NORTHRIM BANCORP INC - Quarter Report: 2004 September (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2004

[  ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number 000-33501

NORTHRIM BANCORP, INC.

(Exact name of registrant as specified in its charter)

(907) 562-0062

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).

Yes [X] No [  ]

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

The number of shares of the issuer’s Common Stock outstanding at November 5, 2004 was 6,087,470.

TABLE OF CONTENTS

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NORTHRIM BANCORP, INC.

NORTHRIM BANCORP, INC.

See notes to the consolidated financial statements

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NORTHRIM BANCORP, INC.

See notes to the consolidated financial statements

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NORTHRIM BANCORP, INC.

See notes to the consolidated financial statements

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NORTHRIM BANCORP, INC.

See notes to the consolidated financial statements

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NORTHRIM BANCORP, INC.

1. BASIS OF PRESENTATION

The accompanying unaudited financial statements have been prepared by Northrim BanCorp, Inc. (the “Company”) in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and with instructions to Form 10-Q under the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the interim period ended September 30, 2004, are not necessarily indicative of the results anticipated for the year ending December 31, 2004. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

2. STOCK REPURCHASE

In September 2002, the Board of Directors of the Company approved a plan whereby the Company would periodically repurchase for cash up to approximately 5%, or 306,372, of its shares of common stock in the open market. The Company purchased 224,800 shares of its stock under this program through September 30, 2004, at a total cost of $3.1 million. However, the Company has not repurchased any of these shares in 2004. In August of 2004, the Board of Directors of the Company 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. The Company intends to continue to repurchase its stock from time to time depending upon market conditions, but it can make no assurances that it will continue this program or that it will repurchase all of the authorized shares.

3. ACCOUNTING PRONOUNCEMENTS

None.

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4. LENDING ACTIVITIES

The following table sets forth the Company’s loan portfolio composition by loan type for the dates indicated:

The following table details activity in the Allowance for Loan Losses for the dates indicated:

Nonperforming assets consist of nonaccrual loans, accruing loans of 90 days or more past due, restructured loans, and real estate owned. The following table sets forth information with respect to nonperforming assets:

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At September 30, 2004, December 31, 2003, and September 30, 2003, the Company had loans measured for impairment of $7.9 million, $13.2 million, and $15.6 million, respectively. A specific allowance of $576,000, $580,000, and $1.1 million, respectively, was established for these periods. The decrease in loans measured for impairment at September 30, 2004, as compared to September 30, 2003, and December 31, 2003, resulted in large part from the concentrated collection activities of the Company.

5. INVESTMENT SECURITIES

Investment securities, which include Federal Home Loan Bank stock, totaled $65.1 million at September 30, 2004, a decrease of $8.1 million, or 11%, from $73.2 million at December 31, 2003, and an increase of $2.2 million, or 4%, from $62.9 million at September 30, 2003. Investment securities designated as available for sale comprised 96% of the investment portfolio at September 30, 2004, 97% at December 31, 2003, and 96% at September 30, 2003, and are available to meet liquidity requirements. Both available for sale and held to maturity securities may be pledged as collateral to secure public deposits. At September 30, 2004, $20.8 million in securities, or 32%, of the investment portfolio was pledged, as compared to $16.8 million, or 23%, at December 31, 2003, and $27 million, or 43%, at September 30, 2003.

6. OTHER OPERATING INCOME

Residential Mortgage, LLC (“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, Residential Mortgage Holding Company, LLC (“RML Holding Company”). In this process, RML Holding Company acquired another mortgage company, Pacific Alaska Mortgage Company. Prior to the reorganization, the Company, through Northrim Bank’s wholly-owned subsidiary, Northrim Capital Investments Co. (“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 23.5%. The Company’s share of the earnings from RML Holding Company and its predecessor, RML, decreased by $1 million to $15,000 during the third quarter of 2004 as compared to $1 million in the third quarter of 2003, primarily due to decreased refinance activity, coupled with strong competition for mortgages and key personnel.

The Company owns a 47% equity interest in Elliott Cove Capital Management LLC (“Elliott Cove”), an investment advisory services company, through its wholly–owned subsidiary, Northrim Investment Services Company (“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 July of 2003, the Company made a commitment to loan $625,000 to Elliott Cove. The amount loaned on this commitment at December 31, 2003 was $475,000. In the second quarter of 2004, the Company converted the loan into an additional equity interest in Elliott Cove. At the time of the conversion, the

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amount outstanding on this loan was $625,000. During the first, second, and third quarters of 2004, other investors made additional investments in Elliott Cove. In addition, the Company made a separate commitment to loan Elliott Cove $500,000. The balance outstanding on this commitment at September 30, 2004 was $400,000. Finally, in the third quarter of 2004, the Company made an additional $250,000 investment in Elliott Cove. As a result of the additional investments in Elliott Cove by other investors and the Company’s conversion of its $625,000 loan and its additional investment, its interest in Elliott Cove increased from 43% to 47% between December 31, 2003 and September 30, 2004.

7. DEPOSIT ACTIVITIES

The Alaska Permanent Fund Corporation may invest in certificates of deposit at Alaska banks in an aggregate amount with respect to each bank, not to exceed its capital and at specified rates and terms. The depository bank must collateralize the deposit. At September 30, 2004, the Company held $30 million in certificates of deposit for the Alaska Permanent Fund, collateralized by letters of credit issued by the Federal Home Loan Bank (“FHLB”).

8. EARNINGS PER SHARE

The Company applies APB Opinion No. 25 in accounting for its stock option plans and, accordingly, no compensation cost has been recognized for its stock options in the financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company’s net income would have been reduced to the pro forma amounts indicated below for the third quarter ending September 30, 2004 and 2003:

The per share weighted-average fair value of stock options granted during April 2003, October 2001, and October 2000, was $4.71, $5.51, and $3.20, respectively, on the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions: 2003—expected dividends of $0.38 per share, risk-free rate of 3.83%, volatility of 31.05%, and an expected life of 10 years; 2001—expected dividends of $0.20 per share, risk-free interest rate of 5.83%, volatility of 31.7%, and an expected life of 10

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years; 2000—expected dividends of $0.20 per share, risk-fee interest rate of 5.87%, volatility of 32.1%, and an expected life of 10 years. In addition, the effective tax rate used to compute the net tax effect of the stock–based compensation for the nine-month periods ending September 30, 2003, and September 30, 2004, was 40%.

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NORTHRIM BANCORP, INC.
PART I — FINANCIAL INFORMATION

ITEM TWO

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

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.

OVERVIEW

GENERAL

Northrim BanCorp, Inc. (the “Company”) is a publicly traded bank holding company (Nasdaq: NRIM) with three wholly-owned subsidiaries: Northrim Bank (the “Bank”), a state chartered, full-service commercial bank, Northrim Investment Services Company (“NISC”), which we formed in November 2002 to hold the Company’s 47% equity interest in Elliott Cove Capital Management LLC (“Elliott Cove”), an investment advisory services company; and Northrim Capital Trust I (“NCTI”), an entity that we formed in May 2003 to facilitate a trust preferred securities offering by the Company. We also hold a 23.5% interest in the profits and losses of a residential mortgage holding company, Residential Mortgage Holding Company, LLC (“RML Holding Company”), through the Bank’s wholly-owned subsidiary, Northrim Capital Investments Co. (“NCIC”). Residential Mortgage LLC (“RML”), the predecessor of RML Holding Company, 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.

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BUSINESS OVERVIEW

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 are headquartered in Anchorage and have 10 branch locations: seven in Anchorage, and one each in Fairbanks, Eagle River and Wasilla. In addition, we opened a loan production office (“LPO”) in Seattle, Washington in the second quarter of 2004 that will focus on asset-based lending and operate under the name of Northrim Funding Services, a division of Northrim Bank. The LPO is in the start-up stage and is expected to begin selling its products in the fourth quarter of 2004. Through the branch locations and the LPO, we offer a wide array of commercial bank loan and deposit products, asset-based lending products, investment products, and electronic banking services over the Internet.

BUSINESS STRATEGY

The Company’s goal is to improve earnings and increase shareholder value by implementing a number of strategies that are designed to increase its market share within its major markets that include the areas surrounding Anchorage, Fairbanks, and the Matanuska-Susitna Borough. To achieve these objectives, the Company is pursing the following strategies:

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MARKET AREA

Since it opened for business in late 1990, the economies within the Company’s major markets have grown at a slow but steady pace. Employment growth in the Anchorage area, the Company’s largest market, has averaged between 1.5% and 2.5% for the past several years. The economy has benefited from steady population growth, increases in private and public construction projects, and a strong real estate market. Many of the private construction projects have been funded by large retailers headquartered outside of Alaska that have expanded their operations within the state to meet the demands of the growing population. In contrast, much of the publicly funded construction is for military defense projects at the four major military installations located in the Anchorage and Fairbanks areas as well as for the National Missile Defense project, a portion of which is being constructed at a former military base approximately 100 miles south of Fairbanks. In addition to these large capital projects, the economy has benefited from a strong real estate market that has been fueled in part by the historic drop in interest rates. As interest rates began to rise from their lows in the latter part of 2003, refinance activity within the real estate market began to slow which began to have a negative effect on the income the Company receives from its investment in RML. This trend has continued in 2004 as mortgage interest rates have remained at or above the levels experienced in 2003. As a result, mortgage refinance activity has declined which has caused RML’s earnings to decline in 2004.

The State of Alaska is very dependent upon the oil industry. Revenues from the oil industry fund more than 80% of the cost of state government in Alaska. Oil industry employment and spending levels have been declining for a number of years in the state. Moreover, oil production as measured by daily throughput through the Trans-Alaska oil pipeline has declined from a peak of two million barrels per day in 1989 to a current level of approximately one million barrels per day. As production has declined over time so to have revenues to the State of Alaska. As a result, in 11 out of the past 13 years, Alaska has had to draw from its savings accounts to balance its state budget. However, the State had a small budget surplus for the fiscal year ending June 30, 2004 due to record high oil prices. In addition, due to the continuation of these high oil prices, the State is projecting a budget surplus for fiscal year ending June 30, 2005. In addition, the main savings account for the State, the Constitutional Budget Reserve, which has a current balance of approximately $2 billion, has been the main account from which the State has drawn funds to balance its budget.

THIRD QUARTER RESULTS SUMMARY

At September 30, 2004, the Company had assets of $786 million and gross portfolio loans of $644.3 million, respectively, an increase of 7% and 10%, respectively, as compared to the balances for these accounts at September 30, 2003. The Company’s net income and diluted earnings per share at September 30, 2004, were $2.7 million and $0.43, respectively, a decrease of 1% and 2%, respectively, as compared to the same period in 2003. During the same time, the Company’s net interest income increased $210,000, or 2%, its provision for loan losses decreased $1.2 million, or 90%, its other operating income decreased $1 million, or 54%, and its operating expenses increased $395,000, or 6%. The growth in the Company’s net interest income was more than offset by the increase in other operating expense. However, the Company’s provision for loan losses declined by 90% due to improving credit quality and loan recoveries, which more than offset the decline in other operating income. This led to a slight decline of $22,000 in net earnings and a decline of 2% in diluted earnings per share.

RESULTS OF OPERATIONS

NET INCOME

Net income for the third quarter ended September 30, 2004, was $2.7 million, or $0.43 per diluted share, a decrease in net income of 1%, and a 2% decrease in diluted earnings per share as compared to $2.7 million and $0.44, respectively, in the same period of 2003.

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Net income for the nine months ended September 30, 2004, was $7.8 million, a decrease of $67,000, or 1% from the nine months ended September 30, 2003. Diluted earnings per share were $1.25, compared to $1.27 in the same period in 2003. The relatively flat earnings for the nine-month period ended September 30, 2004, reflects moderate growth in assets, loans, and deposits as well as a large decline in earnings from RML as compared to the nine months ended September 30, 2003. The decline in earnings per share was affected by all of these factors.

NET INTEREST INCOME

Net interest income for the third quarter of 2004 increased $210,000, or 2%, to $10.2 million from $10 million in 2003. The following table compares average balances and rates for the third quarter and nine-month periods ending September 30, 2004 and 2003:

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Interest-earning assets averaged $714.1 million for the third quarter of 2004, an increase of $40.6 million, or 6%, over the $673.5 million average for the comparable period in 2003. The tax equivalent yield on interest-earning assets averaged 6.77% in 2004, a decrease of 10 basis points from 6.87% for the same period in 2003.

Loans, the largest category of interest-earning assets, increased by $30.9 million, or 5%, to an average of $626.9 million in the third quarter of 2004 from $596 million in the same period of 2003. Commercial loans, real estate term loans and construction loans increased by $25 million, $18.7 million, and $14.5 million, respectively, on average between the third quarters. Consumer loans and real estate loans held for resale declined by $3.7 million and $23.2 million, respectively, on average during the same period. The tax equivalent yield on the loan portfolio averaged 7.28% for the third quarter of 2004, a decrease of 2 basis points from 7.30% a year ago. Loan rates have remained steady despite the recent increase in short-term interest rates mainly due to competitive pressures.

Interest-bearing liabilities averaged $492.5 million for the third quarter of 2004, an increase of $7.9 million, or 2%, compared to $484.6 million for the same period in 2003. The average cost of interest-bearing liabilities increased 23 basis points to 1.55% for the third quarter of 2004 compared to 1.32% for the third quarter of 2003. The average cost of funds has increased in response to recent interest rate increases by the Federal Reserve. As a result, the interest rates on interest bearing deposit products have begun to increase. If these recent interest rate increases continue, this could continue to increase the cost of the Company’s deposit accounts, which could also continue to have a negative impact on its net interest margin.

The Company’s net interest income as a percentage of average interest-earning assets (net tax-equivalent margin) was 5.70% for the third quarter of 2004 and 5.92% for the same period in 2003. The decline in the Company’s net interest margin was due to declines in loan rates and investment yields and an increase in deposit costs. The deposit costs have been more sensitive to changes in short-term interest rates while the loan yields have remained constant in the face of competitive pressures.

OTHER OPERATING INCOME

Set forth below is a schedule of the components of and change in Other Operating Income between the third quarters and nine-month periods ending September 30, 2004 and 2003:

Total other operating income for the third quarter of 2004 was $885,000, a decrease of $1 million from the third quarter of 2003.

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. Prior to the reorganization, the Company, through Northrim Bank’s wholly-owned subsidiary, NCIC, owned a 30% interest in the profits

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and losses of RML. Following the reorganization, the Company’s interest in RML Holding Company decreased to 23.5%.

The Company’s share of the earnings from RML Holding Company and its predecessor, RML, decreased by $1 million to $15,000 during the third quarter of 2004 as compared to $1 million in the third quarter of 2003, primarily due to decreased refinance activity combined with strong competition for mortgage volume and key personnel. The large decrease in interest rates and a strong residential housing market fueled increases in mortgage originations from refinances and home purchase loans in the third quarter of 2003. As mortgage rates began to increase in the third quarter of 2003 from the historically low levels experienced earlier in the year, the refinance activity began to decline, which resulted in lower earnings for RML. This trend continued in 2004 with mortgage interest rates rising above those experienced in 2003. As a result, refinance activity declined dramatically in 2004, which caused a large part of the decrease in earnings from RML Holding Company.

The Company’s share of the loss from Elliott Cove was $110,000 for the third quarter of 2004. These losses reflect the start-up costs for Elliott Cove, which began active operations in the fourth quarter of 2002. The Company expects the losses to continue for several years while Elliott Cove builds its assets under management. In July of 2003, the Company made a commitment to loan $625,000 to Elliott Cove. The amount loaned on this commitment at December 31, 2003 was $475,000. In the second quarter of 2004, the Company converted the loan into an additional equity interest in Elliott Cove. At the time of the conversion, the amount outstanding on this loan was $625,000. During the first, second, and third quarters of 2004, other investors made additional investments in Elliott Cove. In addition, the Company made a separate commitment to loan Elliott Cove $500,000. The balance outstanding on this commitment at September 30, 2004 was $400,000. Finally, in the third quarter of 2004, the Company made an additional investment of $250,000 in Elliott Cove. As a result of the additional investments in Elliott Cove by other investors and the Company’s conversion of its $625,000 loan and its additional investment, its interest in Elliott Cove increased from 43% to 47% between December 31, 2003 and September 30, 2004.

EXPENSES

Provision for Loan Losses

The provision for loan losses for the third quarter of 2004 was $143,000, as compared to a provision for loan losses of $1.4 million for the third quarter of 2003. Between December 31, 2003, and September 30, 2004, the Company decreased its nonperforming loans from $10.3 million to $8.4 million. As a result of this reduction in its nonperforming loans and realized loan recoveries, the Company decreased its provision for loan losses and increased the ratio of its allowance for loan losses to nonperforming loans from 96% at September 30, 2003, to 128% at September 30, 2004. The allowance for loan losses was $10.7 million, or 1.66% of total portfolio loans outstanding, which excludes real estate loans for sale, at September 30, 2004, compared to $9.9 million, or 1.70%, of total portfolio loans, at September 30, 2003.

Charge-offs

There was $256,000 in net loan recoveries during the third quarter of 2004, compared to $842,000 of net charge-offs for the same period in 2003. For the first nine months of 2004, net loan charge-offs were $495,000, or 0.11% of average loans annualized, compared to net loan charge-offs of $1.3 million, or .31% of average loans annualized for the same period in 2003.

Other Operating Expense

The following table breaks out the components of and changes in Other Operating Expense between the third quarters and nine-month periods ending September 30, 2004 and 2003:

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Total other operating expense for the third quarter of 2004 was $6.5 million, an increase of $395,000 from the same period in 2003.

There were a number of major reasons for the changes within this category of expenses. First, salaries and benefits increased by $68,000, or 2%, due to salary increases driven by competitive pressures and partially offset by declines in medical costs and incentive accruals. Second, professional and outside services increased by $64,000, or 46%, as the company incurred higher legal fees as compared to the third quarter of 2003 when it received an insurance settlement for costs associated with a lawsuit. Third, software amortization and maintenance expense increased by $55,000, or 22%, due to higher costs associated with larger investments in software and the write-off of a discontinued software system. Finally, other expense increased by $176,000 or 23% due to a variety of expense items during this period.

Income Taxes

The provision for income taxes increased by $27,000, or 2%, to $1.7 million in the third quarter of 2004 compared to $1.7 million in the same period in 2003. The effective tax rates for the third quarter of 2004 and 2003 were 39% and 38%, respectively. The provision for income taxes decreased by $394,000, or 8%, to $4.5 million in the first nine months of 2004 compared to $4.9 million in the same period in 2003. The effective tax rates for the first nine months of 2004 and 2003 were 37% and 38%, respectively.

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 $30.9 million, or 5%, greater in the third quarter of 2004 than in the same period of 2003. Loans comprised 88% of total average earning assets for the third quarter ending September 30, 2004, compared to 89% of total average earning assets for the third quarter ending September 30, 2003. The yield on loans averaged 7.28% for the quarter ended September 30, 2004, compared to 7.30% during the same period in 2003.

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The loan portfolio, excluding real estate loans for sale, grew $61.0 million, or 10% from September 30, 2003, as compared to September 30, 2004. Commercial real estate loans increased $27.7 million, or 12%, commercial loans increased $19.1 million, or 9%, construction loans increased $17.2 million, or 17%, and consumer loans decreased $3.1 million, or 7%, during the third quarter of 2004 as compared to the same period in 2003. Funding for the growth in loans during the third quarter of 2004 came from a decrease in short-term investments and an increase in non interest-bearing and interest-bearing sources of funds and capital.

We began a program in 1998 of purchasing single-family mortgage loans originated from our affiliated mortgage holding company, RML Holding Company. These loans, which are committed for sale to mortgage investors, have generally been held by the Company for less than 45 days. At September 30, 2004, these loans totaled $465,000 compared to $2.6 million on September 30, 2003.

Loan Portfolio Composition: Loans, excluding real estate loans for sale, increased to $644.3 million at September 30, 2004, from $599.7 million at December 31, 2003. At September 30, 2004, 44% of the portfolio was scheduled to mature over the next 12 months, and 22% was scheduled to mature between October 1, 2005, and September 30, 2009. Future growth in loans is generally dependent on new loan demand and deposit growth, and is constrained by the Company’s policy of being “well-capitalized.”

The following table sets forth the Company’s loan portfolio composition by loan type for the dates indicated:

Nonperforming Loans; Real Estate Owned: Nonperforming assets consist of nonaccrual loans, accruing loans that are 90 days or more past due, restructured loans, and real estate owned. The following table sets forth information with respect to nonperforming assets:

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Nonaccrual, Accruing Loans 90 Days or More Past Due and Restructured Loans: The Company’s financial statements are prepared based on the accrual basis of accounting, including recognition of interest income on the Company’s loan portfolio, unless a loan is placed on a nonaccrual basis. For financial reporting purposes, amounts received on nonaccrual loans generally will be applied first to principal and then to interest only after all principal has been collected.

Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower, have been granted due to the borrower’s weakened financial condition. Interest on restructured loans will be accrued at the restructured rates when it is anticipated that no loss of original principal will occur and the interest can be collected.

Total nonperforming loans at September 30, 2004, were $8.4 million, or 1.3% of total portfolio loans, a decrease of $1.9 million from $10.3 million at December 31, 2003, and an decrease of $2.1 million from $10.4 million at September 30, 2003. The decrease in the non-performing loans in the third quarter of 2004 as compared to December 31, 2003, was due in part to concentrated collection activities by the Company. In addition, the Company continues to write-down assets to their estimated fair market value when they are in a non-performing status.

At September 30, 2004, December 31, 2003, and September 30, 2003, the Company had loans measured for impairment of $7.9 million, $13.2 million, and $15.6 million, respectively. A specific allowance of $576,000, $580,000, and $1.1 million, respectively, was established for these periods. The decrease in loans measured for impairment at September 30, 2004, as compared to September 30, 2003, and December 31, 2003, resulted in large part from the concentrated collection activities of the Company.

Potential Problem Loans: At September 30, 2004, December 31, 2003, and September 30, 2003, the Company had potential problem loans of $936,000, $0 and $2.8 million, respectively. Potential problem loans are loans which are currently performing and are not included in nonaccrual, accruing loans 90 days or more past due, or restructured loans at the end of the applicable period, about which the Company has developed serious doubts as to the borrower’s ability to comply with present repayment terms and which may later be included in nonaccrual, past due, or restructured loans.

Analysis of Allowance for Loan Losses: The Allowance for Loan Losses was $10.7 million, or 1.66% of total portfolio loans outstanding, at September 30, 2004, compared to $9.9 million, or 1.70%, of total portfolio loans at September 30, 2003. The Allowance for Loan Losses represented 128% of non-performing loans at September 30, 2004, as compared to 96% of non-performing loans at September 30, 2003. Management believes that at September 30, 2004, the Allowance for Loan Losses was adequate to cover losses that are reasonably likely in light of our current loan portfolio and existing and expected economic conditions.

The following table details activity in the Allowance for Loan Losses for the dates indicated:

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