UNITED STATES SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2003
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number 000-33501
NORTHRIM BANCORP, INC.
(907) 562-0062(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).
Yes [X] No [ ]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed bySection 13 of the Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.
The number of shares of the issuer’s Common Stock outstanding at October 24, 2003 was6,015,708.
TABLE OF CONTENTS
NORTHRIM BANCORP, INC.TABLE OF CONTENTS
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NORTHRIM BANCORP, INC.PART I - FINANCIAL INFORMATIONITEM ONE
NORTHRIM BANCORP, INC.CONSOLIDATED BALANCE SHEETSSeptember 30, 2003, 2002 and December 31, 2002
See notes to the consolidated financial statements
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NORTHRIM BANCORP, INC.CONSOLIDATED STATEMENTS OF INCOMEFOR THE QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
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NORTHRIM BANCORP, INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOMEFOR THE QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
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NORTHRIM BANCORP, INC.CONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
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NORTHRIM BANCORP, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(unaudited)September 30, 2003 and 2002
The accompanying unaudited financial statements have been prepared by Northrim BanCorp, Inc. (the “Company”) in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and with instructions to Form 10-Q under the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the interim period ended September 30, 2003, are not necessarily indicative of the results anticipated for the year ending December 31, 2003. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
In September 2002, the Board of Directors of the Company approved a plan whereby the Company would periodically repurchase for cash up to approximately 5%, or 306,372, of its shares of stock in the open market. The Company purchased 224,800 shares of its stock under this program through September 30, 2003, at a total cost of $3.1 million, with 13,800 of those shares repurchased in the third quarter of 2003 at a cost of $241,500. The Company intends to continue to repurchase its stock from time to time depending upon market conditions.
In April 2003, the Financial Accounting Standards Board (“FASB”) issued Statement No. 149, Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities. Statement No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FASB Statement No. 133. The Standard has multiple effective date provisions depending on the nature of the amendment to Statement No. 133. The Company believes the adoption of Statement No. 149 will have no impact on its financial statements.
In May 2003, the FASB issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.Statement No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 30, 2003, except for mandatorily redeemable financial instruments of nonpublic entities. The statement required that trust preferred securities be treated as a liability.
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The following table sets forth the Company’s loan portfolio composition by loan type for the dates indicated:
The following table details activity in the Allowance for Loan Losses for the dates indicated:
Nonperforming assets consist of nonaccrual loans, accruing loans of 90 days or more past due, restructured loans, and real estate owned. The following table sets forth information with respect to nonperforming assets:
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At September 30, 2003, December 31, 2002, and September 30, 2002, the Company had loans measured for impairment of $15.6 million, $3.1 million, and $4.5 million, respectively. A specific allowance of $1.1 million, $271,000, and $1 million, respectively, was established for these periods. The increase in loans measured for impairment in the third quarter of 2003 resulted in large part from the remaining portion of one relationship being added to loans measured for impairment as well as the inclusion of three larger commercial loans. These loans comprise 67% of the loans measured for impairment.
The Alaska Permanent Fund Corporation may invest in certificates of deposit at Alaska banks in an aggregate amount with respect to each bank, not to exceed its capital and at specified rates and terms. The depository bank must collateralize the deposit. At September 30, 2003, the Company held $35.1 million in certificates of deposit for the Alaska Permanent Fund, collateralized by available-for-sale securities and letters of credit issued by the Federal Home Loan Bank (“FHLB”).
The Company applies APB Opinion No. 25 in accounting for its stock option plans and, accordingly, no compensation cost has been recognized for its stock options in the financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company’s net income would have been reduced to the pro forma amounts indicated below for the third quarter and nine-month period ending September 30, 2003 and 2002:
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The per share weighted-average fair value of stock options granted during April 2003, October 2001, and October 2000, was $4.71, $5.51, and $3.20, respectively, on the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions: 2003–expected dividends of $.38 per share, risk-free rate of 3.83%, volatility of 31.05%, and an expected life of 10 years; 2001–expected dividends of $.20 per share, risk-free interest rate of 5.83%, volatility of 31.7%, and an expected life of 10 years; 2000–expected dividends of $.20 per share, risk-fee interest rate of 5.87%, volatility of 32.1%, and an expected life of 10 years. In addition, the effective tax rate used to compute the net tax effect of the stock -based compensation for the three and nine month periods ending September 30, 2002, and September 30, 2003, was 40%.
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NORTHRIM BANCORP, INC.PART I - FINANCIAL INFORMATION
ITEM TWO
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS
Cautionary Note Regarding Forward-Looking Statements
This Form 10-Q may include “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and the rules promulgated thereunder (the “Exchange Act”). Forward-looking statements are based on management’s beliefs and assumptions based on currently available information, and we have not undertaken to update these statements except as required by the Exchange Act, and the rules promulgated thereunder. All statements other than statements of historical fact regarding our financial position, business strategy and management’s plans and objectives for future operations are forward-looking statements. When used in this report, the words “will,” “anticipate,” “believe,” “estimate,” “expect,” “should,” and “intend” and words or phrases of similar meaning, as they relate to the Company or management, are intended to help identify forward-looking statements. Although we believe that management’s expectations as reflected in forward-looking statements are reasonable, we cannot assure readers that those expectations will prove to be correct. Forward-looking statements are subject to various risks and uncertainties that may cause our actual results to differ materially and adversely from our expectations as indicated in the forward-looking statements. These risks and uncertainties include our ability to maintain or expand our market share or net interest margins, and to implement our marketing and growth strategies. Further, actual results may be affected by our ability to compete on price and other factors with other financial institutions; customer acceptance of new products and services; the regulatory environment in which we operate; and general trends in the local, regional and national banking industry. In addition, there are risks inherent in the Company’s industry relating to collectibility of loans and changes in interest rates. Many of these risks, as well as other risks that may have a material adverse impact on our operations and business, are identified in our other filings with the Federal Deposit Insurance Corporation (the “FDIC”) and those identified from time to time in our filings with the Securities and Exchange Commission. However, you should be aware that these factors are not an exhaustive list, and you should not assume these are the only factors that may cause our actual results to differ from our expectations.
OVERVIEW
Northrim BanCorp, Inc. is a publicly traded bank holding company (Nasdaq: NRIM) with three wholly-owned subsidiaries, Northrim Bank (the “Bank”), a state chartered, full-service commercial bank, Northrim Investment Services Company (“NISC”), which we formed in November 2002 to hold the Company’s 43% equity interest in Elliott Cove Capital Management LLC (“Elliott Cove”), an investment advisory services company, and Northrim Capital Trust I (“NCTI”), an entity that we formed in May of this year to facilitate a trust preferred securities offering by the Company. We also hold a 50% equity interest and a 30% interest in the profits and losses of a residential mortgage company, Residential Mortgage LLC (“RML”), through the Bank’s wholly-owned subsidiary, Northrim Capital Investment Company (“NCIC”). RML was formed in 1998 and has offices throughout Alaska. We are headquartered in Anchorage and have 10 branch locations: seven in Anchorage, and one each in Fairbanks, Eagle River and Wasilla. We offer a wide array of commercial bank loan and deposit products, including electronic banking services over the Internet.
We opened the Bank for business in Anchorage in 1990. The Bank became the wholly-owned subsidiary of the Company effective December 31, 2001, when we completed our bank holding company reorganization. We opened our first branch, in Fairbanks, in 1996, and our second location in Anchorage in 1997. During the second quarter of 1999, we purchased eight branches located in Anchorage, Eagle River and Wasilla from Bank of America. This acquisition resulted in us acquiring $114 million in loans, $124 million in deposits and $2 million in fixed assets for a net payout of $5.9 million.
One of our major objectives is to increase our market share in Anchorage and Fairbanks, Alaska’s two largest urban areas. We estimate that we hold a 22% share of the commercial bank deposit market in Anchorage and an 8% share of the Fairbanks market as of June 30, 2003.
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In January 2002, we moved from a supermarket branch into a full-service branch to provide a higher level of service to the growing Eagle River market. In December 2002, we completed construction of our Wasilla Financial Center and moved from our existing supermarket branch and loan production office. We moved from our supermarket branch in west Anchorage into a freestanding facility in February 2003. In addition, we are exploring other branching options and are currently analyzing additional market opportunities in the Fairbanks area.
The Company’s total assets and deposits at September 30, 2003, were $736.1 million and $644.2 million, respectively, increases of 5% and 3%, respectively, from December 31, 2002. Total assets and deposits increased 4% and 2%, respectively, from September 30, 2002. Net loans were $575.9 million at September 30, 2003, an increase of 9% from December 31, 2002, and 13% from September 30, 2002.
RESULTS OF OPERATIONS
NET INCOME
Net income for the third quarter ended September 30, 2003, was $2.7 million, or $0.44 per diluted share, an increase in net income of 22%, and a 26% increase in diluted earnings per share as compared to $2.2 million and $0.35 in the same period of 2002. The earnings increase for the three-month period ended September 30, 2003, reflects moderate growth in assets, loans, and deposits along with substantial growth in earnings from the Company’s interest in RML as compared to the three months ended September 30, 2002. The growth in earnings per share was affected by all of these factors as well as the Company’s stock repurchase program under which it has repurchased 189,800 of its shares between September 30, 2002 and September 30, 2003.
Net income for the nine months ended September 30, 2003, was $7.9 million, an increase of $1.7 million, or 27% from the nine months ended September 30, 2002. Diluted earnings per share were $1.27, compared to $0.98 in the same period in 2002. The earnings increase for the nine-month period ended September 30, 2003, reflects moderate growth in assets, loans, and deposits as well as a large growth in earnings from RML as compared to the nine months ended September 30, 2002. The growth in earnings per share was affected by all of these factors as well as the Company’s stock repurchase program under which it has repurchased 189,800 of its shares between September 30, 2002 and September 30, 2003.
NET INTEREST INCOME
Net interest income for the third quarter of 2003 increased $930,000, or 10%, to $10 million from $9.1 million in 2002. The following table compares average balances and rates for the third quarter and nine-month period ending September 30, for 2003 and 2002:
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Interest-earning assets averaged $673.5 million for the third quarter of 2003, an increase of $63.4 million, or 10%, over the $610.1 million average for the comparable period in 2002. The tax equivalent yield on interest-earning assets averaged 6.87% in 2003, a decrease of 70 basis points from 7.57% for the same period in 2002.
Loans, the largest category of interest-earning assets, increased by $76.4 million, or 15%, to an average of $596 million in the third quarter of 2003 from $519.6 million in the same period of 2002. Commercial loans, real estate term loans, construction loans and real estate loans held for resale increased by $29.2 million, $13.2 million, $23.5 million, and $20.7 million, respectively, on average between the third quarters. Consumer loans declined $10.2 million on average during the same period. The tax equivalent yield on the loan portfolio averaged 7.30% for the third quarter of 2003, a decrease of 88 basis points from 8.18% a year
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ago due, in part, to a drop in the prime-lending rate of 75 basis points from September 30, 2002, to September 30, 2003. The Company had $176.5 million in loans indexed to the prime-lending rate on September 30, 2003, or 30% of total loans, as compared to $150.8 million, or 29%, on September 30, 2002. The long decline in interest rates has also led to an increase in refinance activity in the Company’s commercial real estate portfolio, which is typically comprised of longer-term loans. Continuing refinance activity as a result of lower rates may put further downward pressure on the Company’s interest margin in the future. However, the Company’s net loan fees amortized in the third quarter ended September 30, 2003, totaled $1.2 million, an increase of 95% from fees of $605,000 in the third quarter ended September 30, 2002, as a result of larger loan volumes and an increase in refinance activity.
Interest-bearing liabilities averaged $484.6 million for the third quarter of 2003, an increase of $39.1 million, or 9%, compared to $445.5 million for the same period in 2002. The average cost of interest-bearing liabilities decreased 94 basis points to 1.32% for the third quarter of 2003 compared to 2.26% for the third quarter of 2002. The decrease in the average cost of funds was largely due to the repricing of deposit accounts in response to the Federal Reserve’s rate reductions over the last year. The weighted average life of the Company’s certificate of deposits is less than one year. The cost of these deposits should further decline if market interest rates remain at reduced levels, as deposits originated at higher interest rates during earlier periods mature, and are repriced to the current rates. However, as interest rates approach historically low levels, the Company may not be able to fully reprice these liabilities to maintain its net interest margin. Moreover, interest rates could increase in the future in response to an improvement in the general economy of the United States. An increase in general interest rates could cause an increase in the cost of the Company’s deposit accounts which could also have a negative impact on its net interest margin.
The Company’s net interest income as a percentage of average interest-earning assets (net tax-equivalent margin) was 5.92% for the third quarter of 2003 and for the same period in 2002. Due to the absolute low level of interest rates, the drop in the cost of the Company’s interest-bearing liabilities had less of an effect on its net interest margin. In addition, 28% of the Company’s earning-assets were funded by non interest-bearing liabilities that were not affected by this decrease in interest rates on interest-bearing liabilities. Thus, despite the fact that the net tax equivalent yield on the Company’s earning-assets declined by less than the cost of its interest-bearing liabilities, the net tax-equivalent margin remained the same in the third quarter of 2003 as compared to the third quarter of 2002.
Net interest income for the first nine months of 2003 increased by $4 million, or 16% from $25.2 million in 2002. The increase was due in large part to a $59.5 million increase in average interest-earning assets between the periods, funded in part by a $34.3 million increase in average interest-bearing liabilities. The net tax equivalent margin for the first nine months of 2003 increased by 28 basis points to 6.10% from 5.82% for the same period in 2002. The average net tax equivalent yield on interest-earning assets decreased by 46 basis points to 7.17% for the first nine months in 2003 from 7.63% in the same nine-month period one year ago. The average cost of interest-bearing liabilities decreased 98 basis points to 1.47% for the first nine months of 2003, from 2.45% for the same nine-month period in 2002.
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OTHER OPERATING INCOME
Set forth below is a schedule of the components of and change in Other Operating Income between the third quarters and nine-month periods ending September 30, 2003 and 2002:
Total other operating income for the third quarter of 2003 was $1.9 million, an increase of $489,000 from the third quarter of 2002.
The Company’s share of the earnings from RML increased by $516,000 to $1 million during the third quarter of 2003 as compared to $502,000 in the third quarter of 2002, primarily due to increased refinance activity. The large decrease in interest rates and a strong residential housing market fueled increases in mortgage originations from refinances and home purchase loans in the third quarter of 2003. However, in the latter part of the third quarter, mortgage interest rates began to rise which may have the effect of decreasing refinance activity if that trend continues in the future.
The Company’s share of the loss from Elliott Cove was $105,000 for the third quarter of 2003 and $430,000 for the nine-month period ended September 30, 2003. These losses reflect the start-up costs for Elliott Cove, which began active operations in the fourth quarter of 2002. The Company expects these losses to continue for several years while Elliott Cove builds its assets under management. In July of this year, the Company made a commitment to loan $625,000 to Elliott Cove. The Company started advancing the funds in installments beginning in September 2003, with the final installment due to Elliott Cove on or before February 2004. At the Company’s option, the loan is repayable by June 30, 2006, or convertible so that the Company’s total equity interest in Elliott Cove would increase to 58% as compared to the 43% interest that it currently owns in Elliott Cove. The Company will earn 5% interest on the loan.
EXPENSES
Provision for Loan Losses
The provision for loan losses for the third quarter of 2003 was $1.4 million, compared to $980,000 for the same period one year ago. We increased the provision in 2003 because of loan growth, loss inherent in the portfolio, and an increase in non-performing loans. The allowance for loan losses was $9.9 million, or 1.70% of total portfolio loans outstanding (which excludes $2.6 million of real estate loans for sale), at September 30, 2003, compared to $8.3 million, or 1.61%, of total portfolio loans, at September 30, 2002.
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Charge-offs
There was $842,000 in net loan charge-offs during the third quarter of 2003, compared to $271,000 of net charge-offs for the same period in 2002. For the first nine months of 2003 net loan charge-offs were $1.3 million, or 0.31% (annualized) of average loans, compared to net loan charge-offs of $801,000 for the same period in 2002.
Other Operating Expense
The following table breaks out the components of and change in Other Operating Expense between the third quarters and nine-month periods ending September 30, 2003 and 2002:
Total other operating expense for the third quarter of 2003 was $6.2 million, an increase of $266,000 from the same period in 2002.
The major reasons for the changes within this category of expenses were as follows: First, salaries and benefits increased by $434,000, or 13%, due to increases in full time equivalent employees and wage increases over the prior period. Second, professional and outside services decreased by $215,000, due in part, to a refund of legal fees at the conclusion of a legal dispute that were covered by the Company’s insurance and lower consulting expenses. Finally, software amortization on check sorting equipment and maintenance expense increased due to larger and more complex systems.
Income Taxes
The provision for income taxes increased $268,000, or 19%, to $1.7 million in the third quarter of 2003 compared to $1.4 million in the same period in 2002. The effective tax rates for the third quarter of 2003 and 2002 were 38% and 39%, respectively. The provision for income taxes increased $1.2 million, or 33%, to $4.9 million in the first nine months of 2003 compared to $3.7 million in the same period in 2002. The effective tax rates for the first nine months of 2003 and 2002 were 38% and 37%, respectively.
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FINANCIAL CONDITION
ASSETS
Loans and Lending Activities
General: Our loan products include short- and medium-term commercial loans, commercial credit lines, construction and real estate loans, consumer loans, and credit cards. 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 higher net interest margins than other types of lending. However, they also involve greater risks, including greater exposure to changes in local economic conditions, than certain other types of lending.
Loans are the highest yielding component of earning assets. Average loans were $76.4 million, or 15%, greater in the third quarter of 2003 than in the same period of 2002. Loans comprised 89% of total average earning assets for the third quarter ending September 30, 2003, compared to 85% of total average earning assets for the third quarter ending September 30, 2002. The yield on loans averaged 7.30% for the quarter ended September 30, 2003, compared to 8.18% during the same period in 2002.
Growth in the loan portfolio for the nine-month period ending September 30, 2003, compared to the same period in 2002 was $69.1 million, or 13%. Commercial loans increased $37.7 million, or 21%, commercial real estate loans increased $21.6 million, or 11%, construction loans increased $20.6 million, or 26%, real estate loans for sale loans decreased $2.2 million, or 46%, and consumer loans decreased $8.8 million, or 17%, during the third quarter of 2003 as compared to the same period in 2002. Funding for the growth in loans during the third quarter of 2003 came from a decrease in investments and an increase in non interest-bearing sources of funds and capital.
We began a program in 1998 of purchasing single-family mortgage loans originated from our affiliated mortgage company, RML. These loans, which are committed for sale to mortgage investors, have generally been held by the Company for less than 45 days. At September 30, 2003, these loans totaled $2.6 million compared to $4.8 million on September 30, 2002.
Loan Portfolio Composition: Loans, excluding real estate loans for sale, increased to $583.2 million at September 30, 2003, from $527.6 million at December 31, 2002. At September 30, 2003, 55% of the portfolio was scheduled to mature over the next 12 months and 28% was scheduled to mature between October 1, 2004, and September 30, 2008. Future growth in loans is generally dependent on new loan demand and deposit growth, and is constrained by the Company’s policy of being “well-capitalized.”
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Nonperforming Loans; Real Estate Owned: Nonperforming assets consist of nonaccrual loans, accruing loans that are 90 days or more past due, restructured loans, and real estate owned. The following table sets forth information with respect to nonperforming assets:
Nonaccrual, Accruing Loans 90 Days or More Past Due and Restructured Loans: The Company’s financial statements are prepared on the accrual basis of accounting, including recognition of interest income on its loan portfolio, unless a loan is placed on a nonaccrual basis. For financial reporting purposes, amounts received on nonaccrual loans generally will be applied first to principal and then to interest only after all principal has been collected.
Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower, have been granted due to the borrower’s weakened financial condition. Interest on restructured loans will be accrued at the restructured rates when it is anticipated that no loss of original principal will occur and the interest can be collected.
Total nonperforming loans at September 30, 2003, were $10.3 million, or 1.8% of total portfolio loans, an increase of $4.6 million from $5.7 million at December 31, 2002, and an increase of $4.8 million from $5.6 million at September 30, 2002. The increase in nonperforming loans in the third quarter of 2003 resulted in large part from the remaining portion of one relationship being categorized as non-performing and the inclusion of three larger commercial loans in the non-performing category. These loans comprise 59% of the non-performing loan totals.
At September 30, 2003, December 31, 2002, and September 30, 2002, the Company had loans measured for impairment loans of $15.6 million, $3.1 million, and $4.5 million, respectively. A specific allowance of $1.1 million, $271,000, and $1 million, was established for these periods.
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Potential Problem Loans: At September 30, 2003, the Company had identified $8.1 million of potential problem loans, as compared to $2.9 million at December 31, 2002, and zero one-year ago. Potential problem loans are loans which are currently performing and are not included in nonaccrual, accruing loans 90 days or more past due, or restructured loans at the end of the applicable period, but about which there has developed serious doubts as to the borrower’s ability to comply with present repayment terms and, which may later be included in nonaccrual, past due, or restructured loans.
Analysis of Allowance for Loan Losses: The Allowance for Loan Losses was $9.9 million, or 1.70% of total portfolio loans outstanding (which excludes $2.6 million of real estate loans for sale), at September 30, 2003, compared to $8.3 million, or 1.61%, of total portfolio loans at September 30, 2002. The Allowance for Loan Losses represented 96% of non-performing loans at September 30, 2003, as compared to 148% of non-performing loans at September 30, 2002. Management believes that at September 30, 2003, the Allowance for Loan Losses was adequate to cover losses that are reasonably likely in light of our current loan portfolio and existing and expected economic conditions. Management anticipates additional provisions to the Allowance for Loan Losses in future periods due to expected growth in the loan portfolio and a perceived continued softening of the overall state and local economies.
Investment Securities
Investment securities, which include Federal Home Loan Bank stock, totaled $62.9 million at September 30, 2003, a decrease of $18.4 million, or 23%, from $81.3 million at December 31, 2002, and a decrease of $18.4 million, or 23%, from $81.3 million at September 30, 2002. Investment securities designated as available for sale comprised 96% of the investment portfolio at September 30, 2003, December 31, 2002, and September 30, 2002, and are available to meet liquidity requirements. Both available for sale and held to maturity securities may be pledged as collateral to secure public deposits. At September 30, 2003, $27 million in securities, or 43%, of the investment portfolio were pledged, as compared to $40.7 million, or 50%, at December 31, 2002, and $37.7 million, or 46%, at September 30, 2002.
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LIABILITIES
Deposits
General: Deposits are the Company’s primary source of new funds. Total deposits increased $17.8 million to $644.2 million at September 30, 2003, up 3% from $626.4 million at December 31, 2002, and up 2% from $633.7 million at September 30, 2002. The Company’s deposits generally are expected to fluctuate according to the level of the Company’s market share, economic conditions, and normal seasonal trends.
Certificates of Deposit: The only deposit category with stated maturity dates is certificates of deposit. At September 30, 2003, the Company had $164.2 million in certificates of deposit, of which $124.5 million, or 76%, are scheduled to mature over the next 12 months compared to $117.2 million, or 72%, at December 31, 2002, and to $138 million, or 82%, one year ago.
The following table sets forth the scheduled maturities of the Company’s certificates of deposit for the dates indicated:
Alaska Permanent Fund Deposits: The Alaska Permanent Fund Corporation may invest in certificates of deposit at Alaska banks in an aggregate amount with respect to each bank, not to exceed its capital and at specified rates and terms. The depository bank must collateralize the deposit. At September 30, 2003, the Company held $35.1 million in certificates of deposit for the Alaska Permanent Fund, collateralized by available-for-sale securities and a letter of credit issued by the Federal Home Loan Bank (“FHLB”).
Borrowings
Federal Home Loan Bank: At September 30, 2003, the Company’s maximum borrowing line from the FHLB was approximately $75.1 million with $25 million committed to secure public deposits and $3.4 million in long-term advances, compared to $5 million to secure public deposits and $3.8 million in long-term advances at December 31, 2002. Additional advances are dependent on 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.
Other Short-term Borrowing: At September 30, 2003, the Company had no short-term (original maturity of one year or less) borrowings that exceeded 30% of shareholders’ equity.
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CAPITAL
Shareholders’ Equity
Shareholders’ equity was $72.5 million at September 30, 2003, compared to $68.4 million at December 31, 2002, an increase of 6%. The Company earned net income of $7.9 million during the nine-month period ending September 30, 2003. However, the Company’s equity was decreased by dividends paid and declared that totaled $1.4 million and the stock repurchase plan outlined below.
Capital Requirements and Ratios
The Company is 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. As of September 30, 2003, the Company and the Bank met all applicable capital adequacy requirements.
The FDIC has in place qualifications for banks to be classified as “well-capitalized.” As of June 13, 2003, the most recent notification from the FDIC categorized the Bank as “well-capitalized.” There were no conditions or events since the FDIC notification that have changed the Bank’s classification.
The following table illustrates the capital requirements for the Company and its actual capital ratios that exceed these requirements:
Stock Repurchase Plan
In September of last year, the Board of Directors of the Company approved a plan whereby the Company would periodically repurchase, for cash, up to approximately 5%, or 306,372, of its shares of stock in the open market. The Company purchased 224,800 shares of its stock under this program through September 30, 2003, at a total cost of $3.1 million, with 13,800 of those shares repurchased in the third quarter of 2003 at a cost of $241,500. The Company intends to continue to repurchase its stock from time to time depending upon market conditions.
Trust Preferred Issuance
On May 8, 2003, the Company’s newly formed subsidiary, Northrim Capital Trust I, issued trust preferred securities in the principal amount of $8 million. These securities carry an interest rate of LIBOR plus 3.15% that was initially set at 4.45% and adjusted quarterly. The securities have a maturity date of May 15, 2033, and are callable by the Company within the first five years. These securities are treated as Tier 1 capital by the Company’s regulators for capital adequacy calculations.
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CAPITAL EXPENDITURES AND COMMITMENTS
None.
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ITEM THREE
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate, credit, and operations risks are the most significant market risks, which affect the Company’s performance. The Company relies on loan review, prudent loan underwriting standards, and an adequate allowance for credit losses to mitigate credit risk.
The Company utilizes a simulation model to monitor and manage interest rate risk within parameters established by its internal policy. The model projects the impact of a 100 basis point increase and a 100 basis point decrease, from prevailing interest rates, on the balance sheet for a period of 12 months.
The Company is currently liability sensitive, meaning that interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period. Therefore, a significant increase in market rates of interest could adversely impact net interest income. Conversely, a declining interest rate environment may improve net interest income. However, due to the historically low level of interest rates, the Company may be unable to pass additional declines through to its deposit customers, which could have an adverse effect on its net interest income.
Generalized assumptions are made on how investment securities, classes of loans and various deposit products might respond to the interest rate changes. These assumptions are inherently uncertain, and as a result, the model cannot precisely estimate net interest income nor precisely predict the impact of higher or lower interest rates on net interest income. Actual results may differ materially from simulated results due to factors such as timing, magnitude, and frequency of rate changes, customer reaction to rate changes, changes in market conditions, the absolute level of interest rates, and management strategies, among other factors.
The results of the simulation model at September 30, 2003, indicate that, if interest rates increased an immediate 100 basis points, the Company would experience a decrease in net interest income of approximately $1 million over the next 12 months. Similarly, the simulation model indicates that, if interest rates decreased an immediate 100 basis points, the Company would experience a decrease in net interest income of approximately $100,000 over the next 12 months. Due to the fact that interest rates are at historically low levels, the simulation model did not take the 100-point decrease in interest rates into full effect. As a result, this decrease in interest rates in the simulation model had a smaller effect on the Company’s simulated net interest income.
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ITEM FOUR
CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Our principal executive and financial officers supervised and participated in this evaluation. Based on this evaluation, our principal executive and financial officers each concluded that the disclosure controls and procedures are effective in timely alerting them to material information required to be included in the periodic reports to the Securities and Exchange Commission. The design of any system of controls is based in part upon various assumptions about the likelihood of future events, and there can be no assurance that any of our plans, products, services or procedures will succeed in achieving their intended goals under future conditions. In addition, there have been no significant changes in our internal controls or in other factors known to management that could significantly affect our internal controls subsequent to our most recent evaluation. We have found no facts that would require us to take any corrective actions with regard to significant deficiencies or material weaknesses.
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PART II — OTHER INFORMATION
ITEM SIX
EXHIBITS AND REPORTS ON FORM 8-K
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SIGNATURES
Under the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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