Edgar Filing: NORTHRIM BANCORP INC

(In Thousands)

June 30, 2018

December 31, 2017

Balance of mortgage loans serviced for others

MSR as a percentage of serviced loans

Document

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2018

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

For the transition period from_____to____

Commission File Number 000-33501

NORTHRIM BANCORP, INC.

(Exact name of registrant as specified in its charter)



Alaska		92-0175752
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

3111 C Street

Anchorage, Alaska 99503

(Address of principal executive offices) (Zip Code)

(907) 562-0062

(Registrant’s telephone number, including area code)

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.

ý Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

ý Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

Large Accelerated Filer ¨ Accelerated Filer ý Non-accelerated Filer ¨

Smaller Reporting Company ¨ Emerging Growth Company ¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

¨ Yes ý No

The number of shares of the issuer’s Common Stock, par value $1 per share, outstanding at August 7, 2018 was 6,872,959.



TABLE OF CONTENTS

Part I	FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)
	Consolidated Balance Sheets	3
	Consolidated Statements of Income	4
	Consolidated Statements of Comprehensive Income	5
	Consolidated Statements of Changes in Shareholders' Equity	6
	Consolidated Statements of Cash Flows	7
	Notes to the Consolidated Financial Statements	9
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	42
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	57
Item 4.	Controls and Procedures	58

Part II	OTHER INFORMATION
Item 1.	Legal Proceedings	58
Item 1A.	Risk Factors	58
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	58
Item 3.	Defaults Upon Senior Securities	58
Item 4.	Mine Safety Disclosures	58
Item 5.	Other Information	59
Item 6.	Exhibits	59
SIGNATURES		60

PART I. FINANCIAL INFORMATION

These consolidated financial statements should be read in conjunction with the financial statements, accompanying notes and other relevant information included in Northrim BanCorp, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2017.

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED FINANCIAL STATEMENTS

NORTHRIM BANCORP, INC.

Consolidated Balance Sheets

(Unaudited)



	June 30, 2018			December 31, 2017
(In Thousands, Except Share Data)	June 30, 2018			December 31, 2017
ASSETS
Cash and due from banks		$26,355			$25,016
Interest bearing deposits in other banks	9,775			52,825
Investment securities available for sale, at fair value	264,124			307,019
Marketable equity securities	6,006			5,731
Investment in Federal Home Loan Bank stock	2,104			2,115
Loans held for sale	54,306			43,979
Loans	967,702			954,953
Allowance for loan losses	(20,108		)	(21,461		)
Net loans	947,594			933,492
Purchased receivables, net	20,323			22,231
Mortgage servicing rights, at fair value	8,733			7,305
Other real estate owned, net	8,959			8,651
Premises and equipment, net	38,113			37,867
Goodwill	15,017			15,017
Other intangible assets, net	1,172			1,207
Other assets	67,859			56,141
Total assets		$1,470,440			$1,518,596
LIABILITIES
Deposits:
Demand		$401,925			$414,686
Interest-bearing demand	246,628			252,009
Savings	237,978			247,458
Money market	223,189			243,603
Certificates of deposit less than $250,000	67,099			69,283
Certificates of deposit $250,000 and greater	28,702			31,244
Total deposits	1,205,521			1,258,283
Securities sold under repurchase agreements	27,695			27,746
Borrowings	7,312			7,362
Junior subordinated debentures	10,310			10,310
Other liabilities	20,146			22,093
Total liabilities	1,270,984			1,325,794
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value, 2,500,000 shares authorized, none issued or outstanding	—			—
Common stock, $1 par value, 10,000,000 shares authorized, 6,872,959 and 6,871,963 issued and outstanding at June 30, 2018 and December 31, 2017, respectively	6,873			6,872
Additional paid-in capital	62,187			61,793
Retained earnings	131,097			124,407
Accumulated other comprehensive loss, net of tax	(701		)	(270		)
Total shareholders' equity	199,456			192,802
Total liabilities and shareholders' equity		$1,470,440			$1,518,596

See notes to consolidated financial statements

NORTHRIM BANCORP, INC.

Consolidated Statements of Income

(Unaudited)



	Three Months Ended					Six Months Ended
	June 30,					June 30,
(In Thousands, Except Per Share Data)	2018			2017		2018			2017
Interest Income
Interest and fees on loans and loans held for sale		$14,036			$13,601		$27,299			$26,839
Interest on investment securities available for sale	1,302			1,124		2,556			2,202
Dividends on marketable equity securities	84			86		166			172
Interest on investment securities held to maturity	—			11		—			21
Dividends on Federal Home Loan Bank stock	14			6		26			11
Interest on deposits in other banks	159			64		343			112
Total Interest Income	15,595			14,892		30,390			29,357
Interest Expense
Interest expense on deposits	446			451		818			896
Interest expense on securities sold under agreements to repurchase	8			8		17			16
Interest expense on borrowings	57			39		115			77
Interest expense on junior subordinated debentures	95			150		188			291
Total Interest Expense	606			648		1,138			1,280
Net Interest Income	14,989			14,244		29,252			28,077
(Benefit) provision for loan losses	(300		)	300		(300		)	700
Net Interest Income After Provision for Loan Losses	15,289			13,944		29,552			27,377
Other Operating Income
Mortgage banking income	5,478			6,351		10,422			11,801
Purchased receivable income	867			776		1,707			1,465
Bankcard fees	707			658		1,332			1,239
Service charges on deposit accounts	376			409		730			848
Gain on sale of securities, net	—			—		—			14
Employee benefit plan income	—			961		—			1,897
Other income	886			607		1,585			1,403
Total Other Operating Income	8,314			9,762		15,776			18,667
Other Operating Expense
Salaries and other personnel expense	11,362			11,793		21,947			22,635
Data processing expense	1,323			1,453		2,871			2,700
Occupancy expense	1,020			1,664		2,720			3,285
Professional and outside services	554			612		1,053			1,234
Marketing expense	462			891		1,094			1,401
Insurance expense	178			194		474			447
Intangible asset amortization expense	17			27		35			53
OREO expense, net rental income and gains on sale	11			83		114			260
Compensation expense - RML acquisition payments	—			—		—			174
Other operating expense	1,679			1,793		3,093			2,936
Total Other Operating Expense	16,606			18,510		33,401			35,125
Income Before Provision for Income Taxes	6,997			5,196		11,927			10,919
Provision for income taxes	1,167			1,455		2,035			3,256
Net Income	5,830			3,741		9,892			7,663
Less: Net income attributable to the noncontrolling interest	—			152		—			249
Net Income Attributable to Northrim BanCorp, Inc.		$5,830			$3,589		$9,892			$7,414
Earnings Per Share, Basic		$0.85			$0.52		$1.44			$1.07
Earnings Per Share, Diluted		$0.84			$0.51		$1.42			$1.06
Weighted Average Shares Outstanding, Basic	6,872,371			6,910,679		6,872,167			6,910,230
Weighted Average Shares Outstanding, Diluted	6,976,985			6,997,727		6,972,744			6,996,160

See notes to consolidated financial statements

NORTHRIM BANCORP, INC.

Consolidated Statements of Comprehensive Income

(Unaudited)

2010



	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2018			2017			2018			2017
Net income		$5,830			$3,741			$9,892			$7,663
Other comprehensive income (loss), net of tax:
Securities available for sale:
Unrealized (losses) gains arising during the period		($119	)		$90			($1,107	)		$687
Reclassification of net (gains) losses included in net income (net of tax
(benefit) expense) of $0 and $0 for the second quarter of 2018 and 2017,
respectively, and $0 and $6 for the six months ended June 30, 2018 and
2017, respectively)	—			—			—			(8		)
Derivatives and hedging activities:
Unrealized gains arising during the period	154			—			621			—
Income tax benefit (expense) related to unrealized gains and losses	143			(31		)	246			(254		)
Other comprehensive income (loss), net of tax	178			59			(240		)	425
Comprehensive income	6,008			3,800			9,652			8,088
Less: comprehensive income attributable to the noncontrolling interest	—			152			—			249
Comprehensive income attributable to Northrim BanCorp, Inc.		$6,008			$3,648			$9,652			$7,839

See notes to consolidated financial statements

NORTHRIM BANCORP, INC.

Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)



	Common Stock					Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Non-controlling Interest			Total
	Number of Shares		Par Value
(In Thousands)	Number of Shares		Par Value
Balance as of January 1, 2017	6,898			$6,898			$62,952			$117,141			($397	)		$118			$186,712
Cash dividend declared	—		—			—			(5,970		)	—			—			(5,970		)
Stock-based compensation expense	—		—			665			—			—			—			665
Exercise of stock options and vesting of restricted stock units, net	32		32			(275		)	—			—			—			(243		)
Treasury stock buy-back	(58	)	(58		)	(1,549		)	—			—			—			(1,607		)
Distributions to noncontrolling interest	—		—			—			—			—			(445		)	(445		)
Other comprehensive income, net of tax	—		—			—			—			212			—			212
Reclassification for remeasuring of deferred tax assets related to investment securities	—		—			—			85			(85		)	—			—
Net income attributable to the noncontrolling interest	—		—			—			—			—			327			327
Net income attributable to Northrim BanCorp, Inc.	—		—			—			13,151			—			—			13,151
Balance as of December 31, 2017	6,872			$6,872			$61,793			$124,407			($270	)		$—			$192,802

Cash dividend declared	—		—			—			(3,331		)	—			—			(3,331		)
Stock-based compensation expense	—		—			412			—			—			—			412
Exercise of stock options and vesting of restricted stock units, net	1		1			(18		)	—			—			—			(17		)
Other comprehensive loss, net of tax	—		—			—			—			(240		)	—			(240		)
Cumulative effect of adoption of accounting principles related to premium amortization of investment securities	—		—			—			(62		)	—			—			(62		)
Reclassification for cumulative effect of adoption of accounting principles related to fair value measurement of equity securities	—		—			—			191			(191		)	—			—
Net income attributable to Northrim BanCorp, Inc.	—		—			—			9,892			—			—			9,892
Balance as of June 30, 2018	6,873			$6,873			$62,187			$131,097			($701	)		$—			$199,456

See notes to consolidated financial statements

NORTHRIM BANCORP, INC.

Consolidated Statements of Cash Flows

(Unaudited)



	Six Months Ended June 30,
(In Thousands)	2018			2017
Operating Activities:
Net income		$9,892			$7,663
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Gain on sale of securities, net	—			(14		)
Loss on disposal of premises and equipment	3			3
Depreciation and amortization of premises and equipment	768			1,317
Amortization of software	431			110
Intangible asset amortization	35			53
Amortization of investment security premium, net of discount accretion	106			101
Change in fair value of marketable equity securities	173			—
(Increase) decrease deferred tax asset, net	(156		)	576
Stock-based compensation	412			279
Deferral of loan fees and (costs), net	51			(20		)
(Benefit) provision for loan losses	(300		)	700
Reserve for purchased receivables	1			23
Additions to mortgage servicing rights carried at fair value	(1,572		)	(1,437		)
Change in fair value of mortgage servicing rights carried at fair value	144			(234		)
Gain on sale of loans	(7,398		)	(8,711		)
Proceeds from the sale of loans held for sale	254,323			257,446
Origination of loans held for sale	(257,252		)	(259,002		)
Gain on sale of other real estate owned	(49		)	(155		)
Impairment on other real estate owned	—			266
Net changes in assets and liabilities:
Increase in accrued interest receivable	(104		)	(29		)
Increase in other assets	(11,023		)	(819		)
Decrease in other liabilities	(1,996		)	(1,988		)
Net Cash Used by Operating Activities	(13,511		)	(3,872		)
Investing Activities:
Investment in securities:
Purchases of investment securities available for sale	(25,731		)	(16,283		)
Purchases of marketable equity securities	(998		)	—
Purchases of FHLB stock	—			(2,993		)
Proceeds from sales/calls/maturities of securities available for sale	67,401			50,867
Proceeds from calls/sales of marketable equity securities	500			—
Proceeds from redemption of FHLB stock	11			2,965
Decrease in purchased receivables, net	1,908			633
Increase in loans, net	(14,388		)	(16,677		)
Proceeds from sale of other real estate owned	276			2,315
Proceeds from sale of premises and equipment	3			116
Purchases of premises and equipment	(1,020		)	(2,115		)
Net Cash Provided (Used) by Investing Activities	27,962			18,828
Financing Activities:
Decrease in deposits	(52,762		)	(33,343		)
Decrease in securities sold under repurchase agreements	(51		)	(3,215		)
Decrease in borrowings	(50		)	(24		)
Distributions to noncontrolling interest	—			(234		)
Cash dividends paid	(3,299		)	(2,898		)
Net Cash Used by Financing Activities	(56,162		)	(39,714		)
Net Change in Cash and Cash Equivalents	(41,711		)	(24,758		)



Cash and Cash Equivalents at Beginning of Period	77,841		50,551
Cash and Cash Equivalents at End of Period		$36,130		$25,793

Supplemental Information:
Income taxes paid		$324		$3,839
Interest paid		$1,070		$1,211
Transfer of loans to other real estate owned		$535		$—
Transfer of premises to other real estate owned		$—		$167
Cash dividends declared but not paid		$32		$26

See notes to consolidated financial statements

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation and Significant Accounting Policies

The accompanying unaudited consolidated financial statements and corresponding footnotes 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, as amended. The year-end Consolidated Balance Sheet data was derived from the Company's audited financial statements. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The Company owns a 100% interest in Residential Mortgage Holding Company, LLC the parent company of Residential Mortgage, LLC (collectively "RML") and consolidates their balance sheets and income statement into its financial statements. The Company owned a 50.1% interest in Northrim Benefits Group, LLC ("NBG") through August 14, 2017, and consolidates NBG's balance sheets and income statements into its financial statements through the date of the sale on August 14, 2017. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain immaterial reclassifications have been made to prior year amounts to maintain consistency with the current year with no impact on net income or total shareholders’ equity. The Company determined that it operates in two primary operating segments: Community Banking and Home Mortgage Lending. The Company has evaluated subsequent events and transactions for potential recognition or disclosure. Operating results for the interim period ended June 30, 2018, are not necessarily indicative of the results anticipated for the year ending December 31, 2018. These consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. The Company’s significant accounting policies are discussed in Note 1 to the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2017.

Reclassification of Prior Year Presentation

Certain prior year amounts have been reclassified for consistency with the current period presentation. These reclassifications had no effect on the reported results of operations.

Recent Accounting Pronouncements

Accounting pronouncements implemented in 2018

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In general, this new guidance requires companies to use more judgment and make more estimates than under current guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied to all of the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. The Company has reviewed all revenue sources to determine the sources that are in scope for this guidance. As a bank, key revenue sources, including interest income and mortgage banking income have been identified as out of scope of this new guidance. The Company's overall assessment of material in-scope revenue sources include service charges on deposits, bankcard fees, and other miscellaneous revenue sources. The Company adopted the guidance on January 1, 2018, utilizing the modified retrospective approach, which did not have a material impact on how the Company recognizes revenue or on our consolidated financial statements and disclosures. See Note 2 of the Notes to Consolidated Financial Statements included in Item 1 of this report for disclosures related to revenue generated from contracts with customers.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). The new guidance is intended to improve the recognition and measurement of financial instruments. ASU 2016-01 requires that equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. In addition, the amendment requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial

statements. ASU 2016-01 also eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The amendment also requires a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument specific credit risk (also referred to as "own credit") when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. The Company adopted the guidance on January 1, 2018 and reclassified $191,000 in unrealized gains on its investments in preferred stock from other comprehensive income to retained earnings. Adoption of the guidance does not have a material or significant impact on the Company's consolidated financial statements. As of January 1, 2018, unrealized gains and losses on marketable securities are included in other operating income in the Consolidated Statement of Income.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 provides guidance on eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. The Company adopted the guidance on January 1, 2018 and made an accounting policy election to classify distributions from equity method investees using the cumulative earnings approach. Accordingly, these distributions are recorded as cash inflows in the operating activity section of the Statement of Cash Flows. Adoption of the guidance does not have a material or significant impact on the Company's consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (“ASU 2017-09”). ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The Company adopted the guidance on January 1, 2018 and it did not have a material impact on the Company’s consolidated financial position or results of operations.

In March 2017, the FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (“ASU 2017-08”). ASU 2017-08 amends the amortization period for certain purchased callable debt securities held at a premium by shortening the amortization period for the premium to the earliest call date. Under the current guidance, entities generally amortize the premium as an adjustment of yield over the contractual life of the instrument. ASU 2017-08 is effective for the Company’s financial statements for annual and interim periods beginning on or after December 15, 2018, and should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings. The Company early adopted this standard in the first quarter of 2018, which resulted in a $62,000 decrease in beginning retained earnings through a cumulative-effect adjustment.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (“ASU 2017-12”). ASU 2017-12 improves the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. In addition to that main objective, the amendments in this ASU make certain targeted improvements to simplify the application of the hedge accounting guidance in current GAAP based on the feedback received from preparers, auditors, users, and other stakeholders. ASU 2017-12 is effective for the Company’s financial statements for annual and interim periods beginning on or after December 15, 2018, and all transition requirements and elections must be applied to hedging relationships existing (that is, hedging relationships in which the hedging instrument has not expired, been sold, terminated, or exercised or the entity has not removed the designation of the hedging relationship) on the date of adoption. The Company early adopted this standard in the first quarter of 2018, and it did not have a significant impact on the Company’s consolidated financial position or results of operations.

Accounting pronouncements to be implemented in future periods

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 requires lessees, among other things, to recognize lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous authoritative guidance. This update also introduces new disclosure requirements for leasing arrangements. ASU 2016-02 is effective for the Company’s financial statements for annual and interim periods beginning on or after December 15, 2018, and must be applied prospectively. Although an estimate of the impact of the new leasing standard has not yet been determined, the Company expects a significant new lease asset and related lease liability on the balance sheet due to the number of leased properties the Company currently has that are accounted for under current operating lease guidance.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (“ASU 2016-13”). ASU 2016-13 is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments

held by financial institutions and other organizations. The standard requires the measurement of all expected credit losses for certain financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates, but will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. ASU 2016-13 requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization's portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for specified periods. ASU 2016-13 is effective for the Company’s financial statements for annual and interim periods beginning on or after December 15, 2019, and must be applied prospectively. The Company has formed a cross-functional team to begin implementation efforts of this new guidance. The team is evaluating the data elements and modeling options that are expected to be critical to the new process and has engaged external consulting services related to this effort. An estimate of the impact of this standard on the Company's consolidated financial position and results of operations has not yet been determined; however, the impact is expected to be significant and the impact on the Company's process for calculating the allowance for loan losses ("Allowance") is also expected to be significant.

In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (“ASU 2017-04”). ASU 2017-04 simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. ASU 2017-04 is effective for the Company’s financial statements for annual and interim periods beginning on or after December 15, 2019, and must be applied on a prospective basis. The Company does not believe that the adoption of this standard will have a material impact on the Company’s consolidated financial position or results of operations.

2. Revenue

The Company's revenue is included in net interest income and other operating income on its Consolidated Statements of Income. ASU 2014-09, which amends Topic 606 in the Accounting Standards Codification ("ASC"), establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity's contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.

The majority of our ongoing revenue-generating transactions are not subject to ASC 606, including revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, purchased receivable income, financial guarantees, and derivatives are also not in scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as deposit related fees, interchange fees, merchant services income, and commissions from the sales of mutual funds and other investments. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below.

Bankcard fees

Bankcard fees are primarily comprised of debit card income and ATM fees. Debit card income is primarily comprised of interchange fees earned whenever the Company’s debit cards are processed through card payment networks such as Visa or MasterCard. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. The Company’s performance obligation for bankcard fees are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payments are typically received immediately or in the following month.

Service charges on deposit accounts

Service charges on deposit accounts consist of general service fees for monthly account maintenance, activity- or transaction-based fees, and account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), and other deposit account related fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when our performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed. Payments for service charges on deposit accounts are primarily received immediately or in the following month through a direct charge to customers’ accounts.

Other

Other operating income consists of other recurring revenue streams such as merchant services income, commissions from sales of mutual funds and other investments, safety deposit box rental fees, bank check and other check fees, unrealized gains and losses on marketable securities, and other miscellaneous revenue streams. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. The Company’s performance obligation for merchant services income is largely satisfied, and related revenue recognized, when the transactions have been completed. Payment is typically received immediately or in the following month. The Company earns commissions from the sale of mutual funds as periodic service fees (i.e., trailers) from Elliott Cove Capital Management typically based on a percentage of net asset value. Trailer revenue is recorded over time, quarterly, as net asset value is determined. The Company also earns commission income from the sale of annuity products. The Company acts as an intermediary between the Company's customer and Elliott Cove Investment Advisors for these transactions, and Commissions from annuity product sales are recorded when the Company’s performance obligation is satisfied, which is generally upon the issuance of the annuity policy. The Company does not earn trailer fees on annuity sales. Payment for commissions from sales of mutual funds and other investments and annuity sales is typically received in the following quarter. Other service charges include revenue from safety deposit box rental fees, processing wire transfers, bank check and other check fees, and other services. The Company’s performance obligations for these other revenue streams are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payments are typically received immediately or in the following month.

The following presents other operating income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three and six month periods ended June 30, 2018 and 2017:



(In Thousands)			Three months ended				Six months ended
Other operating income			2018		2017		2018		2017
	In-scope of Topic 606:
		Bankcard fees		$707		$658		$1,332		$1,239
		Service charges on deposit accounts	376		409		730		848
		Other	436		348		799		723
	Other operating income (in-scope of Topic 606)			$1,519		$1,415		$2,861		$2,810
	Other operating income (out-of-scope of Topic 606)		6,795		8,347		12,915		15,857
Total other operating income				$8,314		$9,762		$15,776		$18,667

Contract Balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s other operating revenue streams are largely based on transactional activity, or standard month-end revenue accruals. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of June 30, 2018 and December 31, 2017, the Company did not have any significant contract balances.

Contract Acquisition Costs

In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, the Company did not capitalize any contract acquisition cost.

3. Cash and Cash Equivalents

The Company is required to maintain a $761,000 minimum average daily balance with the Federal Reserve Bank of San Francisco ("Federal Reserve Bank") for purposes of settling financial transactions and charges for Federal Reserve Bank services. The Company is also required to maintain cash balances or deposits with the Federal Reserve Bank sufficient to meet its statutory reserve requirements.

The Company is required to maintain a $500,000 balance with a correspondent bank for outsourced servicing of ATMs.

The Company is required to maintain a $100,000 and $300,000 balance with a correspondent bank to collateralize the initial margin and the fair value exposure of its interest rate swap, respectively.

4. Investment Securities

The carrying values and estimated fair values of investment securities at the periods indicated are presented below:



(In Thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
June 30, 2018
Securities available for sale
U.S. Treasury and government sponsored entities		$210,973		$13		$2,294		$208,692
Municipal securities	11,938		22		25		11,935
Corporate bonds	37,143		358		11		37,490
Collateralized loan obligations	6,001		7		1		6,007
Total securities available for sale		$266,055		$400		$2,331		$264,124
December 31, 2017
Securities available for sale
U.S. Treasury and government sponsored entities		$250,794		$3		$1,336		$249,461
Municipal securities	14,395		72		46		14,421
Corporate bonds	36,654		478		—		37,132
Collateralized loan obligations	6,000		5		—		6,005
Total securities available for sale		$307,843		$558		$1,382		$307,019

Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2018 and December 31, 2017 were as follows:



	Less Than 12 Months				More Than 12 Months				Total
(In Thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
June 30, 2018:
Securities Available for Sale
U.S. Treasury and government sponsored entities		$101,236		$1,495		$102,446		$799		$203,682		$2,294
Corporate bonds	4,008		11		—		—		4,008		11
Collateralized loan obligations	2,999		1		—		—		2,999		1
Municipal securities	2,907		7		1,361		18		4,268		25
Total		$111,150		$1,514		$103,807		$817		$214,957		$2,331

December 31, 2017:
Securities Available for Sale
U.S. Treasury and government sponsored entities		$116,331		$496		$122,605		$840		$238,936		$1,336
Municipal securities	3,994		17		2,298		29		6,292		46
Total		$120,325		$513		$124,903		$869		$245,228		$1,382

The unrealized losses on investments in U.S. treasury and government sponsored entities, corporate bonds, collateralized loan obligations, and municipal securities in both periods were caused by changes in interest rates. At June 30, 2018 and December 31, 2017, there were 24 available-for-sale securities with unrealized losses that have been in a loss position for less than twelve months. There were 17 securities as of June 30, 2018 and December 31, 2017 that have been in an unrealized loss position for more than twelve months. The contractual terms of the investments in a loss position do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because it is more likely than not that the Company will hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.

At June 30, 2018 and December 31, 2017, $53.6 million and $51.6 million in securities were pledged for deposits and borrowings, respectively.

The amortized cost and estimated fair values of debt securities and preferred stock at June 30, 2018, are distributed by contractual maturity as shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Although preferred stock has no stated maturity, it is aggregated in the calculation of weighted average yields presented below in the category of investments that mature in ten years or more.



(In Thousands)	Amortized Cost		Fair Value		Weighted Average Yield
US Treasury and government sponsored entities
Within 1 year		$52,510		$52,396	1.08	%
1-5 years	155,133		152,981		1.76	%
5-10 years	3,330		3,315		3.00	%
Total		$210,973		$208,692	1.61	%
Corporate bonds
1-5 years		$21,700		$21,904	3.20	%
5-10 years	15,443		15,586		3.44	%
Total		$37,143		$37,490	3.30	%
Collateralized loan obligations
5-10 years		$3,000		$2,999	3.81	%
Over 10 years	3,001		3,008		4.11	%
Total		$6,001		$6,007	3.96	%
Preferred stock
Over 10 years		$5,868		$6,006	5.77	%
Total		$5,868		$6,006	5.77	%
Municipal securities
Within 1 year		$2,607		$2,606	1.32	%
1-5 years	9,331		9,329		2.42	%
Total		$11,938		$11,935	2.18	%

The proceeds and resulting gains and losses, computed using specific identification, from sales of investment securities for the three and six month periods ending June 30, 2018 and 2017, are as follows:



(In Thousands)	Proceeds		Gross Gains		Gross Losses
Three Months Ended June 30, 2018
Available for sale securities		$—		$—		$—
Three Months Ended June 30, 2017
Available for sale securities		$—		$—		$—
Six Months Ended June 30, 2018
Available for sale securities		$—		$—		$—
Six Months Ended June 30, 2017
Available for sale securities		$10,010		$14		$—

A summary of interest and dividend income for the three and six month periods ending June 30, 2018 and 2017, on available for sale investment securities and marketable equity securities are as follows:



	Three Months Ended June 30,				Six Months Ended June 30,
(In Thousands)	2018		2017		2018		2017
US Treasury and government sponsored entities		$895		$824		$1,785		$1,602
Other	427		294		787		583
Total taxable interest income		$1,322		$1,118		$2,572		$2,185
Municipal securities		$64		$92		$150		$189
Total tax-exempt interest income		$64		$92		$150		$189
Total		$1,386		$1,210		$2,722		$2,374

5. Loans and Credit Quality

The following table presents total portfolio loans by portfolio segment and class of financing receivable, based on the Company's asset quality rating ("AQR") criteria:



(In Thousands)	Commercial		Real estate construction one-to-four family		Real estate construction other		Real estate term owner occupied		Real estate term non-owner occupied		Real estate term other		Consumer secured by 1st deeds of trust		Consumer other		Total
June 30, 2018
AQR Pass		$293,585		$31,064		$58,369		$118,385		$311,312		$54,820		$20,364		$20,799		$908,698
AQR Special Mention	4,357		—		—		4,433		18,432		611		353		22		28,208
AQR Substandard	29,791		—		—		4,566		473		—		103		70		35,003
Subtotal		$327,733		$31,064		$58,369		$127,384		$330,217		$55,431		$20,820		$20,891		$971,909
Less: Unearned origination fees, net of origination costs																	(4,207		)
Total loans																		$967,702
December 31, 2017
AQR Pass		$277,371		$31,201		$80,093		$127,059		$307,780		$39,777		$21,846		$19,895		$905,022
AQR Special Mention	4,921		—		—		2,095		11,051		634		3		22		18,726
AQR Substandard	31,222		—		—		2,888		482		—		767		2		35,361
Subtotal		$313,514		$31,201		$80,093		$132,042		$319,313		$40,411		$22,616		$19,919		$959,109
Less: Unearned origination fees, net of origination costs																	(4,156		)
Total loans																		$954,953

Loans are carried at their principal amount outstanding, net of charge-offs, unamortized fees and direct loan origination costs. Loan balances are charged-off to the Allowance when management believes that collection of principal is unlikely. Interest income on loans is accrued and recognized on the principal amount outstanding except for loans in a nonaccrual status. All classes of loans are placed on nonaccrual and considered impaired when management believes doubt exists as to the collectability of the interest or principal. Cash payments received on nonaccrual loans are directly applied to the principal balance. Generally, a loan may be returned to accrual status when the delinquent principal and interest is brought current in accordance with the terms of the loan agreement. Additionally, certain ongoing performance criteria, which generally includes a performance period of six months, must be met in order for a loan to be returned to accrual status. Loans are reported as past due when installment payments, interest payments, or maturity payments are past due based on contractual terms.

Nonaccrual loans: Nonaccrual loans net of government guarantees totaled $16.3 million and $21.2 million at June 30, 2018 and December 31, 2017, respectively. Nonaccrual loans at the periods indicated are presented below by segment:



(In Thousands)	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days Past Due			Current			Total
June 30, 2018
Commercial		$—		$—		$1,769			$13,465			$15,234
Real estate term owner occupied	—		—		—			1,331			1,331
Consumer other	—		41		20			9			70
Total nonperforming loans	—		41		1,789			14,805			16,635
Government guarantees on nonaccrual loans	—		—		(73		)	(254		)	(327		)
Net nonaccrual loans		$—		$41		$1,716			$14,551			$16,308
December 31, 2017
Commercial		$810		$—		$2,652			$16,455			$19,917
Real estate term owner occupied	—		—		—			1,331			1,331
Consumer secured by 1st deeds of trust	—		—		378			—			378
Total nonperforming loans	810		—		3,030			17,786			21,626
Government guarantees on nonaccrual loans	—		—		(94		)	(373		)	(467		)
Net nonaccrual loans		$810		$—		$2,936			$17,413			$21,159

Past Due Loans: Past due loans and nonaccrual loans at the periods indicated are presented below by segment:



(In Thousands)	30-59 Days Past Due Still Accruing		60-89 Days Past Due Still Accruing		Greater Than 90 Days Still Accruing		Total Past Due		Nonaccrual		Current		Total
June 30, 2018
Commercial		$973		$110		$—		$1,083		$15,234		$311,416		$327,733
Real estate construction one-to-four family	—		—		—		—		—		31,064		31,064
Real estate construction other	—		—		—		—		—		58,369		58,369
Real estate term owner occupied	—		—		—		—		1,331		126,053		127,384
Real estate term non-owner occupied	—		—		—		—		—		330,217		330,217
Real estate term other	584		27		—		611		—		54,820		55,431
Consumer secured by 1st deed of trust	—		152		—		152		—		20,668		20,820
Consumer other	9		—		—		9		70		20,812		20,891
Subtotal		$1,566		$289		$—		$1,855		$16,635		$953,419		$971,909
Less: Unearned origination fees, net of origination costs													(4,207		)
Total														$967,702
December 31, 2017
Commercial		$503		$—		$240		$743		$19,917		$292,854		$313,514
Real estate construction one-to-four family	—		—		—		—		—		31,201		31,201
Real estate construction other	90		—		—		90		—		80,003		80,093
Real estate term owner occupied	966		—		—		966		1,331		129,745		132,042
Real estate term non-owner occupied	—		—		—		—		—		319,313		319,313
Real estate term other	—		—		—		—		—		40,411		40,411
Consumer secured by 1st deed of trust	363		—		—		363		378		21,875		22,616
Consumer other	161		53		12		226		—		19,693		19,919
Subtotal		$2,083		$53		$252		$2,388		$21,626		$935,095		$959,109
Less: Unearned origination fees, net of origination costs													(4,156		)
Total														$954,953

Impaired Loans: The Company considers a loan to be impaired when it is probable that it will be unable to collect all amounts due according to the contractual terms of the loan agreement. Once a loan is determined to be impaired, the impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate, except that if the loan is collateral dependent, the impairment is measured by using the fair value of the loan’s collateral. Nonperforming loans with an outstanding balance of $50,000 or greater are individually evaluated for impairment based upon the borrower’s overall financial condition, resources, and payment record, and the prospects for support from any financially responsible guarantors.

At June 30, 2018 and December 31, 2017, the recorded investment in loans that are considered to be impaired was $38.1 million and $32.0 million, respectively. The following table presents information about impaired loans by class as of the periods indicated:



(In Thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance
June 30, 2018
With no related allowance recorded
Commercial - AQR special mention		$2,212		$2,212		$—
Commercial - AQR substandard	29,376		31,412		—
Real estate term owner occupied- AQR substandard	4,566		4,566		—
Real estate term non-owner occupied- AQR pass	371		371		—
Real estate term non-owner occupied- AQR substandard	473		473		—
Real estate term other - AQR pass	514		514		—
Consumer secured by 1st deeds of trust - AQR pass	133		133		—
Consumer secured by 1st deeds of trust - AQR substandard	103		103		—
Subtotal		$37,748		$39,784		$—



With an allowance recorded
Commercial - AQR substandard	$373	$373	$73
Subtotal	$373	$373	$73



Total
Commercial - AQR special mention		$2,212		$2,212		$—
Commercial - AQR substandard	29,749		31,785		73
Real estate term owner-occupied - AQR substandard	4,566		4,566		—
Real estate term non-owner occupied - AQR pass	371		371		—
Real estate term non-owner occupied - AQR substandard	473		473		—
Real estate term other - AQR pass	514		514		—
Consumer secured by 1st deeds of trust - AQR pass	133		133		—
Consumer secured by 1st deeds of trust - AQR substandard	103		103		—
Total		$38,121		$40,157		$73



(In Thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance
December 31, 2017
With no related allowance recorded
Commercial - AQR special mention		$2,153		$2,153		$—
Commercial - AQR substandard	16,671		17,742		—
Real estate term owner occupied - AQR substandard	2,862		2,862		—
Real estate term non-owner occupied - AQR pass	303		303		—
Real estate term non-owner occupied - AQR special mention	89		89		—
Real estate term non-owner occupied - AQR substandard	482		482		—
Real estate term other - AQR pass	559		559		—
Consumer secured by 1st deeds of trust - AQR pass	136		136		—
Consumer secured by 1st deeds of trust - AQR substandard	724		809		—
Subtotal		$23,979		$25,135		$—



With an allowance recorded
Commercial - AQR substandard	$7,988	$7,988	$966
Subtotal	$7,988	$7,988	$966



Total
Commercial - AQR special mention		$2,153		$2,153		$—
Commercial - AQR substandard	24,659		25,730		966
Real estate term owner occupied - AQR substandard	2,862		2,862		—
Real estate term non-owner occupied - AQR pass	303		303		—
Real estate term non-owner occupied - AQR special mention	89		89		—
Real estate term non-owner occupied - AQR substandard	482		482		—
Real estate term other - AQR pass	559		559		—
Consumer secured by 1st deeds of trust - AQR pass	136		136		—
Consumer secured by 1st deeds of trust - AQR substandard	724		809		—
Total		$31,967		$33,123		$966

The unpaid principal balance included in the tables above represents the recorded investment at the dates indicated, plus amounts charged off for book purposes.

The following tables summarize our average recorded investment and interest income recognized on impaired loans for the three and six month periods ended June 30, 2018 and 2017:



Three Months Ended June 30,	2018						2017
(In Thousands)	Average Recorded Investment		Interest Income Recognized			Average Recorded Investment			Interest Income Recognized
With no related allowance recorded
Commercial - AQR special mention		$2,223			$34			$—			$—
Commercial - AQR substandard	30,657			172			25,412			258
Real estate term owner occupied- AQR substandard	4,575			53			6,079			63
Real estate term non-owner occupied- AQR pass	378			6			371			18
Real estate term non-owner occupied- AQR substandard	475			8			688			9
Real estate term other - AQR pass	527			7			604			11
Real estate term other - AQR substandard	—			—			651			11
Consumer secured by 1st deeds of trust - AQR pass	141			4			—			—
Consumer secured by 1st deeds of trust - AQR special mention	—			—			141			3
Consumer secured by 1st deeds of trust - AQR substandard	103			1			287			5
Subtotal		$39,079			$285			$34,233			$378



With an allowance recorded
Commercial - AQR substandard	$378	$7	$2,611	$—
Subtotal	$378	$7	$2,611	$—



Total
Commercial - AQR special mention		$2,223		$34		$—		$—
Commercial - AQR substandard	31,035		179		28,023		258
Real estate term owner-occupied - AQR substandard	4,575		53		6,079		63
Real estate term non-owner occupied - AQR pass	378		6		371		18
Real estate term non-owner occupied - AQR substandard	475		8		688		9
Real estate term other - AQR pass	527		7		604		11
Real estate term other - AQR substandard	—		—		651		11
Consumer secured by 1st deeds of trust - AQR pass	141		4		—		—
Consumer secured by 1st deeds of trust - AQR special mention	—		—		141		3
Consumer secured by 1st deeds of trust - AQR substandard	103		1		287		5
Total Impaired Loans		$39,457		$292		$36,844		$378



Six Months Ended June 30,	2018						2017
(In Thousands)	Average Recorded Investment		Interest Income Recognized			Average Recorded Investment			Interest Income Recognized
With no related allowance recorded
Commercial - AQR special mention		$2,232			$65			$26			$1
Commercial - AQR substandard	24,637			257			21,500			333
Real estate term owner occupied- AQR pass	—			—			125			5
Real estate term owner occupied- AQR substandard	4,583			77			5,704			147
Real estate term non-owner occupied- AQR pass	339			11			378			32
Real estate term non-owner occupied- AQR special mention	44			2			—			—
Real estate term non-owner occupied- AQR substandard	477			15			692			29
Real estate term other - AQR pass	539			16			614			22
Real estate term other - AQR substandard	—			—			657			23
Consumer secured by 1st deeds of trust - AQR pass	139			7			—			—
Consumer secured by 1st deeds of trust - AQR special mention	—			—			142			7
Consumer secured by 1st deeds of trust - AQR substandard	175			6			371			7
Consumer other - AQR substandard	—			—			26			1
Subtotal		$33,165			$456			$30,235			$607



With an allowance recorded
Commercial - AQR substandard		$3,773		$7		$6,924		$—
Commercial - AQR doubtful	27		—		—		—
Consumer secured by 1st deeds of trust - AQR substandard	120		—		—		—
Subtotal		$3,920		$7		$6,924		$—



Total
Commercial - AQR special mention		$2,232		$65		$26		$1
Commercial - AQR substandard	28,410		264		28,424		333
Commercial - AQR doubtful	27		—		—		—
Real estate term owner-occupied - AQR pass	—		—		125		5
Real estate term owner-occupied - AQR substandard	4,583		77		5,704		147
Real estate term non-owner occupied - AQR pass	339		11		378		32
Real estate term non-owner occupied - AQR special mention	44		2		—		—
Real estate term non-owner occupied - AQR substandard	477		15		692		29
Real estate term other - AQR pass	539		16		614		22
Real estate term other - AQR substandard	—		—		657		23
Consumer secured by 1st deeds of trust - AQR pass	139		7		—		—
Consumer secured by 1st deeds of trust - AQR special mention	—		—		142		7
Consumer secured by 1st deeds of trust - AQR substandard	295		6		371		7
Consumer other - AQR substandard	—		—		26		1
Total Impaired Loans		$37,085		$463		$37,159		$607

Purchased Credit Impaired Loans: The Company acquired 18 purchased credit impaired loans in connection with its acquisition of Alaska Pacific Bancshares, Inc. on April 1, 2014 subject to the requirements of FASB ASC 310-30 Loans and Debt Securities Acquired with Deteriorated Credit Quality. This group of loans consists primarily of commercial and commercial real estate loans, and unlike a pool of consumer mortgages, it is not practicable for the Company to analyze the accretable yield of these loans. As such, the Company has elected the cost recovery method of income recognition for these loans, and thus no accretable yield has been identified for these loans. At the acquisition date, April 1, 2014, the fair value of this group of loans was $3.9 million. The carrying value of these loans as of June 30, 2018 was $806,000.

Troubled Debt Restructurings: Loans classified as troubled debt restructurings (“TDR”) totaled $23.8 million and $23.8 million at both June 30, 2018 and December 31, 2017. A TDR is a loan to a borrower that is experiencing financial difficulty that has been modified from its original terms and conditions in such a way that the Company is granting the borrower a concession that it would not grant otherwise. The Company has granted a variety of concessions to borrowers in the form of loan modifications. The modifications granted can generally be described in the following categories:

Rate Modification: A modification in which the interest rate is changed.

Term Modification: A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Payment Modification: A modification in which the dollar amount of the payment is changed, or in which a loan is converted to interest only payments for a period of time is included in this category.

Combination Modification: Any other type of modification, including the use of multiple categories above.

AQR pass graded loans included above in the impaired loan data are loans classified as TDRs. By definition, TDRs are considered impaired loans. All of the Company's TDRs are included in impaired loans.

The following table presents the breakout between newly restructured loans that occurred during the six months ended June 30, 2018 and restructured loans that occurred prior to 2018 that are still included in portfolio loans:



	Accrual Status		Nonaccrual Status		Total Modifications
(In Thousands)	Accrual Status		Nonaccrual Status		Total Modifications
New Troubled Debt Restructurings
Commercial - AQR substandard		$1,179		$559		$1,738
Real estate term owner occupied- AQR substandard	363		1,331		1,694
Subtotal		$1,542		$1,890		$3,432
Existing Troubled Debt Restructurings		$7,554		$12,772		$20,326
Total		$9,096		$14,662		$23,758

The following tables present newly restructured loans that occurred during the six months ended June 30, 2018 and 2017, by concession (terms modified):



		June 30, 2018
	Number of Contracts	Rate Modification		Term Modification		Payment Modification		Combination Modification		Total Modifications
(In Thousands)	Number of Contracts	Rate Modification		Term Modification		Payment Modification		Combination Modification		Total Modifications
Pre-Modification Outstanding Recorded Investment:
Commercial - AQR substandard	4		$—		$—		$2,704		$—		$2,704
Real estate term owner occupied- AQR substandard	2	—		—		1,694		—		1,694
Total	6		$—		$—		$4,398		$—		$4,398
Post-Modification Outstanding Recorded Investment:
Commercial - AQR substandard	4		$—		$—		$1,738		$—		$1,738
Real estate term owner occupied- AQR substandard	2	—		—		1,694		—		1,694
Total	6		$—		$—		$3,432		$—		$3,432



		June 30, 2017
	Number of Contracts	Rate Modification		Term Modification		Payment Modification		Combination Modification		Total Modifications
(In Thousands)	Number of Contracts	Rate Modification		Term Modification		Payment Modification		Combination Modification		Total Modifications
Pre-Modification Outstanding Recorded Investment:
Commercial - AQR substandard	2		$—		$10,665		$210		$—		$10,875
Total	2		$—		$10,665		$210		$—		$10,875
Post-Modification Outstanding Recorded Investment:
Commercial - AQR substandard	2		$—		$10,165		$210		$—		$10,375
Total	2		$—		$10,165		$210		$—		$10,375

The Company had no commitments to extend additional credit to borrowers whose terms have been modified in TDRs. There were $965,000 charge offs in the six months ended June 30, 2018 on loans that were newly classified as TDRs during the same period.

All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation of the Allowance. There were no TDRs with specific impairment at June 30, 2018 and two TDRs with specific impairment at December 31, 2017.

The Company had no TDRs that subsequently defaulted within the first twelve months of restructure, during the twelve month period ending December 31, 2017. The loans in the following table are past due nonaccrual loans. The following table presents TDRs that occurred during the twelve month period ending June 30, 2018 that subsequently defaulted during the six months ended June 30, 2018:



		June 30, 2018
	Number of Contracts	Recorded Investment
(In Thousands)	Number of Contracts	Recorded Investment
Troubled Debt Restructurings that Subsequently Defaulted:
Commercial - AQR substandard	2		$559
Total	2		$559

6. Allowance for Loan Losses

The following tables detail activity in the Allowance for the periods indicated:



Three Months Ended June 30,	Commercial			Real estate construction one-to-four family			Real estate construction other		Real estate term owner occupied			Real estate term non-owner occupied			Real estate term other			Consumer secured by 1st deed of trust			Consumer other			Unallocated			Total
2018
Balance, beginning of period		$5,684			$608			$1,069		$2,174			$6,379			$1,025			$305			$315			$2,890			$20,449
Charge-Offs	(77		)	—			—		—			—			—			(2		)	(21		)	—			(100		)
Recoveries	54			—			—		—			—			1			—			4			—			59
Provision (benefit)	(35		)	(12		)	17		(4		)	(160		)	(25		)	49			98			(228		)	(300		)
Balance, end of period		$5,626			$596			$1,086		$2,170			$6,219			$1,001			$352			$396			$2,662			$20,108
Balance, end of period:
Individually evaluated
for impairment		$73			$—			$—		$—			$—			$—			$—			$—			$—			$73
Balance, end of period:
Collectively evaluated
for impairment		$5,553			$596			$1,086		$2,170			$6,219			$1,001			$352			$396			$2,662			$20,035
2017
Balance, beginning of period		$5,701			$549			$1,383		$2,372			$7,207			$774			$311			$391			$1,205			$19,893
Charge-Offs	(202		)	—			—		—			(5		)	—			—			—			—			(207		)
Recoveries	71			—			—		—			—			—			2			2			—			75
Provision (benefit)	252			(28		)	134		(18		)	(127		)	—			14			(31		)	104			300
Balance, end of period		$5,822			$521			$1,517		$2,354			$7,075			$774			$327			$362			$1,309			$20,061
Balance, end of period:
Individually evaluated
for impairment		$394			$—			$—		$—			$—			$—			$—			$—			$—			$394
Balance, end of period:
Collectively evaluated
for impairment		$5,428			$521			$1,517		$2,354			$7,075			$774			$327			$362			$1,309			$19,667



Six Months Ended June 30,	Commercial			Real estate construction one-to-four family			Real estate construction other			Real estate term owner occupied			Real estate term non-owner occupied		Real estate term other			Consumer secured by 1st deed of trust			Consumer other			Unallocated			Total
2018
Balance, beginning of period		$6,172			$629			$1,566			$2,194			$6,043		$725			$315			$307			$3,510			$21,461
Charge-Offs	(1,042		)	—			—			—			—		—			(91		)	(71		)	—			(1,204		)
Recoveries	143			—			—			—			—		2			1			5			—			151
Provision (benefit)	353			(33		)	(480		)	(24		)	176		274			127			155			(848		)	(300		)
Balance, end of period		$5,626			$596			$1,086			$2,170			$6,219		$1,001			$352			$396			$2,662			$20,108
Balance, end of period:
Individually evaluated
for impairment		$73			$—			$—			$—			$—		$—			$—			$—			$—			$73
Balance, end of period:
Collectively evaluated
for impairment		$5,553			$596			$1,086			$2,170			$6,219		$1,001			$352			$396			$2,662			$20,035
2017
Balance, beginning of period		$5,535			$550			$1,465			$2,358			$6,853		$819			$313			$408			$1,396			$19,697
Charge-Offs	(464		)	—			—			—			—		(5		)	—			(17		)	—			(486		)
Recoveries	144			—			—			—			—		—			2			4			—			150
Provision (benefit)	607			(29		)	52			(4		)	222		(40		)	12			(33		)	(87		)	700
Balance, end of period		$5,822			$521			$1,517			$2,354			$7,075		$774			$327			$362			$1,309			$20,061
Balance, end of period:
Individually evaluated
for impairment		$394			$—			$—			$—			$—		$—			$—			$—			$—			$394
Balance, end of period:
Collectively evaluated
for impairment		$5,428			$521			$1,517			$2,354			$7,075		$774			$327			$362			$1,309			$19,667

The following is a detail of the recorded investment in the loan portfolio, segregated by amounts evaluated individually or collectively in the Allowance at the periods indicated:



(In Thousands)	Commercial		Real estate construction one-to-four family		Real estate construction other		Real estate term owner occupied		Real estate term non-owner occupied		Real estate term other		Consumer secured by 1st deed of trust		Consumer other		Total
June 30, 2018
Balance, end of period		$327,733		$31,064		$58,369		$127,384		$330,217		$55,431		$20,820		$20,891		$971,909
Balance, end of period:
Individually evaluated
for impairment		$31,961		$—		$—		$4,566		$844		$514		$236		$—		$38,121
Balance, end of period:
Collectively evaluated
for impairment		$295,772		$31,064		$58,369		$122,818		$329,373		$54,917		$20,584		$20,891		$933,788
December 31, 2017
Balance, end of period		$313,514		$31,201		$80,093		$132,042		$319,313		$40,411		$22,616		$19,919		$959,109
Balance, end of period:
Individually evaluated
for impairment		$26,812		$—		$—		$2,862		$874		$559		$860		$—		$31,967
Balance, end of period:
Collectively evaluated
for impairment		$286,702		$31,201		$80,093		$129,180		$318,439		$39,852		$21,756		$19,919		$927,142

The following represents the balance of the Allowance for the periods indicated segregated by segment and class:



(In Thousands)	Commercial		Real estate construction 1-4 family		Real estate construction other		Real estate term owner occupied		Real estate term non-owner occupied		Real estate term other		Consumer secured by 1st deeds of trust		Consumer other		Unallocated		Total
June 30, 2018
Individually evaluated for impairment:
AQR Substandard		$73		$—		$—		$—		$—		$—		$—		$—		$—		$73
Collectively evaluated for impairment:
AQR Pass	5,453		596		1,086		2,089		5,627		990		343		373		—		16,557
AQR Special Mention	100		—		—		81		592		11		9		1		—		794
AQR Substandard	—		—		—		—		—		—		—		22		—		22
Unallocated	—		—		—		—		—		—		—		—		2,662		2,662
		$5,626		$596		$1,086		$2,170		$6,219		$1,001		$352		$396		$2,662		$20,108
December 31, 2017
Individually evaluated for impairment:
AQR Substandard		$966		$—		$—		$—		$—		$—		$—		$—		$—		$966
Collectively evaluated for impairment:
AQR Pass	5,079		629		1,566		2,154		5,680		725		315		305		—		16,453
AQR Special Mention	120		—		—		40		363		—		—		1		—		524
AQR Substandard	7		—		—		—		—		—		—		1		—		8
Unallocated	—		—		—		—		—		—		—		—		3,510		3,510
		$6,172		$629		$1,566		$2,194		$6,043		$725		$315		$307		$3,510		$21,461

7. Purchased Receivables

Purchased receivables are carried at their principal amount outstanding, net of a reserve for anticipated losses that have not yet been identified, and have a maturity of less than one year. Purchased receivable balances are charged against this reserve when management believes that collection of principal is unlikely. Management evaluates the adequacy of the reserve for purchased receivable losses based on historical loss experience by class of receivable and its assessment of current economic conditions. As of June 30, 2018, the Company has one class of purchased receivables. There were no purchased receivables past due at June 30, 2018 or December 31, 2017, and there were no restructured purchased receivables at June 30, 2018 or December 31, 2017.

Income on purchased receivables is accrued and recognized on the principal amount outstanding using an effective interest method except when management believes doubt exists as to the collectability of the income or principal. As of June 30, 2018, the Company is accruing income on all purchased receivable balances outstanding.

The following table summarizes the components of net purchased receivables for the periods indicated:



(In Thousands)	June 30, 2018			December 31, 2017
Purchased receivables		$20,524			$22,431
Reserve for purchased receivable losses	(201		)	(200		)
Total		$20,323			$22,231

The following table sets forth information regarding changes in the purchased receivable reserve for the three and six month periods ending June 30, 2018 and 2017, respectively:



	Three Months Ended June 30,					Six Months Ended June 30,
(In Thousands)	2018			2017		2018		2017
Balance, beginning of period		$209			$183		$200		$171
Charge-offs	—			—		—		—
Recoveries	—			—		—		—
Charge-offs net of recoveries	—			—		—		—
Reserve for purchased receivables	(8		)	11		1		23
Balance, end of period		$201			$194		$201		$194

8. Mortgage Servicing Rights

The following table details the activity in the Company's mortgage servicing rights ("MSR") for the three and six months ended June 30, 2018 and 2017:



	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2018			2017			2018			2017

Balance, beginning of period		$8,039			$5,325			$7,305			$4,157
Additions for new MSR capitalized	812			551			1,572			1,437
Changes in fair value:
Due to changes in model inputs of assumptions ⁽¹⁾	110			45			365			520
Other ⁽²⁾	(228		)	(93		)	(509		)	(286		)
Balance, end of period		$8,733			$5,828			$8,733			$5,828

⁽¹⁾Principally reflects changes in discount rates and prepayment speed assumptions, which are primarily affected by changes in interest rates.

⁽²⁾Represents changes due to collection/realization of expected cash flows over time.

The following table details information related to our serviced mortgage loan portfolio as of June 30, 2018 and December 31, 2017:

The Company recognized servicing fees of $1.3 million and $838,000 during the three month periods ending June 30, 2018 and 2017 and $2.4 million and $2.0 million during the six month periods ending June 30, 2018 and 2017, respectively, which includes revenues recognized at origination of new mortgage servicing rights, late fees, and ancillary fees as a component of other noninterest income in the Company's Consolidated Statements of Income.

The following table outlines the key assumptions used in measuring the fair value of mortgage servicing rights as of June 30, 2018 and December 31, 2017:



	2018		2017

Constant prepayment rate	7.75	%	9.00	%
Discount rate	9.89	%	9.45	%

Key economic assumptions and the sensitivity of the current fair value for mortgage servicing rights to immediate adverse changes in those assumptions at June 30, 2018 and December 31, 2017 were as follows:



(In Thousands)				June 30, 2018			December 31, 2017
Aggregate portfolio principal balance					$472,190			$406,291
Weighted average rate of note				3.80		%	3.77		%

June 30, 2018	Base			1.0% Adverse Rate Change			2.0% Adverse Rate Change
Conditional prepayment rate	7.75		%	20.22		%	21.95		%
Discount rate	9.89		%	8.89		%	7.89		%
Fair value MSR		$8,733			$5,445			$5,189
Percentage of MSR	1.85		%	1.15		%	1.10		%

December 31, 2017
Conditional prepayment rate	9.00		%	23.33		%	25.25		%
Discount rate	9.45		%	8.45		%	7.45		%
Fair value MSR		$7,305			$4,343			$4,109
Percentage of MSR	1.80		%	1.07		%	1.01		%

The above tables show the sensitivity to market rate changes for the par rate coupon for a conventional one-to-four family Alaska Housing Finance Corporation/FNMA/FHLMC serviced home loan. The above tables reference a 100 basis point and 200 basis point decrease in note rates.

These sensitivities are hypothetical and should be used with caution as the tables above demonstrate the Company’s methodology for estimating the fair value of MSR is highly sensitive to changes in key assumptions. For example, actual prepayment

experience may differ and any difference may have a material effect on MSR fair value. Changes in fair value resulting from changes in assumptions generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, in these tables, the effects of a variation in a particular assumption on the fair value of the MSR is calculated without changing any other assumption; in reality, changes in one factor may be associated with changes in another (for example, decreases in market interest rates may provide an incentive to refinance; however, this may also indicate a slowing economy and an increase in the unemployment rate, which reduces the number of borrowers who qualify for refinancing), which may magnify or counteract the sensitivities. Thus, any measurement of MSR fair value is limited by the conditions existing and assumptions made at a particular point in time. Those assumptions may not be appropriate if they are applied to a different point in time.

9. Derivatives

Interest rates swaps related to community banking activities

The Company enters into commercial loan interest rate swap agreements with commercial banking customers which are offset with a corresponding swap agreement with a third party financial institution ("counterparty"). The Company has agreements with its counterparties that contain provisions that provide that if the Company fails to maintain its status as a well-capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements. These agreements also require that the Company and the counterparty collateralize any fair value shortfalls that exceed $250,000 with eligible collateral, which includes cash and securities backed with the full faith and credit of the federal government. Similarly, the Company could be required to settle its obligations under the agreement if specific regulatory events occur, such as if the Company were issued a prompt corrective action directive or a cease and desist order, or if certain regulatory ratios fall below specified levels. The Company pledged $300,000 in available for sale securities to collateralize fair value shortfalls on interest rate swap agreements as of both June 30, 2018 and December 31, 2017.

The Company had interest rate swaps related to commercial loans with an aggregate notional amount of $11.5 million and $12.5 million at June 30, 2018 and December 31, 2017, respectively. At June 30, 2018, the notional amount of interest rate swaps is made up of one variable to fixed rate swap to a commercial loan customer totaling $5.7 million, and one fixed to variable rate swap with a counterparty totaling $5.7 million. Changes in fair value from these two interest rate swaps offset each other in the first six months of 2018. The Company did not recognize any fee income related to interest rate swaps in the three and six month periods ending June 30, 2018 and recognized $16,000 in fee income in the three and six month periods ending June 30, 2017. Interest rate swap income is recorded in other income on the Consolidated Statements of Income. None of these interest rate swaps are designated as hedging instruments.

The Company entered into an interest rate swap in the third quarter of 2017 to hedge the variability in cash flows arising out of its junior subordinated debentures, which is floating rate debt, by swapping the cash flows with an interest rate swap which receives floating and pays fixed. The Company has designated this interest rate swap as a hedging instrument. The interest rate swap effectively fixes the Company's interest payments on the $10.0 million of junior subordinated debentures held under Northrim Statutory Trust 2 at 3.72% through its maturity date. The floating rate that the dealer pays is equal to the three month LIBOR plus 1.37% which reprices quarterly on the payment date. This rate was 3.71% as of June 30, 2018. The Company pledged $400,000 in cash to collateralize initial margin and fair value exposure of our counterparty on this interest rate swap as of June 30, 2018. Changes in the fair value of this interest rate swap are reported in other comprehensive income. The unrealized gain on this interest rate swap was $805,000 as of June 30, 2018.

Interest rates swaps related to home mortgage banking activities

The Company also uses derivatives to hedge the risk of changes in the fair values of interest rate lock commitments. The Company enters into commitments to originate residential mortgage loans at specific rates; the value of these commitments are detailed in the table below as "interest rate lock commitments". The Company also hedges the interest rate risk associated with its residential mortgage loan commitments, which are referred to as "retail interest rate contracts" in the table below. Market risk with respect to commitments to originate loans arises from changes in the value of contractual positions due to changes in interest rates. RML had commitments to originate mortgage loans held for sale totaling $84.1 million and $43.6 million at June 30, 2018 and December 31, 2017, respectively. Changes in the value of RML's interest rate derivatives are recorded in the mortgage banking income on the Consolidated Statements of Income. None of these derivatives as designated as hedging instruments.

The following table presents the fair value of derivatives not designated as hedging instruments at June 30, 2018 and December 31, 2017:



(In Thousands)	Asset Derivatives
		June 30, 2018		December 31, 2017
	Balance Sheet Location	Fair Value		Fair Value

Interest rate swaps	Other assets		$151		$77
Interest rate lock commitments	Other assets	1,417		873
Total			$1,568		$950



(In Thousands)	Liability Derivatives
		June 30, 2018		December 31, 2017
	Balance Sheet Location	Fair Value		Fair Value

Interest rate swaps	Other liabilities		$151		$77
Retail interest rate contracts	Other liabilities	134		—
Total			$285		$77

The following table presents the net gains (losses) of derivatives not designated as hedging instruments for the six month periods ending June 30, 2018 and 2017:



(In Thousands)	Income Statement Location	June 30, 2018			June 30, 2017
Interest rate contracts	Mortgage banking income			$373			($112	)
Interest rate lock commitments	Mortgage banking income		484			171
Total				$857			$59

Our derivative transactions with counterparties under International Swaps and Derivative Association master agreements include "right of set-off" provisions. "Right of set-off" provisions are legally enforceable rights to offset recognized amounts and there may be an intention to settle such amounts on a net basis. We do not offset such financial instruments for financial reporting purposes.

The following table summarizes the derivatives that have a right of offset as of June 30, 2018 and December 31, 2017:



June 30, 2018					Gross amounts not offset in the Statement of Financial Position
(In Thousands)	Gross amounts of recognized assets and liabilities	Gross amounts offset in the Statement of Financial Position		Net amounts of assets and liabilities presented in the Statement of Financial Position	Financial Instruments		Collateral Posted		Net Amount
Asset Derivatives
Interest rate swaps	$151		$—	$151		$—		$—		$151

Liability Derivatives
Interest rate swaps	$151		$—	$151		$—	$151			$—
Retail interest rate contracts	134	—		134	—		—		134

December 31, 2017					Gross amounts not offset in the Statement of Financial Position
(In Thousands)	Gross amounts of recognized assets and liabilities	Gross amounts offset in the Statement of Financial Position		Net amounts of assets and liabilities presented in the Statement of Financial Position	Financial Instruments		Collateral Posted		Net Amount
Asset Derivatives
Interest rate swaps	$77		$—	$77		$—		$—		$77

Liability Derivatives
Interest rate swaps	$77		$—	$77		$—	$77			$—
Retail interest rate contracts	—	—		—	—		—		—

10. Stock Incentive Plan

The Company adopted the 2017 Stock Option Plan (“2017 Plan”) following shareholder approval of the 2017 Plan at the 2017 Annual Meeting. Subsequent to the adoption of the 2017 Plan, no additional grants may be issued under the prior plans. The 2017 Plan provides for grants of up to 350,000 shares of common stock.

Stock Options: Under the 2017 Plan and previous plans, certain key employees have been granted the option to purchase set amounts of common stock at the market price on the day the option was granted. Optionees, at their own discretion, may cover the cost of exercise through the exchange at the then fair value of already owned shares of the Company’s stock. Options are granted for a 10-year period and vest on a pro-rata basis over the initial three years from grant.

The Company measures the fair value of each stock option at the date of grant using the Black-Scholes option pricing model. For the quarters ended June 30, 2018 and 2017, the Company recognized $32,000 and $34,000, respectively, in stock option compensation expense as a component of salaries and other personnel expense. For the six months ended June 30, 2018 and 2017, the Company recognized $108,000 and $66,000, respectively, in stock option compensation expense as a component of salaries and other personnel expense.

The Company allows stock options to be exercised through cash or cashless transactions. Cashless stock option exercises require a portion of the options exercised to be net settled in satisfaction of the exercise price and applicable tax withholding requirements. The Company issued 996 shares from the exercise of stock options for the three and six month periods ended June

30, 2018. The Company received zero cash for the stock option exercises in the three and six months ended June 30, 2018. In the three and six months ended June 30, 2018, the Company net settled $56,000 for cashless stock option exercises. The Company withheld $73,000 to pay for stock option exercises or income taxes that resulted from the exercise of stock options in the three and six months ended June 30, 2018.

The Company issued 814 and 12,789 shares, respectively, from the exercise of stock options in the three and six month periods ended June 30, 2017. The Company received zero cash for stock option exercises in the three and six months ended June 30, 2017. In the three months ended June 30, 2017 the Company net settled $62,000 for cashless stock option exercises. In the six months ended June 30, 2017 the Company net settled $862,000 for cashless stock option exercises. The Company withheld $74,000 and $1.0 million to pay for stock option exercises or income taxes that resulted from the exercise of stock options in the three and six months ended June 30, 2017.

There were no stock options granted in the three and six months ended June 30, 2018.

There were 3,775 stock options granted in the three and six months ended June 30, 2017.

Restricted Stock Units: The Company grants restricted stock units to certain key employees periodically. Recipients of restricted stock units do not pay any cash consideration to the Company for the shares and receive all dividends with respect to such shares when the shares vest. Restricted stock units cliff vest at the end of a three-year time period. For the three months ended June 30, 2018 and 2017, the Company recognized $126,000 and $118,000, respectively, in restricted stock unit compensation expense as a component of salaries and other personnel expense. For the six months ended June 30, 2018 and 2017, the Company recognized $304,000 and $214,000, respectively, in restricted stock unit compensation expense as a component of salaries and other personnel expense.

There were no restricted stock units granted in the three and six month periods ended June 30, 2018.

There were 2,337 restricted stock units granted in the three and six month periods ended June 30, 2017.

11. Fair Value of Assets and Liabilities

Fair Value Hierarchy

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. GAAP established a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:


•	Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets. A quoted market price in an active market provides the most reliable evidence of fair value and is used to measure fair value whenever available. A contractually binding sales price also provides reliable evidence of fair value.


•	Level 2: Valuation is based upon quoted market prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.


•	Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market, or inputs that require significant management judgment or estimation, some of which may be internally developed.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Investment securities available for sale and marketable securities: Fair values for are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

Loans held for sale: Due to the short term nature of these instruments, the carrying amounts reported in the consolidated balance sheets represent their fair values.

Mortgage servicing rights: MSR do not trade in an active market with readily observable market data and as a result, the Company classifies the fair value of these assets as Level 3 measurement. In order to determine the fair value of MSRs, the present value of net expected future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds,

escrow calculations, delinquency rates, and ancillary fee income net of servicing costs. The model assumptions are also compared to publicly filed information from several large MSR holders, as available.

Derivative instruments: The fair value of the interest rate lock commitments are estimated using quoted or published market prices for similar instruments, adjusted for factors such as pull-through rate assumptions based on historical information, where appropriate. The pull-through rate assumptions are considered Level 3 valuation inputs and are significant to the interest rate lock commitment valuation; as such, the interest rate lock commitment derivatives are classified as Level 3. Interest rate contracts are valued in a model, which uses as its basis a discounted cash flow technique incorporating credit valuation adjustments to reflect nonperformance risk in the measurement of fair value. Although the Company has determined that the majority of inputs used to value its interest rate derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of June 30, 2018, the Company has assessed the significance of the impact of these adjustments on the overall valuation of its interest rate positions and has determined that they are not significant to the overall valuation of its interest rate derivatives. As a result, the Company has classified its interest rate derivative valuations in Level 2 of the fair value hierarchy.

Assets Subject to Nonrecurring Adjustment to Fair Value:

The Company is also required to measure certain assets such as equity method investments, goodwill, intangible assets, impaired loans, and other real estate owned (“OREO”) at fair value on a nonrecurring basis in accordance with GAAP. Any nonrecurring adjustments to fair value usually result from the write down of individual assets.

The Company uses either in-house evaluations or external appraisals to estimate the fair value of OREO and impaired loans as of each reporting date. In-house appraisals are considered Level 3 inputs and external appraisals are considered Level 2 inputs. The Company’s determination of which method to use is based upon several factors. The Company takes into account compliance with legal and regulatory guidelines, the amount of the loan, the size of the assets, the location and type of property to be valued and how critical the timing of completion of the analysis is to the assessment of value. Those factors are balanced with the level of internal expertise, internal experience and market information available, versus external expertise available such as qualified appraisers, brokers, auctioneers and equipment specialists.

The Company uses external sources to estimate fair value for projects that are not fully constructed as of the date of valuation. These projects are generally valued as if complete, with an appropriate allowance for cost of completion, including contingencies developed from external sources such as vendors, engineers and contractors. The Company believes that recording other real estate owned that is not fully constructed based on as if complete values is more appropriate than recording other real estate owned that is not fully constructed using as is values. We concluded that as-is-complete values are appropriate for these types of projects based on the accounting guidance for capitalization of project costs and subsequent measurement of the value of real estate. GAAP specifically states that estimates and cost allocations must be reviewed at the end of each reporting period and reallocated based on revised estimates. The Company adjusts the carrying value of other real estate owned in accordance with this guidance for increases in estimated cost to complete that exceed the fair value of the real estate at the end of each reporting period.

Limitations

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Estimated fair values as of the periods indicated are as follows:



	June 30, 2018				December 31, 2017
(In Thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Level 1 inputs:
Cash, due from banks and deposits in other banks		$36,130		$36,130		$77,841		$77,841
Investment securities available for sale	60,175		60,175		59,117		59,117
Marketable equity securities	6,006		6,006		—		—

Level 2 inputs:
Investment securities available for sale	203,949		203,949		253,633		253,633
Investment in Federal Home Loan Bank stock	2,104		2,104		2,115		2,115
Accrued interest receivable	4,489		4,489		4,385		4,385
Interest rate swaps	956		956		261		261

Level 3 inputs:
Loans and loans held for sale¹	1,022,008		995,564		999,445		1,001,346
Purchased receivables, net	20,323		20,323		22,231		22,231
Interest rate lock commitments	1,417		1,417		873		873
Mortgage servicing rights	8,733		8,733		7,305		7,305

Financial liabilities:
Level 2 inputs:
Deposits		$1,205,521		$1,204,467		$1,258,283		$1,257,670
Securities sold under repurchase agreements	27,695		27,695		27,746		27,746
Borrowings	7,312		7,023		7,362		7,308
Accrued interest payable	91		91		24		24
Interest rate swaps	151		151		77		77
Retail interest rate contracts	134		134		—		—
Level 3 inputs:
Junior subordinated debentures	10,310		10,202		10,310		9,856

¹Carrying amount is net of unearned income. In accordance with the prospective adoption of ASU 2016-01, the fair value of loans and loans held for sale as of June 30, 2018 was measured using an exit price notion. The fair value of loans as of December 31, 2017 was measured using an entry price notion.

The following table sets forth the balances as of the periods indicated of assets measured at fair value on a recurring basis:



(In Thousands)	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
June 30, 2018
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities		$208,692		$39,534		$169,158		$—
Municipal securities	11,935		—		11,935		—
Corporate bonds	37,490		20,641		16,849		—
Collateralized loan obligations	6,007		—		6,007		—
Total available for sale securities		$264,124		$60,175		$203,949		$—
Preferred stock		$6,006		$6,006		$—		$—
Total marketable equity securities		$6,006		$6,006		$—		$—
Interest rate swaps		$956		$—		$956		$—
Interest rate lock commitments	1,417		—		—		1,417
Mortgage servicing rights	8,733		—		—		8,733
Total other assets		$11,106		$—		$956		$10,150
Liabilities:
Interest rate swaps		$151		$—		$151		$—
Retail interest rate contracts	134		—		134		—
Total other liabilities		$285		$—		$285		$—
December 31, 2017
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities		$249,461		$49,878		$199,583		$—
Municipal securities	14,421		—		14,421		—
Corporate bonds	37,132		3,508		33,624		—
Collateralized loan obligations	6,005		—		6,005		—
Total available for sale securities		$307,019		$53,386		$253,633		$—
Preferred stock		$5,731		$5,731		$—		$—
Total marketable securities		$5,731		$5,731		$—		$—
Interest rate swaps		$261		$—		$261		$—
Interest rate lock commitments	873		—		—		873
Mortgage servicing rights	7,305		—		—		7,305
Total other assets		$8,439		$—		$261		$8,178
Liabilities:
Interest rate swaps		$77		$—		$77		$—
Total other liabilities		$77		$—		$77		$—

The following table provides a reconciliation of the assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three and six month periods ended June 30, 2018 and 2017:



(In Thousands)	Beginning balance		Change included in earnings			Purchases and issuances		Sales and settlements			Ending balance		Net change in unrealized gains (losses) relating to items held at end of period
Three Months Ended June 30, 2018
Interest rate lock commitments		$1,323		($602	)		$5,800		($5,104	)		$1,417		$1,417
Mortgage servicing rights	8,039		(118		)	812		—			8,733		—
Total		$9,362		($720	)		$6,612		($5,104	)		$10,150		$1,417
Three Months Ended June 30, 2017
Interest rate lock commitments		$1,534		($102	)		$4,445		($4,540	)		$1,337		$1,337
Mortgage servicing rights	5,325		(48		)	551		—			5,828		—
Total		$6,859		($150	)		$4,996		($4,540	)		$7,165		$1,337



(In Thousands)	Beginning balance		Change included in earnings			Purchases and issuances		Sales and settlements			Ending balance		Net change in unrealized gains (losses) relating to items held at end of period
Six Months Ended June 30, 2018
Interest rate lock commitments		$873		($1,002	)		$9,484		($7,938	)		$1,417		$1,417
Mortgage servicing rights	7,305		(144		)	1,572		—			8,733		—
Total		$8,178		($1,146	)		$11,056		($7,938	)		$10,150		$1,417
Six Months Ended June 30, 2017
Interest rate lock commitments		$1,137		($418	)		$7,501		($6,883	)		$1,337		$1,337
Mortgage servicing rights	4,157		234			1,437		—			5,828		—
Total		$5,294		($184	)		$8,938		($6,883	)		$7,165		$1,337

As of and for the periods ending June 30, 2018 and December 31, 2017, except for certain assets as shown in the following table, no impairment or valuation adjustment was recognized for assets recognized at fair value on a nonrecurring basis. For loans measured for impairment, the Company classifies fair value measurements using observable inputs, such as external appraisals, as Level 2 valuations in the fair value hierarchy, and unobservable inputs, such as in-house evaluations, as Level 3 valuations in the fair value hierarchy.



(In Thousands)	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
June 30, 2018
Loans measured for impairment		$373		$—		$—		$373
Total		$373		$—		$—		$373
December 31, 2017
Loans measured for impairment		$7,988		$—		$—		$7,988
Other real estate owned	3,927		—		—		3,927
Other assets - equity method investment	2,292		—		—		2,292
Total		$14,207		$—		$—		$14,207

The following table presents the gains and (losses) resulting from nonrecurring fair value adjustments for the three and six month periods ended June 30, 2018 and 2017:



	Three Months Ended June 30,					Six Months Ended June 30,
(In Thousands)	2018		2017			2018		2017
Loans measured for impairment		$299		$600			$893		$220
Other real estate owned	—		(100		)	—		(266		)
Total loss from nonrecurring measurements		$299		$500			$893		($46	)

Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3)

The following table provides a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a recurring and nonrecurring basis at June 30, 2018 and December 31, 2017:



Financial Instrument	Valuation Technique	Unobservable Input	Weighted Average Rate Range
June 30, 2018
Loans measured for impairment	In-house valuation of collateral	Discount rate	25% - 65%
Interest rate lock commitment	External pricing model	Pull through rate	92.22	%
Mortgage servicing rights	Discounted cash flow	Constant prepayment rate	7.66% - 9.79%
		Discount rate	9.87% - 11.00%
December 31, 2017
Loans measured for impairment	In-house valuation of collateral	Discount rate	32% - 40%
	Discounted cash flow	Discount rate	14	%
Other real estate owned	Fair value of collateral	Estimated capital costs to complete improvements	25% - 32%
Interest rate lock commitment	External pricing model	Pull through rate	93.05	%
Mortgage servicing rights	Discounted cash flow	Constant prepayment rate	8.94% - 11.34%
		Discount rate	9.42% - 10.05%

12. Segment Information

The Company's operations are managed along two operating segments: Community Banking and Home Mortgage Lending. The Community Banking segment's principal business focus is the offering of loan and deposit products to business and consumer customers in its primary market areas. As of June 30, 2018, the Community Banking segment operated 14 branches throughout Alaska. The Home Mortgage Lending segment's principal business focus is the origination and sale of mortgage loans for 1-4 family residential properties.

Summarized financial information for the Company's reportable segments and the reconciliation to the consolidated financial results is shown in the following tables:



	Three Months Ended June 30, 2018
(In Thousands)	Community Banking			Home Mortgage Lending		Consolidated

Interest income		$15,057			$538		$15,595
Interest expense	443			163		606
Net interest income	14,614			375		14,989
Benefit for loan losses	(300		)	—		(300		)
Other operating income	2,836			5,478		8,314
Other operating expense	11,748			4,858		16,606
Income before provision for income taxes	6,002			995		6,997
Provision for income taxes	882			285		1,167
Net income attributable to Northrim BanCorp, Inc.		$5,120			$710		$5,830



	Three Months Ended June 30, 2017
(In Thousands)	Community Banking		Home Mortgage Lending		Consolidated

Interest income		$14,482		$410		$14,892
Interest expense	529		119		648
Net interest income	13,953		291		14,244
Provision for loan losses	300		—		300
Other operating income	3,411		6,351		9,762
Other operating expense	13,284		5,226		18,510
Income before provision for income taxes	3,780		1,416		5,196
Provision for income taxes	871		584		1,455
Net income	2,909		832		3,741
Less: net income attributable to the noncontrolling interest	152		—		152
Net income attributable to Northrim BanCorp, Inc.		$2,757		$832		$3,589



	Six Months Ended June 30, 2018
(In Thousands)	Community Banking			Home Mortgage Lending		Consolidated

Interest income		$29,520			$870		$30,390
Interest expense	870			268		1,138
Net interest income	28,650			602		29,252
Benefit for loan losses	(300		)	—		(300		)
Other operating income	5,354			10,422		15,776
Other operating expense	24,115			9,286		33,401
Income before provision for income taxes	10,189			1,738		11,927
Provision for income taxes	1,541			494		2,035
Net income attributable to Northrim BanCorp, Inc.		$8,648			$1,244		$9,892



	Six Months Ended June 30, 2017
(In Thousands)	Community Banking		Home Mortgage Lending		Consolidated

Interest income		$28,597		$760		$29,357
Interest expense	1,095		185		1,280
Net interest income	27,502		575		28,077
Provision for loan losses	700		—		700
Other operating income	6,866		11,801		18,667
Compensation expense - RML acquisition payments	174		—		174
Other operating expense	24,906		10,045		34,951
Income before provision for income taxes	8,588		2,331		10,919
Provision for income taxes	2,293		963		3,256
Net income	6,295		1,368		7,663
Less: net income attributable to the noncontrolling interest	249		—		249
Net income attributable to Northrim BanCorp, Inc.		$6,046		$1,368		$7,414



June 30, 2018
(In Thousands)	Community Banking		Home Mortgage Lending		Consolidated

Total assets		$1,392,329		$78,111		$1,470,440
Loans held for sale		$—		$54,306		$54,306



December 31, 2017
(In Thousands)	Community Banking		Home Mortgage Lending		Consolidated

Total assets		$1,452,602		$65,994		$1,518,596
Loans held for sale		$—		$43,979		$43,979

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion should be read in conjunction with the unaudited consolidated financial statements of Northrim BanCorp, Inc. (the “Company”) and the notes thereto presented elsewhere in this report and with the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Except as otherwise noted, references to "we", "our", "us" or "the Company" refer to Northrim BanCorp, Inc. and its subsidiaries that are consolidated for financial reporting purposes.

Note Regarding Forward Looking-Statements

This quarterly report on Form 10-Q includes “forward-looking statements,” as that term is defined for purposes of Section 21E of the Securities Exchange Act of 1934, as amended, which are not historical facts. These forward-looking statements describe management’s expectations about future events and developments such as future operating results, growth in loans and deposits, continued success of the Company’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 “anticipate,” “believe,” “expect,” “intend” and similar expressions in part to help identify forward-looking statements. Forward-looking statements reflect management’s current plans and 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; our ability to maintain or expand our market share or net interest margin; our ability to maintain asset quality; our ability to implement our marketing and growth strategies; and our ability to execute our business plan. Further, actual results may be affected by competition 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 Part II. Item 1A Risk Factors of this report and Item 1A in the Company's Annual Report on Form 10-K for the year ended December 31, 2017, as well as in our other filings with the Securities and Exchange Commission. However, you should be aware that these factors are not an exhaustive list, and you should not assume these are the only factors that may cause our actual results to differ from our expectations. In addition, you should note that forward looking statements are made only as of the date of this report and that we do not intend to update any of the forward-looking statements or the uncertainties that may adversely impact those statements, other than as required by law.

Critical Accounting Policies

The preparation of the consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable; however, actual results may differ significantly from these estimates and assumptions which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and on our results of operations for the reporting periods.

The accounting policies that involve significant estimates and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities, are considered critical accounting policies. The Company’s critical accounting policies include those that address the accounting for the allowance for loan losses ("Allowance"), valuation of goodwill and other intangible assets, the valuation of other real estate owned, and the valuation of mortgage servicing rights. These critical accounting policies are further described in Item 7, Management’s Discussion and Analysis, and in Note 1, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. Management has applied its critical accounting policies and estimation methods consistently in all periods presented in these consolidated financial statements.

Update on Economic Conditions

The U.S Department of Commerce Bureau of Economic Analysis reports that Alaska has generated three consecutive quarters of Gross State Product growth, due in large part to the recent increases in the price of oil. According to the Alaska Department of Labor and Workforce Development, Alaska is still losing ground on wages, but the losses are getting smaller. In the fourth quarter of 2017, wages contracted by 0.5%. In addition, the State of Alaska Department of Labor estimates that employment decreased by 0.5% in June of this year compared to June of 2017.

The rising price of oil and news from successful exploratory wells on the North Slop by ConocoPhillips are bright spots for the Alaska economy, as expanded drilling activity is expected to bring jobs, increase tax revenues and generate opportunities for service providers throughout the state. A recent article by the Alaska Journal of Commerce noted that company leaders said July 16 that four more wells drilled into Willow early this year indicate the field could hold between 500 million and 1.1 billion barrels of gross resources that will cost between $4 billion and $6 billion to fully develop, with the first oil potentially in the 2024-25 time frame. It was also noted that roughly 75 percent of the company's prospective acreage in the area is yet to be drilled.

In June 2018, the Alaska state legislature passed and the governor signed a budget plan that significantly reduces the state budget deficit. For the first time since the Alaska Permanent Fund was established in 1976, the legislature authorized the state to allocate a portion of the earnings from the $65 billion Fund to cover operating expenses for the state.

The Federal Open Market Committee ("FOMC") increased the target federal funds rate in June of 2018 from 1.75% to 2.00%. Along with the rate increase came a notable change to the FOMC's statement. Language indicating that it expected the economy to grow at a pace warranting "gradual" rate increases was removed, which is a signal that it may raise rates four times in 2018, up from the three increases expected earlier this year.

Highlights and Summary of Performance - Second Quarter of 2018

The Company reported net income attributable to the Company and diluted earnings per share of $5.8 million and $0.84, respectively, for the second quarter of 2018 compared to net income attributable to the Company and diluted earnings per share of $3.6 million and $0.51, respectively, for the second quarter of 2017. The Company reported net income attributable to the Company and diluted earnings per share of $9.9 million and $1.42, respectively, for the first six months of 2018 compared to net income attributable to the Company and diluted earnings per share of $7.4 million and $1.06, respectively, for the same period in 2017. The increase in net income in both of these periods is primarily due to an increase in net interest income mostly due to increases in interest rates, a decrease in other operating expense due to one-time costs associated with the core conversion that were incurred in 2017, a decrease in the provision for loan losses due to a decline in specific impairment and improving qualitative factors in the Company's calculation of the Allowance, and a decrease in the provision for income taxes resulting from enacted federal tax legislation that lowered federal corporate tax rates effective January 1, 2018. The Company's effective tax rate decreased to 17% in the second quarter of 2018 as compared to 28% in the second quarter of 2017.

Other financial measures are shown in the table below:



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
Return on average assets	1.58	%	0.96	%	1.34	%	1.00	%
Return on average shareholders' equity	11.79	%	7.43	%	10.13	%	7.86	%
Dividend payout ratio	28.56	%	40.87	%	33.67	%	39.44	%

Credit Quality

Nonperforming assets: Nonperforming assets, net of government guarantees at June 30, 2018 decreased $4.7 million, or 17% to $24.0 million as compared to $28.7 million at December 31, 2017. Other real estate owned ("OREO"), net of government guarantees, increased $361,000 to $7.7 million at June 30, 2018 as compared to $7.3 million at December 31, 2017 as additions to OREO, which were comprised of four single-family mortgage properties, were only partially offset by sales of OREO during the period. Nonperforming loans, net of government guarantees decreased $5.1 million during the first six months of 2018 as compared to December 31, 2017, primarily due to paydowns. Nonperforming purchased receivables were zero at both June 30, 2018 and December 31, 2017.

The following table summarizes OREO activity for the three and six month periods ending June 30, 2018 and 2017:



	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
	(In Thousands)
Balance, beginning of the period		$8,815			$5,802			$8,651			$6,574
Transfers from loans	300			167			535			167
Proceeds from the sale of other real estate owned	(205		)	(1,668		)	(276		)	(2,315		)
Gain on sale of other real estate owned, net	49			114			49			155
Impairment on other real estate owned	—			(100		)	—			(266		)
Balance at end of period	8,959			4,315			8,959			4,315
Government guarantees	(1,280		)	—			(1,280		)	—
Balance at end of period, net of government guarantees		$7,679			$4,315			$7,679			$4,315

Potential problem loans: Potential problem loans are loans which are currently performing in accordance with contractual terms but 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 impaired loans. These loans are closely monitored and their performance is reviewed by management on a regular basis. At June 30, 2018, management had identified potential problem loans of $11.3 million as compared to potential problem loans of $9.5 million at December 31, 2017. The increase in potential problem loans from December 31, 2017 to June 30, 2018 is primarily the result of the addition of four commercial relationships.

Troubled debt restructurings (“TDRs”): TDRs are those loans 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 TDRs 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, which is generally after a period of six months. The Company had $9.1 million in loans classified as TDRs that were performing and $14.7 million in TDRs included in nonaccrual loans at June 30, 2018 for a total of approximately $23.8 million. At December 31, 2017 there were $7.7 million in loans classified as TDRs that were performing and $16.2 million in TDRs included in nonaccrual loans for a total of $23.8 million. The increase in performing TDRs at June 30, 2018 is primarily the result of the restructuring of three loans within one relationship in the first six months of 2018. The decrease in TDRs included in nonaccrual loans at June 30, 2018 is the result of pay downs in the first six months of 2018, which were only partially offset by the restructuring of three loans within one relationship during the same period. See Note 5 of the Notes to Consolidated Financial Statements included in Item 1 of this report for further discussion of TDRs.

RESULTS OF OPERATIONS

Income Statement

Net Income

Net income attributable to the Company for the second quarter of 2018 increased $2.2 million, or 62%, to $5.8 million as compared to $3.6 million for the same period in 2017. Net income attributable to the Company for the first half of 2018 increased $2.5 million, or 33%, to $9.9 million compared to $7.4 million in the first half of 2017. Both periods included increases in net interest income and decreases in other operating expenses, the provision for loan losses, and the provision for income taxes.

Net Interest Income/Net Interest Margin

Net interest income for the second quarter of 2018 increased $745,000, or 5%, to $15.0 million as compared to $14.2 million for the second quarter in 2017. Net interest margin increased 30 basis points to 4.50% in the second quarter of 2018 as compared to 4.20% in the second quarter of 2017. Net interest income for the first half of 2018 increased $1.2 million, or 4%, to $29.3 million as compared to $28.1 million for the first half of 2017. Net interest margin increased 22 basis points to 4.39% in the first half of 2018 as compared to 4.17% in the second quarter of 2017. The increases in net interest income in both of these periods was primarily the result of higher interest income on all interest-earning assets as well as lower interest expense on deposits and borrowings compared to the same periods in 2017. Changes in net interest margin in both the quarter and six months ended June 30, 2018 as compared to the same period in the prior year are detailed below:



	Three Months Ended June 30, 2018 vs. June 30, 2017
Nonaccrual interest adjustments	—	%
Interest rates and loan fees	0.24	%
Volume and mix of interest-earning assets	0.06	%
Change in NIM	0.30	%



	Six Months Ended June 30, 2018 vs. June 30, 2017
Nonaccrual interest adjustments	—	%
Interest rates and loan fees	0.18	%
Volume and mix of interest-earning assets	0.04	%
Change in NIM	0.22	%

Components of Net Interest Margin

The following table compares average balances and rates as well as net tax equivalent margins on earning assets for the three-month periods ended June 30, 2018 and 2017:



(Dollars in Thousands)	Three Months Ended June 30,
												Interest income/									Average Yields/Costs
	Average Balances						Change					expense				Change					Tax Equivalent
	2018			2017			$			%		2018		2017		$			%		2018		2017		Change
Loans^1,2		$963,724			$969,051			($5,327	)	(1	)%		$13,513		$13,205		$308		2	%	5.65	%	5.51	%	0.14	%
Loans held for sale	48,608			40,906			7,702			19	%	523		396		127			32	%	4.32	%	3.88	%	0.44	%

Short-term investments³	35,846			25,489			10,357			41	%	159		64		95			148	%	1.75	%	1.00	%	0.75	%
Long-term investments⁴	287,003			325,515			(38,512		)	(12	)%	1,400		1,227		173			14	%	2.09	%	1.65	%	0.44	%
Total investments	322,849			351,004			(28,155		)	(8	)%	1,559		1,291		268			21	%	2.06	%	1.61	%	0.45	%
Interest-earning assets	1,335,181			1,360,961			(25,780		)	(2	)%	15,595		14,892		703			5	%	4.74	%	4.45	%	0.29	%
Nonearning assets	145,520			145,859			(339		)	—	%
Total		$1,480,701			$1,506,820			($26,119	)	(2	)%

Interest-bearing demand		$247,283			$213,832			$33,451		16	%		$34		$3		$31		1,033	%	0.06	%	0.03	%	0.03	%
Savings deposits	243,611			250,277			(6,666		)	(3	)%	127		131		(4		)	(3	)%	0.21	%	0.10	%	0.11	%
Money market deposits	231,734			240,603			(8,869		)	(4	)%	154		117		37			32	%	0.27	%	0.09	%	0.18	%
Time deposits	95,964			131,405			(35,441		)	(27	)%	131		200		(69		)	(35	)%	0.55	%	0.66	%	(0.11	)%
Total interest-bearing deposits	818,592			836,117			(17,525		)	(2	)%	446		451		(5		)	(1	)%	0.22	%	0.22	%	—	%
Borrowings	44,897			51,976			(7,079		)	(14	)%	160		197		(37		)	(19	)%	1.40	%	1.49	%	(0.09	)%
Total interest-bearing liabilities	863,489			888,093			(24,604		)	(3	)%	606		648		(42		)	(6	)%	0.28	%	0.29	%	(0.01	)%
Demand deposits and other noninterest-bearing liabilities	418,937			425,071			(6,134		)	(1	)%
Equity	198,275			193,656			4,619			2	%
Total		$1,480,701			$1,506,820			($26,119	)	(2	)%
Net interest income													$14,989		$14,244		$745		5	%
Net interest margin																					4.50	%	4.20	%	0.30	%
Average loans to average interest-earning assets	72.18		%	71.20		%
Average loans to average total deposits	79.13		%	77.86		%
Average non-interest deposits to average total deposits	32.79		%	32.82		%
Average interest-earning assets to average interest-bearing liabilities	154.63		%	153.25		%

¹Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled $671,000 and $889,000 in the second quarter of 2018 and 2017, respectively.

²Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loan balances were $17.5 million and $15.2 million in the second quarter of 2018 and 2017, respectively.

³Consists of interest bearing deposits in other banks.

⁴Consists of investment debt securities available for sale, equity securities, investment securities held to maturity, and investment in Federal Home Loan Bank stock.

The following tables set forth the changes in consolidated net interest income attributable to changes in volume and to changes in interest rates for the three-month periods ending June 30, 2018 and 2017. 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 rates:



(In Thousands)	Three Months Ended June 30, 2018 vs. 2017
	Increase (decrease) due to
	Volume			Rate			Total
Interest Income:
Loans		($11	)		$319			$308
Loans held for sale	79			48			127
Short-term investments	33			62			95
Long-term investments	(138		)	311			173
Total interest income		($37	)		$740			$703

Interest Expense:
Interest-bearing deposits		($5	)		$—			($5	)
Borrowings	(25		)	(12		)	(37		)
Total interest expense		($30	)		($12	)		($42	)

The following table compares average balances and rates as well as net tax equivalent margins on earning assets for the six-month periods ended June 30, 2018 and 2017:



(Dollars in Thousands)	Six Months Ended June 30,
												Interest income/									Average Yields/Costs
	Average Balances						Change					expense				Change					Tax Equivalent
	2018			2017			$			%		2018		2017		$			%		2018		2017		Change
Loans^1,2		$959,743			$969,768			($10,025	)	(1	)%		$26,459		$26,108		$351		1	%	5.59	%	5.47	%	0.12	%
Loans held for sale	41,594			37,688			3,906			10	%	840		731		109			15	%	4.07	%	3.91	%	0.16	%

Short-term investments³	41,977			24,495			17,482			71	%	343		112		231			206	%	1.63	%	0.91	%	0.72	%
Long-term investments⁴	300,476			324,639			(24,163		)	(7	)%	2,748		2,406		342			14	%	1.96	%	1.62	%	0.34	%
Total investments	342,453			349,134			(6,681		)	(2	)%	3,091		2,518		573			23	%	1.94	%	1.58	%	0.36	%
Interest-earning assets	1,343,790			1,356,590			(12,800		)	(1	)%	30,390		29,357		1,033			4	%	4.61	%	4.43	%	0.18	%
Nonearning assets	143,565			142,650			915			1	%
Total		$1,487,355			$1,499,240			($11,885	)	(1	)%

Interest-bearing demand		$242,961			$202,978			$39,983		20	%		$58		$19		$39		205	%	0.05	%	0.03	%	0.02	%
Savings deposits	245,381			248,557			(3,176		)	(1	)%	249		260		(11		)	(4	)%	0.20	%	0.10	%	0.10	%
Money market deposits	238,186			241,395			(3,209		)	(1	)%	260		220		40			18	%	0.22	%	0.09	%	0.13	%
Time deposits	97,510			132,305			(34,795		)	(26	)%	251		397		(146		)	(37	)%	0.52	%	0.61	%	(0.09	)%
Total interest-bearing deposits	824,038			825,235			(1,197		)	—	%	818		896		(78		)	(9	)%	0.20	%	0.22	%	(0.02	)%
Borrowings	45,577			52,275			(6,698		)	(13	)%	320		384		(64		)	(17	)%	1.39	%	1.45	%	(0.06	)%
Total interest-bearing liabilities	869,615			877,510			(7,895		)	(1	)%	1,138		1,280		(142		)	(11	)%	0.26	%	0.29	%	(0.03	)%
Demand deposits and other noninterest-bearing liabilities	420,847			431,403			(10,556		)	(2	)%
Equity	196,893			190,327			6,566			3	%
Total		$1,487,355			$1,499,240			($11,885	)	(1	)%
Net interest income													$29,252		$28,077		$1,175		4	%
Net interest margin																					4.39	%	4.17	%	0.22	%
Average loans to average interest-earning assets	71.42		%	71.49		%
Average loans to average total deposits	78.30		%	78.35		%
Average non-interest deposits to average total deposits	32.77		%	33.33		%
Average interest-earning assets to average interest-bearing liabilities	154.53		%	154.60		%

¹Interest income includes loan fees. Loan fees recognized during the period and included in the yield calculation totaled $1.3 million and $1.8 million in the first six months of 2018 and 2017, respectively.

²Nonaccrual loans are included with a zero effective yield. Average nonaccrual loans included in the computation of the average loan balances were $18.9 million and $14.8 million in the first six months of 2018 and 2017, respectively.

³Consists of interest bearing deposits in other banks.

⁴Consists of investment debt securities available for sale, equity securities, investment securities held to maturity, and investment in Federal Home Loan Bank stock.

The following tables set forth the changes in consolidated net interest income attributable to changes in volume and to changes in interest rates for the six-month periods ending June 30, 2018 and 2017. 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 rates:



(In Thousands)	Six Months Ended June 30, 2018 vs. 2017
	Increase (decrease) due to
	Volume			Rate			Total
Interest Income:
Loans		($62	)		$413			$351
Loans held for sale	78			31			109
Short-term investments	110			121			231
Long-term investments	(188		)	530			342
Total interest income		($62	)		$1,095			$1,033

Interest Expense:
Interest-bearing deposits		($1	)		($77	)		($78	)
Borrowings	(48		)	(16		)	(64		)
Total interest expense		($49	)		($93	)		($142	)

Provision for Loan Losses

The provision for loan losses was a benefit of $300,000 for the three and six month periods ending June 30, 2018. The provision for loan losses for the three and six month periods ending June 30, 2017 was $300,000 and $700,000, respectively. The provision for loan losses decreased in both periods of 2018 as compared to the same periods a year ago due to a decrease in impairment for specifically measured loans and an improvement in the qualitative factors that management utilizes in the calculation of the allowance for loan losses ("Allowance"). Nonperforming loans, net of government guarantees decreased in the second quarter of 2018 and adversely classified loans remained consistent with 2017 ending balances. The ratio of the Allowance to total nonperforming loans, net of government guarantees was 123% at June 30, 2018 as compared to 100% at December 31, 2017. See "Analysis of the Allowance for Loan Losses" under the "Financial Condition-Balance Sheet Overview" and Note 6 of the Notes to Consolidated Financial Statements included in Item 1 of this report for more information on changes in the Company's Allowance.

Other Operating Income

Other operating income for the three-month period ended June 30, 2018, decreased $1.4 million, or 15%, to $8.3 million as compared to the same period in 2017 primarily due to a $961,000 decrease in employee benefit plan income and an $873,000 decrease in mortgage banking income. Other operating income for the six-month period ended June 30, 2018, decreased $2.9 million, or 15%, to $15.8 million as compared to the same period in 2017 primarily due to a $1.9 million decrease in employee benefit plan income and a $1.4 million decrease in mortgage banking income. The decrease in employee benefit plan income in both periods resulted from the sale of the Company's interest in Northrim Benefits Group, LLC ("NBG") in the third quarter of 2017. Decreased mortgage banking income was primarily the result of decreased yield on mortgage loans sold for both periods.

Other Operating Expense

Other operating expense for the second quarter of 2018 decreased $1.9 million, or 10%, to $16.6 million as compared to the same period in 2017 due to a $1.5 million, or 12%, decrease in the Community Banking segment and a $368,000, or 7%, decrease in the Home Mortgage Lending segment. In the Community Banking segment, other operating expenses in the second quarter of 2017 included $633,000 of one-time costs related to the conversion of the Company's core system which occurred in May 2017. Additionally, occupancy expense in the second quarter of 2018 included a one-time cumulative technical correction that decreased depreciation expense in the period by $670,000. Marketing expense decreased $410,000 in the second quarter of 2018 as compared to the second quarter of 2017 primarily due to a reduction in charitable contributions, however the Company expects total charitable contributions expense in 2018 to be consistent with 2017 by the end of the year. The decrease in expense in the Home Mortgage Lending segment in the second quarter of 2018 compared to the same period in 2017 is primarily due to a reduction in salaries and benefit costs that resulted from a reduction of full time equivalent employees at RML.

Other operating expense for the first six months of 2018 decreased $1.7 million, or 5%, to $33.4 million as compared to the same period in 2017 due to a $912,000, or 4%, decrease in the Community Banking segment and a $759,000, or 8%, decrease in the Home Mortgage Lending segment. In the Community Banking segment, other operating expenses included $764,000 of one-time costs related to the conversion of the Company's core system which occurred in May 2017. Additionally, occupancy expense included a one-time technical correction for depreciation expense of $670,000. These decreases were partially offset by increases of $290,000, $139,000, and $132,000, in employee group medical costs, Company 401(k) match contributions to employees, and equity compensation expense. The decrease in the expenses in the Home Mortgage Lending segment in the first six months of 2018 compared to the same period in 2017 is primarily due to a reduction in salaries and benefit costs that resulted from a reduction of full time equivalent employees at RML.

Income Taxes

The provision for income taxes for the three and six month periods ending June 30, 2018, decreased $288,000 or 20%, and $1.2 million, or 38%, as compared to the same periods in 2017, primarily due to a decrease in the enacted federal corporate tax rate that was partially offset by an increase in pre-tax income. The effective tax rate for the three-month period ending June 30, 2018 decreased to 17% from 28%, and the effective tax rate for the six-month period ending June 30, 2018 decreased to 17% from 30% compared to the same periods in 2017.

FINANCIAL CONDITION

Balance Sheet Overview

Investment Securities

Investment securities at June 30, 2018 decreased 14%, or $42.6 million, to $270.1 million from $312.8 million at December 31, 2017 primarily due to a decrease in deposits during the same period. Additionally, some proceeds from maturities and security calls were invested in portfolio loans in the first six months of 2018. The table below details portfolio investment balances by portfolio investment type:



	June 30, 2018				December 31, 2017
	Dollar Amount		Percent of Total		Dollar Amount		Percent of Total
(In Thousands)	Dollar Amount		Percent of Total		Dollar Amount		Percent of Total
	Balance		% of total		Balance		% of total
U.S. Treasury and government sponsored entities		$208,692	77.3	%		$249,461	79.8	%
Municipal securities	11,935		4.4	%	14,421		4.6	%
Corporate bonds	37,490		13.9	%	37,132		11.9	%
Collateralized loan obligations	6,007		2.2	%	6,005		1.9	%
Preferred stock	6,006		2.2	%	5,731		1.8	%
Total portfolio investments		$270,130				$312,750

Loans and Lending Activities

Our loan products include short and medium-term commercial loans, commercial credit lines, construction and real estate loans, and consumer loans. From our inception, we have emphasized commercial, land development and home construction, and commercial real estate lending. This type of lending has generally provided us with market opportunities and higher net interest margins than other types of lending. However, it also involves greater risks, including greater exposure to changes in local economic conditions, than certain other types of lending.

Portfolio loans increased by $12.7 million, or 1%, to $967.7 million at June 30, 2018 from $955.0 million at December 31, 2017, primarily as a result of increased commercial loans, real estate term loans relating to non-owner occupied properties, and other term real estate loans. This increase was partially offset by decreased real estate construction loans in the first six months of 2018 due to the term out of construction projects that were completed in the first six months of 2018. Real estate construction one-to-four family loans, which are mostly residential housing construction loans remained consistent at 3% of portfolio loans at both June 30, 2018 and December 31, 2017.

The following table details loan balances by loan type as of the dates indicated:



	June 30, 2018					December 31, 2017
	Dollar Amount			Percent of Total		Dollar Amount			Percent of Total
(In Thousands)	Dollar Amount			Percent of Total		Dollar Amount			Percent of Total
Commercial		$327,733		33.9	%		$313,514		32.8	%
Real estate construction one-to-four family	31,064			3.2	%	31,201			3.3	%
Real estate construction other	58,369			6.0	%	80,093			8.4	%
Real estate term owner occupied	127,384			13.2	%	132,042			13.8	%
Real estate term non-owner occupied	330,217			34.0	%	319,313			33.4	%
Real estate term other	55,431			5.7	%	40,411			4.2	%
Consumer secured by 1st deeds of trust	20,820			2.2	%	22,616			2.4	%
Consumer other	20,891			2.2	%	19,919			2.1	%
Subtotal		$971,909					$959,109
Less: Unearned origination fee,
net of origination costs	(4,207		)	(0.4	)%	(4,156		)	(0.4	)%
Total loans		$967,702					$954,953

Information about loans directly exposed to the oil and gas industry

The Company defines "direct exposure" to the oil and gas industry as companies that it has identified as significantly reliant upon activity related to the oil and gas industry, such as oilfield services, lodging, equipment rental, transportation, and other logistic services specific to the industry. The Company estimates that $60.6 million, or approximately 6% of loans as of June 30, 2018 have direct exposure to the oil and gas industry as compared to $70.8 million, or approximately 7% of loans as of December 31, 2017. The Company has no loans to oil producers or exploration companies as of June 30, 2018 or December 31, 2017, but the totals noted include a loan related to construction of an oil rig. The balance of this loan was $7.3 million and $9.2 million at June 30, 2018 and December 31, 2017, respectively, and is classified as an AQR pass loan in both periods. The Company's unfunded commitments to borrowers that have direct exposure to the oil and gas industry was $38.1 million and $53.5 million at June 30, 2018 and December 31, 2017, respectively. The portion of the Company's allowance for loan losses that related to the loans with direct exposure to the oil and gas industry was estimated at $1.5 million and $1.8 million as of June 30, 2018 and December 31, 2017, respectively.

The following table details loan balances by loan segment and class of financing receivable for loans with direct oil and gas exposure as of the dates indicated:



(In Thousands)	Commercial		Real estate construction one-to-four family		Real estate construction other		Real estate term owner occupied		Real estate term non-owner occupied		Real estate term other		Consumer secured by 1st deeds of trust		Consumer other		Total
June 30, 2018
AQR Pass		$38,817		$—		$—		$5,280		$7,571		$—		$—		$417		$52,085
AQR Special Mention	—		—		—		2,407		—		—		—		—		2,407
AQR Substandard	6,093		—		—		—		—		—		—		—		6,093
Total		$44,910		$—		$—		$7,687		$7,571		$—		$—		$417		$60,585
December 31, 2017
AQR Pass		$48,601		$—		$—		$9,731		$7,778		$—		$—		$435		$66,545
AQR Substandard	4,234		—		—		—		—		—		—		—		4,234
Total		$52,835		$—		$—		$9,731		$7,778		$—		$—		$435		$70,779

Analysis of Allowance for Loan Losses

The Company maintains an Allowance to reflect management's assessment of probable, estimable losses inherent in the loan portfolio. The Allowance is increased by provisions for loan losses and loan recoveries and decreased by loan charge-offs. The size of the Allowance is determined through quarterly assessments of probable estimated losses in the loan portfolio. Our methodology for making such assessments and determining the adequacy of the Allowance includes the following key elements:

•

A specific allocation for impaired loans. Management determines the fair value of the majority of these loans based on the underlying collateral values. This analysis is based upon a specific analysis for each impaired loan, including external appraisals on loans secured by real property, management’s assessment of the current market, recent payment history, and an evaluation of other sources of repayment. In-house evaluations of fair value are used in the impairment analysis in some situations. Inputs to the in-house evaluation process include information about sales of comparable properties in the appropriate markets and changes in tax assessed values. The Company obtains appraisals on real and personal property that secure its loans during the loan origination process in accordance with regulatory guidance and its loan policy. The Company obtains updated appraisals on loans secured by real or personal property based upon its assessment of changes in the current market or particular projects or properties, information from other current appraisals, and other sources of information. Appraisals may be adjusted downward by the Company based on its evaluation of the facts and circumstances on a case by case basis. External appraisals may be discounted when management believes that the absorption period used in the appraisal is unrealistic, when expected liquidation costs exceed those included in the appraisal, or when management’s evaluation of deteriorating market conditions warrants an adjustment. Additionally, the Company may also adjust appraisals in the above circumstances between appraisal dates. The Company uses the information provided in these updated appraisals along with its evaluation of all other information available on a particular property as it assesses the collateral coverage on its performing and nonperforming loans and the impact that may have on the adequacy of its Allowance. The specific allowance for impaired loans, as well as the overall Allowance, may increase based on the Company’s assessment of updated appraisals. See Note 11 of the Notes to Consolidated Financial

Statements included in Item 1 of this report for further discussion of the Company’s estimation of impaired loans measured at fair value.

When the Company determines that a loss has occurred on an impaired loan, a charge-off equal to the difference between carrying value and fair value is recorded. If a specific allowance is deemed necessary for a loan, and then that loan is partially charged off, the loan remains classified as a nonperforming loan after the charge-off is recognized.

•

A general allocation. The Company has identified segments and classes of loans not considered impaired for purposes of establishing the general allocation allowance. The Company disaggregates the loan portfolio into segments and classes based on its assessment of how different pools of loans with like characteristics in the portfolio behave over time. This determination is based on historical experience and management’s assessment of how current facts and circumstances are expected to affect the loan portfolio.

The Company first disaggregates the loan portfolio into the following eight segments: commercial, real estate construction one-to-four family, real estate construction other, real estate term owner occupied, real estate term non- owner occupied, real estate term other, consumer secured by 1st deeds of trust, and other consumer loans. After division of the loan portfolio into segments, the Company then further disaggregates each of the segments into classes. The Company has a total of five classes, which are based off of the Company's loan risk grading system known as the Asset Quality Rating (“AQR”) system. The risk ratings are discussed in Note 5 to the Consolidated Financial Statements included in Item 8 of the Company's Annual Report on Form 10-K for the year ending December 31, 2017. There are five loan classes: pass (pass AQR grades, which are grades 1 – 6), special mention, substandard, doubtful, and loss. There have been no changes to these loan classes in 2018.

After the portfolio has been disaggregated into segments and classes, the Company calculates a general reserve for each segment and class based on the average loss history for each segment and class. The Company uses a look-back period of five years in the calculation of average historical loss rates. After the Company calculates a general allocation using our loss history, the general reserve is then adjusted for qualitative factors by segment and class. Qualitative factors are based on management’s assessment of current trends that may cause losses inherent in the current loan portfolio to differ significantly from historical losses. Some factors that management considers in determining the qualitative adjustment to the general reserve include our concentration of large borrowers; national and local economic trends; general business conditions; trends in local real estate markets; economic, political, and industry specific factors that affect resource development in Alaska; effects of various political activities; peer group data; and internal factors such as underwriting policies and expertise of the Company’s employees.

•

An unallocated reserve. The unallocated portion of the Allowance provides for other credit losses inherent in our loan portfolio that may not have been contemplated in the specific and general components of the Allowance, and it acknowledges the inherent imprecision of all loss prediction models. The unallocated component is reviewed periodically based on trends in credit losses and overall economic conditions. At June 30, 2018 and December 31, 2017, the unallocated allowance as a percentage of the total Allowance was 13% and 16%, respectively.

The following table sets forth information regarding changes in the Allowance for the periods indicated:



	Three Months Ended June 30,					Six Months Ended June 30,
(In Thousands)	2018			2017		2018			2017
Balance at beginning of period		$20,449			$19,893		$21,461			$19,697
Charge-offs:
Commercial	77			202		1,042			464
Real estate term other	—			5		—			5
Consumer secured by 1st deeds of trust	2			—		91			—
Consumer other	21			—		71			17
Total charge-offs	100			207		1,204			486
Recoveries:
Commercial	54			71		143			144
Real estate term other	1			—		2			—
Consumer secured by 1st deeds of trust	—			2		1			2
Consumer other	4			2		5			4
Total recoveries	59			75		151			150
Net, charge-offs	41			132		1,053			336
(Benefit) provision for loan losses	(300		)	300		(300		)	700
Balance at end of period		$20,108			$20,061		$20,108			$20,061

While management believes that it uses the best information available to determine the Allowance, unforeseen market conditions and other events could result in adjustment to the Allowance, and net income could be significantly affected if circumstances differed substantially from the assumptions used in making the final determination of the Allowance. Moreover, bank regulators frequently monitor banks' loan loss allowances, and if regulators were to determine that the Company’s Allowance is inadequate, they may require the Company to increase the Allowance, which may adversely impact the Company’s net income and financial condition.

Deposits

Deposits are the Company’s primary source of funds. Total deposits decreased $52.8 million to $1.206 billion at June 30, 2018 from $1.258 billion at December 31, 2017. The following table summarizes the Company's composition of deposits as of the periods indicated:



	June 30, 2018				December 31, 2017
(In thousands)	Balance		% of total		Balance		% of total
Demand deposits		$401,925	33	%		$414,686	33	%
Interest-bearing demand	246,628		20	%	252,009		20	%
Savings deposits	237,978		20	%	247,458		20	%
Money market deposits	223,189		19	%	243,603		19	%
Time deposits	95,801		8	%	100,527		8	%
Total deposits		$1,205,521				$1,258,283

The Company’s mix of deposits continues to contribute to a low cost of funds with balances in transaction accounts representing 92% of total deposits at June 30, 2018 and December 31, 2017.

The only deposit category with stated maturity dates is certificates of deposit. At June 30, 2018, the Company had $95.8 million in certificates of deposit as compared to certificates of deposit of $100.5 million at December 31, 2017. At June 30, 2018, $61.2 million, or 64%, of the Company’s certificates of deposits are scheduled to mature over the next 12 months as compared to $66.0 million, or 66%, of total certificates of deposit at December 31, 2017. The aggregate amount of certificates of deposit in amounts of $100,000 and greater at June 30, 2018 and December 31, 2017, was $57.8 million and $61.4 million, respectively.

The following table sets forth the amount outstanding of deposits in amounts of $100,000 and greater by time remaining until maturity and percentage of total deposits as of June 30, 2018:



	Time Certificates of Deposit
	of $100,000 or More
			Percent of Total Deposits
(In Thousands)	Amount		Percent of Total Deposits
Amounts maturing in:
Three months or less		$15,792	27	%
Over 3 through 6 months	7,736		13	%
Over 6 through 12 months	13,601		24	%
Over 12 months	20,713		36	%
Total		$57,842	100	%

There were no depositors with deposits representing 10% or more of total deposits at June 30, 2018 or December 31, 2017.

Borrowings

FHLB: Northrim Bank (the "Bank") is a member of the Federal Home Loan Bank of Des Moines (the "FHLB"). As a member, the Bank is eligible to obtain advances from the FHLB. FHLB advances are dependent on the availability of acceptable collateral such as marketable securities or real estate loans, although all FHLB advances are secured by a blanket pledge of the Bank’s assets. At June 30, 2018, our maximum borrowing line from the FHLB was $509.3 million, approximately 35% of the Bank’s assets, subject to the FHLB’s collateral requirements. The Company has outstanding advances of $7.3 million as of June 30, 2018 which were originated to match fund low income housing projects that qualify for long term fixed interest rates. The first advance is a $2.0 million FHLB Community Investment Program advance which was originated on March 22, 2013. It has an eighteen year term with a 30 year amortization period, which mirrors the term of the term real estate loan made to the borrower, and a fixed rate of 3.12%. The second advance is a $2.2 million FHLB Community Investment Cash Advance Program advance that was originated in the second quarter of 2016. This advance has a 20 year term with a 30 year amortization period, which mirrors the term of the term real estate loan made to the borrower, and a fixed interest rate of 2.61%. The last advance is a $3.1 million FHLB Community Investment Cash Advance Program advance that was originated in the third quarter of 2017. This advance has a 20 year term with a 30 year amortization period and a fixed interest rate of 3.25%, which mirrors the term of the loan made to the borrower. All of these FHLB advances are included in borrowings.

Federal Reserve Bank: The Federal Reserve Bank of San Francisco (the "Federal Reserve Bank") is holding $70.7 million of loans as collateral to secure advances made through the discount window on June 30, 2018. There were no discount window advances outstanding at June 30, 2018 or December 31, 2017.

Other Short-term Borrowings: Securities sold under agreements to repurchase were $27.7 million, for both June 30, 2018 and December 31, 2017. The average balance outstanding of securities sold under agreements to repurchase during the three month periods ending June 30, 2018 and 2017 was $27.3 million and $27.9 million, respectively, and $27.9 million and $28.2 million, respectively, in the six month periods ending June 30, 2018 and 2017. The maximum outstanding at any month-end was $27.7 million and $27.8 million, respectively, during the same three month periods ending June 30, 2018 and 2017 and $31.0 and $31.8 million, respectively, for the six month periods ending June 30, 2018 and 2017. The securities sold under agreements to repurchase are held by the FHLB under the Company’s control.

The Company is subject to provisions under Alaska state law, which generally limit the amount of outstanding debt to 15% of total assets or $218.3 million and $225.8 million at June 30, 2018 and December 31, 2017, respectively.

At June 30, 2018 and December 31, 2017, the Company had no short-term (original maturity of one year or less) borrowings that exceeded 30% of shareholders’ equity.

Long-term Borrowings. The Company had no long-term borrowing outstanding other than the FHLB advance noted above as of June 30, 2018 or December 31, 2017.

Liquidity and Capital Resources

The Company is a single bank holding company and its primary ongoing source of liquidity is from dividends received from the Bank. Such dividends arise from the cash flow and earnings of the Bank. Banking regulations and regulatory authorities may limit the amount of, or require the Bank to obtain certain approvals before paying, dividends to the Company. Given that the Bank currently meets and the Bank anticipates that they will continue to meet, all applicable capital adequacy requirements for a “well-capitalized” institution by regulatory standards, the Company expects to continue to receive dividends from the Bank during 2018.

The Company manages its liquidity through its Asset and Liability Committee. Our primary sources of funds are customer deposits and advances from the FHLB. These funds, together with loan repayments, loan sales, other borrowed funds, retained earnings, and equity are used to make loans, to acquire securities and other assets, and to fund deposit flows and continuing operations. The primary sources of demands on our liquidity are customer demands for withdrawal of deposits and borrowers' demands that we advance funds against unfunded lending commitments. Our total unfunded commitments to fund loans and letters of credit at June 30, 2018 were $241.4 million. 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 June 30, 2018 were $1.206 billion.

As shown in the Consolidated Statements of Cash Flows included in Part I - Item 1 "Financial Statements" of this report, net cash used in operating activities was $13.5 million for the first six months of 2018 primarily due to an increase in other accounts receivable and cash used in connection with the origination of loans held for sale being only partially offset by proceeds from the sale of loans held for sale. Net cash provided by investing activities was $28.0 million for the same period, primarily due proceeds from maturities of investment securities, which were only partially offset by cash invested into portfolio loans and purchases of new investment securities. Net cash used in financing activities in the first half of 2018 was $56.2 million, primarily due to a decrease in deposits.

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 June 30, 2018, our funds available for borrowing under our existing lines of credit were $572.5 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 to fund our ongoing operating activities and our anticipated capital requirements for at least 12 months.

The Company issued 996 shares of its common stock in the first six months of 2018 and did not repurchase any shares of its common stock under the Company's publicly announced repurchase program. At June 30, 2018, the Company had 6,872,959 shares of its common stock outstanding.

Capital Requirements and Ratios

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 June 30, 2018, that the Company and the Bank met all applicable capital adequacy requirements for a “well-capitalized” institution by regulatory standards.

The table below illustrates the capital requirements in effect in 2018 for the Company and the Bank and the actual capital ratios for each entity that exceed these requirements. Management intends to maintain capital ratios for the Bank in 2018, exceeding the FDIC’s requirements for the “well-capitalized” classification. The capital ratios for the Company exceed those for the Bank primarily because the $10 million trust preferred securities offering completed in the fourth quarter of 2005 is 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 $10 million more in regulatory capital than the Bank at both June 30, 2018 and December 31, 2017, which explains most of the difference in the capital ratios for the two entities.



	Minimum Required Capital	Well-Capitalized	Actual Ratio Company	Actual Ratio Bank


June 30, 2018
Total risk-based capital	8.00%	10.00%	16.35%	14.48%
Tier 1 risk-based capital	6.00%	8.00%	15.10%	13.22%
Common equity tier 1 capital	4.50%	6.50%	14.35%	13.22%
Leverage ratio	4.00%	5.00%	13.23%	11.59%
December 31, 2017
Total risk-based capital	8.00%	10.00%	15.90%	14.08%
Tier 1 risk-based capital	6.00%	8.00%	14.65%	12.83%
Common equity tier 1 capital	4.50%	6.50%	13.89%	12.83%
Leverage ratio	4.00%	5.00%	12.41%	10.87%

See Note 21 of the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2017 for a detailed discussion of the capital ratios. The requirements for "well- capitalized" come from the Prompt Correction Action rules. See Item 1 - Business - Supervision and Regulation in the Company's Annual Report on Form 10-K for the year ended December 31, 2017. These rules apply to the Bank but not to the Company. Under the rules of the Federal Reserve Bank, a bank holding company such as the Company is generally defined to be "well capitalized" if its Tier 1 risk-based capital ratio is 8.0% or more and its total risk-based capital ratio is 10.0%or more.

Off-Balance Sheet Items

The Company is a party to financial instruments with off-balance sheet risk. Among the off-balance sheet items entered into in the ordinary course of business are commitments to extend credit, commitments to originate loans held for sale and the issuance of letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized on the balance sheet. Certain commitments are collateralized. 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. As of June 30, 2018 and December 31, 2017, the Company’s commitments to extend credit and to provide letters of credit which are not reflected on its balance sheet amounted to $241.4 million and $291.5 million, respectively. Additionally, the Company had commitments to originate loans held for sale of $84.1 million and $43.6 million, as of June 30, 2018 and December 31, 2017, respectively. Since many of the commitments are expected to expire without being drawn upon, these total commitment amounts do not necessarily represent future cash requirements. The Company has established reserves of $118,000 and $152,000 at June 30, 2018 and December 31, 2017 respectively, for losses related to these commitments that are recorded in other liabilities on the consolidated balance sheet.

Capital Expenditures and Commitments

At June 30, 2018 the Company has capital commitments of $670,000 related to planned improvements to the Company's corporate office building, a new branch, and other branch improvements. These capital expenditures are expected to be incurred in the second half of 2018.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our assessment of market risk as of June 30, 2018 indicates that there are no material changes in the quantitative and qualitative disclosures from those in our Annual Report on Form 10-K for the year ended December 31, 2017.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, we evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934). 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 as of June 30, 2018, the disclosure controls and procedures are effective in timely alerting them to material information required to be included in the periodic reports to the Securities and Exchange Commission. The design of any system of controls is based in part upon various assumptions about the likelihood of future events, and there can be no assurance that any of our plans, products, services or procedures will succeed in achieving their intended goals under future conditions.

Changes in Internal Control over Disclosure and Reporting

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15-d-15(f) of the Securities Exchange Act of 1934) that occurred during the quarterly period ended June 30, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

During the normal course of its business, the Company is a party to various debtor-creditor legal actions, disputes, claims, and litigation related to the conduct of its banking business. These include cases filed as a plaintiff in collection and foreclosure cases, and the enforcement of creditors’ rights in bankruptcy proceedings. Management does not expect that the resolution of these matters will have a material effect on the Company’s business, financial position, results of operations, or cash flows.

ITEM 1A. RISK FACTORS

For information regarding risk factors, please refer to Item 1A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. These risk factors have not materially changed as of June 30, 2018.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a)-(b) Not applicable

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

(a) Not applicable

(b) There have been no material changes to the procedures by which shareholders may nominate directors to the Company’s board of directors.

ITEM 6. EXHIBITS



31.1	Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a)
31.2	Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a)
32.1	Certification of Chief Executive Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
32.2	Certification of Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350



101.INS	XBRL Instance Document
101.SCH	XBRL Schema Document
101.CAL	XBRL Calculation Linkbase Document
101.LAB	XBRL Labels Linkbase Document
101.PRE	XBRL Presentation Linkbase Document
101.DEF	XBRL Definition Linkbase Document

Notes to Exhibits List:

______________________________________________________________________________________________________

Attached as Exhibit 101 to this report are the following formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheet, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income and Changes in Shareholders’ Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to the Consolidated Financial Statements. In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

NORTHRIM BANCORP, INC.



August 7, 2018	By	/s/ Joseph M. Schierhorn
		Joseph M. Schierhorn
		Chairman, President, Chief Executive Officer and Chief Operating Officer
		(Principal Executive Officer)



August 7, 2018	By	/s/ Jed W. Ballard
		Jed W. Ballard
		Executive Vice President, Chief Financial Officer
		(Principal Financial and Accounting Officer)