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Northrim BanCorp 10-K 2007
e10vk
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
 
ANNUAL REPORT UNDER SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
 
Commission File Number 0-33501
 
 
     
Alaska
  92-0175752
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification Number)
3111 C Street
Anchorage, Alaska 99503
(Address of principal executive offices) (Zip Code)
 
Registrant’s Telephone Number, Including Area Code:
(907) 562-0062
 
Securities Registered Pursuant to Section 12(b) of the Act:
None
 
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $1.00 Par Value
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (17 C.F.R. 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.  Yes o     No þ
 
Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o               Accelerated filer þ               Non-Accelerated filer o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ
 
The aggregate market value of common stock held by non-affiliates of registrant at June 30, 2006, was $133,680,506.
 
The number of shares of registrant’s common stock outstanding at March 1, 2007, was 6,115,822.
 
Documents incorporated by reference and parts of Form 10-K into which incorporated: The portions of the Proxy Statement for Northrim BanCorp’s Annual Shareholders’ Meeting to be held on May 3, 2007, referenced in Part III of this Form 10-K are incorporated by reference therein.
 


 

 
 
         
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Northrim BanCorp, Inc.
       
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Financial Section
       
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 EXHIBIT 10.16
 EXHIBIT 10.17
 EXHIBIT 10.18
 EXHIBIT 10.19
 EXHIBIT 10.20
 EXHIBIT 23
 EXHIBIT 24
 EXHIBIT 31.1
 EXHIBIT 31.2
 EXHIBIT 32.1
 EXHIBIT 32.2
 
 
 
This report includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements describe Northrim’s management’s expectations about future events and developments such as future operating results, growth in loans and deposits, continued success of Northrim’s style of banking, and the strength of the local economy. All statements other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, made in this report are forward-looking. We use words such as “anticipates,” “believes,” “expects,” “intends” and similar expressions in part to help identify forward-looking statements. Forward-looking statements reflect management’s current expectations and are inherently uncertain. Our actual results may differ significantly from management’s expectations, and those variations may be both material and adverse. Forward-looking statements are subject to various risks and uncertainties that may cause our actual results to differ materially and adversely from our expectations as indicated in the forward-looking statements. These risks and uncertainties include: the general condition of, and changes in, the Alaska economy; factors that impact our net interest margins; and our ability to maintain asset quality. 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 and economy. Many of these risks, as well as other risks that may have a material adverse impact on our operations and business, are identified in our filings with the SEC. However, you should be aware that these factors are not an exhaustive list, and you should not assume these are the only factors that may cause our actual results to differ from our expectations. In addition, you should note that we do not intend to update any of the forward-looking statements or the uncertainties that may adversely impact those statements.


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Northrim BanCorp, Inc.
About the Company
 
 
Northrim BanCorp, Inc. (the “Company”) is a publicly traded bank holding company with four 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 equity interest in Elliott Cove Capital Management LLC, (“Elliott Cove”), an investment advisory services company; Northrim Capital Trust 1 (“NCT1”), an entity that we formed in May of 2003 to facilitate a trust preferred security offering by the Company; and Northrim Statutory Trust 2 (“NST2”), an entity that we formed in December of 2005 to facilitate a trust preferred security offering by the Company. We also hold a 24% interest in the profits and losses of a residential mortgage holding company, Residential Mortgage Holding Company LLC (“RML Holding Company”) through Northrim Bank’s wholly-owned subsidiary, Northrim Capital Investments Co. (“NCIC”). The predecessor of RML Holding Company, Residential Mortgage LLC (“RML”), was formed in 1998 and has offices throughout Alaska. We also operate in the Washington and Oregon market areas through Northrim Funding Services, a division of the Bank that was formed in 2004. In March and December of 2005, NCIC purchased ownership interests totaling 50.1% in Northrim Benefits Group, LLC (“NBG”), an insurance brokerage company that focuses on the sale and servicing of employee benefit plans. Finally, in the first quarter of 2006, through NISC, we purchased a 24% interest in Pacific Wealth Advisors, LLC (“PWA”), an investment advisory and wealth management business located in Seattle, Washington.
 
The Company is regulated by the Board of Governors of the Federal Reserve System, and the Bank is regulated by the Federal Deposit Insurance Corporation (“FDIC”), and the State of Alaska Department of Community and Economic Development, Division of Banking, Securities and Corporations. We began banking operations in Anchorage in December 1990, and formed the Company in connection with our reorganization into a holding company structure; that reorganization was completed effective December 31, 2001. We make our Securities Exchange Act reports available free of charge on our Internet web site, www.northrim.com. Our reports can also be obtained through the Securities and Exchange Commission’s EDGAR database at www.sec.gov.
 
We opened for business in 1990 shortly after the dramatic consolidation of the Alaska banking industry in the late 1980s that left three large commercial banks with over 93% of commercial bank deposits in greater Anchorage. Through the successful implementation of our “Customer First Service” philosophy of providing our customers with the highest level of service, we capitalized on the opportunity presented by this consolidation and carved out a market niche among small business and professional customers seeking more responsive and personalized service.
 
We grew substantially in 1999 when we completed a public stock offering in which we raised $18.5 million and acquired eight branches from Bank of America. The Bank of America branch acquisition was completed in June 1999 and increased our outstanding loans by $114 million, our deposits by $124 million, and provided us fixed assets valued at $2 million, for a purchase price of $5.9 million, in addition to the net book value of the loans and fixed assets. The stock offering allowed us to achieve the Bank of America acquisition while remaining well-capitalized under bank regulatory guidelines.
 
We have grown to be the third largest commercial bank in Anchorage and Alaska in terms of deposits, with $794.9 million in total deposits and $925.6 million in total assets at December 31, 2006. Through our 10 branches, we are accessible by approximately 65% of the Alaska population.
 
  •     Anchorage: We have two major financial centers in Anchorage, four smaller branches, and one supermarket branch. We are also exploring future branching opportunities in this market.
 
  •     Fairbanks: We opened our financial center in Fairbanks, Alaska’s second largest city, in mid-1996. This branch has given us a strong foothold in Interior Alaska, and management believes that there is significant potential to increase our share of that market. We plan to begin construction of a second branch in the Fairbanks market in the second quarter of 2007.
 
  •     Eagle River: We also serve Eagle River, a community outside of Anchorage. In January of 2002, we moved from a supermarket branch into a full-service branch to provide a higher level of service to this growing market.
 
  •     Wasilla: Wasilla is a rapidly growing market in the Matanuska Valley outside of Anchorage where we completed construction of a new financial center in December of 2002 and moved from our supermarket branch and loan production office into this new facility.


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As of December 31, 2006, the Company owned a 47% equity interest in Elliott Cove, an investment advisory services company, through its wholly — owned subsidiary, NISC. Elliott Cove began active operations in the fourth quarter of 2002 and has had start-up losses since that time as it continues to build its assets under management. In addition to its ownership interest, the Company provides Elliott Cove with a line of credit that has a committed amount of $750,000 and an outstanding balance of $617,000 as of December 31, 2006.
 
As of December 31, 2006, there are 11 Northrim Bank employees who are licensed as IAR’s and actively selling the Elliott Cove product. We plan to continue to use the Elliott Cove products to strengthen our existing customer relationships and bring new customers into the Bank. In addition, as Elliott Cove builds its assets under management, we expect that it will reach a break-even point on a monthly basis on its operations in 2008.
 
 
In the third quarter of 2004, we formed Northrim Funding Services (“NFS”) as a division of the Bank. NFS is based in Bellevue, Washington and provides short-term working capital to customers in the states of Washington and Oregon by purchasing their accounts receivable. During its second full year of operations in 2006, the employees of NFS expanded the base of their operations. In 2007, we expect NFS to continue to penetrate its market and increase its market share in the purchased receivables business.
 
 
In the first part of 2005, we launched our High Performance Checking (“HPC”) product consisting of several consumer checking accounts tailored to the needs of specific segments of our market, including a totally free checking product. We supported the new products with a targeted marketing program and extensive branch sales promotions. Through the concentrated efforts of our branch employees, we increased the number of our deposit accounts and the balances in them.
 
In the fourth quarter of 2006, we introduced HPC for our business checking accounts. In 2007, we plan to continue to support the HPC consumer and business checking products with the same program of targeted marketing and branch promotions in an effort to continue to expand our core deposits.
 
 
In addition to our acquisition strategy, we are pursuing a strategy of aggressive internal growth. Our success will depend on our ability to manage our credit risks and control our costs while providing competitive products and services. To achieve our objectives, we are pursuing the following business strategies:
 
  •     Providing Customer First Service: We believe that we provide a high level of customer service. Our guiding principle is to serve our market areas by operating with a “Customer First Service” philosophy, affording our customers the highest priority in all aspects of our operations. To achieve this objective, our management emphasizes the hiring and retention of competent and highly motivated employees at all levels of the organization. Management believes that a well-trained and highly motivated core of employees allows maximum personal contact with customers in order to understand and fulfill customer needs and preferences. This “Customer First Service” philosophy is combined with our emphasis on personalized, local decision making.
 
  •     Emphasizing Business and Professional Lending: We endeavor to provide commercial lending products and services, and to emphasize relationship banking with businesses and professional individuals. Management believes that our focus on providing financial services to businesses and professional individuals has and may continue to increase lending and core deposit volumes.
 
  •     Providing Competitive and Responsive Real Estate Lending: We estimate that we are a major land development and residential construction lender and an active lender in the commercial real estate market. Management believes that our willingness to provide these services in a professional and responsive manner has contributed significantly to our growth. Because of our relatively small size, our experienced senior management can be more involved with serving customers and making credit decisions, allowing us to compete more favorably for lending relationships.
 
  •     Pursuing Strategic Opportunities for Additional Growth: Management believes that the Bank of America branch acquisition in 1999 significantly strengthened our local market position and enabled us to further capitalize on expansion opportunities resulting from the demand for a locally based banking institution providing a high level of service. Not only did the acquisition increase our size, number of branch offices and lending capacity, but it also expanded our consumer


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  lending, further diversifying our loan portfolio. We expect to continue seeking similar opportunities to further our growth while maintaining a high level of credit quality. We plan to affect our growth strategy through a combination of growth at existing branch locations, new branch openings, primarily in Anchorage, Wasilla and Fairbanks, and strategic banking and non-banking acquisitions.
 
  •     Developing a Sales Culture: In 2003, we conducted extensive sales training throughout the Company and developed a comprehensive approach to sales. Since then, we have continued with this sales training in all of our major customer contact areas. Our goal throughout this process is to increase and broaden the relationships that we have with new and existing customers and to continue to increase our market share within our existing markets.
 
 
We provide a wide range of banking services in South Central and Interior Alaska to businesses, professionals, and individuals with high service expectations.
 
Deposit Services: Our deposit services include noninterest-bearing checking accounts and interest-bearing time deposits, checking accounts, and savings accounts. Our interest-bearing accounts generally earn interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. We have two deposit products that are indexed to specific U.S. Treasury rates.
 
Several of our innovative deposit services and products are:
 
  •     An indexed money market deposit account;
 
  •     A “Jump-Up” certificate of deposit (“CD”) that allows additional deposits with the opportunity to increase the rate to the current market rate for a similar term CD;
 
  •     An indexed CD that allows additional deposits, quarterly withdrawals without penalty, and tailored maturity dates; and
 
  •     Arrangements to courier noncash deposits from our customers to their branch.
 
Lending Services: We are an active lender with an emphasis on commercial and real estate lending. We also believe we have a significant niche in construction and land development lending in Anchorage, Fairbanks, and the Matanuska Valley (near Anchorage). To a lesser extent, we provide consumer loans. See “— Lending Activities.”
 
Other Customer Services: In addition to our deposit and lending services, we offer our customers several 24-hour services: Telebanking, faxed account statements, Internet banking for individuals and businesses, and automated teller services. Other special services include personalized checks at account opening, overdraft protection from a savings account, extended banking hours (Monday through Friday, 9 a.m. to 6 p.m. for the lobby, and 8 a.m. to 7 p.m. for the drive-up, and Saturday 10 a.m. to 3 p.m.), commercial drive-up banking with coin service, automatic transfers and payments, wire transfers, direct payroll deposit, electronic tax payments, Automated Clearing House origination and receipt, cash management programs to meet the specialized needs of business customers, and courier agents who pick up noncash deposits from business customers.
 
Directors and Executive Officers: The following table presents the names and occupations of our directors and executive officers.
 
     
Executive Officers/Age   Occupation
 
*R. Marc Langland, 65
  Chairman, President, & CEO of the Company and the Bank, and Director, Alaska Air Group
*Christopher N. Knudson, 53
  Executive Vice President and Chief Operating Officer of the Company and the Bank
Joseph M. Schierhorn, 49
  Executive Vice President, Chief Financial Officer, and Compliance Manager of the Company and the Bank
Joseph M. Beedle, 55
  Executive Vice President of the Company and Chief Lending Officer of the Bank
Victor P. Mollozzi, 57
  Senior Vice President, Senior Credit Officer of the Bank
 
*Indicates individual serving as both director and executive officer.


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Directors/Age   Occupation
 
Larry S. Cash, 55
  President and CEO, RIM Architects (Alaska), Inc.; CEO, RIM Architects (Guam), LLC.
Mark G. Copeland, 64
  Owner and sole member of Strategic Analysis, LLC, a management consulting firm
Frank A. Danner, 73
  Secretary/Treasurer, IMEX, Ltd. dba Dynamic Properties (real estate firm)
Ronald A. Davis, 74
  Former Vice President, Acordia of Alaska Insurance (full service insurance agency)
Anthony Drabek, 59
  President and CEO, Natives of Kodiak, Inc. (Alaska Native Corporation), Chairman and President, Koncor Forest Products Co.; Secretary/Director, Atikon Forest Products Co.
Richard L. Lowell, 66
  Former Chairman, Ribelin Lowell Alaska USA Insurance Brokers, Inc. (insurance brokerage firm)
Irene Sparks Rowan, 65
  Former Chairman and Director, Klukwan, Inc. (Alaska Native Corporation) and its subsidiaries
John C. Swalling, 57
  President, Swalling & Associates, P.C. (accounting firm)
David G. Wight, 66
  Former President and CEO, Alyeska Pipeline Service Company, and Director, Storm Cat Energy Corporation


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    2006   2005   2004   2003   2002
 
    Unaudited
    (In Thousands Except Per Share Data)
 
Net interest income
  $47,522   $43,908   $41,271   $39,267   $34,670
Provision for loan losses
  2,564   1,170   1,601   3,567   3,095
Other operating income
  7,658   4,833   3,792   6,089   5,199
Other operating expense
  31,368   29,477   26,535   24,728   23,061
 
 
Income before income taxes and minority interest
  21,248   18,094   16,927   17,061   13,713
Minority interest in subsidiaries
  296        
Pre tax income
  20,952   18,094   16,927   17,061   13,713
Income taxes
  7,978   6,924   6,227   6,516   5,171
 
 
Net income
  $12,974   $11,170   $10,700   $10,545   $8,542
 
 
                     
Earnings per share:
                   
Basic
  $2.12   $1.78   $1.68   $1.68   $1.33
Diluted
  2.09   1.72   1.63   1.61   1.29
Cash dividends per share
  0.47   0.43   0.38   0.33   0.20
                     
Assets
  $925,620   $895,580   $800,726   $738,569   $704,249
Loans
  717,056   705,059   678,269   601,119   534,990
Deposits
  794,904   779,866   699,061   646,197   626,415
Long-term debt
  2,174   2,574   2,974   3,374   3,774
Junior subordinated debentures
  18,558   18,558   8,000   8,000  
Shareholders’ equity
  95,418   84,474   83,358   75,285   68,373
                     
Book value
  $15.61   $13.86   $13.01   $11.82   $10.66
Tangible book value
  $14.48   $12.65   $11.97   $10.73   $9.51
Net interest margin (tax equivalent)
  5.89%   5.66%   5.88%   6.04%   5.82%
Efficiency ratio (cash)(1)
  55.97%   59.72%   58.07%   53.71%   56.92%
Return on assets
  1.46%   1.33%   1.44%   1.50%   1.33%
Return on equity
  14.45%   13.17%   13.50%   14.89%   13.32%
Equity/assets
  10.31%   9.44%   10.41%   10.19%   9.71%
Dividend payout ratio
  21.43%   22.92%   21.57%   19.04%   14.29%
Nonperforming loans/portfolio loans
  0.92%   0.86%   0.97%   1.72%   1.09%
Net charge-offs/average loans
  0.16%   0.18%   0.16%   0.33%   0.36%
Allowance for loan losses/portfolio loans
  1.69%   1.52%   1.59%   1.70%   1.61%
Nonperforming assets/assets
  0.79%   0.69%   0.82%   1.40%   0.81%
                     
Number of banking offices
  10   10   10   10   10
Number of employees (FTE)
  277   272   272   268   246
 
 
 
(1)  In managing our business, we review the efficiency ratio exclusive of intangible asset amortization (see definition in table below), which is not defined in accounting principles generally accepted in the United States (“GAAP”). The efficiency ratio is calculated by dividing noninterest expense, exclusive of intangible asset amortization, by the sum of net interest income and noninterest income. Other companies may define or calculate this data differently. We believe this presentation provides investors with a more accurate picture of our operating efficiency. In this presentation, noninterest expense is adjusted for intangible asset amortization. For additional information see the “Noninterest Expense” section in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation” of this report.


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Years ended December 31,   2006   2005   2004   2003   2002
 
 
Net interest income(1)
  $47,522   $43,908   $41,271   $39,267   $34,670
Noninterest income
  7,658   4,833   3,792   6,089   5,199
Noninterest expense
  31,368   29,477   26,535   24,728   23,061
Intangible asset amortization
  482   368   368   368   368
 
 
Adjusted noninterest expense
  $30,886   $29,109   $26,167   $24,360   $22,693
 
 
                               
Efficiency ratio
  56.85%   60.48%   58.88%   54.52%   57.84%
Efficiency ratio (less intangible asset amortization)
  55.97%   59.72%   58.07%   53.71%   56.92%
Tax rate
  38%   38%   37%   38%   38%
 
 
 
(1)  Amount represents net interest income before provision for loan losses.
(2)  These unaudited schedules provide selected financial information concerning the Company that should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations“ of this report.


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Management’s Discussion and Analysis of Financial Condition and
Results of Operation
 
 
We are a publicly traded bank holding company with four wholly-owned subsidiaries: the Bank, a state chartered, full-service commercial bank; NISC, a company formed to invest in both Elliott Cove, an investment advisory services company, and PWA, an investment advisory and wealth management business located in Seattle, Washington; and NCT1 and NST2, entities formed to facilitate two trust preferred securities offerings. The Bank in turn has a wholly-owned subsidiary, NCIC, which has an interest in RML Holding Company, a residential mortgage holding company and NBG, an insurance brokerage company that provides employee benefits plans to businesses throughout Alaska. We are headquartered in Anchorage and have 10 branch locations, seven in Anchorage, and one each in Fairbanks, Eagle River, and Wasilla. The Bank also operates Northrim Funding Services, a division headquartered in Bellevue, Washington with operations in the Washington and Oregon markets. We offer a wide array of commercial and consumer loan and deposit products, investment products, and 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 purchase price of $5.9 million.
 
One of our major objectives is to increase our market share in Anchorage, Fairbanks, and the Matanuska Valley, Alaska’s three largest urban areas. We estimate that we hold a 21% share of the commercial bank deposit market in Anchorage, a 9% share of the Fairbanks market, and a 10% share of the Matanuska Valley market as of June 30, 2006.
 
Our growth and operations depend upon the economic conditions of Alaska and the specific markets we serve. The economy of Alaska is dependent upon the natural resources industries, in particular oil production, as well as tourism, government, and U.S. military spending. According to the State of Alaska Department of Revenue, approximately 86% of the Alaska state government is funded through various taxes and royalties on the oil industry. Any significant changes in the Alaska economy and the markets we serve eventually could have a positive or negative impact on the Company.
 
During the second quarter of 1999, we sold 1,842,900 shares of our common stock in an underwritten common stock offering that generated $18.5 million in net proceeds. We used the proceeds to purchase the Bank of America branches and to provide capital for additional growth.
 
At December 31, 2006, we had assets of $925.6 million and gross loans of $717.1 million, an increase of 3% and 2%, respectively, over assets of $895.6 million and gross loans of $705.1 million at December 31, 2005. Our net income and diluted earnings per share for 2006 were $13 million and $2.09, respectively, an increase of 16% and 22%, respectively, from $11.2 million and $1.72 at year end 2005. During the same time period, our net interest income increased by $3.6 million, or 8%, to $47.5 million, from $43.9 million for the year ended 2005. Our provision for loan losses in 2006 increased by $1.4 million, or 119% to $2.6 million, from $1.2 million in 2005, as our nonperforming loans increased by $561,000, or 9% for 2006, from $6.1 million in 2005 to $6.6 million for 2006. In contrast, for 2006 our other operating income increased by $2.8 million, or 58%, to $7.7 million from $4.8 million in 2005. The growth in our net interest income combined with the positive effects of the increases in our other operating income was offset in part by an increase in other operating expenses of $1.9 million, or 6%, to $31.4 million in 2006 from $29.5 million for 2005, which resulted in an increase in our net income and earnings per share.
 
Results of Operations
 
 
We earned net income of $13 million in 2006, compared to net income of $11.2 million in 2005, and $10.7 million in 2004. During these periods, net income per diluted share was $2.09, $1.72, and $1.63, respectively.
 
Net Interest Income
 
Our results of operations are dependent to a large degree on our net interest income. We also generate other income, primarily through service charges and fees, earnings from our mortgage affiliate and purchased receivables products, and other sources. Our operating expenses consist in large part of compensation, employee benefits expense, occupancy, and marketing expense. Interest income and cost of funds are affected significantly by general economic conditions, particularly changes in market interest rates, and by government policies and the actions of regulatory authorities.


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Net interest income is the difference between interest income, from loan and investment securities portfolios, and interest expense, on customer deposits and borrowings. Net interest income in 2006 was $47.5 million compared to $43.9 million in 2005, and $41.3 million in 2004, reflecting an increase in our interest-earning assets and the general level of interest rates. Average interest-earning assets increased $32.3 million, or 4%, in 2006 compared to an increase in average interest-bearing liabilities in 2006 of $36 million, or 6%. Average interest-earning assets increased $74.1 million, or 11%, in 2005 compared to an increase in average interest-bearing liabilities in 2005 of $76.1 million, or 15%.
 
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 the level and relative mix of interest-earning assets and interest-bearing liabilities. During the fiscal years ended December 31, 2006, 2005, and 2004, average interest-earning assets were $810.9 million, $778.6 million, and $704.5 million, respectively. During these same periods, net interest margins were 5.86%, 5.64%, and 5.86%, respectively, which reflect our balance sheet mix and premium pricing on loans compared to other community banks and an emphasis on construction lending, which has a higher fee base. Our average yield on earning-assets was 8.57% in 2006, 7.55% in 2005, and 6.89% in 2004, while the average cost of interest-bearing liabilities was 3.63% in 2006, 2.61% in 2005, and 1.48% in 2004.
 
Our net interest margin increased in 2006 from 2005 due to the interaction of several factors. First, in 2006, the cost of interest-bearing liabilities increased by 102 basis points while the yield on interest-earning assets also increased by 102 basis points. During this time, the average balance of our interest-bearing demand deposits increased by $13 million to $78.9 million at December 31, 2006 from $65.9 million at December 31, 2005. The average balance of our demand deposits and other noninterest-bearing liabilities also increased by $5.5 million to $193.5 million at December 31, 2006 from $188 million at December 31, 2005. The increase in these lower cost deposits in 2006 helped to contain the rate of growth in the cost of interest-bearing liabilities. Second, the 102 basis point increase in the yield on earning assets in 2006 had a larger effect on net interest income because it was applied to earning assets with an average balance of $810.9 million versus the 102 basis point increase in the cost of interest-bearing liabilities that was applied to an average balance of $605.6 million. Finally, in 2006, earning assets increased by $32.3 million, or 4% compared to growth of $74.1 million, or 11% in 2005. However, during these same time periods, net interest income increased by $3.6 million, or 8% and $2.6 million, or 6%, respectively in 2006 and 2005. The growth rate of net interest income increased in 2006 while the rate of growth in earning assets decreased, which contributed to the increase in the net interest margin.


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The following table sets forth for the periods indicated, information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities. Resultant yields or costs, net interest income, and net interest margin are also presented:
 
                                     
 
Years Ended December 31,   2006   2005   2004
 
    Average
  Interest
      Average
  Interest
      Average
  Interest
   
    outstanding
  earned/
  Yield/
  outstanding
  earned/
  Yield/
  outstanding
  earned/
  Yield/
    balance   paid(1)   rate   balance   paid(1)   rate   balance   paid(1)   rate
 
    (In Thousands)
 
Assets:
                                   
Loans(2)
  $712,116   $65,347   9.18%   $698,240   $55,870   8.00%   $628,830   $45,898   7.30%
Securities
  71,164   2,757   3.87%   61,125   2,202   3.60%   64,008   2,492   3.89%
Overnight investments
  27,665   1,374   4.97%   19,232   709   3.69%   11,633   164   1.41%
 
 
Total interest-earning assets
  810,945   69,478   8.57%   778,597   58,781   7.55%   704,471   48,554   6.89%
Noninterest-earning assets
  77,920           63,810           54,788        
 
 
Total assets
  $888,865           $842,407           $759,259        
 
 
Liabilities and Shareholders’ Equity
Deposits:
                                   
Interest-bearing demand accounts
  $78,872   $830   1.05%   $65,890   $369   0.56%   $57,373   $221   0.39%
Money market accounts
  151,871   6,053   3.99%   139,331   3,876   2.78%   126,567   1,527   1.21%
Savings accounts
  254,209   10,113   3.98%   207,277   6,263   3.02%   139,876   2,290   1.64%
Certificates of deposit
  94,595   3,320   3.51%   138,284   3,482   2.52%   155,134   2,671   1.72%
 
 
Total interest-bearing deposits
  579,547   20,316   3.51%   550,782   13,990   2.54%   478,950   6,709   1.40%
Borrowings
  26,052   1,640   6.30%   18,792   883   4.70%   14,525   574   3.95%
 
 
Total interest-bearing liabilities
  605,599   21,956   3.63%   569,574   14,873   2.61%   493,475   7,283   1.48%
Demand deposits and other noninterest-bearing liabilities
  193,461           188,000           186,506        
 
 
Total liabilities
  799,060           757,574           679,981        
Shareholders’ equity
  89,805           84,833           79,278        
 
 
Total liabilities and shareholders’ equity
  $888,865           $842,407           $759,259        
 
 
Net interest income
      $47,522           $43,908           $41,271    
 
 
Net interest margin(3)
          5.86%           5.64%           5.86%
 
 
 
(1) Interest income included loan fees.
(2) Nonaccrual loans are included with a zero effective yield.
(3) The net interest margin on a tax equivalent basis was 5.89%, 5.66%, 5.88%, 6.04%, and 5.82%, respectively, for 2006, 2005, 2004, 2003, and 2002.


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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.
 
                         
 
    2006 compared to 2005   2005 compared to 2004
 
    Increase (decrease) due to   Increase (decrease) due to
    Volume   Rate   Total   Volume   Rate   Total
 
 
Interest Income:
                       
Loans
  $1,129   $8,348   $9,477   $5,327   $4,645   $9,972
Securities
  381   174   555   (109)   (181)   (290)
Overnight investments
  371   294   665   157   388   545
 
 
Total interest income
  $1,881   $8,816   $10,697   $5,375   $4,852   $10,227
 
 
Interest Expense:
                       
Deposits:
                       
Interest-bearing demand accounts
  $85   $376   $461   $37   $112   $148
Money market accounts
  375   1,802   2,177   168   2,181   2,349
Savings accounts
  1,605   2,245   3,850   1,441   2,532   3,973
Certificates of deposit
  (1,292)   1,130   (162)   (250)   1,061   811
 
 
Total interest on deposits
  773   5,554   6,326   1,396   5,885   7,281
Borrowings
  403   354   757   188   121   309
 
 
Total interest expense
  $1,176   $5,908   $7,083   $1,584   $6,006   $7,590
 
 
 
Other Operating Income
 
Total other operating income increased $2.8 million, or 59%, in 2006, after increasing $1 million, or 27%, in 2005, and decreasing $2.3 million, or 38%, in 2004. The following table separates the more routine (operating) sources of other income from those that can fluctuate significantly from period to period:
 
                     
 
Years Ended December 31,   2006   2005   2004   2003   2002
 
    (In Thousands)
 
Other Operating Income
                   
Deposit service charges
  $1,975   $1,800   $1,718   $1,805   $1,687
Purchased receivable income
  1,855   993   201   35  
Employee benefit plan income
  1,113        
Electronic banking fees
  790   632   608   563   654
Equity in earnings from RML
  649   493   438   2,785   1,917
Merchant credit card transaction fees
  531   444   414   363   423
Other transaction fees
  227   214   204   247   283
Loan service fees
  531   374   379   416   350
Equity in loss from Elliott Cove
  (230)   (424)   (457)   (554)   (239)
Other income
  217   298   136   74   11
 
 
Operating sources
  7,658   4,824   3,641   5,734   5,086
Gain on sale of securities available for sale, net
    9   151   310   113
Gain on sale of other real estate owned
        45  
 
 
Other sources
    9   151   355   113
 
 
Total other operating income
  $7,658   $4,833   $3,792   $6,089   $5,199
 
 


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Total operating sources of other operating income in 2006 increased $2.8 million, or 59% over 2005 levels. In 2005, this income increased $1.2 million, or 32%, and in 2004, it decreased $2.1 million, or 37% as compared to 2003 levels. The main reason for the increase in other operating income in 2006 was the increase in income from purchased receivables and the consolidation of NBG into the Company’s financial statements.
 
Deposit service charges increased $175,000, or 10%, in 2006 as compared to 2005, and they increased $118,000, or 5%, in 2005 as compared to 2004 due to the increased personal account base that resulted from the marketing of the HPC deposit product. The Company began to market this product in the second quarter of 2005. As a result, the increase in deposit service charges was larger in 2006 than it was in 2005 since 2006 reflected a full year of activity with the HPC product.
 
Income from the Company’s purchased receivable products increased by $862,000, or 87%, in 2006 as compared to 2005, and this income increased $792,000, or 394%, in 2005 as compared to 2004. The Company uses these products to purchase accounts receivable from its customers and provide them with working capital for their businesses. While the customers are responsible for collecting these receivables, the Company mitigates this risk with extensive monitoring of the customers’ transactions and control of the proceeds from the collection process. The Company earns income from the purchased receivable product by charging finance charges to its customers for the purchase of their accounts receivable. The income from this product has grown as the Company has used it to purchase more receivables from its customers. The Company expects the income level from this product to show growth on a year-over-year comparative basis as the Company increases this line of business at NFS as it continues to increase its market share.
 
In December of 2005, the Company, through its wholly-owned subsidiary NCIC, purchased an additional 40.1% interest in NBG, which brought its ownership interest in this company to 50.1%. As a result of this increase in ownership, the Company now consolidates the balance sheet and income statement of NBG into its financial statements. In 2006, the Company included employee benefit plan income from NBG of $1.1 million in its other operating income. In contrast, the Company did not record any income for this item in its other operating income in 2005 as it purchased a 10% interest in NBG in March of 2005 and accounted for this interest according to the equity method in 2005.
 
The Company’s electronic banking fees increased by $158,000, or 25%, in 2006 as compared to 2005, and these fees increased by $24,000, or 4%, in 2005 as compared to 2004. As the Company increased the number of its deposit accounts through the marketing of the HPC product, it also sold additional services to these new accounts, which helped it to increase its electronic banking fees.
 
Included in operating sources of other operating income in 2006, 2005, and 2004 were $649,000, $493,000, and $438,000, respectively, of income from our share of the earnings from RML. RML was formed in 1998 and has offices throughout Alaska. During the third quarter of 2004, RML reorganized and became a wholly-owned subsidiary of a newly formed holding company, RML Holding Company. In this process, RML Holding Company acquired another mortgage company, Pacific Alaska Mortgage Company (“PAM”). In the first quarter of 2005, PAM was merged into RML. Prior to the reorganization, the Company, through Northrim Bank’s wholly-owned subsidiary, NCIC, owned a 30% interest in the profits and losses of RML. Following the reorganization, the Company’s interest in RML Holding Company decreased to 24%.
 
Earnings from RML and RML Holding Company have fluctuated with activity in the housing market, which has been affected by local economic conditions and changes in mortgage interest rates. In 2003, and 2002, declining mortgage interest rates generated a significant increase in the demand for mortgage loans by consumers both for the refinance of existing loans and the purchase of new homes. Mortgage rates began to increase in the third quarter of 2003 from the historic lows reached in the second quarter. As a result, the refinance activity in the mortgage industry began to decrease in the latter part of 2003. Due to this trend of increasing long-term mortgage interest rates and the costs associated with the merger of RML and PAM, our share of the earnings from RML declined in 2004. In 2005 and 2006, RML Holding Company began to realize some efficiencies from its merger and increased its income from its combined operations.
 
Merchant credit card transaction fees increased by $87,000, or 20% in 2006 as compared to 2005, and these fees increased by $30,000, or 7%, in 2005 as compared to 2004 as the Company increased the sales volume of this product to its larger account base.
 
Loan service fees increased by $157,000, or 42% in 2006 as compared to 2005 as the Company increased the collection of late fees on its loan portfolio. In contrast, loan service fees decreased by $5,000, or 1%, in 2005 as compared to 2004.
 
Our share of the loss from Elliott Cove decreased to $230,000 in 2006, as compared to losses of $424,000 and $457,000, respectively, in 2005 and 2004 as Elliott Cove increased its assets under management, which provided it with increased revenues.
 
Other income decreased by $81,000, or 27%, to $217,000 at December 31, 2006 from $298,000 at December 31, 2005. In the first quarter of 2006, through our subsidiary, NISC, the Company purchased a 24% interest in PWA. PWA is a holding company that owns Pacific Portfolio Consulting, LLC (“PPC”) and Pacific Portfolio Trust Company (“PPTC”). PPC is an investment advisory company with an existing client base while PPTC is a start-up operation. In 2006, the Company incurred a loss of $126,000 on its investment in PWA. The losses from PWA were partially offset by increases in commissions that the Company receives for its sales of


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the Elliott Cove investment products, which were accounted for as other operating income. Finally, the Company expects to incur losses over the next several years as PWA builds the customer base of its combined operations.
 
Included in other sources of income is gain on sale of other real estate owned and gain on available for sale securities. No net security gains were recorded in 2006, whereas $9,000 of net gains was recorded in 2005, and $151,000 was recorded in 2004. In 2005, this income decreased $142,000, or 94%; and in 2004, it decreased $204,000, or 57%.
 
 
Provision for Loan Losses: The provision for loan losses in 2006 was $2.6 million, compared to $1.2 million in 2005 and $1.6 million in 2004. We increased the provision for loan losses in 2006 due to overall loan growth and an increase in our nonperforming loans. In 2006, nonperforming loans increased to $6.6 million from a balance of $6.1 million at December 31, 2005. In addition, net loan charge-offs were $1.1 million, or 0.16% of average loans, in 2006 as compared to $1.2 million, or 0.18% of average loans, in 2005 and $1 million, or 0.16% of average loans, in 2004. The allowance for loan losses also increased in 2006 as a result of the increases in nonperforming loans and was $12.1 million, or 1.69% of portfolio loans as compared to $10.7 million, or 1.52% of portfolio loans at December 31, 2005 and $10.8 million, or 1.59% of portfolio loans, at December 31, 2004. Likewise, the coverage ratio of the allowance for loan losses versus nonperforming loans increased to 183% in 2006 as compared to a coverage ratio of 176% in 2005 and 163% in 2004.
 
Other Operating Expense: Other operating expense increased $1.9 million, or 6%, in 2006, $2.9 million, or 11%, in 2005, and $1.8 million, or 7%, in 2004. The following table breaks out the other operating expense categories:
 
                     
 
Years ended December 31,   2006   2005   2004   2003   2002
 
    (In Thousands)
 
Other Operating Expense
                   
Salaries and other personnel expense
  $19,277   $17,656   $15,708   $14,180   $13,023
Occupancy, net
  2,503   2,417   2,130   2,000   2,040
Equipment, net
  1,350   1,371   1,372   1,504   1,405
Marketing
  1,641   1,657   1,201   1,205   1,136
Intangible asset amortization
  482   368   368   368   368
Other expenses
  6,115   6,008   5,756   5,471   5,089
 
 
Total other operating expense
  $31,368   $29,477   $26,535   $24,728   $23,061
 
 
 
Salaries and other personnel expense increased $1.6 million, or 9%, in 2006, $1.9 million, or 12%, in 2005, and $1.5 million, or 11%, in 2004, reflecting increases in salary and benefit costs throughout this time due in part to ongoing competition for our employees, which placed upward pressure on our salary structure. In 2006, the increase in the Company’s salary costs was partially offset by a $357,000 decrease in its health care costs. The Company does not expect continuing declines in its health care costs. Moreover, due to the tight labor market in the Company’s major markets and ongoing competition for its employees, the Company expects further increases in salaries and benefits. In addition, as noted above, the Company now accounts for NBG on a consolidated basis. In 2006, the Company included $446,000 of NBG’s salary and benefit costs in its own salary and benefit costs. Also, in the first quarter of 2006, the Company adopted FASB Statement 123R, Share-Based Payment. As a result, in 2006 the Company recorded $256,000 in additional expense associated with its stock options.
 
Between 2006 and 2004, our occupancy expenses increased by $373,000, or 18%, to $2.5 million from $2.1 million, as we incurred higher costs in our new branch locations and occupied additional space at our main Financial Center.
 
Marketing costs decreased by $16,000, or 1%, in 2006, increased by $456,000, or 38%, in 2005, and decreased $4,000, or less than 1%, in 2004. The main reason for the increase in marketing expenses in 2005 was the costs associated with marketing our HPC product. Although the Company has incurred additional marketing expenses due to promoting its HPC Program in 2006, those costs have been offset by a decrease in other marketing expenses such as advertising for some of the Company’s other products. The Company plans to continue to market its HPC Program as it has since the second quarter of 2005. Moreover, the company expects to incur increased marketing costs for the HPC for business product that it will begin marketing in 2007. The Company expects that the Bank will increase its deposit accounts and balances as it continues to implement the HPC Program over the next year. Furthermore, the Company expects that the additional deposit accounts will continue to generate increased fee income that will offset a majority of the increased marketing costs associated with the HPC Program.
 
Intangible asset amortization increased by $114,000 or 31% to $482,000 at December 31, 2006 from $368,000 at December 31, 2005, as the Company began to amortize the customer relationship intangible asset associated with NBG. As noted


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above, the Company purchased an additional 40.1% interest in NBG in December of 2005, which increased its ownership interest in this company to 50.1%. The Company has invested $1.1 million in NBG since its initial investment in the first quarter of 2005 and has attributed all of this investment to an intangible asset represented by the value of the customer relationships of NBG. The Company is amortizing the NBG intangible asset over a ten-year period on a straight-line basis. In 2006, the amortization expense on the NBG intangible asset was $115,000, which accounts for the increase in amortization expense in that year. Prior to the Company’s additional investment in NBG in December of 2005, the Company accounted for its investment in NBG according to the equity method and did not record its amortization expense on the NBG investment on a separate basis. The other portion of intangible asset amortization at December 31, 2006 pertains to the core deposit intangible that was created when the Bank purchased branches from Bank of America in 1999. The amortization on the core deposit intangible will end in June 2007.
 
Other expenses, which includes professional fees, software expenses, ATM and Visa processing fees and other operational expenses, increased $107,000, or 2%, in 2006 as compared to 2005 and increased $252,000, or 4%, in 2005 as compared to 2004 due to changes in a variety of expense accounts.
 
Income Taxes: The provision for income taxes increased $1.1 million, or 15%, to $8 million in 2006, increased $697,000, or 11%, to $6.9 million in 2005, and decreased $289,000, or 4%, to $6.2 million in 2004. The effective tax rate for 2006 and 2005 was 38%, compared to 37% in 2004. The effective tax rate in 2004 was lower than that for 2005 due in part to the favorable resolution of a dispute on a prior year’s tax return recorded in 2004.
 
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 and consumer loans. 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 $13.9 million, or 2% greater in 2006 than in 2005. Average loans were $69.4 million, or 11% greater in 2005 than in 2004. Loans comprised 88% of total earning assets on average in 2006, 90% in 2005 and 89% in 2004. The yield on loans averaged 9.18% in 2006, 8.00% in 2005, and 7.30% in 2004.
 
Growth in the loan portfolio during 2006 was $12 million, or 2%. Commercial loans decreased $336,000, or less than 1%, commercial real estate loans decreased $14.8 million, or 6%, and construction loans increased $21.5 million, or 16%, in 2006. Installment and consumer loans increased $5.6 million, or 15%. Funding for the growth in loans in 2006 came from an increase in interest-bearing liabilities and from noninterest-bearing sources of funds and capital.


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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. We had real estate owned property of $717,000 at December 31, 2006. The following table sets forth information regarding our nonperforming loans and total nonperforming assets:
 
                     
 
December 31,   2006   2005   2004   2003   2002
 
    (In Thousands)
 
Nonperforming loans
                   
Nonaccrual loans
  $5,176   $5,090   $5,876   $7,426   $4,717
Accruing loans past due 90 days or more
  708   981   290   2,283   1,019
Restructured loans
  748     424   597  
 
 
Total nonperforming loans
  6,632   6,071   6,590   10,306   5,736
Real estate owned
  717   105      
 
 
Total nonperforming assets
  $7,349   $6,176   $6,590   $10,306   $5,736
 
 
Allowance for loan losses to portfolio loans
  1.69%   1.52%   1.59%   1.70%   1.61%
Allowance for loan losses to nonperforming loans
  183%   176%   163%   99%   148%
Nonperforming loans to portfolio loans
  0.92%   0.86%   0.97%   1.72%   1.09%
Nonperforming assets to total assets
  0.79%   0.69%   0.82%   1.40%   0.81%
 
 
 
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. Loans are placed on a nonaccrual basis when management believes serious doubt exists about the collectability of principal or interest. Our policy generally is to discontinue the accrual of interest on all loans 90 days or more past due unless they are well secured and in the process of collection. Cash payments on nonaccrual loans are directly applied to the principal balance. The amount of unrecognized interest on nonaccrual loans was $437,000, $353,000, and $658,000, in 2006, 2005, and 2004, respectively.
 
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 December 31, 2006, were $6.6 million, or 0.92% of portfolio loans, an increase of $561,000 from $6.1 million at December 31, 2005, and an increase of $42,000 from $6.6 million at December 31, 2004.
 
Potential Problem Loans: At December 31, 2006, management had identified potential problem loans of $6.4 million as compared to potential problem loans of $9.1 million at December 31, 2005. Loans in the amount of $4.1 million were reported as potential problem loans at December 31, 2005 and December 31, 2006. 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 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 restructured loans.
 
Analysis of Allowance for Loan Losses: The allowance for loan losses is maintained at a level considered adequate by management to provide for inherent loan losses based on management’s assessment of various factors affecting the loan portfolio, including a review of problem loans, business conditions, estimated collateral values, loss experience, credit concentrations, and an overall evaluation of the quality of the underlying collateral, and holding and disposal costs. The allowance is increased by provisions charged to operations and reduced by loans charged off, net of recoveries. Management believes that at December 31, 2006, the allowance is adequate to cover losses that are probable in light of our current loan portfolio and existing economic conditions.
 
While management believes that it uses the best information available to determine the allowance for loan losses, unforeseen market conditions and other events could result in adjustment to the allowance for loan losses, and net income could be significantly affected, if circumstances differed substantially from the assumptions used in making the final determination.


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The following table shows the allocation of the allowance for loan losses for the periods indicated:
 
                                         
 
December 31,   2006   2005   2004   2003   2002
 
        % of Total
      % of Total
      % of Total
      % of Total
      % of Total
Balance applicable to:   Amount   Loans(1)   Amount   Loans(1)   Amount   Loans(1)   Amount   Loans(1)   Amount   Loans(1)
 
    (Dollars in Thousands)
 
Commercial
  $8,208   40%   $6,913   41%   $5,130   39%   $5,610   37%   $4,285   35%
Construction
  330   21%   246   19%   276   18%   282   17%   1,327   15%
Real estate term
  964   33%   1,214   35%   1,634   37%   413   40%   275   40%
Loans for sale
    0%     0%     0%     0%     1%
Installment and other consumer
  6   6%   37   5%     6%   3   6%   22   9%
Unallocated
  2,617   0%   2,296   0%   3,724       3,878       2,567    
 
 
Total
  $12,125   100%   $10,706   100%   $10,764   100%   $10,186   100%   $8,476   100%
 
 
 
(1)  Represents percentage of this category of loans to total loans.
 
The following table sets forth for the periods indicated information regarding changes in our allowance for loan losses:
 
                                         
December 31,   2006   2005   2004   2003   2002
    (In Thousands)
 
Balance at beginning of period
  $10,706   $10,764   $10,186   $8,476   $7,200
Charge-offs:
                   
Commercial loans
  (2,545)   (1,552)   (2,067)   (2,067)   (1,791)
Construction loans
    (100)      
Real estate loans
        (127)   (67)
Installment and other consumer loans
  (72)   (63)   (84)   (91)   (257)
 
 
Total charge-offs
  (2,617)   (1,715)   (1,471)   (2,285)   (2,115)
 
 
Recoveries:
                   
Commercial loans
  1,086   418   200   279   168
Construction loans
    15   185    
Real estate loans
  355   15     111   48
Installment and other consumer loans
  31   39   63   38   80
 
 
Total recoveries
  1,472   487   448   428   296
 
 
Charge-offs net of recoveries
  (1,145)   (1,228)   (1,023)   (1,857)   (1,819)
 
 
Provision for loan losses
  2,564   1,170   1,601   3,567   3,095
 
 
Balance at end of period
  $12,125   $10,706   $10,764   $10,186   $8,476
 
 
Ratio of net charge-offs to average loans outstanding during the period
  0.16%   0.18%   0.16%   0.33%   0.36%
 
 
 
Credit Authority and Loan Limits: 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 $16.5 million at December 31, 2006. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Provision for Loan Losses.”


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Loan Policy: 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. We supplement our own supervision of the loan underwriting and approval process with periodic loan reviews by experienced officers who examine quality, loan documentation, and compliance with laws and regulations.
 
Loans Receivable: Loans receivable increased to $717.1 million at December 31, 2006, compared to $705.1 million and $678.3 million at December 31, 2005 and 2004, respectively. At December 31, 2006, 78% of the portfolio was scheduled to mature or reprice in 2007 with 19% scheduled to mature or reprice between 2008 and 2011. Future growth in loans is generally dependent on new loan demand and deposit growth, constrained by our policy of being “well-capitalized” as determined by the FDIC.
 
Loan Portfolio Composition: The following table sets forth at the dates indicated our loan portfolio composition by type of loan:
 
                                                                                 
December 31,   2006   2005   2004   2003   2002
        Percent
      Percent
      Percent
      Percent
      Percent
    Amount   of total   Amount   of total   Amount   of total   Amount   of total   Amount   of total
    (Dollars in Thousands)
 
Commercial loans
  $287,281   40.06%   $287,617   40.79%   $267,737   39.47%   $220,774   36.73%   $187,312   35.01%
Real estate loans:
                                       
Construction
  153,059   21.35%   131,532   18.66%   122,873   18.12%   102,311   17.02%   82,739   15.47%
Real estate term
  237,599   33.14%   252,395   35.80%   252,358   37.21%   239,545   39.85%   212,740   39.77%
Real estate loans for sale
    0.00%     0.00%     0.00%   1,395   0.23%   7,437   1.39%
Installment and other consumer loans
  42,140   5.88%   36,519   5.18%   38,166   5.63%   39,796   6.62%   47,415   8.86%
 
 
Total
  720,079   100.42%   708,063   100.43%   681,134   100.42%   603,821   100.45%   537,643   100.50%
Less:
                                       
Unearned purchase discount
    0.00%     0.00%   (44)   -0.01%   (44)   -0.01%   (44)   -0.01%
Unearned loan fees net of origination costs
  (3,023)   -0.42%   (3,004)   -0.43%   (2,821)   -0.42%   (2,658)   -0.44%   (2,609)   -0.49%
 
 
Net loans
  $717,056   100.00%   $705,059   100.00%   $678,269   100.00%   $601,119   100.00%   $534,990   100.00%
 
 
 
The following table presents at December 31, 2006, the aggregate maturity and repricing data of our loan portfolio:
 
                                 
    Maturity
    Within
  1-5
  Over 5
   
    1 Year   Years   Years   Total
    (In Thousands)
 
Commercial
  $151,755   $87,093   $48,433   $287,281
Construction
  140,775   10,656   1,628   153,059
Real estate term
  59,140   70,870   107,589   237,599
Installment and other consumer
  1,032   8,032   33,076   42,140
 
 
Total
  $352,702   $176,651   $190,726   $720,079
 
 
Fixed interest rate
  $130,689   $56,828   $55,869   $243,386
Floating interest rate
  222,013   119,823   134,857   476,693
 
 
Total
  $352,702   $176,651   $190,726   $720,079
 
 


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Commercial Loans: Our commercial loan portfolio includes both secured and unsecured loans for working capital and expansion. Short-term working capital loans generally are secured by accounts receivable, inventory, or equipment. We also make longer-term commercial loans secured by equipment and real estate. We also make commercial loans that are guaranteed in large part by the Small Business Administration or the Bureau of Indian Affairs and commercial real estate loans that are participated with the Alaska Industrial Development and Export Authority (“AIDEA”). Commercial loans represented 40% of our total loans outstanding as of December 31, 2006 and reprice more frequently than other types of loans, such as real estate loans. More frequent repricing means that 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.
 
Construction Loans:
 
Land Development: We believe we are a major land development and residential construction lender. At December 31, 2006, we had $46.8 million of residential subdivision land development loans outstanding, or 7% of total loans.
 
One-to-Four-Family Residences: We financed approximately one-third of the single-family houses constructed in Anchorage in 2006. We originated one-to-four-family residential construction loans to builders for construction of homes. At December 31, 2006, we had $86.2 million of one-to-four-family residential and condominium construction loans, or 12% of total loans. Of the homes under construction at December 31, 2006, for which these loans had been made, 36% were subject to sale contracts between the builder and homebuyers who were pre-qualified for loans, usually with other financial institutions.
 
Commercial Construction: We also provide construction lending for commercial real estate projects. Such loans generally are made only when there is a firm take-out commitment upon completion of the project by a third party lender.
 
Real Estate Loans for Sale: In 1998, our wholly-owned subsidiary, NCIC, purchased a 30% profits and losses interest of RML, a mortgage company with offices throughout Alaska, in order for us to obtain a presence in the residential mortgage market. As noted above, in the third quarter of 2004, RML merged with PAM, another mortgage company. As a result, we now own 24% of RML Holding Company, the holding company for RML and PAM.
 
Commercial Real Estate: We believe we are an active lender in the commercial real estate market. At December 31, 2006, our commercial real estate loans were $237.6 million, or 33% of our loan portfolio. These loans are typically secured by office buildings, apartment complexes or warehouses. Loan maturities range from 10 to 25 years, ordinarily subject to our right to call the loan within 10 to 15 years of its origination. The interest rate for approximately 49% of these loans originated by Northrim resets every one to five years based on the spread over an index rate, normally prime or the respective Treasury rate.
 
We often sell all or a portion of our commercial real estate loans to two State of Alaska entities that were established to provide long-term financing in the State, AIDEA, and the Alaska Housing Finance Corporation (“AHFC”). We often sell up to a 90% loan participation to AIDEA. AIDEA’s portion of the participated loan typically features a maturity twice that of the portion retained by us and bears a lower interest rate. The blend of our and AIDEA’s loan terms allows us to provide competitive long-term financing to our customers, while reducing the risk inherent in this type of lending. We also originate and sell to AHFC loans secured by multifamily residential units. Typically, 100% of these loans are sold to AHFC and we provide ongoing servicing of the loans for a fee. AIDEA and AHFC make it possible for us to originate these commercial real estate loans and enhance fee income while reducing our exposure to risk.
 
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.
 
Off-Balance Sheet Arrangements — Commitments and Contingent Liabilities: In the ordinary course of business, we enter into various types of transactions that include commitments to extend credit that are not reflected on our balance sheet. 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. Our exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. See Note 18 to “Notes to Consolidated Financial Statements” in our Annual Report for the year ended December 31, 2006. See also “Liquidity and Capital Resources.”
 
Investments and Investment Activities
 
General: Our investment portfolio consists primarily of U.S. Treasury and government sponsored entity securities, and municipal securities. Investment securities totaled $100.3 million at December 31, 2006, an increase of $45.4 million, or 83%, from year-end 2005. The average maturity of the investment portfolio was approximately two years at December 31, 2006.


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Investment securities designated as available for sale comprised 87% of the portfolio 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 December 31, 2006, $15.7 million in securities were pledged for deposits and borrowings.
 
Investment Portfolio Composition: Our investment portfolio is divided into two classes:
 
Securities Available For Sale: These are securities we may hold for indefinite periods of time. These securities include those that management intends to use as part of our asset/liability management strategy and that may be sold in response to changes in interest rates and/or significant prepayment risks. We carry these securities at market value with any unrealized gains or losses reflected as an adjustment to shareholders’ equity.
 
Securities Held To Maturity: These are securities that we have the ability and the intent to hold to maturity. Events that may be reasonably anticipated are considered when determining our intent to hold investment securities to maturity. These securities are carried at amortized cost.
 
The following tables set forth the composition of our investment portfolio at the dates indicated:
 
                 
 
    Amortized
  Market
December 31,   Cost   Value
 
    (In Thousands)
 
Securities Available for Sale:
       
2006:
       
U.S. Treasury
  $16,860   $16,840
Government Sponsored Entities
  70,438   69,971
Mortgage-backed Securities
  183   182
 
 
Total
  $87,481   $86,993
 
 
2005:
       
U.S. Treasury
  $15,930   $15,761
Government Sponsored Entities
  37,140   36,482
Mortgage-backed Securities
  242   240
 
 
Total
  $53,312   $52,483
 
 
2004:
       
U.S. Treasury
  $5,503   $5,481
Government Sponsored Entities
  53,628   53,656
Mortgage-backed Securities
  311   312
 
 
Total
  $59,442   $59,449
 
 
Securities Held to Maturity:
       
2006:
       
Municipal securities
  $11,776   $11,775
 
 
Total
  $11,776   $11,775
 
 
2005:
       
Municipal securities
  $936   $957
 
 
Total
  $936   $957
 
 
2004:
       
Municipal securities
  $724   $771
 
 
Total
  $724   $771
 
 


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For the periods ending December 31, 2006, 2005, and 2004, we held Federal Home Loan Bank (“FHLB”) stock with a book value approximately equal to its market value in the amounts of $1.6 million, $1.6 million, and $1.3 million, respectively.
 
Market Value, Maturities and Weighted Average Yields: The following table sets forth the market value, maturities and weighted average yields of our investment portfolio for the periods indicated as of December 31, 2006:
 
                                         
 
    Maturity
 
    Within
  1-5
  5-10
  Over 10
   
    1 Year   Years   Years   Years   Total
 
    (Dollars In Thousands)
 
Securities Available for Sale:
                   
U.S. Treasury
                   
Balance
  $16,840   $—   $—   $—   $16,840
Weighted Average Yield
  3.78%   0.00%   0.00%   0.00%   3.78%
Government Sponsored Entities
                   
Balance
  16,779   53,192       69,971
Weighted Average Yield
  3.65%   4.96%   0.00%   0.00%   4.65%
Mortgage-Backed Securities
                   
Balance
        182   182
Weighted Average Yield
  0.00%   0.00%   0.00%   5.35%   5.35%
Total
                   
Balance
  $33,619   $53,192   $—   $182   $86,993
Weighted Average Yield
  3.71%   4.96%   0.00%   5.35%   4.48%
Securities Held to Maturity:
                   
Municipal Securities
                   
Balance
  $70   $10,351   $1,354   $—   $11,775
Weighted Average Yield
  4.12%   3.80%   3.76%   0.00%   3.80%
 
 
 
At December 31, 2006, we held no securities of any single issuer (other than government sponsored entities) that exceeded 10% of our shareholders’ equity.
 
Purchased Receivables
 
General: We purchase accounts receivable from our business customers and provide them with short-term working capital. We provide this service to our customers in Alaska with our Business Manager® and MedCash Manager® products and in Washington and Oregon through NFS.
 
Our purchased receivable balances increased in 2006 to $21.2 million, as compared to $12.2 million in 2005. The funding for this growth in purchased receivables came from an increase in interest-bearing liabilities and from noninterest-bearing sources of funds and capital.
 
Policy and Authority Limits: 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 Board of Directors.
 
Liabilities
 
Deposits
 
General: Deposits are our primary source of funds. Total deposits increased 2% to $794.9 million at December 31, 2006, compared with $779.9 million at December 31, 2005, and $699.1 million at December 31, 2004. Our deposits generally are expected to fluctuate according to the level of our market share, economic conditions, and normal seasonal trends.


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Average Balances and Rates: The following table sets forth the average balances outstanding and average interest rates for each major category of our deposits, for the periods indicated:
 
                                                                                 
 
December 31,   2006   2005   2004   2003   2002
 
    Average
  Average
  Average
  Average
  Average
  Average
  Average
  Average
  Average
  Average
    balance   rate paid   balance   rate paid   balance   rate paid   balance   rate paid   balance   rate paid
 
    (Dollars in Thousands)
 
Interest-bearing demand accounts
  $78,872   1.05%   $65,890   0.56%   $57,373   0.39%   $52,955   0.39%   $49,198   0.72%
Money market accounts
  151,871   3.99%   139,331   2.78%   126,567   1.21%   134,582   0.96%   131,227   1.57%
Savings accounts
  254,209   3.98%   207,277   3.02%   139,876   1.64%   104,158   1.13%   82,061   1.84%
Certificates of deposit
  94,595   3.51%   138,284   2.52%   155,134   1.72%   164,847   2.14%   172,531   3.50%
 
 
Total interest-bearing accounts
  579,547   3.51%   550,782   2.54%   478,950   1.40%   456,542   1.36%   435,017   2.29%
Noninterest-bearing demand accounts
  185,958       182,535       181,731       159,858       135,181    
 
 
Total average deposits
  $765,505       $733,317       $660,681       $616,400       $570,198    
 
 
 
Certificates of Deposit: The only deposit category with stated maturity dates is certificates of deposit. At December 31, 2006, we had $85.9 million in certificates of deposit, of which $59.4 million, or 69%, are scheduled to mature in 2007.
 
Alaska Certificates of Deposit: The Alaska Certificate of Deposit (“Alaska CD”) is a savings deposit product with an open-ended maturity, interest rate that adjusts to an index that is tied to the two-year United States Treasury Note, and limited withdrawals. The total balance in the Alaska CD at December 31, 2006, was $207.5 million, an increase of $9.5 million as compared to the balance of $198 million at December 31, 2005.
 
Alaska Permanent Fund: The Alaska Permanent Fund 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 December 31, 2006, we did not hold any certificates of deposit for the Alaska Permanent Fund.
 
Borrowings
 
FHLB: At December 31, 2006, our maximum borrowing line from the FHLB was equal to $107 million, approximately 12% of the Company’s assets. At December 31, 2006, there was $2.2 million outstanding on the line. At December 31, 2005, there was $2.6 million outstanding on the line and an additional $15.5 million of the borrowing line was committed to secure public deposits. FHLB advances are secured by a blanket pledge of the Company’s assets.
 
Other Short-term Borrowing: At December 31, 2006, there were no short-term (original maturity of one year or less) borrowings that exceeded 30% of shareholders’ equity.
 
Contractual Obligations
 
The following table references contractual obligations of the Company for the periods indicated:
 
                                         
 
    Payments Due by Period
 
    Within
  1-3
  3-5
  Over
   
December 31, 2006   1 Year   Years   Years   5 Years   Total
 
    (In Thousands)
 
Long-term debt obligations
  $400   $800   $800   $18,732   $20,732
Operating lease obligations
  1,434   2,928   2,867   3,711   10,940
Other long-term liabilities
  1,217   3,277       4,494
 
 
Total
  $3,051   $7,005   $3,667   $22,443   $36,166
 
 
 


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Table of Contents

                                         
 
    Payments Due by Period
 
    Within
  1-3
  3-5
  Over
   
December 31, 2005   1 Year   Years   Years   5 Years   Total
 
    (In Thousands)
 
Long-term debt obligations
  $400   $800   $800   $18,574   $20,574
Operating lease obligations
  1,338   2,420   225   1,544   5,527
Other long-term liabilities
         
 
 
Total
  $1,738   $3,220   $1,025   $20,118   $26,101
 
 
 
Long-term debt obligations consist of (a) $2.2 million advance from the FHLB that was originated on May 7, 2002, matures on May 7, 2012, and bears interest at 5.46%, (b) $8.2 million junior subordinated debentures that were originated on May 8, 2003, mature on May 15, 2033, and bear interest at a rate of LIBOR plus 3.15%, adjusted quarterly, and (c) $10.3 million junior subordinated debentures that were originated on December 16, 2005, mature on December 15, 2035, and bear interest at a rate of LIBOR plus 1.37%, adjusted quarterly. The operating lease obligations are more fully described at Note 18 of the Company’s annual report. Other long-term liabilities consist of amounts that the Company owes for its investments in Delaware limited partnerships that develop low-income housing projects throughout the United States. The Company purchased a $3 million interest in CharterMac Corporate Partners XXXIII, L.P., (“CharterMac”), in September 2006 and a $3 million interest in U.S.A. Institutional Tax Credit Fund LVII L.P. (“USA 57”) in December 2006. The investments in CharterMac and USA 57 will be funded in 2009 and 2010, respectively.
 
Liquidity and Capital Resources
 
Our primary sources of funds are customer deposits and advances from the Federal Home Loan Bank of Seattle. 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 lending commitments at December 31, 2006, were $172 million, and we do not expect that all of these loans are likely to be fully drawn upon at any one time. Additionally, as noted above, our total deposits at December 31, 2006, were $794.9 million.
 
The sources by which we meet the liquidity needs of our customers are current assets and borrowings available through our correspondent banking relationships and our credit lines with the Federal Reserve Bank and the FHLB. At December 31, 2006, our current assets were $459 million and our funds available for borrowing under our existing lines of credit were $166.4 million. Given these sources of liquidity and our expectations for customer demands for cash and for our operating cash needs, we believe our sources of liquidity to be sufficient in the foreseeable future.
 
In September 2002, our Board of Directors approved a plan whereby we would periodically repurchase for cash up to approximately 5%, or 306,372, of our shares of common stock in the open market. In August of 2004, the Board of Directors amended the stock repurchase plan and increased the number of shares available under the program by 5% of total shares outstanding, or 304,283 shares. We purchased 550,942 shares of our stock under this program through December 31, 2006 at a total cost of $10.8 million at an average price of $19.64, which left a balance of 59,713 shares available under the stock repurchase program. 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 repurchase all of the authorized shares.

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The stock repurchase program had an effect on earnings per share because it decreased the total number of shares outstanding in 2006, 2005, 2003, and 2002, by 17,500, 308,642, 155,800, and 69,000 shares respectively. The Company did not repurchase any of its shares in 2004. The table below shows this effect on diluted earnings per share as adjusted for the 5% stock dividend in 2006.
 
                 
 
        Diluted
    Diluted EPS
  EPS without
Years Ending:   as Reported   Stock Repurchase
2006
  $2.09   $1.92
2005
  $1.72   $1.64
2004
  $1.63   $1.57
2003
  $1.61   $1.57
2002
  $1.29   $1.28
 
 
 
On May 8, 2003, the Company’s newly formed subsidiary, Northrim Capital Trust 1, issued trust preferred securities in the principal amount of $8 million. These securities carry an interest rate of LIBOR plus 3.15% per annum that was initially set at 4.45% adjusted quarterly. The securities have a maturity date of May 15, 2033, and are callable by the Company on or after May 15, 2008. These securities are treated as Tier 1 capital by the Company’s regulators for capital adequacy calculations. The interest cost to the Company of the trust preferred securities was $665,000 in 2006. At December 31, 2006, the securities had an interest rate of 8.52%.
 
On December 16, 2005, the Company’s newly formed subsidiary, Northrim Statutory Trust 2, issued trust preferred securities in the principal amount of $10 million. These securities carry an interest rate of LIBOR plus 1.37% per annum that was initially set at 5.86% adjusted quarterly. The securities have a maturity date of March 15, 2036, and are callable by the Company on or after March 15, 2011. These securities are treated as Tier 1 capital by the Company’s regulators for capital adequacy calculations. The interest cost to the Company of these securities was $654,000 in 2006. At December 31, 2006, the securities had an interest rate of 6.73%.
 
Our shareholders’ equity at December 31, 2006, was $95.4 million, as compared to $84.5 million at December 31, 2005. The Company earned net income of $13 million during 2006, issued 38,000 shares through the exercise of stock options, and repurchased 17,500 shares of its common stock under the Company’s publicly announced repurchase program. In addition, on September 1, 2006, the Company paid a 5% stock dividend to shareholders of record as of August 18, 2006. As a result, the Company issued 290,727 of its shares along with a cash dividend of $2,000 to pay for fractional shares. At December 31, 2006, the Company had 6.1 million shares of its common stock outstanding.
 
We are subject to minimum capital requirements. Federal banking agencies have adopted regulations establishing minimum requirements for the capital adequacy of banks and bank holding companies. The requirements address both risk-based capital and leverage capital. We believe as of December 31, 2006, that the Company and Northrim Bank met all applicable capital adequacy requirements.
 
The FDIC has in place qualifications for banks to be classified as “well-capitalized.” As of June 15, 2006, the most recent notification from the FDIC categorized Northrim Bank as “well-capitalized.” There were no conditions or events since the FDIC notification that we believe have changed Northrim Bank’s classification.
 
The table below illustrates the capital requirements for the Company and the Bank and the actual capital ratios for each entity that exceed these requirements. The capital ratios for the Company exceed those for the Bank primarily because the $8 million trust preferred securities offering that the Company completed in the second quarter of 2003 and another offering of $10 million completed in the fourth quarter of 2005 are included in the Company’s capital for regulatory purposes although they are accounted for as a long-term debt in our financial statements. The trust preferred securities are not accounted for on the Bank’s financial


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statements nor are they included in its capital. As a result, the Company has $18 million more in regulatory capital than the Bank, which explains most of the difference in the capital ratios for the two entities.
 
                                 
   
    Adequately -
    Well -
    Actual
    Actual
 
December 31, 2006
  Capitalized     Capitalized     Ratio BHC     Ratio Bank  
   
Tier 1 risk-based capital
    4.00%       6.00%       12.95%       11.09%  
Total risk-based capital
    8.00%       10.00%       14.21%       12.35%  
Leverage ratio
    4.00%       5.00%       11.71%       10.06%  
 
 
(See Note 19 of the Consolidated Financial Statements for a detailed discussion of the capital ratios.)
 
 
The primary impact of inflation on our operations is increased operating costs. Unlike most industrial companies, virtually all 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.
 
 
Our common stock trades on the Nasdaq Stock Market under the symbol, “NRIM.” We are aware that large blocks of our stock are held in street name by brokerage firms. At December 31, 2006, the number of shareholders of record of our common stock was 187.
 
We began paying regular cash dividends of $0.05 per share in the second quarter of 1996. In the second quarters of 2006, 2005, and 2004, we paid cash dividends of $0.125, $0.11, and $0.095 per share, respectively. Cash dividends totaled $2.8 million, $2.6 million, and $2.3 million in 2006, 2005, and 2004, respectively. On January 11, 2007, the Board of Directors approved payment of a $0.125 per share dividend on February 9, 2007, to shareholders of record on January 29, 2007. On August 3, 2006, the Board of Directors approved payment of a 5% stock dividend on September 1, 2006, of the Company’s common stock as of the close of business August 18, 2006. The Company and the Bank are subject to restrictions on the payment of dividends pursuant to applicable federal and state banking regulations.
 
The following are high and low sales prices as reported by Nasdaq. Prices do not include retail markups, markdowns or commissions. Prices have been adjusted for applicable stock dividends.
 
                                 
   
    First
    Second
    Third
    Fourth
 
    Quarter     Quarter     Quarter     Quarter  
   
2006
                               
High
  $ 21.77     $ 23.90     $ 27.33     $ 27.68  
Low
  $ 20.70     $ 21.37     $ 22.04     $ 25.89  
2005
                               
High
  $ 23.98     $ 23.81     $ 23.90     $ 24.29  
Low
  $ 22.10     $ 21.02     $ 22.27     $ 22.14  
 
 


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Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters
 
 
The graph shown below depicts the total return to shareholders during the period beginning after December 31, 2001, and ending December 31, 2006. The definition of total return includes appreciation in market value of the stock, as well as the actual cash and stock dividends paid to shareholders. The comparable indices utilized are the Russell 3000 Index, representing approximately 98% of the U.S. equity market, and the SNL Financial Bank Stock Index, comprised of publicly traded banks with assets of $500 million to $1 billion, which are located in the United States. The graph assumes that the value of the investment in the Company’s common stock and each of the three indices was $100 on December 31, 2001, and that all dividends were reinvested.
 
 
(Performance Graph)
 
                                                 
 
December 31,   2001   2002   2003   2004   2005   2006
 
 
Northrim BanCorp, Inc. 
  100.00   95.91   166.68   173.87   175.88   213.55
Russell 3000
  100.00   78.46   102.83   115.11   122.16   141.35
SNL $500M-$1B Bank Index
  100.00   127.67   184.09   208.62   217.57   247.44
 
 


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Repurchase of Securities
 
The Company did not repurchase any of its common stock in the fourth quarter of 2006.
 
Equity Compensation Plan Information
 
                         
 
            Number of securities
    Number of securities
      remaining available for
    to be issued
  Weighted-average
  future issuance under
    upon exercise of
  exercise price of
  equity compensation plans
    outstanding options,
  outstanding options,
  (Excluding Securities
    warrants and rights
  warrants and rights
  Reflected in Column
Plan Category   (a)   (b)   (a))
 
Equity compensation plans approved by security holders
  439,027   $13.37   173,734
 
 
Total
  439,027   $13.37   173,734
 
 
 
 
Between February of 2006 and December of 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 155, Accounting for Certain Hybrid Financial Instruments, Statement No. 156, Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140, Statement No. 157, Fair Value Measurements, Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132R, and FASB Interpretation 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109. The Company believes the adoption of these Statements will have no impact on its financial statements.
 
In December 2004, the FASB issued Statement No. 123R, Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services primarily in share-based payment transactions with its employees. This Statement supersedes the provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance.
 
As of January 1, 2006, the Company adopted FASB No. 123R according to the modified prospective method, which requires measurement of compensation cost from January 1, 2006 for all unvested stock-based awards at fair value on the date of grant and recognition of the compensation associated with these stock-based awards over the service period for the awards that are expected to vest. In accordance with the modified prospective transition method, results for prior periods have not been restated.
 
The adoption of FASB No. 123R resulted in additional stock compensation expense of $256,000 for the year ending December 31, 2006. The Company recognized a tax benefit of $74,000 related to stock compensation expense on non-qualified stock options.
 
The fair value of restricted stock units is determined based on the number of shares granted and the quoted price of the Company’s stock on the date of grant, and the fair value of stock options is determined using the Black-Scholes valuation model, which is consistent with the Company’s valuation techniques previously utilized for options in footnote disclosures required under FASB 123R. The Company recognizes the fair value of the restricted stock units and stock options as expense over the required service period, net of estimated forfeitures, using the straight line attribution method for stock-based payment grants previously granted but not fully vested at January 1, 2006 as well as grants made after January 1, 2006 as prescribed in FASB 123R. As a result, the Company recognized expense of $134,000 on the fair value of restricted stock units and $256,000 on the fair value of stock options for a total of $390,000 in stock-based compensation expense for the year ending December 31, 2006.
 
Prior to January 1, 2006, the Company accounted for stock-based awards using the intrinsic value method, which followed the recognition and measurement principles of APB Opinion No. 25.


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Outlined below are valuation assumptions used in the Black-Scholes valuation model for stock options that were used in estimating the fair value for each stock option granted in November of 2006 and 2005 and in December of 2004.
 
                         
 
    Granted
 
Options:   Nov. 2006   Nov. 2005   Dec. 2004
 
Expected option life (years)
  7.4   7.5   7.7
Risk free rate
  4.57%   4.45%   4.09%
Dividends per share
  $0.56   $0.50   $0.44
Expected volatility factor
  37.44%   37.06%   39.28%
 
 
 
The expected life represents the weighted average period of time that options granted are expected to be outstanding when considering vesting periods and the exercise history of the Company. The risk free rate is based upon the equivalent yield of a United States Treasury zero-coupon issue with a term equivalent to the expected life of the option. The expected dividends are based on projected dividends for the Company at the date of the option grant taking into account projected net income growth, dividend pay-out ratios, and other factors. The expected volatility is based upon the historical price volatility of the Company’s stock. See “Note 17 Options” for additional information.
 
 
Stock-based compensation for the period prior to January 1, 2006 was determined using the intrinsic value method. The following table illustrates the effect on net income and earnings per share as if the fair value based method under FASB 123R had been applied to all outstanding and unvested awards in periods prior to January 1, 2006:
 
                         
 
        2005   2004
 
Net income (in thousands)
  As reported   $11,170   $10,700
Less stock-based employee compensation
      (173)   (163)
 
 
Net income
  Pro forma   $10,997   $10,537
 
 
Earnings per share, basic
  As reported   $1.78   $1.68
    Pro forma   $1.75   $1.65
Earnings per share, diluted
  As reported   $1.72   $1.63
    Pro forma   $1.70   $1.60
 
 
 
Prior to the adoption of FASB 123R, the Company presented any tax benefits of deductions resulting from the exercise of stock options within operating cash flows in the condensed consolidated statements of cash flow. FASB 123R requires tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (“excess tax benefits”) to be classified and reported as both an operating cash outflow and a financing cash inflow upon adoption of FASB 123R. Accordingly, the Company has recognized these excess tax benefits in the condensed statement of cash flow for the year ended December 31, 2006.
 
FASB Staff Position No. FAS No. 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” (“FSP 123R-3”), effective November 10, 2005, provides for a practical transition method that may be elected to calculate the pool of excess tax benefits available to absorb tax deficiencies upon the adoption of FASB 123R. The method comprises a computational component that establishes the beginning balance of the additional paid in capital (“APIC”) pool related to employee compensation and a simplified method to determine the subsequent impact on the APIC pool of awards that are fully vested and outstanding upon the adoption of FASB 123R. The Company has elected to use the long haul method to calculate the beginning balance of the APIC pool as opposed to electing this simplified method.


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Quantitative and Qualitative Disclosure About Market Risk
 
Our results of operations depend substantially on our net interest income. Like most financial institutions, our interest income and cost of funds are affected by general economic conditions, levels of market interest rates, and by competition, and in addition, our community banking focus makes our results of operations particularly dependent on the Alaska economy.
 
The purpose of asset/liability management is to provide stable net interest income growth by protecting our earnings from undue interest rate risk, which arises from changes in interest rates and changes in the balance sheet mix, and by managing the risk/return relationships between liquidity, interest rate risk, market risk, and capital adequacy. We maintain an asset/liability management policy that provides guidelines for controlling exposure to interest rate risk by setting a target range and minimum for the net interest margin and running simulation models under different interest rate scenarios to measure the risk to earnings over the next 12-month period.
 
In order to control interest rate risk in a rising interest rate environment, our philosophy is to shorten the average maturity of the investment portfolio and emphasize the pricing of new loans on a floating rate basis in order to achieve a more asset sensitive position, therefore, allowing quicker repricings and maximizing net interest margin. Conversely, in a declining interest rate environment, our philosophy is to lengthen the average maturity of the investment portfolio and emphasize fixed rate loans, thereby becoming more liability sensitive. In each case, the goal is to exceed our targeted net interest margin range without exceeding earnings risk parameters.
 
Our excess liquidity not needed for current operations has generally been invested in short-term assets or securities, primarily securities issued by government sponsored entities. The securities portfolio contributes to our profits and plays an important part in the overall interest rate management. The primary tool used to manage interest rate risk is determination of mix, maturity, and repricing characteristics of the loan portfolios. The loan and securities portfolios must be used in combination with management of deposits and borrowing liabilities and other asset/liability techniques to actively manage the applicable components of the balance sheet. In doing so, we estimate our future needs, taking into consideration historical periods of high loan demand and low deposit balances, estimated loan and deposit increases, and estimated interest rate changes.
 
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, such as early withdrawal of time deposits and prepayment of loans, 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.


27


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The following table sets forth the estimated maturity or repricing, and the resulting interest rate gap, of our interest-earning assets and interest-bearing liabilities at December 31, 2006. The amounts in the table are derived from internal data based upon regulatory reporting formats and, therefore, may not be wholly consistent with financial information appearing elsewhere in the audited financial statements that have been prepared in accordance with generally accepted accounting principles. The amounts shown below could also be significantly affected by external factors such as changes in prepayment assumptions, early withdrawals of deposits, and competition.
 
                                 
 
    Estimated maturity or repricing at December 31, 2006
    Within 1 year   1-5 years   ³5 years   Total
 
    (In Thousands)
Interest-Earning Assets:
               
Money market investments
  $18,717   $—   $—   $18,717
Investment securities
  33,690   63,543   3,092   100,325
Loans:
               
Commercial
  239,215   43,966   1,429   284,610
Real estate construction
  150,808   506   1,628   152,942
Real estate term
  153,748   75,337   6,238   235,323
Installment and other consumer
  15,549   14,829   11,650   42,028
 
 
Total interest-earning assets
  $611,727   $198,181   $24,037   $833,945
Percent of total interest-earning assets
  73%   24%   3%   100%
 
 
Interest-Bearing Liabilities:
               
Interest-bearing demand accounts
  $89,476   $—   $—   $89,476
Money market accounts
  157,345       157,345
Savings accounts
  255,822       255,822
Certificates of deposit
  59,357   26,537   24   85,918
FHLB advances
      2,174   2,174
Other borrowings
  4,328       4,328
Junior subordinated debentures
  18,558       18,558
 
 
Total interest-bearing liabilities
  $584,886   $26,537   $2,198   $613,621
Percent of total interest-bearing liabilities
  95%   4%   0%   100%
 
 
Interest sensitivity gap
  $26,841   $171,644   $21,839   $220,324
Cumulative interest sensitivity gap
  $26,841   $198,485   $220,324    
Cumulative interest sensitivity gap as a percentage of total assets
  3%   21%   24%    
 
 
 
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 to 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.
 
We utilize a simulation model to monitor and manage interest rate risk within parameters established by our 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


28


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balance sheet over a period of 12 months. 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 would differ from simulated results due to factors such as timing, magnitude and frequency of rate changes, customer reaction to rate changes, changes in market conditions and management strategies, among other factors.
 
Based on the results of the simulation models at December 31, 2006, we expect an increase in net interest income of $250,000 million and a decrease of $292,000 million in net interest income over a 12-month period, if interest rates decreased or increased an immediate 100 basis points, respectively.
 
 
The preparation of financial statements in conformity with generally accepted accounting principles involves the use of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses during the reporting period. Actual results could differ from those estimates.
 
Our estimate for the loan loss reserve is based on our assessment of various factors affecting the loan portfolio, including a review of problem loans, business conditions, estimated collateral values, loss experience, credit concentrations, and an overall evaluation of the quality of the underlying collateral, and holding and disposal costs. While we believe that we have used the best information available to determine the allowance for loan losses, unforeseen market conditions and other events could result in adjustment to the allowance for loan losses, and net income could be significantly affected, if circumstances differed substantially from the assumptions used in making the final determination.
 
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 our disclosure controls and procedures were effective in timely alerting them to material information required to be included in our 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. There were no changes in the Company’s internal controls over financial reporting that occurred during the period covered by this report that have materially affected, or are likely to materially affect, the Company’s internal control over financial reporting.
 
 
Management of the Company is responsible for establishing and maintaining internal control over financial reporting as defined in Rules 13a-15(f) and 15(d)-15(f) of the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.
 
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006. In making this assessment management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated Framework.
 
Based on our assessment and the criteria discussed above, management believes that, as of December 31, 2006, the Company maintained effective internal control over financial reporting.
 
The Company’s registered public accounting firm has issued an attestation report on management’s assessment of the Company’s internal control over financial reporting. This report follows below.


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Table of Contents

 
 
The Board of Directors of
Northrim BanCorp, Inc.:
 
We have audited management’s assessment, included in the accompanying Management’s Report on Effectiveness of Internal Control Over Financial Reporting, that Northrim BanCorp, Inc. and subsidiaries (the Company) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
 
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
 
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
In our opinion, management’s assessment that Northrim BanCorp, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Northrim BanCorp, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Northrim BanCorp, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, shareholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2006, and our report dated February 16, 2007 expressed an unqualified opinion on those consolidated financial statements.
 
KPMG LLC SIGNATURE
 
/s/ KPMG LLP
Anchorage, Alaska
February 16, 2007


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The Board of Directors of
Northrim BanCorp, Inc.:
 
We have audited the accompanying consolidated balance sheets of Northrim BanCorp, Inc. and subsidiaries (the Company) as of December 31, 2006 and 2005, and the related consolidated statements of income, shareholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Northrim BanCorp, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Northrim BanCorp, Inc’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 16, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
 
KPMG LLC SIGNATURE
 
/s/ KPMG LLP
Anchorage, Alaska
February 16, 2007


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NORTHRIM BANCORP, INC.
Consolidated Balance Sheets
December 31, 2006 and 2005
 
         
    2006   2005
    (In Thousands Except Share Amounts)
 
Assets
       
Cash and due from banks (Note 2)
  $25,565   $28,854
Money market investments (Note 3)
  18,717   60,836
Investment securities held to maturity (Note 4)
  11,776   936
Investment securities available for sale (Note 4)
  86,993   52,483
Investment in Federal Home Loan Bank stock (Note 4)
  1,556   1,556
 
 
Total Portfolio Investments
  100,325   54,975
Loans (Note 5)
  717,056   705,059
Allowance for loan losses (Note 6)
  (12,125)   (10,706)
 
 
Net Loans
  704,931   694,353
Purchased receivables
  21,183   12,198
Accrued interest receivable
  4,916   4,397
Premises and equipment, net (Note 7)
  12,874   10,603
Intangible assets (Notes 1 and 8)
  6,903   7,385
Other assets (Notes 1 and 8)
  30,206   21,979
 
 
Total Assets
  $925,620   $895,580
 
 
Liabilities
       
Deposits:
       
Demand
  $206,343   $196,616
Interest-bearing demand
  89,476   75,988
Savings
  48,330   46,790
Alaska CDs
  207,492   197,989
Money market
  157,345   151,903
Certificates of deposit less than $100,000 (Note 9)
  57,601   59,331
Certificates of deposit greater than $100,000 (Note 9)
  28,317   51,249
 
 
Total Deposits
  794,904   779,866
Borrowings (Note 10)
  6,502   8,415
Junior subordinated debentures (Note 11)
  18,558   18,558
Other liabilities
  10,209   4,267
 
 
Total Liabilities
  830,173   811,106
 
 
Minority interest in subsidiaries
  29  
         
Shareholders’ Equity (Note 16 and 17)
       
Common stock, $1 par value, 10,000,000 shares authorized,
6,114,247 and 5,803,487 shares issued and outstanding
at December 31, 2006 and 2005, respectively
  6,114   5,803
Additional paid-in capital
  46,379   39,161
Retained earnings
  43,212   39,999
Accumulated other comprehensive income-
net unrealized gains/losses on available for sale on investment securities
  (287)   (489)
 
 
Total Shareholders’ Equity
  95,418   84,474
 
 
Commitments and contingencies (Notes 2, 4, 10, 15, 18, 19, and 22)
       
 
 
Total Liabilities and Shareholders’ Equity
  $925,620   $895,580
 
 
 
See accompanying notes to the consolidated financial statements.


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NORTHRIM BANCORP, INC.
Consolidated Statements of Income
Years Ended December 31, 2006, 2005 and 2004
 
             
 
    2006   2005   2004
 
    (In Thousands Except Per Share Amounts)
 
Interest Income
           
Interest and fees on loans
  $65,347   $55,870   $45,898
Interest on investment securities-available for sale (Note 4)
  2,396   2,171   2,400
Interest on investment securities-held to maturity (Note 4)
  403   31   92
Interest on money market investments
  1,375   709   164
 
 
Total Interest Income
  69,521   58,781   48,554
Interest Expense
           
Interest expense on deposits and borrowings (Note 12)
  21,999   14,873   7,283
 
 
Net Interest Income
  47,522   43,908   41,271
Provision for loan losses (Note 6)
  2,564   1,170   1,601
 
 
Net Interest Income After Provision for Loan Losses
  44,958   42,738   39,670
Other Operating Income
           
Service charges on deposit accounts
  1,975   1,800   1,718
Purchased receivable income
  1,855   993   201
Employee benefit plan income
  1,113    
Equity in earnings from mortgage affiliate
  649   493   438
Equity in loss from Elliott Cove
  (230)   (424)   (457)
Other income
  2,296   1,971   1,892
 
 
Total Other Operating Income
  7,658   4,833   3,792
 
 
Other Operating Expense
           
Salaries and other personnel expense
  19,277   17,656   15,708
Occupancy, net
  2,503   2,417   2,130
Equipment expense
  1,350   1,371   1,372
Marketing expense
  1,641   1,657   1,201
Intangible asset amortization expense
  482   368   368
Other expense
  6,115   6,008   5,756
 
 
Total Other Operating Expense
  31,368   29,477   26,535
 
 
Income Before Income Taxes and Minority Interest
  21,248   18,094   16,927
Minority interest in subsidiaries
  296    
 
 
Income Before Income Taxes
  20,952   18,094   16,927
Provision for income taxes (Note 13)
  7,978   6,924   6,227
 
 
Net Income
  $12,974   $11,170   $10,700
 
 
Earnings Per Share, Basic
  $2.12   $1.78   $1.68
 
 
Earnings Per Share, Diluted
  $2.09   $1.72   $1.63
 
 
Weighted Average Shares Outstanding, Basic
  6,120,002   6,286,774   6,383,281
 
 
Weighted Average Shares Outstanding, Diluted
  6,205,826   6,481,794   6,584,146
 
 
 
See accompanying notes to the consolidated financial statements.


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NORTHRIM BANCORP, INC.
Consolidated Statements of Changes in
Shareholders’ Equity and Comprehensive Income
Years Ended December 31, 2006, 2005 and 2004
 
                                                 
    Common Stock                
 
                    Accumulated
   
            Additional
      other
   
    Number
  Par
  paid-in
  Retained
  comprehensive
   
    of shares   value   capital   earnings   income   Total
 
    (In Thousands)
 
Balance as of January 1, 2004
  6,050   $6,050   $45,615   $22,997   $623   $75,285
                         
Cash dividend declared
        (2,308)     (2,308)
Exercise of Stock Options
  39   39   (150)       (111)
Excess tax benefits from share-based payment arrangements
      411       411
Comprehensive income:
                       
Change in unrealized holding (gain/loss) on available for sale investment securities, net of related income tax effect (Note 14)
          (619)   (619)
                         
Net Income
        10,700     10,700
                         
Total Comprehensive Income
                      10,081
 
 
Balance as of December 31, 2004
  6,089   $6,089   $45,876   $31,389   $4   $83,358
                         
Cash dividend declared
        (2,560)     (2,560)
Stock option expense
      68       68
Exercise of stock options
  23   23   106       129
Excess tax benefits from share-based payment arrangements
      140       140
Treasury stock buy-back
  (309)   (309)   (7,029)       (7,338)
Comprehensive income:
                       
Change in unrealized holding (gain/loss) on available for sale investment securities, net of related income tax effect (Note 14)
          (493)   (493)
                         
Net Income
        11,170     11,170
                         
Total Comprehensive Income
                      10,677
 
 
Balance as of December 31, 2005
  5,803   $5,803   $39,161   $39,999   ($489)   $84,474
                         
Cash dividend declared
        (2,780)     (2,780)
Stock dividend
  291   291   6,690   (6,981)    
Stock option expense
      390       390
Exercise of stock options
  38   38   300       338
Excess tax benefits from share-based payment arrangements
      230       230
Treasury stock buy-back
  (18)   (18)   (392)       (410)
Comprehensive income:
                       
Change in unrealized holding (gain/loss) on available for sale investment securities, net of related income tax effect (Note 14)
          202   202
                         
Net Income
        12,974     12,974
                         
Total Comprehensive Income
                      13,176
 
 
Balance as of December 31, 2006
  6,114   $6,114   $46,379   $43,212   ($287)   $95,418
 
 
 
See accompanying notes to the consolidated financial statements.


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NORTHRIM BANCORP, INC.
Consolidated Statements of Cash Flows
Years Ended December 31, 2006, 2005 and 2004
 
             
 
    2006   2005   2004
 
    (In Thousands)
Operating Activities:
           
Net income
  $12,974   $11,170   $10,700
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
           
Security (gains), net
    (9)   (151)
Depreciation and amortization of premises and equipment
  1,116   1,244   1,142
Amortization of software
  354   544   558
Intangible asset amortization
  482   368   368
Amortization of investment security premium, net of discount accretion
  (133)     151
Deferred tax (benefit)
  (1,826)   (821)   (1,260)
Stock-based compensation
  390   68  
Excess tax benefits from share-based payment arrangements
  (230)   (140)   (411)
Deferral of loan fees and costs, net
  19   183   163
Provision for loan losses
  2,564   1,170   1,601
Earnings in excess of distributions from RML
  (124)   (11)   (71)
Equity in loss from Elliott Cove
  230   424   457
Minority interest in subsidiaries
  296    
(Increase) in accrued interest receivable
  (519)   (719)   (378)
(Increase) in other assets
  (7,234)   (494)   (656)
Increase (decrease) of other liabilities
  6,160   578   296
 
 
Net Cash Provided by Operating Activities
  14,519   13,555   12,509
 
 
Investing Activities:
           
Investment in securities:
           
Purchases of investment securities — available-for-sale
  (40,643)   (10,874)   (28,341)
Purchases of investment securities — held-to-maturity
  (10,905)   (277)  
Proceeds from sales/maturities of securities — available-for-sale
  6,608   17,012   38,559
Proceeds from calls/maturities of securities — held-to-maturity
  65   65   220
Investment in Federal Home Loan Bank stock, net
    (254)   244
Investment in purchased receivables, net
  (8,985)   (10,007)   (1,729)
Investments in loans:
           
Sales of loans and loan participations
  22,601   25,116   20,036
Loans made, net of repayments
  (35,762)   (53,317)   (98,373)
Investment in Elliott Cove
  (210)   (150)   (250)
Investment in NBG
    (1,146)  
Subscription in PWA
    (2,015)  
Loan to Elliott Cove, net of repayments
  58   (575)   (250)
Loan to PWA, net of repayments
  385   (385)    
Purchases of premises and equipment
  (3,387)   (1,264)   (618)
 
 
Net Cash Used by Investing Activities
  (70,175)   (38,071)   (70,502)
 
 
Financing Activities:
           
Increase in deposits
  15,038   80,805   52,864
Increase (decrease) in borrowings
  (1,913)   1,937   1,335
Distributions to minority interests
  (267)    
Proceeds from issuance of common stock
  338   129   (111)
Excess tax benefits from share-based payment arrangements
  230   140   411
Proceeds from issuance of junior subordinated debentures
    10,000  
Repurchase of common stock
  (410)   (7,338)  
Cash dividends paid
  (2,768)   (2,560)   (2,308)
 
 
Net Cash Provided by Financing Activities
  10,248   83,113   52,191
 
 
Net Increase (Decrease) by Cash and Cash Equivalents
  (45,408)   58,597   (5,802)
Cash and cash equivalents at beginning of period
  89,690   31,093   36,895
 
 
Cash and Cash Equivalents at End of Year
  $44,282   $89,690   $31,093
 
 
Supplemental Information:
           
Income taxes paid
  $9,296   $7,550   $6,825
Interest paid
  $21,891   $14,741   $7,766
Conversion of Elliott Cove loan to equity
  $—   $—   $625
 
 
 
 
See accompanying notes to the consolidated financial statements.


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Notes to Consolidated Financial Statements
 
NOTE 1 — Organization and Summary of Significant Accounting Policies
 
Northrim BanCorp, Inc. (the “Company”) is a bank holding company whose subsidiaries are Northrim Bank (the “Bank”), which serves Anchorage, Eagle River, the Matanuska Valley, Fairbanks, Alaska, and the Pacific Northwest through its Northrim Funding Services division (“NFS”); Northrim Investment Services Company (“NISC”) which holds the Company’s interest in both Elliott Cove Capital Management LLC (“Elliott Cove”), an investment advisory services company, and Pacific Wealth Advisors (“PWA”), an investment advisory and wealth management business located in Seattle, Washington; and Northrim Capital Trust 1 (“NCT1”) and Northrim Statutory Trust 2 (“NST2”), entities that were formed to facilitate trust preferred securities offerings by the Company. The Company is regulated by the State of Alaska and the Federal Reserve Board. The Company was incorporated in Alaska, and its primary market areas include Anchorage, the Matanuska Valley, and Fairbanks, Alaska, where the majority of its lending and deposit activities have been with Alaska businesses and individuals.
 
Effective December 31, 2001, Northrim Bank became a wholly-owned subsidiary of a new bank holding company, Northrim BanCorp, Inc. The Bank’s shareholders agreed to exchange their ownership in the Bank for ownership in the Company. The ownership interests in the Company are the same as the ownership interests in the Bank prior to the exchange. The exchange has been accounted for similarly to a pooling of interests.
 
The Bank formed a wholly-owned subsidiary, Northrim Capital Investments Co. (“NCIC”), in 1998. This subsidiary owns a 24% profit interest in Residential Mortgage Holding Company LLC (“RML Holding Company”), a residential mortgage holding company that owns one mortgage company, Residential Mortgage LLC (“RML”). RML has branches throughout Alaska. The Company accounts for RML Holding Company using the equity method. In addition, NCIC owns a 50.1% interest in Northrim Benefits Group, LLC (“NBG”), an insurance brokerage company that provides employee benefit plans to businesses throughout Alaska.
 
Estimates and Assumptions: In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenue and expenses for the period and the disclosure of contingent assets and liabilities in accordance with generally accepted accounting principles. Actual results could differ from those estimates.
 
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing balances with other banks, money market investments including interest-bearing balances with the FHLB, banker’s acceptances, commercial paper, securities purchased under agreement to resell, and federal funds sold.
 
Investment Securities: Securities available-for-sale are stated at fair value with unrealized holding gains and losses, net of tax, excluded from earnings and reported as a net amount in a separate component of other comprehensive income, unless an unrealized loss is deemed other than temporary. The gain or loss on available-for-sale securities sold is determined on a specific identification basis.
 
Held-to-maturity securities are stated at cost, adjusted for amortization of premium and accretion of discount on a level-yield basis. The Company has the ability and intent to hold these securities to maturity.
 
A decline in the market value of any available for sale or held to maturity security below cost that is deemed other than temporary results in a charge to earnings and the establishment of a new cost basis for the security. Unrealized investment securities losses are evaluated at least quarterly on a specific identification basis for securities with similar attributes to determine whether such declines in value should be considered “other than temporary” and therefore be subject to immediate loss recognition in income. Although these evaluations involve significant judgment, an unrealized loss in the fair value of a debt security is generally deemed to be temporary when the fair value of the security is below the carrying value primarily due to changes in interest rates, there has not been significant deterioration in the financial condition of the issuer, and the Company has the intent and ability to hold the security for a sufficient time to recover the carrying value. Other factors that may be considered in determining whether a decline in the value is “other than temporary” include ratings by recognized rating agencies; actions of commercial banks or other lenders relative to the continued extension of credit facilities to the issuer of the security; the financial condition, capital strength and near-term prospects of the issuer, and recommendations of investment advisors or market analysts.
 
Loans and Loan Fees: Loans are carried at their principal amount outstanding, adjusted for the net of unamortized fees and related direct loan origination costs. Interest income on loans is accrued and recognized on the principal amount outstanding except for loans in a non-accrual status. Loans are placed on non-accrual when management believes doubt exists as to the collectibility of the interest or principal. Cash payments received on non-accrual loans are directly applied to the principal balance. Loan origination fees received in excess of direct origination costs are deferred and accreted to interest income using a method approximating the level-yield method over the life of the loan.


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Allowance for Loan Losses: The allowance for loan losses is a management estimate of the reserve necessary to absorb probable losses in the Company’s loan portfolio. The Company charges off the balance of a loan or writes down a portion of a loan when it identifies a loss in the respective loan. In determining the adequacy of the allowance, management evaluates prevailing economic conditions, results of regular examinations and evaluations of the quality of the loan portfolio by external parties, actual loan loss experience, the extent of existing risks in the loan portfolio, commitments to lend other funds, and other pertinent factors. Future additions to the allowance may be necessary based on changes in economic conditions and other factors used in evaluating the loan portfolio. Additionally, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require additions to the allowance based on their judgments of information available to them at the time of their examination.
 
The allowance for impaired loans is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans.
 
Purchased Receivables: The Bank purchases accounts receivable at a discount from its customers. The purchased receivables are carried at cost. The discount and fees charged to the customer are earned while the balances of the purchases are outstanding.
 
Premises and Equipment: Premises and equipment, including leasehold improvements, are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization expense for financial reporting purposes is computed using the straight-line method based upon the shorter of the lease term or the estimated useful lives of the assets that vary according to the asset type and include; vehicles at 3 years, furniture and equipment ranging between 3 and 7 years, leasehold improvements ranging between 2 and 11 years, and buildings over 39 years. Maintenance and repairs are charged to current operations, while renewals and betterments are capitalized.
 
Intangible Assets: As part of an acquisition of branches from Bank of America in 1999, the Company recorded $6.9 million of goodwill and $2.9 million of core deposit intangible. In accordance with Statements of Financial Accounting Standards (SFAS) No. 142 “Goodwill and Other Intangible Assets,” management reviews goodwill annually for impairment by reviewing a number of key market indicators. In addition, the Company amortizes its core deposit intangible over 8 years using a straight-line method. Finally, the Company recorded $1.1 million in intangible assets related to customer relationships purchased in the acquisition of an additional 40.1% of NBG in December 2005. The Company amortizes this intangible over its estimated life of ten years.
 
Other Assets: Other assets include purchased software and prepaid expenses. These assets are carried at amortized cost and are amortized using the straight-line method over their estimated useful life or the term of the agreement. Also included in other assets is the deferred tax asset and the Company’s investments in RML Holding Company, Elliott Cove, NBG, and three low income housing partnerships. These partnerships include Related Corporate Partners XXII, L.P., (“RCP”), CharterMac Corporate Partners XXXIII, L.P., (“CharterMac”) and U.S.A. Institutional Tax Credit Fund LVII L.P. (“USA 57”). These entities are all Delaware limited partnerships. The Company purchased a $3 million interest in each of these partnerships in January 2003, September 2006 and December 2006, respectively.
 
Other Real Estate: Other real estate represents properties acquired through foreclosure or its equivalent. Prior to foreclosure, the carrying value is adjusted to the lower of cost or fair market value of the real estate to be acquired by a charge to the allowance for loan loss. Any subsequent reduction in the carrying value is charged against earnings.
 
Advertising: Advertising, promotion and marketing costs are expensed as incurred. For the periods ending December 31, 2006, 2005, and 2004, the Company reported total expenses of $1.6 million, $1.7 million, and $1.2 million, respectively.
 
Income Taxes: The Company uses the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
 
Earnings Per Share: Earnings per share is calculated using the weighted average number of shares and dilutive common stock equivalents outstanding during the period. Stock options, as described in Note 17, are considered to be common stock equivalents. Incremental shares were 92,782, 178,681, and 191,300 for 2006, 2005, and 2004, respectively. On September 1, 2006, the Company paid a 5% stock dividend to shareholders of record as of August 18, 2006. As a result, the Company issued 290,727 of its shares along with a cash dividend of $2,000 to pay for fractional shares.
 
Stock Option Plans: The Company accounts for its stock option plans in accordance with the provisions of FASB Statement No. 123R, “Share Based-Payment”, a revision of FASB 123 “Accounting for Stock — Based Compensation”. FASB Statement No. 123R establishes accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. In accordance with FASB Statement No. 148, “Accounting for Stock-Based Compensation —


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Transition and Disclosure”, the Company has elected the modified prospective method for recognition of compensation cost associated with stock options and has elected to recognize compensation expense for options with pro-rata vesting using the straight-line method. Accordingly, results for prior periods have not been restated. Prior to January 1, 2006 the Company accounted for its stock options in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, for the years ending December 31, 2005 and 2004, compensation expense is calculated using the intrinsic-value-based method of accounting. Under this method, expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price.
 
The following table illustrates the effect on net income if the fair-value-based method had been applied to all outstanding and unvested awards in each period in which the intrinsic-value-based method of accounting was applied:
 
             
 
        2005   2004
 
Net income (in thousands)
  As reported   $11,170   $10,700
Less stock-based employee compensation
      (173)   (163)
 
 
Net income
  Pro forma   $10,997   $10,537
 
 
Earnings per share, basic
  As reported   $1.78   $1.68
    Pro forma   $1.75   $1.65
Earnings per share, diluted
  As reported   $1.72   $1.63
    Pro forma   $1.70   $1.60
 
 
 
Comprehensive Income: Comprehensive income consists of net income and net unrealized gains (losses) on securities after tax effect and is presented in the consolidated statements of shareholders’ equity and comprehensive income.
 
Reclassifications: Certain reclassifications have been made to prior year amounts, due primarily to aggregation, to maintain consistency with the current year with no impact on net income or total shareholders’ equity.
 
Segments: The Company has identified only one reportable segment.
 
Geographic Concentration and Alaska Economy: The Company’s growth and operations depend upon the economic conditions of Alaska and the specific markets it serves. The economy in Alaska is dependent upon the natural resources industries, in particular oil production, as well as tourism, government, and U.S. military spending. Approximately 86% of the Alaska state government is funded through various taxes and royalties on the oil industry. Any significant changes in the Alaska economy and the markets the Company serves eventually could have a positive or negative impact on the Company.
 
Consolidation Policy: The consolidated financial statements include the financial information for Northrim BanCorp, Inc. and its wholly-owned subsidiaries that include Northrim Bank, and NISC. All intercompany balances have been eliminated in consolidation. The Company accounts for its investments in RML Holding Company, Elliott Cove, and Pacific Wealth Advisors, LLC using the equity method.
 
 
The Company is required to maintain a $500,000 minimum average daily balance with the Federal Reserve Bank for purposes of settling financial transactions and charges for Federal Reserve Bank services. The Company is also required to maintain cash balances or deposits with the Federal Reserve Bank sufficient to meet its statutory reserve requirements. The average reserve requirement for the maintenance period, which included December 31, 2006, was $0.
 
 
Money market investment balances are as follows:
 
         
December 31,   2006   2005
    (In Thousands)
 
Interest bearing deposits at Federal Home Loan Bank (FHLB)
  $18,717   $54,036
Fed funds sold
    6,800
 
 
Total
  $18,717   $60,836
 
 
 
All money market investments had a one-day maturity.


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NOTE 4 — Investment Securities
 
The carrying values and approximate market values of investment securities are presented below:
 
                 
 
        Gross
  Gross
   
    Amortized
  Unrealized
  Unrealized
  Market
    Cost   Gains   Losses   Value
 
    (In Thousands)
 
2006:
               
Securities Available for Sale
               
U.S. Treasury
  $16,860   $—   $20   $16,840
Government Sponsored Entities
  70,438   16   483   69,971
Mortgage-backed Securities
  183     1   182
 
 
Total
  $87,481   $16   $504   $86,993
 
 
Securities Held to Maturity
               
Municipal Securities
  $11,776   $32   $33   $11,775
 
 
Federal Home Loan Bank Stock
  $1,556   $—   $—   $1,556
 
 
2005:
               
Securities Available for Sale
               
U.S. Treasury
  $15,930   $—   $169   $15,761
Government Sponsored Entities
  37,140     659   36,482
Mortgage-backed Securities
  242     2   240
 
 
Total
  $53,312   $—   $830   $52,483
 
 
Securities Held to Maturity
               
Municipal Securities
  $936   $28   $7   $957
 
 
Federal Home Loan Bank Stock
  $1,556   $—   $—   $1,556
 
 
 
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2006 and 2005 were as follows:
 
                         
 
December 31,   Less Than 12 Months   More Than 12 Months   Total
 
        Unrealized
      Unrealized
      Unrealized
    Fair Value   Losses   Fair Value   Losses   Fair Value   Losses
 
    (In Thousands)
 
2006:
                       
Securities Available for Sale
                       
U.S. Treasury
  $5,862   $5   $10,978   $15   $16,840   $20
Government Sponsored Entities
      39,966   483   39,966   483
Mortgage-backed Securities
      182   1   182   1
 
 
Total
  $5,862   $5   $51,126   $499   $56,988   $504
 
 
Securities Held to Maturity
                       
Municipal Securities
  $8,105   $30   $274   $3   $8,379   $33
 
 
 


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December 31,   Less Than 12 Months   More Than 12 Months   Total
 
        Unrealized
      Unrealized
      Unrealized
    Fair Value   Losses   Fair Value   Losses   Fair Value   Losses
 
    (In Thousands)
 
2005:
                       
Securities Available for Sale
                       
U.S. Treasury
  $4,883   $53   $10,878   $116   $15,761   $169
Government Sponsored Entities
  10,519   176   25,963   483   36,482   659
Mortgage-backed Securities
  240   2       240   2
 
 
Total
  $15,642   $231   $36,841   $599   $52,483   $830
 
 
Securities Held to Maturity
                       
Municipal Securities
  $270   $7       $270   $7
 
 
 
The unrealized losses on investments in U.S. Treasury and government sponsored entities were caused by interest rate increases. At December 31, 2006, there were fifteen of these securities in an unrealized loss position of $504,000. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because the Company has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.
 
The amortized cost and market values of debt securities at December 31, 2006, are distributed by contractual maturity as shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
                         
 
    Within
          Over
  Amortized
  Market
    1 Year   1-5 Years   5-10 Years   10 Years   Cost   Value
 
    (In Thousands)
 
Securities Available for Sale
                       
U.S. Treasury
  $16,860   $—   $—   $—   $16,860   $16,840
Government Sponsored Entities
  16,902   53,536       70,438   69,971
Mortgage-backed Securities
        183   183   182
 
 
Total
  $33,762   $53,536   $—   $183   $87,481   $86,993
 
 
Weighted Average Yield
  3.71%   4.96%   0.00%   5.35%   4.48%  
 
 
Securities Held to Maturity
                       
Municipal Securities
  $70   $10,357   $1,349   $—   $11,776   $11,775
 
 
Weighted Average Yield
  4.12%   3.80%   3.76%   0.00%   3.80%  
 
 

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The proceeds and resulting gains and losses, computed using specific identification, from sales of investment securities are as follows:
 
             
 
        Gross
 
Gross
December 31,   Proceeds   Gains   Losses
 
    (In Thousands)
 
2006:
           
Available-for-Sale Securities
  $—   $—   $—
Held-to-Maturity Securities
  $—   $—   $—
2005:
           
Available-for-Sale Securities
  $6,148   $44   $35
Held-to-Maturity Securities
  $—   $—   $—
2004:
           
Available-for-Sale Securities
  $3,789   $151   $—
Held-to-Maturity Securities
  $—   $—   $—
 
 
 
The Company pledged $15.7 million and $20.9 million of investment securities at December 31, 2006, and 2005, respectively, as collateral for public deposits and borrowings.
 
A summary of taxable interest income on available for sale investment securities is as follows:
 
             
 
December 31,  
2006
  2005   2004
 
    (In Thousands)
 
U.S. Treasury
  $438   $472   $67
Government Sponsored Entities
  1,948   1,688   2,319
Other
  10   11   14
 
 
Total
  $2,396   $2,171   $2,400
 
 
 
Included in investment securities is a required investment in stock of the FHLB. The amount of the required investment is based on the Company’s capital stock and lending activity, and amounted to $1.6 million for both 2006 and 2005.


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NOTE 5 — Loans
 
The composition of the loan portfolio is presented below:
 
         
 
December 31,  
2006
  2005
 
    (In Thousands)
 
Commercial
  $287,281   $287,617
Real estate construction
  153,059   131,532
Real estate term
  237,599   252,395
Installment and other consumer
  42,140   36,519
 
 
Sub-total
  720,079   708,063
Less: Unearned origination fees, net of origination costs
  (3,023)   (3,004)
 
 
Total loans
  717,056   705,059
Allowance for loan losses
  (12,125)   (10,706)
 
 
Net Loans
  $704,931   $694,353
 
 
 
The Company’s primary market areas are Anchorage, the Matanuska Valley, and Fairbanks, Alaska, where the majority of its lending has been with Alaska businesses and individuals. At December 31, 2006, approximately 71% and 27% of the Company’s loans are secured by real estate, or for general commercial uses, including professional, retail, and small businesses, respectively. Substantially all of these loans are collateralized and repayment is expected from the borrowers’ cash flow or, secondarily, the collateral. The Company’s exposure to credit loss, if any, is the outstanding amount of the loan if the collateral is proved to be of no value.
 
Non-accrual loans totaled $5.2 million and $5.1 million at December 31, 2006, and 2005, respectively. Interest income which would have been earned on non-accrual loans for 2006, 2005, and 2004 amounted to $437,000, $353,000, and $658,000, respectively. There are no commitments to lend additional funds to borrowers whose loans are in a non-accrual status or are troubled debt restructurings.
 
At December 31, 2006, and 2005, the recorded investment in loans that are considered to be impaired was $32 million and $18.3 million, respectively, (of which $5.2 million and $5 million, respectively, were on a non-accrual basis). A specific allowance of $4.3 million was established for the $32 million of impaired loans. The average recorded investment in impaired loans during the years ended December 31, 2006, and 2005, was approximately $32.2 million and $18.1 million, respectively. For the years ended December 31, 2006, 2005, and 2004, the Company recognized interest income on these impaired loans of $2.5 million, $945,000, and $117,000, respectively.
 
At December 31, 2006, and 2005, there were no loans pledged as collateral to secure public deposits.
 
At December 31, 2006, and 2005, the Company serviced $97 million and $90 million of loans, respectively, which had been sold to various investors without recourse. At December 31, 2006, and 2005, the Company held $1.1 million and $734,000, respectively, in trust for these loans for the payment of such items as taxes, insurance, and maintenance costs.


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Maturities and sensitivity of accrual loans to changes in interest rates as of December 31, 2006 are as follows:
 
                 
 
   
Maturity
 
    Within
      Over
   
    1 Year   1-5 Years   5 Years   Total
 
    (In Thousands)
 
Commercial
  $149,325   $86,951   $48,334   $284,610
Construction
  140,658   10,656   1,628   152,942
Real estate term
  58,131   70,772   106,420   235,323
Installment and other consumer
  1,032   8,032   32,964   42,028
 
 
Total
  $349,146   $176,411   $189,346   $714,903
 
 
Fixed interest rate
  $130,312   $56,601   $54,489   $241,402
Floating interest rate
  218,834   119,810   134,857   473,501
 
 
Total
  $349,146   $176,411   $189,346   $714,903
 
 
 
Certain directors, and companies of which directors are principal owners, have loans and other transactions such as insurance placement and architectural fees with the Company. Such transactions are made on substantially the same terms, including interest rates and collateral required, as those prevailing for similar transactions of unrelated parties. An analysis of the loan transactions follows:
 
         
December 31,   2006   2005
    (In Thousands)
 
Balance, beginning of the year
  $2,995   $3,132
Loans made
  11,520   16,848
Repayments or change to nondirector status
  13,392   16,985
 
 
Balance, end of year
  $1,123   $2,995
 
 
 
The Company’s unfunded loan commitments to these directors or their related interests on December 31, 2006, and 2005, were $3.4 million and $1.5 million, respectively.


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The following is a detail of the allowance for loan losses:
 
             
 
December 31,   2006   2005   2004
 
    (In Thousands)
 
Balance, beginning of the year
  $10,706   $10,764   $10,186
Provision charged to operations
  2,564   1,170   1,601
Charge-offs:
           
Commercial
  (2,544)   (1,552)   (1,387)
Construction
    (100)  
Real estate
     
Installment and other consumer
  (72)   (63)   (84)
 
 
Total Charge-offs
  (2,616)   (1,715)   (1,471)
 
 
Recoveries:
           
Commercial
  1,086   418   200
Construction
    15   185
Real estate
  354   15  
Installment and other consumer
  31   39   63
 
 
Total Recoveries
  1,471   487   448
 
 
Charge-offs net of recoveries
  (1,145)   (1,228)   (1,023)
 
 
Balance, End of Year
  $12,125   $10,706   $10,764
 
 
 
At December 31, 2006, the allowance for loan losses was $12.1 million as compared to balances of $10.7 million and $10.8 million, respectively, at December 31, 2005 and 2004. The increase in the allowance for the loan losses between December 31, 2006 and December 31, 2005 was caused in part by an increase in loans measured for impairment that increased to $32 million at December 31, 2006 from $18.3 million at December 31, 2005, as well as growth in the loan portfolio.
 
 
The following summarizes the components of premises and equipment:
 
             
 
December 31,   Useful Life   2006   2005
 
        (In Thousands)
 
Land
      $1,443   $1,443
Vehicle
  3 years   61   61
Furniture and equipment
  3-7 years   9,608   8,915
Tenant improvements
  2-11 years   7,307   4,839
Buildings
  39 years   6,865   6,848
 
 
Total Premises and Equipment
      25,284   22,106
Accumulated depreciation and amortization
      (12,410)   (11,503)
 
 
Total Premises and Equipment, Net
      $12,874   $10,603
 
 
 
During 1991, the Company purchased the building in which it operates and simultaneously sold the building to a partnership, in which three of the Company’s directors had an approximate 54% ownership interest. The net gain on the sale of the building, $176,000, was being amortized over the lease term; approximately $12,000 was recognized in 2004, at which time the gain was fully amortized.


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NOTE 8 — Other Assets
 
A summary of intangible assets and other assets is as follows:
 
         
 
December 31,   2006   2005
 
    (In Thousands)
 
Intangible assets:
       
Goodwill
  $5,735   $5,735
Core deposits intangible
  163   531
NBG customer relationships
  1,005   1,119
 
 
Total
  $6,903   $7,385
 
 
Prepaid expenses
  $719   $572
Software
  553   466
Deferred taxes, net
  10,560   8,838
Note receivable from Elliott Cove
  617   1,060
Investment in Elliott Cove
  80   101
Investment in PWA
  1,894   2,015
Investment in RML Holding Company
  4,327   4,203
Investment in Low Income Housing Partnerships
  8,220   2,440
Other assets
  3,236   2,284
 
 
Total
  $30,206   $21,979
 
 
 
As part of the acquisition of branches from Bank of America in 1999, the Company recorded goodwill and a core deposit intangible (“CDI”). The CDI is net of accumulated amortization of $2.8 million and $2.4 million for the periods ending December 31, 2006, and 2005, respectively. The Company intends to continue amortizing the CDI through June of 2007, which will be the remainder of its useful life.
 
In the first quarter of 2005, NCIC purchased a 10% interest in NBG, an insurance brokerage company that provides employee benefit plans to businesses throughout Alaska. In the fourth quarter of 2005, NCIC purchased an additional 40.1% interest in NBG, bringing its ownership interest to 50.1%. The Company has invested $1.1 million in NBG and has attributed all of this investment to an intangible asset represented by the value of the customer relationships of NBG. The Company is amortizing the NBG intangible asset over a ten-year period on a straight-line basis. In 2006, the amortization expense on the NBG intangible asset was $115,000.
 
The Company recorded amortization expense of its intangible assets of $482,000, $368,000, and $368,000 in 2006, 2005, and 2004, respectively. The increase in the amortization expense in 2006 resulted from the additional amortization expense on the NBG intangible asset. The amortization expense that is required on these assets as of December 31, 2006, is as follows:
 
     
 
Year Ending December 31:
 
(In Thousands)
 
2007
  $278
2008
  115
2009
  115
2010
  115
2011
  115
Thereafter
  430
 
 
Total
  $1,168
 
 


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As of December 31, 2006, the Company owns a 47% equity interest in Elliott Cove, an investment advisory services company, through its wholly — owned subsidiary, NISC. Elliott Cove began active operations in the fourth quarter of 2002 and has had start-up losses since that time as it continues to build its assets under management. In addition to its ownership interest, the Company provides Elliott Cove with a line of credit that has a committed amount of $750,000 and an outstanding balance of $617,000 as of December 31, 2006.
 
In the fourth quarter of 2005, the Company, through NISC, purchased subscription rights to an ownership interest in Pacific Wealth Advisors, LLC (“PWA”), an investment advisory and wealth management business located in Seattle, Washington. The Company also made commitments to make two loans to PWA of $225,000 and $175,000, respectively. There were no outstanding balances on these two commitments as of December 31, 2006. Subsequent to the investment in these subscription rights, PWA purchased Pacific Portfolio Consulting L.P., an investment advisory business, and formed Pacific Portfolio Trust Company. After the completion of these transactions, NISC owned a 24% interest in PWA and applies the equity method of accounting for its ownership interest in PWA.
 
RML was formed in 1998 and has offices throughout Alaska. During the third quarter of 2004, RML reorganized and became a wholly-owned subsidiary of a newly formed holding company, RML Holding Company. In this process, RML Holding Company acquired another mortgage company, PAM, which was merged into RML in the first quarter of 2005. Prior to the reorganization, the Company, through Northrim Bank’s wholly-owned subsidiary, NCIC, owned a 30% interest in the profits of RML. As a result of the reorganization, the Company now owns a 24% interest in the profits of RML Holding Company and applies the equity method of accounting for its ownership interest in RML.
 
Below is summary balance sheet and income statement information for RML Holding Company.
 
         
 
December 31,   2006   2005
 
    (In Thousands)
 
Assets
       
Current assets
  $53,072   $70,315
Long-term assets
  6,455   5,958
 
 
Total Assets
  $59,527   $76,273
 
 
         
Liabilities
       
Current liabilities
  $41,980   $58,285
Long-term liabilities
  964   1,906
 
 
Total Liabilities
  42,944   60,191
 
 
Shareholders’ Equity
  16,583   16,082
 
 
Total Liabilities and Shareholders’ Equity
  $59,527   $76,273
 
 
Income/expense
       
Gross income
  $17,036   $15,819
Total expense
  14,403   13,107
Joint venture allocations
  102   (522)
 
 
Net Income
  $2,735   $2,190
 
 
 
In December of 2006, September of 2006 and January of 2003 the Company made investments of $3 million each in USA 57, CharterMac and RCP, respectively. The Company earns a return on its investments in the form of tax credits and deductions that flow through to it as a limited partner in these partnerships over a fifteen, eighteen and eighteen-year period, respectively.
 
 
The aggregate amount of certificates of deposit in amounts of $100,000 or more at December 31, 2006, and 2005, was $28.3 million and $51.2 million, respectively.


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At December 31, 2006, the scheduled maturities of certificates of deposit (excluding Alaska CD’s, which do not have scheduled maturities) are as follows:
 
     
 
Year Ending December 31:
 
(In Thousands)
 
2007
  $59,357
2008
  16,852
2009
  9,425
2010
  146
2011
  114
Thereafter
  24
 
 
Total
  $85,918
 
 
 
At December 31, 2006, the Company did not hold any certificates of deposit from a public entity collateralized by letters of credit issued by the Federal Home Loan Bank compared to 2005 where the Company held $15 million of these types of deposits.
 
 
The Company has a line of credit with the FHLB of Seattle approximating 12% of assets, or $107 million at December 31, 2006. The line is secured by a blanket pledge of the Company’s assets. At December 31, 2006, and 2005, there was $2.2 million and $18.1 million committed on the line, respectively. At December 31, 2005, there was $2.6 million outstanding on the line and an additional $15.5 million of the borrowing line was committed to secure public deposits. The outstanding balances on the FHLB line of credit at December 31, 2006, and 2005, of $2.2 million and $2.6 million, respectively, have a maturity date of May 7, 2012.
 
The Company entered into a note agreement with the Federal Reserve Bank on the payment of tax deposits. The Federal Reserve has the option to call the note at any time. The balance at December 31, 2006, and 2005, was $1 million.
 
The Federal Reserve Bank is holding $55.5 million of loans as collateral to secure advances made through the discount window on December 31, 2006. There were no discount window advances outstanding at December 31, 2006.
 
Securities sold under agreements to repurchase were $3.3 million with an interest rate of 3.69%, and $4.9 million with an interest rate of 2.28%, at December 31, 2006, and 2005, respectively. The average balance outstanding of securities sold under agreement to repurchase during 2006 and 2005 was $3.3 million and $2.8 million, respectively, and the maximum outstanding at any month-end was $6.7 million and $5.4 million, respectively. The securities sold under agreement to repurchase are held by the Federal Home Loan Bank under the Company’s control.
 
 
In May of 2003, the Company formed a wholly-owned Delaware statutory business trust subsidiary, Northrim Capital Trust 1 (the “Trust”), which issued $8 million of guaranteed undivided beneficial interests in the Company’s Junior Subordinated Deferrable Interest Debentures (“Trust Preferred Securities”). These debentures qualify as Tier 1 capital under Federal Reserve Board guidelines. All of the common securities of the Trust are owned by the Company. The proceeds from the issuance of the common securities and the Trust Preferred Securities were used by the Trust to purchase $8.2 million of junior subordinated debentures of the Company. The Trust Preferred Securities of the Trust are not consolidated in the Company’s financial statements in accordance with FASB Interpretation No. 46R (“FIN 46”); therefore, the Company has recorded its investment in the Trust as an other asset and the subordinated debentures as a liability. The debentures which represent the sole asset of the Trust, accrue and pay distributions quarterly at a variable rate of 90-day LIBOR plus 3.15% per annum, adjusted quarterly, of the stated liquidation value of $1,000 per capital security. The interest rate on these debentures was 8.52% at December 31, 2006. The interest cost to the Company on these debentures was $665,000 in 2006 and $523,000 in 2005. The Company has entered into contractual arrangements which, taken collectively, fully and unconditionally guarantee payment of: (i) accrued and unpaid distributions required to be paid on the Trust Preferred Securities; (ii) the redemption price with respect to any Trust Preferred Securities called for redemption by the Trust and (iii) payments due upon a voluntary or involuntary dissolution, winding up or liquidation of the Trust. The Trust Preferred Securities are mandatorily redeemable upon maturity of the debentures on May 15, 2033, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by the Trust in whole or in part, on or after May 15, 2008. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued but unpaid interest.


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In December of 2005, the Company formed a wholly-owned Connecticut statutory business trust subsidiary, Northrim Statutory Trust 2 (the “Trust 2”), which issued $10 million of guaranteed undivided beneficial interests in the Company’s Junior Subordinated Deferrable Interest Debentures (“Trust Preferred Securities 2”). These debentures qualify as Tier 1 capital under Federal Reserve Board guidelines. All of the common securities of Trust 2 are owned by the Company. The proceeds from the issuance of the common securities and the Trust Preferred Securities 2 were used by Trust 2 to purchase $10.3 million of junior subordinated debentures of the Company. The Trust Preferred Securities of the Trust 2 are not consolidated in the Company’s financial statements in accordance with FIN 46; therefore, the Company has recorded its investment in the Trust 2 as an other asset and the subordinated debentures as a liability. The debentures which represent the sole asset of Trust 2, accrue and pay distributions quarterly at a variable rate of 90-day LIBOR plus 1.37% per annum, adjusted quarterly, of the stated liquidation value of $1,000 per capital security. The interest rate on these debentures was 6.73% at December 31, 2006. The interest cost to the Company on these debentures was $654,000 in 2006 and $26,000 in 2005. The Company has entered into contractual arrangements which, taken collectively, fully and unconditionally guarantee payment of: (i) accrued and unpaid distributions required to be paid on the Trust Preferred Securities 2; (ii) the redemption price with respect to any Trust Preferred Securities 2 called for redemption by Trust 2 and (iii) payments due upon a voluntary or involuntary dissolution, winding up or liquidation of Trust 2. The Trust Preferred Securities 2 are mandatorily redeemable upon maturity of the debentures on March 15, 2036, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by Trust 2 in whole or in part, on or after March 15, 2011. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued but unpaid interest.
 
 
Interest expense on deposits and borrowings is presented below:
 
<
             
 
December 31,   2006   2005   2004
 
    (In Thousands)
 
Interest-bearing demand accounts
  $830   $369   $221
Money market accounts
  6,053   3,876   1,527
Savings accounts
  10,113   6,263   2,290
Certificates of deposit greater than $100,000
  1,425   2,170   1,620