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Section 1: 10-Q (10-Q)

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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)
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
Part II
OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.



1



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

2


CONSOLIDATED FINANCIAL STATEMENTS
NORTHRIM BANCORP, INC.
Consolidated Balance Sheets
(Unaudited)
 
June 30,
2018
 
December 31,
2017
(In Thousands, Except Share Data)
 
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

3



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

4



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


5



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)
 
 
 
 
 
 
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

6



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
)

7



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

8



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

9



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

10



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.

11



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.



12



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



13



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.


14



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



$—


15



    
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.

16



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




17



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.

18



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


19



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