NORTHRIM BANCORP INC - Annual Report: 2003 (Form 10-K)

SECURITIES AND EXCHANGE COMMISSION

Form 10-K

ANNUAL REPORT UNDER SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2003

Commission File Number 0-33501

Northrim BanCorp, Inc.

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
(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of the Securities and 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 [X] No [   ]

Indicate by check mark if the registrant is an accelerated filer within the meaning of Rule 12b-2 under the Securities Exchange Act of 1934, as amended. Yes [X]  No [   ]

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 [   ] No [X]

The aggregate market value of common stock held by non-affiliates of registrant at June 30, 2003, was $103,333,186.

The number of shares of registrant’s common stock outstanding at February 26, 2004, was 6,052,669.

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 6, 2004, referenced in Part III of this Form 10-K are incorporated by reference therein.

Table of Contents

Northrim BanCorp, Inc.
Table of Contents

Note Regarding Forward-Looking Statements

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 Northrim Bank’s filings with the FDIC and those identified from time to time 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

Overview

     Northrim BanCorp, Inc. (the “Company”) is a publicly traded bank holding company with three wholly-owned subsidiaries, Northrim Bank (the “Bank”), a state chartered, full-service commercial bank; Northrim Investment Services Company (“NISC”), which we formed in November 2002 to hold the Company’s 43% equity interest in Elliott Cove Capital Management LLC, (“Elliott Cove”), an investment advisory services company; and Northrim Capital Trust 1 (“NCT1”), an entity that we formed in May of 2003 to facilitate a trust preferred security offering by the Company. We also hold a 30% interest in the profits and losses of a residential mortgage company, Residential Mortgage LLC (“RML”) through Northrim Bank’s wholly-owned subsidiary, Northrim Capital Investment Corporation (“NCIC”). RML was formed in 1998 and has offices throughout Alaska.

     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, 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 SEC’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.

     In January 2002, we moved our Eagle River Branch from a supermarket branch into a full-service branch to provide a higher level of service to the growing Eagle River market. In December 2002, we completed construction of our Wasilla Financial Center and moved from our existing supermarket branch and loan production office. We moved from our supermarket branch in west Anchorage into a freestanding facility in February 2003. In addition, we plan to explore other branching opportunities in our major markets in the future.

     We have grown to be the third largest commercial bank in Anchorage and Alaska in terms of deposits, with $646.2 million in total deposits and $738.6 million in total assets at December 31, 2003. Through our 10 branches, we are accessible by approximately 75% of the Alaska population.

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New Core Software System

     In 2000, we selected a new software system to process our loan, deposit and general ledger accounts. We converted to the new system in the second quarter of 2001. This system, which utilizes an Oracle database and real-time customer transaction posting, initiates the process of modernizing our backroom processing. In 2002, we took additional steps by adding an item imaging system and upgrading our Internet banking capabilities. As a result, we moved item processing back in-house as it had been out-sourced due to the rapid expansion that followed the Bank of America branch purchase. We also revamped our customers’ statements and began providing statements with imaged items in January 2003. In 2004, we plan to add document imaging to this system to allow us to electronically store our records and documents. These initiatives are being pursued to improve service levels to customers and achieve operational efficiencies.

Elliott Cove Capital Management LLC

     In the fourth quarter of 2002, we made an initial investment of $375,000 in Elliott Cove through our wholly-owned subsidiary, NISC. In 2003, we made additional investments in Elliott Cove through NISC totaling $375,000. In addition to the equity investments, we made a loan to Elliott Cove that totaled $125,000 at December 31, 2002. In July of 2003, we made a commitment to loan $625,000 to Elliott Cove. The balance outstanding on this commitment at December 31, 2003, was $475,000. The loan is convertible to equity in Elliott Cove and the Company intends to make this conversion in 2004. Finally, in February of 2004, we made a commitment to loan Elliott Cove $500,000 in the form of a one year revolving line of credit.

     During the first quarter of 2003, 10 Northrim Bank employees completed training and earned their series 65 securities licenses and became Registered Investment Advisors (“RIA”). In the second quarter of 2003, we began to offer Elliott Cove investment products to our customers through the sales efforts of the RIAs. We hope to use the Elliott Cove products to diversify our product offerings in an effort to strengthen our existing customer relationships and bring new customers into the Bank. However, we expect to incur losses on the Elliott Cove investment for several years as Elliott Cove builds its assets under management.

Business Strategies

     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:

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Services

     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 non-interest-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. Our money market deposit account pays interest based on the 90-day U.S. Treasury rate.

Several of our innovative deposit services and products are:

Lending Services: We are an active lender with an emphasis on commercial and real estate lending. We also 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 non-cash deposits from business customers.

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Directors and Executive Officers: The following table presents the names and occupations of our directors and executive officers.

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Selected Financial Data

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Management’s Discussion and Analysis of Financial Condition and
Results of Operation

Overview

     We are a publicly traded bank holding company with three wholly-owned subsidiaries: the Bank, a state chartered, full-service commercial bank; NISC, a company formed to invest in Elliott Cove, an investment advisory services company; and NCT1, an entity formed to facilitate a trust preferred securities offering. We are headquartered in Anchorage and have 10 branch locations, seven in Anchorage, and one each in Fairbanks, Eagle River, and Wasilla. We offer a wide array of commercial 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 and Fairbanks, Alaska’s two largest urban areas. We estimate that we hold a 21% share of the commercial bank deposit market in Anchorage and a 7% share of the Fairbanks market as of June 30, 2003.

     Our growth and operations depend upon the economic conditions of Alaska and the specific markets it serves. 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. Approximately 40% of the Alaska economy is generated from the oil industry, and about 75% 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, 2003, we had assets of $738.6 million and gross loans of $601.1 million, an increase of 5% and 12%, respectively, over the previous year. Our net income and diluted earnings per share for 2003 were $10.5 million and $1.69, respectively; an increase of 23% and 25%, respectively, from 2002. During the same time, our net interest income increased by $4.6 million, or 13%, and our other operating income grew by $890,000, or 17%. The growth in our income was coupled with smaller growth in our other operating expenses of $1.7 million, or 7%, which contributed to the larger increase in our net income and earnings per share.

Results of Operations

Net Income

     We earned net income of $10.5 million in 2003, compared to net income of $8.5 million in 2002, and $7.1 million in 2001. Net income per diluted share was $1.69, $1.35, and $1.13, 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 other sources. Our operating expenses consist primarily of compensation, employee benefits expense, and occupancy 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.

     Net interest income is the difference between interest income, principally from loan and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Net interest income in 2003 was $39.3 million compared to $34.7 million in 2002, and $31.3 million in 2001, reflecting an increase in our interest-earning assets. Average interest-earning assets increased $53.8 million, or 9%, in 2003 compared to an increase in average interest-bearing liabilities in 2003 of $28.2 million, or 6%. Average interest-earning assets increased $61.4 million, or 11%, in 2002 compared to an increase in average interest-bearing liabilities in 2002 of $32.9 million, or 8%.

     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, 2003, 2002,

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and 2001, average interest-earning assets were $653.5 million, $599.7 million and $538.3 million, respectively. During these same periods, net interest margins were 6.01%, 5.78% and 5.82%, 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 7.03% in 2003, 7.48% in 2002, and 8.93% in 2001, while the average cost of interest-bearing liabilities was 1.42% in 2003, 2.30% in 2002, and 4.10% in 2001.

     Our net interest margin increased in 2003 from 2002 for several reasons. First, interest rates declined to historically low levels with the rates on interest bearing liabilities declining by 88 basis points versus a 45 basis point decline in earning assets. Second, fee income increased in 2003 to $5.1 million versus $3.8 million in 2002. Finally, we received the benefit of pre-payment penalties as several long-term real estate loans were refinanced that had early pre-payment penalties. The total amount of pre-payment penalties earned in 2003 was $477,000, which increased our net interest margin by seven basis points based upon average interest-earning assets of $653.5 million.

     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.

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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.

Other Operating Income

     Total other income increased $890,000, or 17%, in 2003, after increasing $433,000, or 9%, in 2002, and $1.3 million, or 39%, in 2001. The following table separates the more routine (recurring) sources of other income from those that can fluctuate significantly from period to period:

     The recurring sources of operating income in 2003 increased $648,000, or 13%. In 2002, this income increased $405,000, or 9%, and in 2001, it increased $1.3 million, or 39%. Deposit service charges and loan service fees increased in 2003 from 2002, due to enhanced methods to collect business analysis fees and loan late fees. Merchant credit card fees decreased due

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to a shared revenue contract with the vendor, which in turn reduced our risk in this area. Electronic banking fees decreased due to changes in how customers are using debit cards resulting in lower fees. Finally, we recorded $2.8 million of income as our share of the earnings from RML as compared to $1.9 million in 2002, and a $554,000 loss from our share of the loss of Elliott Cove compared to a loss of $239,000 in 2002.

     Included in recurring sources of other operating income in 2003, 2002, and 2001 are $2.8 million, $1.9 million, and $1.2 million, respectively, of income from our share of the earnings from RML. Earnings from RML have fluctuated with activity in the housing market, which has been affected by local economic conditions and changes in mortgage interest rates. In 2003, 2002, and 2001, declining mortgage interest rates generated a major 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. If this trend of increasing long-term mortgage rates continues, our share of the earnings from RML could decline in 2004.

     Our share of the loss from Elliott Cove increased to $554,000 in 2003, as compared to a loss of $239,000 in 2002. Elliott Cove began operations in 2002 and developed a model to sell its products through RIAs at community banks. Elliott Cove earns revenue by charging fees to its customers based upon a percentage of assets that it manages for them. The major expenses for the company are for personnel, other overhead expenses, and the commissions that it pays to community banks that use RIAs to sell its products. We started actively selling its investment products through our RIAs in the second quarter of 2003 after 10 of our employees obtained their Series 65 security license and became certified as RIAs. We expect that Elliott Cove will continue to incur losses as it continues to build its assets under management.

     The other sources of other operating income increased $242,000 in 2003, or 214%. In 2002, this income increased $28,000, or 33%; and in 2001, it increased $18,000, or 27%. Security gains of $310,000 were recorded in 2003, $113,000 of gains were recorded in 2002, and $47,000 were recorded in 2001. We also recorded a gain on the sale of other real estate owned of $45,000 in 2003, and $38,000 in 2001.

Expenses

Provision for Loan Losses: The provision for loan losses in 2003 was $3.6 million, compared to $3.1 million in 2002 and $2.3 million in 2001. We increased the provision in 2003, 2002, and 2001 because of loan growth, loss inherent in the portfolio, and increases in charge-offs and non-performing loans. The allowance for loan losses was $10.2 million, or 1.69% of total loans, at December 31, 2003, $8.5 million, or 1.58% of total loans, at December 31, 2002, and $7.2 million, or 1.49% of total loans, at December 31, 2001.

Charge-Offs: Net loan charge-offs were $1.9 million, or 0.33% of average loans, in 2003, $1.8 million, or 0.36% of average loans, in 2002, and $1.3 million, or 0.29% of average loans, in 2001.

Other Operating Expense: Other operating expense increased $1.7 million, or 7%, in 2003, $492,000, or 2%, in 2002, and $1.3 million, or 6%, in 2001. The following table breaks out the other operating expense categories:

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     Salaries and other personnel expense, occupancy expense and equipment costs, in the aggregate, increased $1.2 million, or 7%, in 2003, $862,000, or 6%, in 2002, and $1.1 million, or 8%, in 2001, reflecting increases for the provision of services in our new branch locations in Wasilla, Eagle River, and West Anchorage. In addition, the costs of amortizing the intangible asset, created as a result of the branch purchase, did not commence until mid-1999. Intangible amortization expense was $368,000 in 2003, 2002, and 2001. In 2002, amortization expense decreased by $464,000 because of the effect of a change in the accounting treatment of goodwill and intangible assets. As a result of the requirements of SFAS No. 142, we no longer amortize goodwill. However, the Company will continue to amortize the core deposit intangible.

     Other expenses increased $393,000, or 11%, in 2003, and they increased $272,000, or 8%, in 2002. The main reasons for the change in 2003 were increases of $85,000, $149,000, and $130,000 in operational charge-offs, software maintenance costs, and education. We had two robberies, several check fraud schemes, and a large merchant services loss that caused the major portion of the increase in operational charge-offs. We had higher software maintenance costs in 2003 due to larger software purchases made mainly in 2002 as we moved our check processing system back in-house, as it was outsourced after the Bank of America branch purchase in 1999. Finally, we had higher education costs in 2003 as we adopted a focused sales program throughout our organization. We expect to incur ongoing costs for continuing sales education but not at the elevated levels of 2003.

     Consulting expenses increased $66,000, or 85%, in 2003, and they decreased $26,000, or 25%, in 2002. These costs increased in 2003 due to consulting expenses associated with the review and enhancement of our information processing and employee benefit systems.

     Legal costs decreased $4,000, or 2%, in 2003, decreased $105,000 or 35%, in 2002, and increased $118,000, or 64%, in 2001. The increase in 2001 was associated in part with litigation issues that were settled favorably for the Company and in part because of legal fees and expenses incurred in connection with our holding company reorganization, which we completed on December 31, 2001.

     Loan collection and ORE costs increased $93,000, or 137%, in 2003, increased $19,000, or 39%, in 2002, and decreased $75,000, or 60%, in 2001. These costs represent the out-of-pocket expense we incurred to liquidate problem assets and manage repossessed property resulting from the collection process. In 2003, these costs increased as we had higher costs associated with the repossession and sale of a property. In contrast, in 2002, we actually had cost recoveries in several of these areas.

     Cash handling costs decreased $39,000, or 15%, in 2003, decreased $58,000, or 18%, in 2002, and decreased $133,000, or 29%, in 2001. These costs decreased over the years as we have renegotiated our contract with our vendor and brought more of these services back in-house as opposed to having them performed by an independent contractor.

     Supply expense decreased by $178,000, or 36%, in 2003, and increased by $49,000, or 11%, in 2002. The main reason for the decreased supply costs in 2003 was a change in vendors coupled with a program that brought the inventory system for a number of our forms in-house.

Income Taxes: The provision for income taxes increased $1.3 million, or 26%, to $6.5 million in 2003, increased $1 million, or 25%, to $5.2 million in 2002, and increased $854,000, or 26%, to $4.1 million in 2001. The effective tax rate for 2003 was 38%, compared to 38% in 2002, and 37% in 2001. The increase in the effective tax rate is due to the Company’s taxable income in excess of $10 million being taxed at a higher rate and the proportion of tax-exempt income to total income declined as the Company grew.

Financial Condition

Assets

Loans and Lending Activities

General: Our loan products include short- and medium-term commercial loans, commercial credit lines, construction and real estate loans, consumer loans, and credit cards. We emphasize providing financial services to small- and medium-sized businesses and to individuals. From our inception, we have emphasized commercial, land development and home construction, and commercial real estate lending. These types of lending have provided us with needed market opportunities and higher net interest margins than other types of lending. However, they also involve greater risks, including greater exposure to changes in local economic conditions, than certain other types of lending.

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     Loans are the highest yielding component of earning assets. Average loans were $63.8 million, or 13% greater in 2003 than in 2002. Average loans were $52.4 million, or 12% greater in 2002 than in 2001. Loans comprised 87% of total earning assets on average in 2003, and 84% in 2002 and 2001. The yield on loans averaged 7.54% in 2003, 8.07% in 2002, and 9.57% in 2001.

     Growth in the loan portfolio during 2003 was $66.1 million, or 12%. Commercial loans increased $33.5 million, or 18%, commercial real estate loans increased $26.8 million, or 13%, and construction loans increased $19.6 million, or 24%, in 2003. Real estate loans for sale decreased $6 million, or 81%, and installment and consumer loans decreased $7.6 million, or 16%. Funding for the growth in loans in 2003 came from an increase in interest-bearing liabilities and from noninterest-bearing sources of funds and capital.

     We began a program in 1998 of purchasing single family mortgage loans originated from our affiliated mortgage company, RML. These loans, which are committed for sale to mortgage investors, have generally been held by the Company for less than 45 days. At December 31, 2003, these loans totaled $1.4 million compared to $7.4 million on December 31, 2002.

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 did not have any real estate owned at December 31, 2003. The following table sets forth information regarding our nonperforming loans and total nonperforming assets:

Nonaccrual, Accruing Loans 90 Days or More Past Due, and Restructured Loans: The Company’s financial statements are prepared on the accrual basis of accounting, including recognition of interest income on its loan portfolio, unless a loan is placed on a nonaccrual basis. 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 and place them on nonaccrual status. Cash payments on nonaccrual loans are directly applied to the principal balance. The amount of unrecognized interest on nonaccrual loans was $690,000, $480,000, and $270,000, in 2003, 2002, and 2001, 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, 2003, were $10.3 million, or 1.71% of total loans, an increase of $4.6 million from $5.7 million at December 31, 2002, and an increase of $6.7 million from $3.6 million at December 31, 2001. The increase in nonperforming loans in 2003, as compared to 2002, resulted in large part from one commercial loan being categorized as non-performing and the remaining portion of two other commercial relationships being categorized as non-performing. These loans comprise 61% of the non-performing loan totals.

Potential Problem Loans: At December 31, 2003, management had identified no potential problem loans. Potential problem loans are loans which are currently performing and are not included in nonaccrual, accruing loans 90 days or more past due, or

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restructured loans that have developed serious doubts as to the borrower’s ability 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, 2003, the allowance is adequate to cover losses that are probable in light of our current loan portfolio and existing and expected 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 differ substantially from the assumptions used in making the final determination.

     The following table shows the allocation of the allowance for loan losses at December 31, 2003, 2002, 2001, 2000, and 1999:

     The following table sets forth for the periods indicted information regarding changes in our allowance for loan losses:

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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 to us, including the indebtedness of any guarantor.

     Generally, we are permitted to make loans to one borrower of up to 15% of our unimpaired capital and surplus. Our loan-to-one-borrower limitation was $12.5 million at December 31, 2003. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Provision for Loan Losses.”

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 $601.1 million at December 31, 2003, compared to $535 million and $482.6 million at December 31, 2002 and 2001, respectively. At December 31, 2003, 65% of the portfolio was scheduled to mature or reprice in 2004 with 33% scheduled to mature or reprice between 2005 and 2008. Future growth in loans is generally dependent on new loan demand and deposit growth, constrained by our policy of being “well-capitalized.”

Loan Portfolio Composition: The following table sets forth at the dates indicated our loan portfolio composition by type of loan:

The following table presents at December 31, 2003, the aggregate maturities of our commercial and real estate construction loans:

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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 and commercial real estate loans that are participated with the Alaska Industrial Development and Export Authority (“AIDEA”). Commercial loans represented 37% of our total loans outstanding as of December 31, 2003. Commercial loans generally provide greater yields 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.

Construction Loans:

Land Development: We are a major land development and residential construction lender. At December 31, 2003, we had $41.6 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 2003. We originated one-to-four-family residential construction loans to builders for construction of homes. At December 31, 2003, we had $54.5 million of one-to-four-family residential and condominium construction loans, or 9% of total loans. Of the homes under construction at December 31, 2003, for which these loans had been made, 55% 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. When originating residential mortgage loans, RML obtains a firm commitment from long-term investors to buy the loans at a specified interest rate and under other specified terms. We buy loans originated by RML and generally hold these loans for less than 45 days before they are purchased by the long-term investor. At December 31, 2003, we held $1.4 million of RML-originated loans, which was less than 1% of our total loans at that date. RML has warehouse lines of credit in place that are independent of the Company with which it finances the majority of its loan production.

Commercial Real Estate: We are an active lender in the commercial real estate market. At December 31, 2003, our commercial real estate loans were $239.5 million, or 40%, 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 25% of these loans originated by Northrim resets every three years based on the spread over an index rate, normally the three-year 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, Alaska Industrial Development and Export Authority (“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, 2003. See also “Liquidity and Capital Resources.”

Investments and Investment Activities

General: Our investment portfolio consists primarily of U.S. Treasury and government agency securities, mortgage-backed securities, and municipal securities. Investment securities totaled $73.2 million at December 31, 2003, a decrease of $8.1 million, or 10%, from year-end 2002. The average maturity of the investment portfolio was 3.6 years at December 31, 2003.

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     Investment securities designated as available for sale comprised 97% of the portfolio and would be 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, 2003, $16.8 million in securities were pledged for deposits.

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 and which we do not intend to hold to maturity. 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, which 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 for the foreseeable future. These securities are carried at amortized cost.

The following tables set forth the composition of our investment portfolio at the dates indicated:

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For the periods ending December 31, 2003, 2002, and 2001, we held FHLB stock with a book value approximately equal to its market value in the amounts of $1.5 million, $1.8 million, and $2.7 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 at December 31, 2003: