of the guidance are only required to be applied on a prospective basis. Adoption of CECL as ofJanuary 1, 2021 resulted in an allowance for loan losses of$16.6 million , which is a$4.5 million decrease in the allowance under the incurred loss model as ofDecember 31, 2020 . This decrease will increase the Company's total shareholder's equity by$3.2 million . The reduction reflects a 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 ofDecember 31, 2020 . In most instances the Company believes that the ACL for residential mortgage loans with long or indeterminate maturities would lead to an increase in the ACL. Adoption of CECL as ofJanuary 1, 2021 resulted in a reserve for unfunded commitments of$1.4 million , which is a$1.2 million increase in the reserve under the incurred loss model as ofDecember 31, 2020 . This increase will decrease the Company's total shareholder's equity by$880,000 . See the "Accounting pronouncements to be implemented in future periods" section in Note 1 of the Notes to Consolidated Financial Statements included in Part II. Item 8 of this report for further discussion of the Company's implementation of CECL. RESULTS OF OPERATIONS Income Statement Net Income Our results of operations are dependent to a large degree on our net interest income. We also generate other income primarily through mortgage banking income, purchased receivables products, service charges and fees, and bankcard fees. Our operating expenses consist in large part of salaries and other personnel costs, 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 of$32.9 million in 2020, compared to net income of$20.7 million in 2019. During these periods, net income per diluted share was$5.11 and$3.04 , respectively. The increase in net income in 2020 compared to 2019 was primarily due to increases in other operating income, specifically mortgage banking income, as well as improved net interest income. 41 --------------------------------------------------------------------------------
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 2020 was$70.7 million , compared to$64.4 million in 2019. The increase in 2020 as compared to 2019 was the result of higher net average interest-earning asset balances which was only partially offset by a decrease in net interest income as a result of decreased interest rates. Additionally, the Company recognized$5.6 million in loan fee income from PPP loans in 2020. During 2020 and 2019, net interest margins were 4.02% and 4.65%, respectively. The decrease in net interest margin in 2020 as compared to 2019 is the result of decreases in the spread between the average yield on interest-earning assets and the average cost of interest-bearing liabilities which was impacted by a decrease in interest rates.
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
2020 2019 2018
Average outstanding Interest income / Average Yield / Average outstanding Interest income / Average Yield / Average outstanding Interest income / Average Yield /
(In Thousands) balance expense Cost balance expense Cost balance expense Cost
Loans (1),(2) $1,339,908 $67,876 5.07 % $1,010,098 $59,919 5.93 % $971,548 $55,526 5.72 %
Loans held for sale 105,287 3,215 3.05 % 56,344 2,231 3.96 % 46,089 2,016 4.37 %
Long-term Investments(3) 247,384 5,316 2.15 % 273,711 7,011 2.56 % 286,426 5,829 2.04 %
Short-term investments(4) 66,260 309 0.47 % 46,404 922 1.99 % 42,386 806 1.90 %
Total interest-earning assets $1,758,839 $76,716 4.36 % $1,386,557 $70,083 5.05 % $1,346,449 $64,177 4.77 %
Noninterest-earning assets 177,208 169,150 146,936
Total $1,936,047 $1,555,707 $1,493,385
Interest-bearing deposits $1,040,606 $5,279 0.51 % $850,202 $4,961 0.58 % $809,808 $2,307 0.28 %
Borrowings 35,918 772 2.15 % 33,730 680 1.37 % 47,570 662 1.39 %
Total interest-bearing liabilities $1,076,524 $6,051 0.56 % $883,932 $5,641 0.64 % $857,378 $2,969 0.35 %
Noninterest-bearing demand deposits 597,610 426,205 417,464
Other liabilities 50,192 36,968 17,521
Equity 211,721 208,602 201,022
Total $1,936,047 $1,555,707 $1,493,385
Net interest income $70,665 $64,442 $61,208
Net interest margin 4.02 % 4.65 % 4.55 %
Average portfolio loans to average-earnings assets 76.18 % 72.85 % 72.16 %
Average portfolio loans to average total deposits 81.79 % 79.14 % 79.16 %
Average non-interest deposits to average total
deposits 36.48 % 33.39 % 34.02 %
Average interest-earning assets to average
interest-bearing liabilities 163.38 % 156.86 % 157.04 %
1Interest income includes loan fees. Loan fees recognized during the period and
included in the yield calculation totaled $8.9 million , $3.3 million and $3.0
million for 2020, 2019 and 2018, respectively.
2Nonaccrual loans are included with a zero effective yield. Average nonaccrual
loans included in the computation of the average loans were $13.8 million , $16.9
million , and $17.5 million in 2020, 2019 and 2018, 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.
42
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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:
2020 compared to 2019 2019 compared to 2018
Increase (decrease) due to Increase (decrease) due to
(In Thousands) Volume Rate Total Volume Rate Total
Interest Income:
Loans $17,590 ($9,633 ) $7,957 $2,246 $2,147 $4,393
Loans held for sale 1,336 (352) 984 374 (159) 215
Long-term investments (634) (1,061) (1,695) (245) 1,427 1,182
Short term investments 779 (1,392) (613) 79 37
116
Total interest income$19,071 ($12,438 )$6,633 $2,454 $3,452 $5,906 Interest Expense: Interest-bearing deposits$763 ($445 )$318 $120 $2,534 $2,654 Borrowings 9 83 92 (29) 47 18 Total interest expense$772 ($362 )$410 $91 $2,581 $2,672 Provision for Loan Losses We recorded a provision for loan losses in 2020 of$2.4 million , compared to a benefit for loan losses of$1.2 million in 2019. The loan loss provision increased in 2020 compared to 2019 primarily due to an increase in the loan portfolio, excluding loans that are guaranteed by the government, and management's assessment about increased risks in the loan portfolio association with the economic impacts of COVID-19. See the "Allowance for Loan Losses" section under "Financial Condition" and Note 6 of the Notes to Consolidated Financial Statements included in Part II. Item 8 of this report for further discussion of these decreases and changes in the Company's Allowance. Other Operating Income The following table details the major components of other operating income for the years endedDecember 31 : (In Thousands) 2020 $ Change %
Change 2019 $ Change % Change 2018 Other Operating Income Mortgage banking income
$52,635 $28,434 117 %$24,201 $3,357 16 %$20,844 Bankcard fees 2,837 (139) (5) % 2,976 165 6 % 2,811 Purchased receivable income 2,650 (621) (19) % 3,271 16 - % 3,255 Service charges on deposit accounts 1,102 (455) (29) % 1,557 49 3 % 1,508 Interest rate swap income 949 (15) (2) % 964 880 1,048 % 84 Commercial servicing revenue 527 (97) (16) % 624 (798) (56) % 1,422 Rental income 278 (219) (44) % 497 (195) (28) % 692 Gain (loss) on sale of securities 98 75 326 % 23 23 100 % - Gain (loss) on marketable equity securities 61 (850) (93) % 911 1,536 246 % (625) Other income 2,191 (131) (6) % 2,322 146 7 % 2,176 Total other operating income$63,328 $25,982 70 %$37,346 $5,179 16 %$32,167 43
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2020 Compared to 2019
The most significant change in other operating income in 2020 was an increase in mortgage banking income which was only partially offset by decreases in gains on marketable equity securities, as well as decreases in purchased receivable income and service charges on deposit accounts. 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 83% of total other operating income in 2020. Mortgage banking income increased in 2020 compared to 2019 mainly due to an increase in mortgage loans originated and sold as this volume increased to$1.30 billion in 2020 from$684 million in 2019. The overall increase in mortgage originations in 2020 as compared to the prior year is primarily the result of the decrease in interest rates during the year that led to increased refinance activity. The Company recognized$61,000 in unrealized gains on marketable equity securities in 2020, an$850,000 decrease as compared to 2019, due to market volatility. Purchased receivable income and service charges on deposit accounts saw significant decreases as compared to 2019. Purchased receivable income decreased as customers reportedly used PPP loans to fund liquidity needs, resulting in decreased outstanding purchased receivable balances. Service charges on deposit accounts decreased due to customer accommodations made by the Company for customers impacted by COVID-19. Other Operating Expense The following table details the major components of other operating expense for the years endedDecember 31 : (In Thousands) 2020 $ Change %
Change 2019 $ Change % Change 2018
Other Operating Expense
Salaries and other personnel expense
19 % $51,317 $6,667 15 % $44,650
Data processing expense 7,668 540 8 % 7,128 1,093 18 % 6,035
Occupancy expense 6,624 17 - % 6,607 471 8 % 6,136
Professional and outside services 3,157 626 25 % 2,531 78 3 % 2,453
Marketing expense 2,320 (53) (2) % 2,373 55 2 % 2,318
Insurance expense 1,228 671 120 % 557 (305) (35) % 862
Compensation expense - RML acquisition
payments - (468) (100) % 468 468 100 % -
Intangible asset amortization 48 (12) (20) % 60 (10) (14) % 70
OREO (income) expense, net rental income and gains on sale:
OREO operating expense 658 (35) (5) % 693 (109) (14) % 802
Rental income on OREO (509) (3) (1) % (506) 35 6 % (541)
Gains on sale of OREO (391) (11) (3) % (380) (377) NM (3)
Subtotal (242) (49) (25) % (193) (451) (175) % 258
Other expenses 7,174 1,184
20 % 5,990 (1,028) (15) % 7,018
Total other operating expense $89,114 $12,276 16 % $76,838 $7,038 10 % $69,800
44--------------------------------------------------------------------------------
2020 Compared to 2019
Other operating expense increased by$12.3 million to$89.1 million in 2020 as compared to$76.8 million in the prior year primarily due to increases in salaries and other personnel expense, as well as smaller increases in insurance expense, professional and outside services, and data processing expense. These increases were only partially offset by a decrease in compensation expense related to RML acquisition payments. 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 required, and therefore no additional expense for RML acquisition payments will be recorded in the future. The$9.8 million increase in salaries and other personnel expense in 2020 as compared to 2019 is the result of the following items. Originator commission expenses increased$5.2 million , or approximately 82% in 2020 compared to 2019 due to increased mortgage production in the home mortgage lending segment. Additionally, overtime expense increased$1 million , or 309% in 2020 compared to 2019 due to increased mortgage production. Salaries increased$1.6 million , or 5%, in 2020 as compared to 2019 due to salary increases and an increase in full-time equivalent employees. Smaller increases also occurred in bonus payments and profit share expense due to the increased mortgage production in the Home Mortgage Lending segment and increased net income for the Community Banking segment. These increases were only partially offset by a$1.6 million increase in salary deferral related to loan production costs and a$696,000 decrease in group medical insurance expense due to lower medical claims associated with the Company's self-insured employee health benefit plan. Insurance expense increased$671,000 primarily as a result of increasedFDIC insurance costs associated with asset growth. Professional and outside services increased$626,000 due to costs associated with increased mortgage production volume. Lastly, data processing expense increased$540,000 in 2020 as compared to 2019 due to costs for improved functionality for digital products and services and the addition of various software applications related to our lending activities.
Income Taxes
The provision for income taxes increased$4.1 million or 76%, to$9.6 million in 2020 as compared to 2019. The increase in 2020 is primarily due to higher pretax income. The Company's effective tax rates were 23% and 21% in 2020 and 2019, respectively. The changes in the Company's effective tax rates for 2020 and 2019 are primarily due to lower tax-exempt income and fewer low income housing tax credits as a percentage of pre-tax income as compared to 2019. FINANCIAL CONDITIONInvestment 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 93% of the portfolio as ofDecember 31, 2020 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 atDecember 31, 2020 decreased$17.4 million , or 6%, to$266.7 million from$284.1 million atDecember 31, 2019 . The decrease atDecember 31, 2020 as compared toDecember 31, 2019 is primarily due to proceeds from sales, maturities, and security calls being used for loan fundings. The average maturity of the investment portfolio was approximately three years atDecember 31, 2020 . Investment securities may be pledged as collateral to secure public deposits or borrowings. AtDecember 31, 2020 and 2019,$77.9 million and$30.6 million in securities were pledged for deposits and borrowings, respectively. Pledged securities increased atDecember 31, 2020 as compared toDecember 31, 2019 primarily due to increased pledges to the FHLB to increase the Company's immediate borrowing capacity atDecember 31, 2020 . 45 -------------------------------------------------------------------------------- The following tables set forth the composition of our investment portfolio atDecember 31 for the years indicated: (In Thousands) Amortized Cost Fair Value Securities Available for Sale: 2020: U.S. Treasury and government sponsored entities$173,318 $174,601 Municipal Securities 820 856 Corporate Bonds 29,951 30,492 Collateralized Loan Obligations 41,782 41,684 Total$245,871 $247,633 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
2020: Preferred Stock$8,395 $9,052 Total$8,395 $9,052 2019: Preferred Stock$7,349 $7,945 Total$7,349 $7,945 2018: Preferred Stock$7,580 $7,265 Total$7,580 $7,265 Securities Held to Maturity: 2020: Corporate Bonds$10,000 $10,000 Total$10,000 $10,000 2019: Corporate Bonds $- $- Total $- $- 2018: Corporate Bonds $- $- Total $- $- 46
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The following table sets forth the market value, maturities, and weighted
average pretax yields of our investment portfolio as of
Maturity
Within Over
(In Thousands) 1 Year 1-5 Years 5-10 Years 10 Years TotalSecurities Available for Sale:
Balance $44,601 $130,000 $- $- $174,601
Weighted average yield 2.06 % 0.82 % - % - % 1.14 %
Municipal securities
Balance $- $856 $- $- $856
Weighted average yield - % 2.14 % - % - % 2.14 %
Corporate bonds
Balance $2,257 $28,235 $- $- $30,492
Weighted average yield 1.23 % 1.36 % - % - % 1.35 %Collateralized loan obligations
Balance $- $- $8,720 $32,964 $41,684
Weighted average yield - % - % 1.70 % 1.60 % 1.62 %
Total
Balance $46,858 $159,091 $8,720 $32,964 $247,633
Weighted average yield 2.02 % 0.92 % 1.70 % 1.60 % 1.25 %
Security Held to Maturity
Corporate bonds
Balance $- $- $10,000 $- $10,000
Weighted average yield - % - % 5.00 % - % 5.00 %Preferred Stock
Balance $- $- $- $9,052 $9,052
Weighted average yield - % - % - % 5.08 % 5.08 %
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, 2020 , 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. Additionally in 2020, we originated a significant amount of PPP
loans and we expect to originate additional PPP loans in 2021.
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 $29.9 million at December 31, 2020 . At December 31,
2020 , the Company had three relationships whose total direct and indirect
commitments exceeded $29.9 million ; however, no individual direct relationship
exceeded the loans-to-one borrower limitation. See "Management's Discussion and
Analysis of Financial Condition and
47
--------------------------------------------------------------------------------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. OurQuality Assurance Department provides a detailed financial analysis of our largest, most complex loans. In addition, theQuality 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, ourInternal 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 theFDIC 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, 2020 December 31, 2019 December 31, 2018 December 31, 2017 December 31, 2016 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
$780,058 54.0 %$412,690 39.5 %$342,420
34.8 %
38,467 2.7 % 38,818 3.7 % 37,111 3.8 % 31,201 3.3 % 26,061 2.7 %
Real estate construction other 80,315 5.6 % 61,808 5.9 % 72,256 7.3 % 80,093 8.4 % 72,159 7.4 %
Real estate term owner occupied 163,597 11.3 % 138,891 13.3 % 126,414 12.8 % 132,042 13.8 % 152,112 15.6 % Real estate term non-owner occupied
309,074 21.4 % 312,960 30.0 % 325,720 33.1 % 319,313 33.4 % 356,411 36.6 % Real estate term other
46,620 3.2 % 42,506 4.1 % 42,039 4.3 % 40,411 4.2 % 45,402 4.7 %
Consumer secured by 1st deeds of trust 15,585 1.1 % 16,198 1.6 % 19,228 2.0 % 22,616 2.4 % 23,280 2.4 %
Consumer other 22,069 1.5 % 24,585 2.4 % 23,645 2.4 % 19,919 2.1 % 25,281 2.6 %
Subtotal $1,455,785 $1,048,456 $988,833 $959,109 $978,508
Less: Unearned origination fee,
net of origination costs (11,735) (0.8) % (5,085) (0.5) % (4,487) (0.5) % (4,156) (0.4) % (4,434) (0.5) %
Total portfolio loans $1,444,050 $1,043,371 $984,346 $954,953 $974,074
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 SBA 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 $780.1 million at December 31, 2020 from $412.7
million at December 31, 2019 and represented approximately 54% and 40% of our
total loans outstanding as of December 31, 2020 and December 31, 2019 ,
respectively. The increase in commercial loans at the end of 2020 is primarily
due to $310.5 million in PPP loans. The Company originated $375.6 million PPP
loans in 2020. As of December 31, 2020 , $65.1 million in PPP loans had been
forgiven by the SBA. 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, 2020 , commercial real estate loans increased to $519.3
million from $494.4 million at December 31, 2019 , and represented approximately
36% and 47% of our loan portfolio as of December 31, 2020 and December 31, 2019 ,
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
48
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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 to builders for construction of homes. The
Company's construction loans increased in 2020 to $118.8 million , up from $100.6
million in 2019, and represented approximately 8% and 10% of our loan portfolio
in December 31, 2020 and December 31, 2019 , respectively. As of December 31,
2020 , approximately $6.0 million or 5%, of the Company's construction loans were
for low income housing tax credit projects as compared to $24.0 million or 24%
as of December 31, 2019 .
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 $65.1 million , or
approximately 4% of loans as of December 31, 2020 have direct exposure to the
oil and gas industry as compared to $79.2 million , or approximately 8% of loans
as of December 31, 2019 . The Company's exposure as a percent of the total loan
portfolio excluding PPP loans as of December 31, 2020 was 6%. The Company has no
loans to oil producers or drilling and exploration companies as of the end of
2020 or 2019, but the $65.1 million outstanding as of December 31, 2020 noted
above does include $3.0 million related to the construction of an oil drilling
rig. The Company's unfunded commitments to borrowers that have direct exposure
to the oil and gas industry were $63.5 million and $31.1 million at December 31,
2020 and 2019, 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 $1.2 million and $1.6 million as of December 31, 2020
and 2019, 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 Consumer
construction Real estate term owner term non-owner Real estate secured by 1st
(In Thousands) Commercial one-to-four family construction other occupied occupied term other deeds of trust Consumer other Total
December 31, 2020
AQR Pass $46,943 $- $- $4,023 $- $- $- $- $50,966
AQR Special Mention 4,597 - - 1,541 6,606 - - - 12,744
AQR Substandard 1,412 - - - - - - - 1,412
Total loans $52,952 $- $- $5,564 $6,606 $- $- $- $65,122
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
49-------------------------------------------------------------------------------- Supplemental information about significant COVID-19 exposure on directly impacted industries: In addition, atDecember 31, 2020 , the Company had$78.9 million , or 5% of portfolio loans, in the tourism sector,$56.1 million , or 4% of portfolio loans, in the aviation (non-tourism) sector,$96.9 million , or 7% of total loans, in the healthcare sector,$17.4 million , or 1%, in retail loans and$31.0 million , or 2% in the restaurant sector, and$37.2 million , or 3% in the accommodations sector. AtDecember 31, 2020 , the Company had$78.9 million , or 7% of portfolio loans excluding PPP loans, in the tourism sector,$56.1 million , or 5% of portfolio loans excluding PPP loans, in the aviation (non-tourism) sector,$96.9 million , or 8% of total loans excluding PPP loans, in the healthcare sector,$17.4 million , or 2% of total loans excluding PPP loans, in retail loans and$31.0 million , or 3% of total loans excluding PPP loans in the restaurant sector, and$37.2 million , or 3% of total loans excluding PPP loans in the accommodations sector.The portion of the Company's Allowance that related to the loans with exposure to these industries is estimated at the following amounts as ofDecember 31, 2020 : (In Thousands) Tourism Aviation (non-tourism) Healthcare Retail Restaurant Accommodations Total Allowance$1,481 $1,049 $1,758 $309 $581 $695 $5,873
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
Maturity
(In Thousands) Within 1 Year 1-5 Years Over 5 Years Total
Commercial $133,528 $418,031 $228,499 $780,058
Real estate construction one-to-four family 36,673 1,794 - 38,467
Real estate construction other 40,665 5,439 34,211 80,315
Real estate term owner occupied 7,344 30,579 125,674 163,597
Real estate term non-owner occupied 10,073 78,453 220,548 309,074
Real estate term other 9,283 10,322 27,015 46,620
Consumer secured by 1st deeds of trust 208 834 14,543 15,585
Consumer other 1,196 4,330 16,543 22,069
Total $238,970 $549,782 $667,033 $1,455,785
Fixed interest rate $92,040 $391,531 $175,677 $659,248
Floating interest rate 146,930 158,251 491,356 796,537
Total $238,970 $549,782 $667,033 $1,455,785 At
As ofDecember 31, 2020 , approximately 44% of commercial loans are variable rate loans, of which 57% reprice within one year. Approximately 38% of variable rate commercial loans reprice to an index based upon the prime rate of interest, 30% reprice based the respectiveFederal Home Loan Bank of Boston (the "Boston FHLB") rate, and 29% reprice based on one-month LIBOR. The Company also uses floors in its commercial loan pricing as loans are originated or renewed during the year. AtDecember 31, 2020 , the interest rates for approximately 85% of commercial real estate loans are variable, of which 41% reset within one year. Approximately 38% 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 respectiveTreasury 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 ("MSRs"): 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 2020 and 2019 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 forFreddie 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 represented approximately 16% and 23% of the mortgages originated by RML in 2020 and 2019, respectively. MSRs are adjusted to fair value quarterly with the change recorded in mortgage banking income. The 50 -------------------------------------------------------------------------------- value of MSRs atDecember 31, 2020 and 2019 were$11.2 million and$11.9 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 is expected to increase as market rates for mortgage loans rise and decrease if market rates fall.
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) 2020 2019 2018 2017 2016 Nonperforming loans Nonaccrual loans$11,120 $15,356 $15,210 $21,626 $13,893 Loans 90 days past due and accruing 449 - - 252 456 Government guarantees on nonperforming loans (1,521) (1,405) (516) (467) (1,413) Net nonperforming loans$10,048 $13,951 $14,694 $21,411 $12,936 Other real estate owned 7,289 7,043 7,962 8,651 6,574 Repossessed assets 231 231 1,242 - - Other real estate owned guaranteed by government (1,279) (1,279) (1,279) (1,333) (195) Net nonperforming assets$16,289 $19,946 $22,619 $28,729 $19,315 Nonperforming loans, net of government guarantees to portfolio loans 0.70 % 1.34 % 1.49 % 2.24 % 1.33 %
Nonperforming assets, net of government guarantees to total assets
0.77 % 1.21 % 1.50 % 1.89 % 1.27 %
Performing restructured loans, net of government
guarantees $832 $1,448 $3,413 $7,668 $6,131
Nonperforming loans plus performing restructured
loans, net of government guarantees $10,880 $15,399 $18,107 $29,079 $19,067
Nonperforming loans plus performing restructured
loans, net of government guarantees to portfolio
loans 0.75 % 1.48 % 1.84 % 3.05 % 1.96 %
Nonperforming assets plus performing restructured
loans, net of government guarantees to total assets 0.81 % 1.30 % 1.73 % 2.40 % 1.67 %
Adversely classified loans, net of government
guarantees $12,768 $22,330 $27,217 $33,845 $35,634
Loans 30-89 days past due and accruing, net of
government guarantees to portfolio loans 0.05 % 0.15 % 0.36 % 0.22 % 0.22 %
Allowance for loan losses to portfolio loans 1.46 % 1.83 % 1.98 % 2.25 % 2.02 %
Allowance for loan losses to nonperforming loans,
net of government guarantees 210 % 137 % 133 % 100 % 152 %
The Company's nonperforming loans, net of government guarantees decreased in
2020 to $10.0 million as compared to $14.0 million in 2019. This decrease was
mostly due to a large nonaccrual loan payoff, as well as principal paydowns and
charge-offs on nonaccrual loans in 2020. There was interest income of $924,000
and $301,000 recognized in net income for 2020 and 2019, respectively, related
to interest collected on nonaccrual loans whose principal has been paid down to
zero. The Company had four relationships that each represented more than 10% of
nonaccrual loans as of December 31, 2020 .
The Company had $832,000 and $1.4 million in loans classified as troubled
debt restructuring loans ("TDRs"), net of government guarantees that were
performing as of December 31, 2020 and 2019, respectively. Additionally, there
were $4.5 million and $8.7 million in TDRs included in nonaccrual loans at
December 31, 2020 and 2019 for total TDRs, net of government guarantees of $5.3
million and $10.1 million at December 31, 2020 and 2019, respectively. The
decrease in TDRs at December 31, 2020 as compared to 2019 was primarily due to
payoffs and paydowns on loans classified as TDRs that were only partially offset
by additions to TDRs in 2020. See Note 5 of the Notes to Consolidated Financial
Statements included in Part II. Item 8 of this report for further discussion of
TDRs.
51
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At December 31, 2020 , management had identified potential problem loans of
$6.1 million as compared to potential problem loans of $9.0 million at December
31, 2019 . 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 $2.9 million decrease in potential problem loans at
December 31, 2020 from December 31, 2019 was primarily due to paydowns and
additional government guarantees that were partially offset by the addition of
new potential problem loans in 2020.
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 that is still held
as of the end of 2020.
The following summarizes OREO activity for the periods indicated: (In Thousands)
2020 2019 2018
Balance, beginning of the year$7,043 $7,962
Transfers from loans 652 -
686
Investment in other real estate owned - -
144
Proceeds from the sale of other real estate owned (797) (1,299)
(1,522)
Gain on sale of other real estate owned, net 391 380
3
Impairment on other real estate owned - - - Balance, end of year 7,289 7,043 7,962 Government guarantees (1,279) (1,279) (1,279)
Balance, end of year, net of government guarantees
$6,683 AtDecember 31, 2020 and 2019 the Company held$6.0 million and$5.8 million , respectively, of OREO assets, net of government guarantees. AtDecember 31, 2020 , OREO consists of$1.2 million in residential lots in various stages of development, a$5.6 million commercial building, and$490,000 of undeveloped land. All OREO property is located inAlaska . 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 2020, the Company transferred two loans to OREO totaling$652,000 . During 2020, the Company received approximately$797,000 in proceeds from the sale of OREO. The Company recognized$391,000 and$380,000 in gains and no losses on the sale of OREO properties in 2020 and 2019, respectively. The Company had remaining accumulated deferred gains on the sale of OREO properties of$123,000 and$231,000 atDecember 31, 2020 and 2019, respectively. The Company did not make any loans to facilitate the sale of OREO in 2020 or 2019. 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 2020 and 2019 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 theAnchorage and theSoutheastern 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: 52 -------------------------------------------------------------------------------- •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 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 Part II. 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 first 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 Part II. 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 2020. 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 inAlaska ; 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
53
--------------------------------------------------------------------------------
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, 2020 and 2019, the unallocated
allowance as a percentage of the total Allowance was 10% and 11%, respectively.
The following table shows the allocation of the Allowance for the years
indicated:
2020 2019 2018 2017 2016
(In Thousands) Amount % of Loans(1) Amount % of Loans(1) Amount % of Loans(1) Amount % of Loans(1) Amount % of Loans(1)
Commercial $7,973 39 % $6,604 39 % $5,660 35 % $6,172 34 % $5,535 28 %
Real estate construction one-to-four
family 679 3 % 643 4 % 675 4 % 629 3 % 550 3 %
Real estate construction other 1,179 6 % 1,017 6 % 1,275 7 % 1,566 8 % 1,465 7 %
Real estate term owner occupied 2,625 11 % 2,188 13 % 2,027 13 % 2,194 14 % 2,358 16 %
Real estate term non-owner occupied 5,133 21 % 5,180 30 % 5,799 33 % 6,043 33 % 6,853 37 %
Real estate term other 779 3 % 671 4 % 716 4 % 725 4 % 819 5 %
Consumer secured by 1st deeds of trust 261 1 % 270 2 % 306 2 % 315 2 % 313 2 %
Consumer other 400 2 % 436 2 % 426 2 % 307 2 % 408 2 %
Unallocated 2,107 - % 2,079 - % 2,635 - % 3,510 - % 1,396 - %
Total $21,136 100 % $19,088 100 % $19,519 100 % $21,461 100 % $19,697 100 %
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) 2020 2019 2018 2017 2016 Balance at beginning of year$19,088
$19,519 $21,461 $19,697 $18,153 Charge-offs: Commercial (1,021) (195) (1,716) (1,611) (903) Real estate construction one-to-four family - - - -
(535)
Real estate term owner occupied (85) - - - - Real estate term other - - (28) (5) - Consumer secured by 1st deeds of trust - (4) (143) (85) (36) Consumer other (15) (18) (39) (43) (8) Total charge-offs (1,121) (217) (1,926) (1,744) (1,482) Recoveries: Commercial 710 908 442 293 699 Real estate term other 2 28 3 2 - Consumer secured by 1st deeds of trust - - 12 2 - Consumer other 25 25 27 11 29 Total recoveries 737 961 484 308 728 Net, (charge-offs) recoveries (384) 744 (1,442) (1,436)
(754)
Provision (benefit) for loan losses 2,432 (1,175) (500) 3,200
2,298
Balance at end of year$21,136 $19,088 $19,519 $21,461
Ratio of net charge-offs (recoveries) to average loans outstanding during the period 0.03 % (0.07) % 0.15 % 0.15 % 0.08 % In accordance with GAAP, loans acquired in connection with our acquisition of Alaska Pacific onApril 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 54 -------------------------------------------------------------------------------- loans sinceApril 1, 2014 . A general allowance for loans acquired fromAlaska Pacific was established if there was deterioration in credit quality of the acquired loans subsequent to acquisition fromApril 1, 2014 throughDecember 31, 2017 . As ofDecember 31, 2020 , 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 impairment on acquired loans atDecember 31, 2020 or 2019. The purchase discount related to acquired credit impaired loans was$328,000 and$345,000 as ofDecember 31, 2020 and 2019, respectively. The provision for loan losses in 2020 as compared to 2019 increased$3.6 million to provision for loan losses of $$2.4 million compared to a benefit of$1.2 million in 2019. This increase is primarily due to management's assessment of risk associated with the economic impacts of 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 determined that an Allowance of$21.1 million , or 1.46% of portfolio loans, is appropriate as ofDecember 31, 2020 based on our analysis of the current credit quality of the portfolio and current economic conditions. 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 theAlaska economy in 2019. 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. 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 inAlaska ,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 decreased atDecember 31, 2020 to$13.9 million from$24.4 million atDecember 31, 2019 , and year-to-date average purchased receivable balances were$14.5 million and$18.8 million in 2020 and 2019, respectively. Purchased receivable income was$2.7 million and$3.3 million in 2020 and 2019, respectively. Purchased receivable income in 2020 decreased from 2019 due to decreased average balances due to customers reportedly using PPP loans to fund liquidity needs instead of selling receivables. The following table sets forth information regarding changes in the purchased receivable reserve for the years indicated: (In Thousands) 2020 2019 2018 Balance at beginning of year$94 $190 $200 Charge-offs - - - Recoveries - - - Net recoveries (charge-offs) - - - Reserve for (recovery from) purchased receivables (21) (96) (10) Balance at end of year$73 $94 $190
Ratio of net charge-offs (recoveries) to average purchased receivables during the period
- % - % - %
Deposits
Deposits are our primary source of funds. Total deposits increased 33% to$1.825 billion atDecember 31, 2020 from$1.372 billion atDecember 31, 2019 . This increase is primarily due to funding PPP loans, but is also due to new client relationships as a result of the Company's significant PPP efforts during 2020. Our deposits generally are expected to fluctuate according to the level of our market share, economic conditions, and normal seasonal trends. 55 -------------------------------------------------------------------------------- The following table sets forth the average balances outstanding and average interest rates for each major category of our deposits, for the periods indicated: 2020 2019 2018 Average rate Average rate Average rate (In Thousands) Average balance paid Average balance paid Average balance paid Interest-bearing demand accounts$387,416 0.16 %$272,895 0.17 %$243,000 0.07 % Money market accounts 219,025 0.32 % 209,245 0.55 % 225,014 0.31 % Savings accounts 257,292 0.28 % 233,057 0.46 % 241,807 0.31 % Certificates of deposit 176,873 1.83 % 135,005 1.67 % 99,987 0.70 % Total interest-bearing accounts 1,040,606 0.51 % 850,202 0.58 % 809,808 0.28 % Noninterest-bearing demand accounts 597,610 426,205 417,464 Total average deposits$1,638,216 $1,276,407 $1,227,272 Certificates of Deposit: The only deposit category with stated maturity dates is certificates of deposit. AtDecember 31, 2020 , we had$175.6 million in certificates of deposit, of which$129.0 million , or 73%, are scheduled to mature in 2021. The Company's certificates of deposit increased to$175.6 million during 2020 as compared to$164.5 million atDecember 31, 2019 . The aggregate amount of certificates of deposit in amounts of$100,000 or more atDecember 31, 2020 and 2019, was$133.3 million and$118.9 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 ofDecember 31, 2020 : Time Certificates of Deposits of$100,000 or More (In Thousands) Amount Percent of Total Deposits Amounts maturing in: Three months or less$26,748 20 % Over 3 through 6 months 20,893 16 % Over 6 through 12 months 52,528 39 % Over 12 months 33,113 25 % Total$133,282 100 % The Company offers the Certificate of Deposit Account Registry Service® (CDARS®) as a member ofPromontory Interfinancial Network , LLCSM (Network). When a Network member places a deposit using CDARS, that certificate of deposit is divided into amounts under the standardFDIC insurance maximum ($250,000 ) and is allocated among member banks, making the large deposit eligible forFDIC insurance. The Company had$9.4 million CDARS certificates of deposits atDecember 31, 2020 and$1.2 million CDARS certificates of deposits atDecember 31, 2019 .
Borrowings
FHLB: The Bank is a member of theFederal 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. AtDecember 31, 2020 , our maximum borrowing line from the FHLB was$946.2 million , approximately 45% of the Bank's assets, subject to the FHLB's collateral requirements. The Company has outstanding advances of$14.8 million as ofDecember 31, 2020 which were originated to match fund low income housing projects that qualify for long term fixed interest rates. These advances have original terms of either 18 or 20 years with 30 year amortization periods and fixed interest rates ranging from 1.23% to 3.25%. 56 --------------------------------------------------------------------------------Federal Reserve Bank : TheFederal Reserve Bank of San Francisco (the "FederalReserve Bank ") is holding$79.5 million of loans as collateral to secure advances made through the discount window as ofDecember 31, 2020 . There were no discount window advances outstanding atDecember 31, 2020 or 2019. The Company$2,000 in interest in 2020 and paid less than$1,000 in interest in 2019 on this agreement. The Company utilized theFederal Reserve Bank's PPPLF to fund SBA PPP loans during the second quarter of 2020, but has repaid those funds in full as ofJune 30, 2020 . This advance had an interest rate of 0.35%. Other Short-term Borrowings: Securities sold under agreements to repurchase were zero as ofDecember 31, 2020 and 2019, respectively. The average balance outstanding of securities sold under agreements to repurchase during 2020 and 2019 was zero and$15.2 million , respectively, and the maximum outstanding at any month-end was zero and$36.6 million , respectively, during the same time periods. The securities sold under agreements to repurchase were held by the FHLB under the Company's control. The Company is subject to provisions underAlaska state law which generally limit the amount of outstanding debt to 35% of total assets or$736.0 million atDecember 31, 2020 and 15% of total assets or$244.7 million atDecember 31, 2019 . As ofApril 7, 2020 , theState of Alaska increased this limit to 35% of total assets. Long-term Borrowings: The Company had no long-term borrowings outstanding other than the FHLB advances noted above as ofDecember 31, 2020 or 2019.
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, 2020:
Certificates of deposit $128,970 $44,237 $630 $1,794 $175,631
Long-term borrowings 312 833 872 12,800 14,817
Junior subordinated debentures - - - 10,310 10,310
Operating lease obligations 2,619 4,140 3,527 4,875
15,161
Other long-term liabilities(1) 9,482 1,654 778 4,291 16,205 Capital commitments 71 - - - 71 Total$141,454 $50,864 $5,807 $34,070 $232,195 December 31, 2019: Certificates of deposit$90,554 $70,734 $1,390 $1,794 $164,472 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 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 (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 Part II. Item 8 below. 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 onDecember 16, 2005 , matures onMarch 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 57 -------------------------------------------------------------------------------- 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 underNorthrim 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 inDelaware limited partnerships that develop low-income housing projects throughoutthe United States . Additional information about these partnerships is included at Note 8 of the Company's Consolidated Financial Statements included in Part II. Item 8 of this report. The Company purchased a$10.7 million interest inR4 Frontier Housing Partners L.P. ,Coronado Park Senior Village L.P. ("R4-Coronado") inMarch 2013 . The investment in R4-Coronado was 99% funded at the end of 2020 and is expected to be fully funded in 2029. The Company purchased an$8.5 million interest inR4 Frontier Housing Partners L.P. ,Mountain View Village V L.P. ("R4-MVV") inMay 2014 . The investment in R4-MVV was 98% funded at the end of 2020 and is expected to be fully funded in 2030. The Company purchased a$6.8 million interest inR4 Frontier Housing Partners L.P. ,PJ33 L.P. ("R4-PJ33") inJune 2016 . The investment in R4-PJ33 was 95% funded at the end of 2020 and is expected to be fully funded in 2032. The Company purchased a$7.3 million interest inR4 Frontier Housing Partners L.P. ,Parkscape L.P. ("R4-Coronado II") inJune 2019 . The investment in R4-Coronado II was 23% funded at the end of 2020 and is expected to be fully funded in 2035. The Company also purchased a$4.0 million interest inR4 Frontier Housing Partners L.P. ,Duke Apartments L.P. ("R4-Duke") inNovember 2019 . The investment in R4-Duke was 9% funded at the end of 2020 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 ofDecember 31, 2020 , we had commitments to extend credit of$375.1 million , which were not reflected on our balance sheet, compared to$301.9 million as ofDecember 31, 2019 . 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 ofDecember 31, 2020 , we had commitments to originate loans held for sale of$150.3 million , which were not reflected in the balance sheet compared to$48.8 million as ofDecember 31, 2019 . 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 ofDecember 31, 2020 , we had standby letters of credit of$2.3 million , which were not reflected on our balance sheet compared to$2.0 million as ofDecember 31, 2019 . 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 atDecember 31, 2020 , which includes commitments to extend credit, commitments to originate loans held for sale and standby letters of credit, were$527.7 million , compared to$352.7 million as ofDecember 31, 2019 . 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$187,000 and$152,000 atDecember 31, 2020 and 2019, respectively, for estimated losses related to these commitments that are recorded in other liabilities on the consolidated balance sheet. 58 -------------------------------------------------------------------------------- Additional information regarding Off-Balance Sheet Arrangements is included in Notes 20 and 21 of the Notes to the Company's Consolidated Financial Statements included in Part II. Item 8 of this report. Liquidity and Capital Resources Our shareholders' equity atDecember 31, 2020 , was$221.6 million , as compared to$207.1 million atDecember 31, 2019 . The Company earned net income of$32.9 million , issued 19,195 shares of common stock through the vesting of restricted stock units and repurchased 327,000 shares during 2020. AtDecember 31, 2020 , the Company had approximately 6.3 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 2021. The Bank manages its liquidity through itsAsset 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 atDecember 31, 2020 , were$527.7 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 atDecember 31, 2020 , were$1.8 billion . As shown in the Consolidated Statements of Cash Flows, net cash used by operating activities was$36.5 million in 2020 and net cash used by operating activities was$821,000 in 2019. The primary source of cash provided by operating activities for all periods presented was positive net income; however, in 2020 and 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 both years. Net cash used by investing activities was$382.8 million in 2020 primarily due to increases in loans, in particular PPP loans. Net cash used by investing activities was$71.9 million in 2019 primarily due to the fact that purchases of investment securities and net investments in loans and purchased receivables exceeded proceeds from sales and maturities of securities available for sale. Financing activities provided cash of$439.8 million in 2020 and$90.6 million in 2019. Financing activities provided cash in 2020 due to an increase in deposits largely due to funding PPP loans that was done via deposit into customer accounts. This increase was only partially offset by the repurchase of 327,000 shares of the Company's common stock for$10.0 million and the payment of dividends to shareholders. 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. 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 theFederal Reserve Bank and the FHLB. AtDecember 31, 2020 , our current assets were$423.8 million and our funds available for borrowing under our existing lines of credit were$1.01 billion . Additionally, the Company can obtain additional nonrecourse borrowings under theFederal Reserve Bank's newly created PPPLF as a source of additional liquidity in order to meet liquidity needs created by the origination of PPP loans without excessive usage of the Company's other existing liquidity sources. The Company had$216.0 million in PPP loans eligible to be pledged for the PPPLF program as ofDecember 31, 2020 . the Company has not obtained any other new borrowing lines or other new sources of liquidity other than the PPPLF program resulting from anticipated liquidity challenges from COVID-19. 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 2020, the Company's Board of Directors approved a quarterly cash dividend of$0.34 per common share for the first and second quarters and$0.35 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. Item 1 of this report. There is no assurance that future cash dividends on common shares will be declared or increased. 59 -------------------------------------------------------------------------------- OnFebruary 25, 2021 , the Board of Directors approved payment of a$0.37 per share dividend onMarch 19, 2021 , to shareholders of record onMarch 11, 2021 . This dividend is$0.02 , or 6%, higher than the Company's dividend of$0.35 that was paid in the fourth quarter of 2020. InSeptember 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 throughDecember 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. InApril 2019 , the Company's Board of Directors 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. OnJanuary 27, 2020 , the Board authorized the repurchase of up to an additional 327,000 shares of common stock. In 2020, the Company repurchased 327,000 shares at an average price of$30.51 . At December, 31, 2020, there were zero shares available under the stock repurchase program. OnFebruary 1, 2021 , the Company announced that its Board of Directors had authorized the repurchase of up to an additional 313,000 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 2020$5.11 $4.22 2019$3.04 $2.59 2018$2.86 $2.56 2017$1.88 $1.69 2016$2.06 $1.87 OnDecember 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 ofMarch 15, 2036 , and are callable by the Company on or afterMarch 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$219,000 in 2020. AtDecember 31, 2020 , the securities had an interest rate of 1.59%. 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$385,000 in 2020 and$389,000 in 2019. 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 ofDecember 31, 2020 , that the Company and the Bank met all applicable capital adequacy requirements for a "well-capitalized" institution by regulatory standards. 60 -------------------------------------------------------------------------------- The table below illustrates the capital requirements in effect in 2020 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 2021, exceeding theFDIC'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 consolidated financial statements. The trust preferred securities are not accounted for on the Bank's financial statements nor are they included in its capital. As a result, the Company has$10 million more in regulatory capital than the Bank atDecember 31, 2020 and 2019, respectively, which explains most of the difference in the capital ratios for the two entities. Minimum Required December 31, 2020 Capital Well-Capitalized Actual Ratio Company Actual Ratio Bank Total risk-based capital 8.00% 10.00% 15.46% 13.13% Tier 1 risk-based capital 6.00% 8.00% 14.20% 11.88% Common equity tier 1 capital 4.50% 6.50% 13.57% 11.89% Leverage ratio 4.00% 5.00% 10.25% 8.55% See Note 24 of the Consolidated Financial Statements included in Part II. Item 8 of this report for a detailed discussion of the capital ratios. The requirements for "well-capitalized" come from the Prompt Correction Action rules. See Part I. Item 1 Supervision and Regulation. These rules apply to the Bank but not to the Company. Under the rules of theFederal 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 Part II. Item 7A of this report regarding how various market risks affect the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is defined as the sensitivity of income, expense, fair value measurements, and capital to changes in interest rates, foreign currency rates, commodity prices, and other relevant market rates or prices. The primary market risks that we are exposed to are interest rate and price risks, in addition to risk in theAlaska economy due to our community banking focus. Price risk is the risk to current or future earnings or capital arising from changes in the value of either assets or liabilities that are entered into as part of distributing or managing risk. Interest rate risk is the risk to current or future earnings or capital arising from changes in interest rates. Generally, there are four sources of interest rate risk as described below: •Re-pricing Risk: Generally, re-pricing risk is the risk of adverse consequences from a change in interest rates that arises because of differences in the timing of when those interest rate changes affect an institution's assets and liabilities. •Basis Risk: Basis risk is the risk of adverse consequences resulting from unequal changes in the spread between two or more rates for different instruments with the same maturity. •Yield Curve Risk: Also called yield curve twist risk, yield curve risk is the risk of adverse consequences resulting from unequal changes in the spread between two or more rates for different maturities for the same instrument. •Option Risk: In banking, option risks are known as borrower options to prepay loans and depositor options to make deposits, withdrawals, and early redemptions. Option risk arises whenever bank products give customers the right, but not the obligation, to alter the quantity of the timing of cash flows.
The Company is exposed to price and interest rate risks in the financial instruments and positions we hold. This includes investment securities, loans, loans held for sale, mortgage servicing rights, deposits, borrowings, and derivative
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--------------------------------------------------------------------------------financial instruments. Market risks such as foreign currency exchange risk and commodity price risk do not arise in the normal course of the Company's business.
The Company's price and interest rate risks are managed by theAsset and Liability Committee , a management committee that identifies and manages the sensitivity of earnings and capital to changing interest rates to achieve our overall financial objectives. Based on economic conditions, asset quality and various other considerations, theAsset and Liability Committee establishes overall balance sheet management policies as well as tolerance ranges for interest rate sensitivity and manages within these ranges. A number of measures are used to monitor and manage interest rate risk, including interest sensitivity (gap) analysis and income simulations. An income simulation model is the primary tool used to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Key assumptions in the model include loan and deposit volumes and pricing, prepayment speeds on fixed rate assets, and cash flows and maturities of investment securities. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes, changes in market conditions and management strategies, among other factors. Although analysis of interest rate gap (the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time) is one standard tool for the measurement of exposure to interest rate risk, we believe that because interest rate gap analysis does not address all factors that can affect earnings performance it should not be used as the primary indicator of exposure to interest rate risk and the related volatility of net interest income in a changing interest rate environment. Interest rate gap analysis is primarily a measure of liquidity based upon the amount of change in principal amounts of assets and liabilities outstanding, as opposed to a measure of changes in the overall net interest margin. The Company uses derivatives in the Home Mortgage Lending segment, including commitments to originate residential mortgage loans at fixed prices, and it enters into forward delivery contracts to sell mortgage-backed securities to broker/dealers at specific prices and dates in order to hedge the interest rate risk in its residential mortgage loan commitments. The Company does not use derivatives outside of these activities in the Home Mortgage Lending segment to manage our interest rate risk exposures. However, the Company does enter into commercial loan interest rate swap agreements in its Community Banking segment in order to provide commercial loan customers the ability to convert from variable to fixed interest rates. Commercial loan interest rate swap agreements are offset with corresponding swap agreements with a third party swap dealer in order to offset the Company's exposure on the fixed component of the customer's interest rate swap. Additional information regarding the Company's customer interest rate swap program is presented in Note 21 of the Notes to Consolidated Financial Statements included in Part II. Item 8 of this report. The following table sets forth the estimated maturity or repricing, and the resulting interest rate gap, of our interest-earning assets (which exclude nonaccrual loans) and interest-bearing liabilities atDecember 31, 2020 . The amounts shown below could be significantly affected by external factors such as changes in prepayment assumptions, early withdrawals of deposits, and competition. 62 --------------------------------------------------------------------------------
Estimated maturity or repricing at
Within 1 year 1-5 years >5 years Total
Interest -Earning Assets:
Interest bearing deposits in other banks $92,661 $- $- Portfolio investments and FHLB Stock 242,121 27,115 - 269,236 Portfolio loans 854,010 526,679 63,976 1,444,665 Loans held for sale 146,178 - - 146,178 Total interest-earning assets$1,334,970 $553,794 $63,976
Percent of total interest-earning assets 68.36 % 28.36 % 3.28 % 100.00 % Interest-Bearing Liabilities: Interest-bearing demand accounts$459,095 $- $-$459,095 Money market accounts 237,705 - - 237,705 Savings accounts 308,725 - - 308,725 Certificates of deposit 130,968 43,345 1,318 175,631 Securities sold under repurchase agreements - - - - Borrowings 764 3,334 10,719 14,817 Junior subordinated debentures - - 10,310
10,310
Total interest-bearing liabilities$1,137,257 $46,679 $22,347
Percent of total interest-bearing liabilities 94.28 % 3.87 % 1.85 % 100.00 % Interest sensitivity gap$197,713 $507,115 $41,629 $746,457 Cumulative interest sensitivity gap$197,713 $704,828 $746,457
Cumulative interest sensitivity gap as a percentage
of total interest-earning assets 10.1 % 36.1 % 38.2 % As stated previously, certain shortcomings, including those described below, are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market interest rates. Additionally, certain assets have features that restrict changes in their interest rates, both on a short-term basis and over the lives of the assets. Further, in the event of a change in market interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables as can the relationship of rates between different loan and deposit categories. Moreover, the ability of many borrowers to service their adjustable-rate debt may decrease in the event of an increase in market interest rates. While the analysis above sets forth the estimated maturity or repricing and the resulting interest rate gap of our interest-earning assets and interest-bearing liabilities, the following tables show the estimated impact on net interest income and net income at one and two year time horizons with instantaneous parallel rate shocks of up 400 basis points, up 300 basis points, up 200 basis points, up 100 basis points, and up 50 basis points. The Company did not perform analyses for rate shock scenarios where interest rates instantaneously drop as ofDecember 31, 2020 because those scenarios do not produce meaningful results in the current low interest rate environment. Due to the various assumptions used for this modeling and potential balance sheet strategies management may implement to mitigate interest rate risk, no assurance can be given that projections will reflect actual results. 63 --------------------------------------------------------------------------------
The following table shows the estimated impact on net interest income under the stated interest rate scenarios:
1st Year Change in 2nd Year Change in
net interest net interest
income from base income from base
(In Thousands) scenario Percentage change scenario Percentage change
Scenario:
Up 400 basis points $8,214 11.66 % $24,825 18.16 %
Up 300 basis points $6,790 9.64 % $20,029 14.65 %
Up 200 basis points $4,420 6.28 % $13,252 9.69 %
Up 100 basis points $2,248 3.19 % $6,826 4.99 %
Up 50 basis points $2,332 3.96 % $3,808 6.80 %
Down 50 basis points NM NM NM NM
Down 100 basis points NM NM NM NM
The following table shows the estimated impact on net income under the stated
interest rate scenarios. The trends in the estimated impact on net income under
the stated interest rate scenarios differ from the table above primarily due to
the inclusion of the estimated impact of changes in other operating income and
expense related to mortgage banking activities:
1st Year Change in 2nd Year Change in
net income from net income from
(In Thousands) base scenario Percentage change base scenario Percentage change
Scenario:
Up 400 basis points ($663 ) (4.02) % $6,337 23.85 %
Up 300 basis points $1,434 8.69 % $8,998 33.86 %
Up 200 basis points $854 5.17 % $6,216 23.39 %
Up 100 basis points $429 2.60 % $3,711 13.97 %
Up 50 basis points $951 5.77 % $3,014 29.91 %
Down 50 basis points NM NM NM NM
Down 100 basis points NM NM NM NM
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