NORTHRIM BANCORP INC - Annual Report: 2005 (Form 10-K)

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, 2005

Commission File Number 0-33501

Northrim BanCorp, Inc.

(Exact name of registrant as specified in its charter)

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 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):

         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, 2005, was $135,083,352.

         The number of shares of registrant’s common stock outstanding at March 1, 2006, was 5,810,961.

         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 4, 2006, referenced in Part III of this Form 10-K are incorporated by reference therein.

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.

Northrim BanCorp, Inc.

About the Company

Overview

         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. Finally, in March and December of 2005, NCIC purchased ownership interests totaling 50.1% in Northrim Benefits Group, LLC (“NBG”), an insurance brokerage company that provides employee benefit plans to businesses 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 (“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.

         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 $779.9 million in total deposits and $895 million in total assets at December 31, 2005. Through our 10 branches, we are accessible by approximately 65% of the Alaska population.

Elliott Cove Capital Management LLC

         The Company owns a 49% 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 July of 2003, the Company made a commitment to loan $625,000 to Elliott Cove. 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, and third and fourth quarters of 2005, other investors made additional investments in Elliott Cove. In addition, the Company made a separate commitment to loan Elliott Cove $500,000 during the first quarter of 2004. In the first quarter of 2005, the Company increased this loan commitment to $750,000. The balance outstanding on this commitment at December 31, 2005 was $675,000. Finally, in the third quarters of 2004 and 2005, the Company made additional investments of $250,000 and $150,000, respectively, 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 investments, its interest in Elliott Cove increased from 43% to 49% between December 31, 2003 and December 31, 2005.

         During the first quarter of 2003, 10 Northrim Bank employees completed training and earned their Series 65 securities licenses and became Investment Advisor Representatives (“IARs”). In the second quarter of 2003, we began to offer Elliott Cove investment products to our customers through the sales efforts of the IARs. As of December 31, 2005, 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 late in 2006.

Northrim Funding Services

         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 first year, the employees of NFS focused on forming a base for their operations. In 2006, we expect NFS to continue to penetrate its market and increase its market share in the purchased receivables business.

High Performance Checking

         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.

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:

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. We have two deposit products that are indexed to specific U.S. Treasury rates.

         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.

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

*Indicates individual serving as both director and executive officer.

Selected Financial Data

Management’s Discussion and Analysis of Financial Condition and

Results of Operation

Overview

         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 Elliott Cove, an investment advisory services company; 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 7% share of the Fairbanks market, and an 8% share of the Matanuska Valley market as of June 30, 2005.

         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. Approximately 85% 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, 2005, we had assets of $895 million and gross loans of $705.1 million, an increase of 12% and 4%, respectively, over the previous year. Our net income and diluted earnings per share for 2005 were $11.2 million and $1.81, respectively; an increase of 4% and 6%, respectively, over 2004. During the same time, our net interest income increased by $2.6 million, or 6%. Our provision for loan losses during that period declined by $431,000, or 27%, as our nonperforming loans declined by $519,000, or 8%. In contrast, our other operating income increased by $1 million, or 27%. The growth in our net interest income combined with the positive effects of the declines in our provision for loan losses and the increases in our other operating income was offset in part by an increase in other operating expenses of $2.9 million, or 11%, which resulted in an increase in our net income and earnings per share.

Results of Operations

Net Income

         We earned net income of $11.2 million in 2005, compared to net income of $10.7 million in 2004, and $10.5 million in 2003. During these periods, net income per diluted share was $1.81, $1.71, and $1.69, 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, 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 2005 was $43.9 million compared to $41.3 million in 2004, and $39.3 million in 2003, reflecting an increase in our interest-earning assets and the general level of interest rates. 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%. Average interest-earning assets increased $51 million, or 8%, in 2004 compared to an increase in average interest-bearing liabilities in 2004 of $23.7 million, or 5%.

         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, 2005, 2004, and 2003, average interest-earning assets were $778.6 million, $704.5 million, and $653.5 million, respectively. During these same periods, net interest margins were 5.64%, 5.86%, and 6.01%, 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 7.55% in 2005, 6.89% in 2004, and 7.03% in 2003, while the average cost of interest-bearing liabilities was 2.61% in 2005, 1.48% in 2004, and 1.42% in 2003.

         Our net interest margin decreased in 2005 from 2004 as the cost of interest-bearing liabilities grew faster than the yield on interest-earning assets. During 2005, the cost of interest-bearing liabilities increased by 113 basis points while the yield on interest-earning assets increased by 66 basis points. In order to counteract the effects of increasing interest rates on our net interest margin, we emphasize the pricing of new loans on a floating rate basis tied primarily to the prime rate of interest, which allows these loans to reprice more frequently and in turn helps to increase our net interest margin.

         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:

         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 $1 million, or 27%, in 2005, after decreasing $2.3 million, or 38%, in 2004, and increasing $890,000, or 17%, in 2003. The following table separates the more routine (operating) sources of other income from those that can fluctuate significantly from period to period:

         The sources of operating income in 2005 increased $1.2 million, or 32%. In 2004, this income decreased $2.1 million, or 37%, and in 2003, it increased $648,000, or 13%. Deposit service charges increased $82,000, or 5%, in 2005. Purchased

receivable income increased $792,000, or 394%, in 2005, due largely to increases in fees earned on our Business Manager^® product that is used to purchase accounts receivable from customers and our activity at NFS. In 2005, our share of earnings from RML was $493,000 as compared to $438,000 in 2004. Merchant credit card and electronic banking fees increased $30,000 and $24,000, respectively, or 7%, and 4%, respectively, as a result of volume increases in these products. Loan service fees decreased $5,000, or 1%, in 2005. Finally, we recorded a $424,000 loss from our share of the loss of Elliott Cove compared to a loss of $457,000 in 2004.

         Included in operating sources of other operating income in 2005, 2004, and 2003 are $493,000, $438,000, and $2.8 million, 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, RML Holding Company began to realize some efficiencies from its merger and increased its income from its combined operations.

         Our share of the loss from Elliott Cove decreased to $424,000 in 2005, as compared to a loss of $457,000 in 2004. 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. 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, and third and fourth quarters of 2005, other investors made additional investments in Elliott Cove. In addition, the Company made a separate commitment to loan Elliott Cove $500,000 during the first quarter of 2004. In the first quarter of 2005, the Company increased this loan commitment to $750,000. The balance outstanding on this commitment at December 31, 2005 was $675,000. Finally, in the third quarters of 2004 and 2005, the Company made additional investments of $250,000 and $150,000, respectively, 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 investments, its interest in Elliott Cove increased from 43% to 49% between December 31, 2003 and December 31, 2005.

         The other sources of other operating income decreased $142,000 in 2005, or 94%. In 2004, this income decreased $204,000, or 57%; and in 2003, it increased $242,000, or 214%. Net security gains of $9,000 were recorded in 2005, $151,000 of net gains were recorded in 2004, and $310,000 were recorded in 2003.

Expenses

Provision for Loan Losses: The provision for loan losses in 2005 was $1.2 million, compared to $1.6 million in 2004 and $3.6 million in 2003. We decreased the provision for loan losses in 2005 due to a decrease in our non-performing loans and an overall improvement in our credit quality indicators. In 2005, non-performing loans decreased to $6.1 million from a balance of $6.6 million at December 31, 2004. In addition, net loan charge-offs were $1.2 million, or 0.18% of average loans, in 2005 as compared to $1 million, or 0.16% of average loans, in 2004 and $1.9 million, or 0.33% of average loans, in 2003. The allowance for loan losses also decreased in 2005 as a result of the decreases in non-performing loans and was $10.7 million, or 1.52% of portfolio loans as compared to $10.8 million, or 1.59% of portfolio loans at December 31, 2004 and $10.2 million, or 1.70% of portfolio loans, at December 31, 2003. While the allowance for loan losses decreased, the coverage ratio of the allowance for loan losses versus non-performing loans increased to 176% in 2005 as compared to a coverage ratio of 163% in 2004 and 99% in 2003.

Other Operating Expense: Other operating expense increased $2.9 million, or 11%, in 2005, $1.8 million, or 7%, in 2004, and $1.7 million, or 7%, in 2003. The following table breaks out the other operating expense categories:

         Salaries and other personnel expense increased $1.9 million, or 12%, in 2005, $1.5 million, or 11%, in 2004, and $1.2 million, or 9%, in 2003, reflecting increases in employees for the provision of services in our new branch locations in Wasilla, Eagle River, and West Anchorage in 2003 and increases in salary and medical benefit costs for them in 2004 and 2005 due in part to ongoing competition for our employees, which placed upward pressure on our salary structure and the absolute level of increases in our medical costs. Between 2002 and 2005, our occupancy expenses increased by $377,000, or 18%, as we incurred higher costs in our new branch locations and occupied additional space at our Main Financial Center. 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 2005, 2004, and 2003. 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 and annually evaluate goodwill for impairment.

         Marketing costs increased by $456,000, or 38%, in 2005, decreased by $4,000, or less than 1%, in 2004, and increased $69,000, or 6%, in 2003. The main reason for the increase in marketing expenses in 2005 was the costs associated with marketing our HPC product. We intend to continue marketing this product in 2006.

         Software amortization decreased $14,000, or 3%, in 2005, and increased $107,000, or 24%, in 2004. These costs increased in 2004 in part as we purchased software for our document imaging system that we implemented throughout the organization in 2003 and 2004.

         Supply expense increased by $31,000, or 13%, in 2005, decreased $70,000, or 22%, in 2004, and decreased $178,000, or 36%, in 2003. The main reason for the decreased supply costs in these years was a change in vendors coupled with a program that brought the inventory system for a number of our forms in-house.

         Legal costs decreased $119,000, or 52%, in 2005, increased $37,000, or 19%, in 2004, and decreased $4,000, or 2%, in 2003.

         Cash handling costs decreased $62,000, or 36%, in 2005, decreased $59,000, or 26%, in 2004, and decreased $39,000, or 14%, in 2003. 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.

         Loan collection and ORE costs decreased $1,000, or 1%, in 2005, decreased $5,000, or 3%, in 2004, and increased $93,000, or 137%, in 2003. These costs represent the out-of-pocket expense we incurred to liquidate problem assets and manage repossessed property resulting from the collection process. Between 2003 and 2005, these costs were higher than those experienced in 2002 due to costs associated with the repossession and sale of a property in 2003 and the efforts that we expended to decrease our non-performing loans in 2004 and 2005.

         Consulting expenses increased $62,000, or 70%, in 2005, decreased $55,000, or 38%, in 2004, and increased $66,000, or 85%, in 2003. These costs increased in 2003 and 2005 due to consulting expenses associated with the review and enhancement of our information processing and employee benefit systems. In 2005, these costs increased due to increased expenses to comply

with the requirements of the Sarbanes-Oxley Act, as well as costs incurred to implement our High Performance Checking program.

         Other expenses increased $355,000, or 8%, in 2005 from 2004, and increased $330,000, or 8%, in 2004 from 2003. A major reason for the change in 2005 was a $95,000 increase in outside service costs that resulted from outsourced internal audit costs due to temporary staff shortages. In addition, operational charge-offs increased by $58,000. The balance of the increase in other expenses was caused by increases in a wide variety of accounts.

Income Taxes: The provision for income taxes increased $697,000, or 11%, to $6.9 million in 2005, decreased $289,000, or 4%, to $6.2 million in 2004, and increased $1.3 million, or 26%, to $6.5 million in 2003. The effective tax rate for 2005 was 38%, compared to 37% in 2004, and 38% in 2003. The effective tax rate in 2004 was lower than that for 2005 and 2003 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, consumer loans, and credit cards. We emphasize providing financial services to small- and medium-sized businesses and to individuals. From our inception, we have emphasized commercial, land development and home construction, and commercial real estate lending. These types of lending have provided us with needed market opportunities and higher net interest margins than other types of lending. However, they also involve greater risks, including greater exposure to changes in local economic conditions, than certain other types of lending.

         Loans are the highest yielding component of earning assets. Average loans were $69.4 million, or 11% greater in 2005 than in 2004. Average loans were $59.3 million, or 10% greater in 2004 than in 2003. Loans comprised 90% of total earning assets on average in 2005, 89% in 2004 and 87% in 2003. The yield on loans averaged 8.00% in 2005, 7.30% in 2004, and 7.54% in 2003.

         Growth in the loan portfolio during 2005 was $26.8 million, or 4%. Commercial loans increased $19.9 million, or 7%, commercial real estate loans increased $37,000, and construction loans increased $8.7 million, or 7%, in 2005. Installment and consumer loans decreased $1.6 million, or 4%. Funding for the growth in loans in 2005 came from an increase in interest-bearing liabilities and from noninterest-bearing sources of funds and capital.

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 $105,000 at December 31, 2005. 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 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 $353,000, $658,000, and $690,000, in 2005, 2004, and 2003, 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, 2005, were $6.1 million, or 0.86% of portfolio loans, a decrease of $519,000 from $6.6 million at December 31, 2004, and a decrease of $4.2 million from $10.3 million at December 31, 2003. The decrease in nonperforming loans in 2005 as compared to 2004 was due to pay-downs and loan charge-offs on a number of loan relationships.

Potential Problem Loans: At December 31, 2005, management had identified problem loans of $9.1 million that were not reported as such at December 31, 2004. 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, 2005, 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.

         The following table shows the allocation of the allowance for loan losses for the periods indicated:

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

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 $14.8 million at December 31, 2005. 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 $705.1 million at December 31, 2005, compared to $678.3 million and $601.1 million at December 31, 2004 and 2003, respectively. At December 31, 2005, 48% of the portfolio was scheduled to mature or reprice in 2006 with 21% scheduled to mature or reprice between 2007 and 2010. 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, 2005, the aggregate maturity and repricing data of our loan portfolio:

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 41% of our total loans outstanding as of December 31, 2005 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 are a major land development and residential construction lender. At December 31, 2005, we had $46.1 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 2005. We originated one-to-four-family residential construction loans to builders for construction of homes. At December 31, 2005, we had $67.2 million of one-to-four-family residential and condominium construction loans, or 10% of total loans. Of the homes under construction at December 31, 2005, for which these loans had been made, 59% 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.

         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. In 2005, we did not purchase any loans from RML. 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, 2005, our commercial real estate loans were $252.4 million, or 36% 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 44% of these loans originated by Northrim resets every three years based on the spread over an index rate, normally prime or 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, 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, 2005. See also “Liquidity and Capital Resources.”

Investments and Investment Activities

General: Our investment portfolio consists primarily of U.S. Treasury and government agency securities, and municipal securities. Investment securities totaled $55 million at December 31, 2005, a decrease of $6.5 million, or 11%, from year-end 2004. The average maturity of the investment portfolio was two years at December 31, 2005.

         Investment securities designated as available for sale comprised 95% 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, 2005, $20.9 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 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:

         For the periods ending December 31, 2005, 2004, and 2003, 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, $1.3 million, and $1.5 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, 2005:

         At December 31, 2005, we held no securities of any single issuer (other than governmental agencies) 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^® product and in Washington and Oregon through NFS.

         Our purchased receivable balances increased in 2005 to $12.2 million, as compared to $2.2 million in 2004. 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 12% to $779.9 million at December 31, 2005, compared with $699.1 million at December 31, 2004, and $646.2 million at December 31, 2003. Our deposits generally are expected to fluctuate according to the level of our market share, economic conditions, and normal seasonal trends.

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:

Certificates of Deposit: The only deposit category with stated maturity dates is certificates of deposit. At December 31, 2005, we had $110.6 million in certificates of deposit, of which $92.1 million, or 83%, are scheduled to mature in 2006. The following table sets forth the amounts and maturities of our certificates of deposit with balances of $100,000 or more, at the dates indicated:

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, 2005, was $198 million, an increase of $74.8 million as compared to the balance of $123.2 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, 2005, we held $15 million in certificates of deposit for the Alaska Permanent Fund, collateralized by letters of credit issued by the FHLB.

Borrowings

FHLB: At December 31, 2005, our maximum borrowing line from the FHLB was equal to $94.2 million, approximately 11% of the Company’s assets. 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, 2005, 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:

         Long-term debt obligations consist of (a) $2.6 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 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 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 investment in Related Corporate Partners XXII, L.P., (“RCP”), a Delaware limited partnership that develops low-income housing projects throughout the United States. The Company purchased a $3 million interest in RCP in January of 2003. The Company paid the final installment on this investment due in October of 2005.

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 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, 2005, were $172.1 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, 2005, were $779.9 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, 2005, our current assets were $457.3 million and our funds available for borrowing under our existing lines of credit were $143.5 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. We purchased 224,800 shares of our stock under this program through December 31, 2004, at a total cost of $3.1 million, at an average price of $13.68 per share. 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 308,642 shares in 2005, which left a balance of 77,213 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.

         The stock repurchase program had an effect on earnings per share because it decreased the total number of shares outstanding in 2002, 2003, and 2005, by 69,000, 155,800, and 308,642 shares respectively. The Company did not repurchase any of its shares in 2004. The table below shows this effect on diluted earnings per share.

         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 $523,000 in 2005. At December 31, 2005, the securities had an interest rate of 7.49%.

         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 $26,000 in 2005. At December 31, 2005, the securities had an interest rate of 5.86%.

         Our shareholders’ equity at December 31, 2005, was $84.5 million, a $1.1 million, or 1%, increase from 2004. 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, 2005, 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 December 15, 2005, 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 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.

(See Note 19 of the Consolidated Financial Statements for a detailed discussion of the capital ratios.)

Effects of Inflation and Changing Prices

         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.

Market for Common Stock

         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, 2005, the number of shareholders of record of our common stock was 197.

         We began paying regular cash dividends of $0.05 per share in the second quarter of 1996. In the second quarter of 2003 and the second quarter of 2005, we increased the cash dividend to $0.095 and $0.11 per share, respectively. Cash dividends totaled $2.6 million, $2.3 million, and $2 million in 2005, 2004, and 2003, respectively. On January 6, 2006, the Board of Directors approved payment of a $0.11 per share dividend on February 3, 2006, to shareholders of record on January 23, 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.

Repurchase of Securities

         The Company repurchased 40,000 shares of its common stock, in the aggregate, during the fourth quarter of 2005 as indicated below:

Equity Compensation Plan Information

Recent Accounting Pronouncements

         Between November of 2004 and December of 2005, the Financial Accounting Standards Board (“FASB”) issued Statement No. 151, Inventory Costs, Statement No. 152, Accounting for Real Estate Time-Sharing Transactions, Statement No. 153, Exchanges of Nonmonetary Assets, and Statement No. 154, Accounting Changes and Error Corrections. 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. The Company intends to apply the provisions of this Statement in accordance with the modified prospective application method and begin to expense the costs associated with its stock options in the first quarter of 2006. Furthermore, as outlined below at Note 9, the Company provides disclosures of the proforma amounts. The Company does not expect the effect of the adoption of Statement No. 123R to be significantly different from the proforma disclosures.

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 governmental agencies. 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 indictor of exposure to interest rate risk and the related volatility of net interest income in a changing interest rate environment. Interest rate gap analysis is primarily a measure of liquidity based upon the amount of change in principal amounts of assets and liabilities outstanding, as opposed to a measure of changes in the overall net interest margin.

         The 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, 2005. 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.

         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 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, 2005, we expect an increase in net interest income of $1.3 million and a decrease of $1.6 million in net interest income over a 12-month period, if interest rates decreased or increased an immediate 100 basis points, respectively. Due to the low level of interest rates, a drop of 100 basis points was unrealistic for some of the interest-bearing deposits since the Company is currently paying less than 100 basis points on some of those products. In these instances, interest rates were reduced less than 100 basis points.

Critical Accounting Estimates

         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

Conclusion Regarding the Effectiveness of Disclosure 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’s Report on 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, 2005. 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, 2005, 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.

Report of Independent Registered Public Accounting Firm

The Board of Directors of

Northrim BanCorp, Inc.:

We have audited management’s assessment, included in the accompanying Management 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, 2005, 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, 2005, 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, 2005, 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, 2005 and 2004, 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, 2005, and our report dated February 10, 2006 expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

Anchorage, Alaska

February 10, 2006

Report of Independent Registered Public Accounting Firm

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, 2005 and 2004, 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, 2005. 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, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, 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, 2005, 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 10, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

/s/ KPMG LLP

Anchorage, Alaska

February 10, 2006

Consolidated Financial Statements

NORTHRIM BANCORP, INC.

Consolidated Balance Sheets

December 31, 2005 and 2004

See accompanying notes to the consolidated financial statements.

NORTHRIM BANCORP, INC.

Consolidated Statements of Income

Years Ended December 31, 2005, 2004 and 2003

See accompanying notes to the consolidated financial statements.

NORTHRIM BANCORP, INC.

Consolidated Statements of Changes in

Shareholders’ Equity and Comprehensive Income

Years Ended December 31, 2005, 2004 and 2003