UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
x☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018 or2021
or
¨☐ 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 000-29480
HERITAGE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
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Washington | | 91-1857900 |
| HERITAGE FINANCIAL CORPORATION |
| (Exact name of registrant as specified in its charter) |
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| Washington | | 91-1857900 |
| (State or other jurisdiction of
incorporation or organization)
| | (I.R.S. Employer
Identification No.)
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201 Fifth Avenue SW, Olympia, WA | Olympia | WA | | 98501 |
| (Address of principal executive offices) | | (Zip Code) |
(360) 943-1500
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| Common Stock | HFWA | NASDAQ Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ¨☒ No ý☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ¨☐ No ý☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý☒ No ¨☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).
Yes ý☒ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act
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| Large accelerated filerý | ☒ | Accelerated filer¨ | ☐ |
| 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 pursuant to Section 13(a) of the Exchange Act. ¨☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨☐ No ý☒
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2018,2021, based on the closing price of its common stock on such date, on the NASDAQ Global Select Market, of $34.85$25.02 per share, and 33,420,42135,457,709 shares held by non-affiliates was $1,164,701,672.$887,151,879. The registrant had 36,879,55735,105,779 shares of common stock outstanding as of February 19, 2019.14, 2022.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 20192022 Annual Meeting of Shareholders will beare incorporated by reference into Part III of this Annual Report on Form 10-K.10-K where indicated. The 2022 Proxy Statement will be filed with the U.S. Securities and Exchange Commission within 120 days after the end of the fiscal year to which this report relates.
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
FORM 10-K
December 31, 20182021
TABLE OF CONTENTS
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Glossary of Acronyms, Abbreviations, and Terms
The acronyms, abbreviations, and terms listed below are used in various sections of this Annual Report on Form 10-K. As used throughout this report, the terms “we”, “our”, or “us” refer to Heritage Financial Corporation and its consolidated subsidiaries, unless the context otherwise requires.
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| ACL | Allowance for Credit Losses |
| AOCI | Accumulated other comprehensive income (loss), net |
| ASC | Accounting Standards Codification |
| ASU | Accounting Standards Update |
| Bank | Heritage Bank |
| BOLI | Bank owned life insurance |
| CA Act | Consolidated Appropriations Act of 2021 |
| CARES Act | Coronavirus Aid, Relief, and Economic Security Act of 2020 |
| CECL | Current Expected Credit Loss |
| CECL Adoption | Bank's adoption on January 1, 2020 of FASB ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the CECL methodology |
| CMO | Collateralized Mortgage Obligation |
| Company | Heritage Financial Corporation and its subsidiaries |
| COVID Modifications | Loans with modifications made in compliance with the CARES Act, as amended, and related regulatory guidance |
| COVID-19 Pandemic | Coronavirus Disease of 2019 Pandemic |
| CRE | Commercial real estate |
| DEI | Diversity, Equity, and Inclusion |
| DFI | Division of Banks of the Washington State Department of Financial Institutions |
| Dodd Frank Act | Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 |
| Economic Growth Act | Economic Growth, Regulatory Relief and Consumer Protection Act |
| Equity Plan | Heritage Financial Corporation 2014 Omnibus Equity Plan |
| Exchange Act | Securities Exchange Act of 1934, as amended |
| FASB | Financial Accounting Standards Board |
| FDIC | Federal Deposit Insurance Corporation |
| Federal Reserve | Board of Governors of the Federal Reserve System |
| Federal Reserve Bank | Federal Reserve Bank of San Francisco |
| FHLB | Federal Home Loan Bank of Des Moines |
| FOMC | Federal Open Market Committee within the Federal Reserve System |
| Form 10-K | Company's Annual Report on Form 10-K |
| GAAP | U.S. Generally Accepted Accounting Principles |
| LIBOR | London Interbank Offering Rate |
| LIHTC | Low-Income Housing Tax Credit partnerships |
| NMTC | New Market Tax Credits |
| MBS | Mortgage-backed security |
| OCC | Office of the Comptroller of the Currency |
| PCD | Purchased Credit Deteriorated; loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected; accounted for under FASB ASC 326 |
| PCI | Purchased Credit Impaired; loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected; accounted for under FASB ASC 310-30 |
| Plan | Heritage Financial Corporation 401(k) Profit Sharing Plan and Trust |
| PPP | Paycheck Protection Program |
| Proxy Statement | Definitive proxy statement for the annual meeting of shareholders to be held on May 3, 2022 |
| Related Party | Certain directors, executive officers and their affiliates |
| ROU | Right-of-Use |
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| SBA | Small Business Administration |
| SEC | Securities and Exchange Commission |
| SM | Special Mention |
| SOFR | Secured Overnight Financing Rate |
| SS | Substandard |
| TDR | Troubled debt restructured |
| Unfunded Commitments | Off-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments |
| USDA | United States Department of Agriculture |
CAUTIONARY NOTE REGARDING FORWARD-LOOKINGFORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K ("Form 10-K") may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated, including:
our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel from our recent mergers with Puget Sound Bancorp, Inc., and Premier Commercial Bancorp, or may in the future acquire, into our operations and our ability to realize related revenue synergies and cost savings within expected time frames or at all, and any goodwill charges related thereto and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, which might be greater than expected;
the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets, which may lead to increased losses and non-performing assets in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to increase our allowance for loan losses and provision for loan losses;
changes in general economic conditions, either nationally or in our market areas;
changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources;
risks related to acquiring assets in or entering markets in which we have not previously operated and may not be familiar;
fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas;
results of examinations of us by the bank regulators, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan losses, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements on us, any of which could affect our ability to continue our growth through mergers, acquisitions or similar transactions and adversely affect our liquidity and earnings;
legislative or regulatory changes that adversely affect our business including but not limited to, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act"), the Expected Credit Loss model required by the Financial Accounting Standards Board through Accounting Standard Update 2016-13 beginning with the Form 10-Q as of the first quarter of 2020, and implementing regulations, changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules as a result of Basel III;
our ability to control operating costs and expenses;
increases in premiums for deposit insurance;
the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;
staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;
disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions;
our ability to retain key members of our senior management team;
costs and effects of litigation, including settlements and judgments;
our ability to implement our growth strategies;
increased competitive pressures among financial service companies;
changes in consumer spending, borrowing and savings habits;
the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
adverse changes in the securities markets;
inability of key third-party providers to perform their obligations to us;
changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board (“FASB"), including additional guidance and
interpretation on accounting issues and details of the implementation of new accounting methods; and
other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this Form 10-K.
Some of these and other factors are discussed in this Form 10-K under the caption Item 1A. Risk Factors and elsewhere in this Form 10-K. Such developments could have a material adverse impact on our business, financial position and results of operations.
We cautionThe Company cautions readers not to place undue reliance on any forward-looking statements on any forward-looking statements discussed in this Form 10-K.statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to us. We dothe Company. The Company does not undertake and specifically disclaimdisclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for future periods to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect ourthe Company’s operating results and stock price performance.
As used throughout this report,The COVID-19 Pandemic is adversely affecting us, our customers, counterparties, employees, and third-party service providers, and the terms “we”, “our”, “us”, “Heritage”ultimate extent of the impacts on our business, financial position, results of operations, liquidity, and prospects is uncertain. Deterioration in general business and economic conditions, including increases in unemployment rates, or turbulence in domestic or global financial markets could adversely affect our revenues and the values of our assets and liabilities, reduce the availability of funding, lead to a tightening of credit, and increase stock price volatility. In addition, changes to statutes, regulations, or regulatory policies or practices as a result of, or in response to the COVID-19 Pandemic, could affect us in substantial and unpredictable ways. Other factors that could cause or contribute to such differences include, but are not limited to:
•the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our ACL on loans and provision for credit losses on loans that may be affected by deterioration in the housing and CRE markets, which may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our ACL on loans no longer being adequate to cover actual losses, and require us to increase our ACL on loans;
•changes in general economic conditions, either nationally or in our market areas;
•changes in the levels of general interest rates, and the relative differences between short-term and long-term interest rates, deposit interest rates, our net interest margin and funding sources;
•risks related to acquiring assets in or entering markets in which we have not previously operated and may not be familiar;
•fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas;
•results of examinations of us by the bank regulators, including the possibility that any such regulatory authority may, among other things, initiate an enforcement action against the Company or our bank subsidiary which could require us to increase our ACL on loans, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements on us, any of which could affect our ability to continue our growth through mergers, acquisitions or similar transactions and adversely affect our liquidity and earnings;
•legislative or regulatory changes that adversely affect our business;
•implementing regulations, changes in regulatory policies and principles, or the “Company” refersinterpretation of regulatory capital or other rules;
•our ability to Heritagecontrol operating costs and expenses;
•increases in premiums for deposit insurance;
•the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;
•difficulties in reducing risk associated with the loans on our Consolidated Statements of Financial CorporationCondition;
•staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and its consolidated subsidiaries, unlesspotential associated charges;
•disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the context otherwise requires.third-party vendors who perform several of our critical processing functions;
•our ability to retain key members of our senior management team;
•costs and effects of litigation, including settlements and judgments;
•our ability to implement our growth strategies;
•our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames or at all, and any goodwill charges related thereto and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, which might be greater than expected;
•increased competitive pressures among financial service companies;
•changes in consumer spending, borrowing and savings habits;
•the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
•adverse changes in the securities markets;
•inability of key third-party providers to perform their obligations to us;
•changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods and as a result of the CARES Act and the CA Act; and
•other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks detailed from time to time in our filings with the SEC including this Form 10-K.
PART I
ITEM 1. BUSINESS
GeneralOverview
Heritage Financial Corporation is a bank holding company that was incorporated in the State of Washington in August 1997. We are primarily engaged in the business of planning, directing, and coordinating the business activities of our wholly owned subsidiary and single reportable segment, Heritage Bank (the "Bank"). The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (“FDIC").Bank.
Heritage Bank is headquartered in Olympia, Washington and conducts business from its 6449 branch offices located primarily along the I-5 corridor in the western Washington and the greater Portland, Oregon area. We additionally have offices located in central Washington, primarily in Yakima County. The deposits of the Bank are insured by the FDIC.
During the last two years, the Company consolidated 13 branches to create a more efficient branch footprint, reducing the branch count to 49 at December 31, 2021 from 62 at December 31, 2019. The Bank integrated these locations into other branches within its network. These actions were the result of the Bank’s increased focus on balancing physical locations and digital banking channels, driven by increased customer usage of online and mobile banking and a commitment to improve digital banking technology.
Our business consists primarily of commercial lending and deposit relationships with small and medium sized businesses and their owners in our market areas and attracting deposits from the general public. We also make real estate construction and land development loans, consumer loans and consumer loans. The Bank also originatesresidential real estate loans for sale or investment purposes one-to-four family residential loans on residential properties located primarily in our market.
General Development of Business
During the last two years, the Bank participated in the SBA's PPP in accordance with the CARES Act and CA Act. The CARES Act initially amended the SBA’s loan program, in which the Bank participates, to create a guaranteed, unsecured loan program, the PPP, to fund payroll and operational costs of eligible businesses, organizations and self-employed persons during the COVID-19 Pandemic. Through the conclusion of the program on May 31, 2021, the Bank had funded 7,184 SBA PPP loans totaling $1.28 billion with an average loan size of $178,000. As of December 31, 2021, total funded SBA PPP loans decreased to $145.8 million, net of unamortized net deferred fees of $4.9 million, due primarily to principal and interest forgiveness payments from the SBA as the Bank began accepting and processing the forgiveness applications during the three months ended December 31, 2020. During the years ended December 31, 2021 and 2020, SBA PPP loans provided an additional $32.1 million and $19.5 million, respectively, of interest and fee income on loans.
A combination of new deposit relationships obtained in conjunction with the SBA PPP lending process and existing customers maintaining higher cash balances due to the COVID-19 Pandemic also caused a material impact to our deposit balances, which increased $1.80 billion, or 39.2%, to $6.38 billion at December 31, 2021 from $4.58 billion at December 31, 2019 and cash balances, which increased $1.49 billion, or 654.0%, to $1.72 billion at December 31, 2021 from $228.6 million at December 31, 2019, which was before the start of the COVID-19 Pandemic.
Business Strategy
Our business strategy is to be a commercial community bank, seeking deposits from our communities and making loans to customers with local ties to our markets. We believe we have an innovative team providing financial services and focusing on the success of our customers. We are committed to being the leading commercial community bank in the Pacific Northwest by continuously improving customer satisfaction, employee empowerment, community investment and shareholder value. Our commitment defines our relationships, sets expectations for our actions and directs decision-making in these four fundamental areas. We will seek to achieve our business goals through the following strategies:
Expand geographically as opportunities present themselves.We are committed to continuing the controlled expansion of our franchise through strategic acquisitions designed to increase our market share and enhance franchise value. We believe that consolidation across the community bank landscape will continue to take place and further believe that, with our capital and liquidity positions, our approach to credit management, and our extensive acquisition experience, we are well-positioned to take advantage of acquisitions or other business opportunities in our market areas. In markets where we wish to enter or expand our business, we will also consider opening de novo branches. In the past, we have successfully integrated acquired institutions and opened de novo branches. We will continue to be disciplined and opportunistic as it pertains to future acquisitions and de novo branching, focusing on the Pacific Northwest markets we know and understand.
Focus on Asset Quality. asset quality.A strong credit culture is a high priority for us. We have a well-developed credit approval structure that has enabled us to maintain a standard of asset quality that we believe is conservativehas moderate risk while at the same time allowing us to achieve our lending objectives. We will continue to focus on loan types and markets that we know well and where
we have a historical record of success. We focus on loan relationships that are well-diversified in both size and industry types. With respect to commercial business lending, which is our predominant lending activity,
we view ourselves as cash-flow lenders obtaining additional support from realistic collateral values, personal guarantees and other secondary sources of repayment. We have a problem loan resolution process that is focused on quick detection and implementing feasible solutions. We seek to maintain strong internal controlssolutions and subject our loans to periodic internal loan reviews.
Maintain Strong Balance Sheet. a strong balance sheet.In addition to our focus on underwriting, we believe that the strength of our balance sheet provides us with the flexibility to manage through a variety of scenarios including additional growth-related activities. As of December 31, 2018, the ratio of our allowance for loan losses to loans receivable, net was 0.96% and the ratio of the allowance for loan losses to nonperforming loans was 255.73%. Our liquidity position was also strong, with $161.9 million$1.72 billion in cash and cash equivalents as of December 31, 2018.2021. As of December 31, 2018,2021, the regulatory capital ratios of our subsidiary bankthe Bank were well in excess of the levels required for “well-capitalized” status, and our consolidated common equity tier 1 capital to risk-weighted assets, total risk-basedleverage capital, Tier 1 risk-based capital, and leveragetotal risk-based capital ratios were 11.7%13.5%, 12.9% 12.1%8.7%, 13.9% and 10.5%14.8%, respectively.
Deposit Growth. Focused deposit growth.Our strategic focus is to continuously grow deposits with emphasis on total relationship banking with our business and retail customers. We continue to seek to increase our market share in the communities we serve by providing exceptional customer service, focusing on relationship development with local businesses and strategic branch expansion. Our primary focus is to maintain a high level of non-maturity deposits to internally fund our loan growth with a low reliance on maturity (certificate) deposits. At December 31, 2018,2021, our non-maturity deposits were 89.5%94.6% of our total deposits. Our technology-based products, including on-lineonline personal financial management, business cash management and business remote deposit products enable us to compete effectively with banks of all sizes. Our retail and commercial management teams are well-seasoned and have strong ties to the communities we serve with a strong focus on relationship building and customer service.
Emphasize business relationships with a focus on commercial lending. We will continue to market primarily commercial business loans and the deposit balances that accompany these relationships. Our seasoned lending staff has extensive knowledge and can add value through a focused advisory role that we believe strengthens our customer relationships and develops loyalty. We currently have and will seek to maintain a diversified portfolio of lending relationships without significant concentrations in any industry.
Recruit and retain highly competent personnel to execute our strategies.Our compensation and staff development programs are aligned with our strategies to grow our loans and corenon-maturity deposits while maintaining our focus on asset quality. Our incentive systems are designed to achieve balanced, high quality asset growth while maintaining appropriate mechanisms to reduce or eliminate incentive payments when appropriate. Our equity compensation programs and retirement benefits are designed to build and encourage employee ownership at all levels of the Company and we align employee performance objectives with corporate growth strategies and shareholder value. We have a strong corporate culture, which is supported by our commitment to internal development and promotion from within as well as the retention of management and officers in key roles.
There have been no material changes to our business strategy during the years ended December 31, 2021 and 2020, except for our participation in the SBA's PPP.
History
Heritage Bank celebrated its 90th anniversary during 2017. The Bank was established in 1927 as a federally-chartedfederally-chartered mutual savings bank. In 1992, the Bank converted to a state-chartedstate-chartered mutual savings bank under the name Heritage Savings Bank. Through the mutual holding company reorganization of the Bank and the subsequent conversion of the mutual holding company, the Bank became a stock savings bank and a wholly-owned subsidiary of the Company effective August 1997. Effective September 1, 2004, Heritage Savings Bank switched its charter from a state-chartered savings bank to a state-chartered commercial bank and changed its legal name from Heritage Savings Bank to Heritage Bank. The following table lists major combinations completed by the Company:
The Company acquired North Pacific Bancorporation in June 1998 and Washington Independent Bancshares and its wholly-owned subsidiary, Central Valley Bank, in March 1999. In June 2006, the Company completed the acquisition of Western Washington Bancorp and its wholly owned subsidiary, Washington State Bank, N.A., at which time Washington State Bank, N.A. was merged into Heritage Bank.
Effective July 30, 2010, Heritage Bank entered into a definitive agreement with the FDIC, pursuant to which Heritage Bank acquired certain assets and assumed certain liabilities of Cowlitz Bank, a Washington state-chartered commercial bank headquartered in Longview, Washington. The acquisition included nine branches of Cowlitz Bank, including its division Bay Bank, which opened as branches of Heritage Bank on August 2, 2010. The acquisition also included the Trust Services Division of Cowlitz Bank.
Effective November 5, 2010, Heritage Bank entered into a definitive agreement with the FDIC, pursuant to which Heritage Bank acquired certain assets and assumed certain liabilities of Pierce Commercial Bank, a Washington state-chartered commercial bank headquartered in Tacoma, Washington. The acquisition included one branch, which opened as a branch of Heritage Bank on November 8, 2010.
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| Type of Combination | | Date of Combination | | Acquired Holding Company Name | | Acquired Bank Name | | Total Assets Acquired
(in millions) |
| Purchase | | June 1998 | | North Pacific Bancorporation | | North Pacific Bank | | $ | 85 | |
| Purchase | | March 1999 | | Washington Independent Bancshares, Inc. | | Central Valley Bank | | 61 | |
| Purchase | | June 2006 | | Western Washington Bancorporation | | Washington State Bank, N.A. | | 57 | |
| FDIC Assisted | | August 2010 | | n/a | | Cowlitz Bank | | 345 | |
| FDIC Assisted | | November 2010 | | n/a | | Pierce Commercial Bank | | 211 | |
| Purchase | | January 2013 | | n/a | | Northwest Commercial Bank | | 65 | |
| Purchase | | July 2013 | | Valley Community Bancshares, Inc. | | Valley Bank | | 237 | |
| Merger | | May 2014 | | Washington Banking Company | | Whidbey Island Bank | | 1,657 | |
| Purchase | | January 2018 | | Puget Sound Bancorp, Inc. | | Puget Sound Bank | | 571 | |
| Purchase | | July 2018 | | Premier Commercial Bancorp | | Premier Community Bank | | 387 | |
On September 14, 2012, the Company announced that it had entered into a definitive agreement along with Heritage Bank, to acquire Northwest Commercial Bank, a full-service commercial bank headquartered in Lakewood, Washington that operated two branch locations in Washington State. The acquisition was completed on January 9, 2013, at which time Northwest Commercial Bank was merged with and into Heritage Bank.
On March 11, 2013, the Company entered into a definitive agreement to acquire Valley Community Bancshares, Inc. and its wholly-owned subsidiary, Valley Bank, both headquartered in Puyallup, Washington, and its eight branches. The acquisition was completed on July 15, 2013.
On April 8, 2013, the Company announced its intent to merge twoDescription of its wholly-owned bank subsidiaries, Central Valley Bank and Heritage Bank, with Central Valley Bank merging into Heritage Bank. The common control merger was completed on June 19, 2013. Central Valley Bank operated as a division of Heritage Bank until September 2018 at which time the five Central Valley Bank branches were renamed to Heritage Bank branches.Business
On October 23, 2013, the Company, the Bank, Washington Banking Company and its wholly-owned subsidiary bank, Whidbey Island Bank, jointly announced the signing of a definitive merger agreement pursuant to which Heritage and Washington Banking Company entered into a strategic merger with Washington Banking Company merging into Heritage ("Washington Banking Merger"). Washington Banking Company branches adopted the Heritage Bank name in all markets, with the exception of six branches in Whidbey Island markets which continue to operate using the Whidbey Island Bank name, as a division of Heritage Bank. The Washington Banking Merger was completed on May 1, 2014.
On July 26, 2017, the Company announced the execution of a definitive agreement to purchase Puget Sound Bancorp, Inc., ("Puget Sound"), the holding company of Puget Sound Bank, a one-branch business bank headquartered in Bellevue, Washington (the "Puget Sound Merger"). The Puget Sound Merger was completed on January 16, 2018.
On March 8, 2018, the Company announced the signing of a definitive agreement to purchase Premier Commercial Bancorp ("Premier Commercial"), the holding company for Premier Community Bank, both of Hillsboro, Oregon, and its six branches (the "Premier Merger"). The Premier Merger was completed on July 2, 2018.
For additional information regarding the Puget Sound Merger and Premier Merger (collectively the "Premier and Puget Mergers"), see Note (2) Business Combinations of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
Retail Banking
We offer a full range of products and services to customers for personal and business banking needs designed to attract both short-term and long-term deposits. Deposits are our primary source of funds. Our personal and business banking customers have the option of selecting from a variety of accounts. The major categories of deposit accounts that we offer are described below. These accounts, with the exception of noninterest demand accounts, generally earn interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits.
Noninterest Demand Deposits. Deposits are noninterest bearing and may be charged service fees based on activity and balances.
Interest Bearing Demand Deposits.Deposits are interest bearing and may be charged service fees based on activity and balances. Interest bearing demand deposits pay interest, but require a higher minimum balance to avoid service charges.
Money Market Accounts.Depositspay an interest rate that is tiered depending on the balance maintained in the account. Minimum opening balances vary.
Savings Accounts.Deposits are interest bearing and allow for unlimited deposits and withdrawals, provided that a minimum balance is maintained.maintained to avoid service charges.
Certificate of Deposit Accounts.Deposits require a minimum deposit of $2,500 and have maturities ranging from three months to five years. Jumbo certificate of deposit accounts are offered in amounts of $100,000 or more for terms of 30seven days to five years.one year.
Our personal checking accounts feature an array of benefits and options, including online banking, online statements, mobile banking with mobile deposit, VISA debit cards and access to more than 32,00037,000 surcharge free Automated Teller Machines ("ATMs") through the MoneyPass network.
We also offer trust servicesinvestment advice through trust powers in the states of Washington and Oregon, and a Wealth Management department that provides objective advice from trusted advisors.
advisers.
Lending Activities
Our lending activities are conducted through Heritagethe Bank. While our focus is on commercial business lending, we also originate consumer loans, real estate construction and land development loans and one-to-four family residential real estate loans. Our loans are originated under policies that are reviewed and approved annually by our Board of Directors. In addition, we have established internal lending guidelines that are updated as needed. These policies and guidelines address underwriting standards, structure and rate considerations, and compliance with laws, regulations and internal lending limits. We conduct post-approval reviews on selected loans and routinely perform internal loan reviews of our loan portfolio to confirm credit quality, proper documentation and compliance with laws and regulations. Loan repayments are considered one of the primary sources of funding for the Bank.
The Company has also acquired loans through mergers and acquisitions, which are designated as "purchased" loans.
Commercial Business Lending
At December 31, 2021 we had $3.19 billion, or 83.7% of our loans receivable, in commercial business loans. We offer different types of commercial business loans, including lines of credit, term equipment financing and term owner-occupied and non-owner occupied commercial real estate loans. We also originate loans that are guaranteed by the U.S. Small Business Administration (“SBA”),SBA, for which Heritagethe Bank is a “preferred lender”, the U.S. Department of Agriculture and the Federal Agricultural Mortgage Corporation. Before extending credit to a business, we review and analyze the borrower’s management ability, financial history, including cash flow of the borrower and all guarantors, and the liquidation value of the collateral. Emphasis is placed on having a comprehensive understanding of the borrower’s global cash flow and performing necessary financial due diligence.
At December 31, 2018 we had $2.94 billion, or 80.4%, of our loans receivable, net in commercial business loans with an average outstanding loan balance of approximately $476,000 at December 31, 2018, excluding loans with no outstanding balance.
We originate commercial real estate loans within our primary market areas with a preference for loans secured by owner-occupied properties. Our underwriting standards require that non-owner occupied and owner occupiedowner-occupied commercial real estate loans not exceed 75% and 80%, respectively, of the lower of appraised value at origination or cost of the underlying collateral. Cash flow debt coverage covenant requirements typically range from 1.15 times to 1.25 times, depending on the type of property. We also stress testActual debt service coverage is usually higher than required covenant thresholds, as loan sizing requires sensitized coverage using an “underwriting”"underwriting" interest rate that is higher than the note rate.
Commercial real estate loans typically involve a greater degree of risk than one-to-four family residential real estate loans. Payments on loans secured by commercial real estate properties are dependent on successful operation and management of the properties and repayment of these loans may be affected by adverse conditions in the real estate market or the economy. We seek to minimize these risks by determining the financial condition of the borrower and any tenants, the quality and value of the collateral, and the management of the property securing the loan. We also generally obtain personal guarantees from the owners of the collateral after a thorough review of personal financial statements. In addition, we review a majority of the individual loans within our commercial real estate loan portfolio annually for various performance of individual loans,related criteria and stress-test loans for potential changes in interest rates, occupancy and collateral values.
See also Item 1A. Risk Factors—Our loan portfolio is concentrated in loans with a higher risk of loss.
The Bank entersmay enter into non-hedging interest rate swap contracts with its commercial customers as necessary, to accommodate thetheir business needs of borrowers.needs. For additional information, see Note (15)(8) Derivative Financial Instruments of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
Residential Real Estate Loans, Originations and Sales
At December 31, 2018, one-to-four family2021, residential real estate loans totaled $101.8 million.$164.6 million, or 4.3% of our loans receivable. The majority of our one-to-four family residential real estate loans are secured by single-family residences located in our primary market areas. Our underwriting standards require that one-to-four family residential real estate loans generally are owner-occupied and do not exceed 80% of the lower of appraised value at origination or cost of the underlying collateral. Terms typically range from 15 to 30 years.
As part of our asset/liability management strategy, we typicallyalso sell a significant portion of our one-to-four familyoriginated residential real estate loans in the secondary market with no recourse and servicing released. See Item 7. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations—Asset/Liability Management. We did not service any of these sold loans during the years ended December 31, 2018, 2017 or 2016.
Real Estate Construction and Land Development
At December 31, 2018,2021, we had $215.5$226.9 million, or 5.9% of our loans receivable, in real estate construction and land development loans, including residential construction loans and commercial and multifamily construction loans.
We originate one-to-four family residential construction loans for the construction of single-family custom homes (where the home buyerowner is the borrower). We also provide financing to builders for the construction of pre-sold homes and in selected cases, to builders for the construction of speculative residential property. Because of the higher risks present in the residential construction industry, our lending to builders is limited to those who have demonstrated a favorable record of performance and who are building in markets that management understands.
We further endeavor to limit our construction lending risk through adherence to strict underwriting guidelines and procedures. Speculative construction loans are short term in nature and have a variable rate of interest. We require builders to have tangible equity in each construction project andproject; have prompt and thorough documentation of all draw requests,requests; and we inspect the project prior to paying any draw requests.
Commercial and multifamily construction loans also have a higher risk because of the construction element and lease-up, if not pre-leased. As a result, this type of construction loan is made only to strong borrowers with sufficient equity into the project and additional resources they can draw on if needed. The Bank performs due diligence to gain comfort that the experience of the general contractor is sufficient to finish the project on budget and on time. Project feasibility is also important and our lenders ensure the project is economically viable. Commercial and multifamily construction loans are monitored through cost reviews, regulatory-compliant appraisals, sufficient equity, engineering inspections and controlled disbursements.
See also Item 1A. Risk Factors—Our loan portfolio is concentrated in loans with a higher risk of loss.
Consumer
At December 31, 2018,2021, we had $395.5$232.5 million, or 6.1% of our loans receivable, in consumer loans. We originate consumer loans and lines of credit that are both secured and unsecured.
During the three months ended March 31, 2020, we ceased indirect auto loan originations, which are classified as consumer loans within loans receivable. These indirect consumer loans are secured by new and used automobile and recreational vehicles and were originated indirectly by established and well-known dealers located in our market areas. In addition, the indirect loans purchased were made to only prime borrowers. At December 31, 2021, we had $117.3 million, or 3.1% of our loans receivable, in indirect auto loans remaining, which is a decrease of 58.7% from $284.0 million as of December 31, 2019, which approximates the balance of indirect auto loans before the runoff of this portfolio started. The majority of our remaining consumer loans are for relatively small amounts disbursed among many individual borrowers.
We also originate indirect consumer loans. These loans are for new and used automobile and recreational vehicles that are originated indirectly by selected dealers located in our market areas. We have limited our indirect loans purchased primarily to dealerships that are established and well-known in their market areas and to applicants that are not classified as sub-prime.
Liquidity
As indicated above, our primary sources of funds are deposits and loan repayments. Scheduled loan repayments are a relatively stable source of funds, while deposits and unscheduled loan prepayments, which are influenced significantly by general interest rate levels, interest rates available on other investments, competition, economic conditions and other factors, may not be stable. Customer deposits remain an important source of funding, but these balances have been influenced in the past by adverse market conditions in the industry and may be affected by future developments such as interest rate fluctuations and new competitive pressures. In addition to customer deposits, management may utilize brokered deposits on an as-needed basis and repurchase agreements. At December 31, 2018, we had brokered deposits of $28.1 million and securities sold under agreement to repurchase of $31.5 million which were secured by investment securities available for sale.
As secondary sources of funding, we might utilize other borrowings on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and match the maturity of repricing intervals of assets. Other borrowings include advances from Federal Home Loan Bank (“FHLB”) of Des Moines and other credit facilities.
Federal Home Loan Bank:
The Bank is a member of the FHLB of Des Moines which is one of 11 regional FHLBs that administer the home financing credit function of savings institutions. Each FHLB serves as a reserve or central bank for its member financial institutions within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB system. It makes loans or advances to members in accordance with policies and procedures, established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Finance Agency. We rely upon advances from the FHLB as a secondary source of liquidity to supplement our supply of lendable funds and meet deposit withdrawal requirements. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based on a percentage of an institution’s assets or on the FHLB’s assessment of the institution’s creditworthiness. Under its current credit policies, the FHLB of Des Moines limits advances to 35% of the Bank's assets.
Advances from the FHLB of Des Moines are typically secured by our first lien one-to-four family residential loans, commercial real estate loans and stock issued by the FHLB, which is owned by us. At December 31, 2018, the Bank maintained a credit facility with the FHLB of Des Moines in the amount of $921.7 million, of which there were no advances.
For membership purposes, the Bank is required to maintain an investment in the stock of the FHLB of Des Moines in an amount equal to 0.12% of the Bank's assets as calculated on an annual basis. In addition to the FHLB stock required for membership, the Bank must purchase activity stock equal to 4.0% of all outstanding borrowing
balances. The activity stock is automatically redeemed in amounts equal to the FHLB advance balances as they are repaid. At December 31, 2018 the Bank had an investment in stock issued by the FHLB of Des Moines carried at a cost basis (par value) of $6.1 million, which entirely represented its membership stock. The Bank was not required to have any activity stock because it did not have any outstanding FHLB advance balance at December 31, 2018.
Other borrowings:
In addition to liquidity provided by FHLB, the Bank maintained an uncommitted credit facility with the Federal Reserve Bank of San Francisco of $37.4 million, of which there were no advances or borrowings outstanding as of December 31, 2018. The Bank also maintains advance lines with Wells Fargo Bank, US Bank, The Independent Bankers Bank and Pacific Coast Bankers’ Bank to purchase federal funds of up to $90.0 million, of which there were no advances or borrowings outstanding as of December 31, 2018.
Supervision and Regulation
We are subject to extensive legislation, regulation, and supervision under federal law and the law of Washington State, which are both primarily intended to protect depositors and the FDIC, and not shareholders. The laws and regulations affecting banks and bank holding companies have changed significantly particularly in connection with the enactment of the Dodd-Frank Act in 2010. Among other changes, the Dodd-Frank Act establishedAdditionally, the Consumer Financial Protection Financial Bureau (“CFPB”) as an independent bureau of the Board of Governors of the Federal Reserve System (“Federal Reserve”). The CFPB assumed responsibilityis responsible for the implementation of the federal financial consumer protection and fair lending laws and regulations and has authority to impose new requirements. See “—Other Regulatory Developments—The Dodd-Frank Act” herein for a discussion of this legislation.
Any change in applicable laws, regulations, or regulatory policies may have a material effect on our business, operations, and prospects. We cannot predict the nature or the extent of the effects on our business and earnings that any fiscal or monetary policies or new Federal or State legislation may have in the future.
The following is a summary discussion of certain laws and regulations applicable to Heritagethe Company and Heritagethe Bank which is qualified in its entirety by reference to the actual laws and regulations.
Heritage Financial Corporation
As a bank holding company registered with the Federal Reserve,we are subject to comprehensive regulation and supervision by the Federal Reserve under the Bank Holding Company Act of 1956, as amended, ("BHCA"), and the regulations of the Federal Reserve. This regulation and supervision is generally intended to ensure that we limit our activities to those allowed by law and that we operate in a safe and sound manner without endangering the financial health of Heritagethe Bank. We are required to file annual and periodic reports with the Federal Reserve and provide additional information as the Federal Reserve may require. The Federal Reserve may examine us, and any of our subsidiaries, and assess us for the cost of such examination.
The Federal Reserve has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders, or require that a holding company divest subsidiaries (including its bank subsidiary). In general, enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. The Company is also required to file certain reports with, and otherwise comply with, the rules and regulations of the Securities and Exchange Commission ("SEC").SEC. The Federal Reserve may also order termination of non-banking activities by non-banking subsidiaries of bank holding companies, or divestiture of ownership and control of a non-banking subsidiary by a bank holding company. Some violations may also result in criminal penalties.
Federal Reserve has a policy provides that a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, the Dodd Frank Act and Federal Reserve policy provides that a bank holding company shall be required to serve as a source of financial strength for its subsidiary bank. A bank holding company’s failure to meet its obligation to serve as a source of strength by providing financial assistance to itsa subsidiary banksbank in financial distress is generally considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve’s regulations or both.
As a bank holding company, we are required to obtain the prior approval of the Federal Reserve to acquire all, or substantially all, of the assets of any other bank or bank holding company. Prior Federal Reserve approval is required for any bank holding company to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if, after such acquisition, the acquiring bank holding company would, directly or indirectly, own or control more than 5% of any class of voting shares of the bank or bank holding company. In addition to the approval of the Federal Reserve, prior approval may for such acquisitions also be necessary from other agencies including the DFI and agencies that regulate the target.
Under the prompt corrective action provisions of the Federal Deposit Insurance Act, a bank holding company with an undercapitalized subsidiary bank must guarantee, within limitations, the capital restoration plan that is required to be implemented for its undercapitalized subsidiary bank. If an undercapitalized subsidiary bank fails to file an acceptable capital restoration plan or fails to implement an accepted plan, the Federal Reserve may, among other restrictions, prohibit the bank holding company or its undercapitalized subsidiary bank from paying any dividend or making any other form of capital distribution without the prior approval of the Federal Reserve. Federal Reserve policy also provides that a bank holding company may pay cash dividends only to the extent that the company’s net income for the past year is sufficient to cover both the cash dividend and a rate of earnings retention that is consistent with
the company’s capital needs, asset quality and overall financial condition. A
Bank regulations also require bank holding company or bank that does not meet thecompanies and banks to maintain minimum capital ratios and capital conservation buffer requirement is subject to restrictions on the payment of dividends. See “—Capitalbuffer. For additional information, see “Capital Adequacy” below. In addition, under Washington corporate law, a company generally may not pay dividends if, after that payment, the company would not be able to pay its liabilities as they become due in the usual course of business or its total assets would be less than its total liabilities.
We, and anyAny subsidiaries which we may control are considered “affiliates” of the BankCompany within the meaning of the Federal Reserve Act, and transactions between our bank subsidiary and affiliates are subject to numerous restrictions. With some exceptions, we and our subsidiaries are prohibited from tying the provision of various products or services, such as extensions of credit, to other products or services offered by us, or our affiliates.
Heritage Bank regulations require bank holding companies and banks to maintain minimum capital ratios. For additional information, see “—Capital Adequacy” below.
Subsidiary Bank
HeritageThe Bank is a Washington state-chartered commercial bank, the deposits of which are insured by the FDIC. Heritage BankFDIC, and is subject to regulation by the FDIC and the Division of Banks of the Washington State Department of Financial Institutions ("Division").DFI.
Applicable Federal and State statutes and regulations which govern a bank’s operations relate to minimum capital requirements, required reserves against deposits, investments, loans, legal lending limits, mergers and consolidation, borrowings, issuance of securities, payment of dividends, establishment of branches, privacy, anti-money laundering and other aspects of its operations, among other things. The DivisionDFI and the FDIC also have authority to prohibit banks under their supervision from engaging in what they consider to be unsafe and unsound practices.
The Bank is required to file periodic reports with the FDIC and the Division and is subject to periodic examinations and evaluations by those regulatory authorities.the FDIC and the DFI. Based upon these evaluations, the regulators may revalue the assets of an institution and require that it establish specific reserves to compensate for the differences between the determined value and the book value of such assets. These examinations must be conducted at least every 12 months.
Dividends paid byThe Bank pays dividends to the Bank provide substantially all of our cash flow.Company. The FDIC and the DivisionDFI also have the general authority to restrict capital distributions by the Bank, including dividends paid by the Bank to Heritage.the Company. Such restrictions are generally tied to the Bank’s capital levels after giving effect to such distributions. For additional information regarding the restrictions on the payment of dividends, see ”—Capital Adequacy" below and Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters And Issuer Purchases Of Equity Securities herein.
Capital Adequacy
The Federal Reserve and FDIC have issued substantially similar risk-based and leverage capital guidelinesregulations applicable to bank holding companies and banks.banks, respectively. In addition, these regulatory agencies may from time to time require that a bank holding company or bank maintain capital above the minimum levels, based on its financial condition or actual or anticipated growth.
Effective January 1, 2015 (with some changes transitioned into full effectiveness over several years), the Company and the Bank became subject to new capital regulations adopted by the Federal Reserve and the FDIC, which establish minimum required risk-based ratios for CET1 capital, Tier 1 and total capital, as well as a minimum leverage ratio risk-weightings of assets and certain other assets for purposes of the risk-based capital ratios; require an additional capital conservation buffer over the minimum required risk-based capital ratios; and define what qualifies as capital for purposes of meeting the capital requirements. These regulations implement the regulatory capital reforms required by the Dodd-Frank Act and the “Basel III” requirements.Basel III requirements, a comprehensive capital framework and rules for U.S. banking organizations approved by the Federal Reserve Board and the FDIC in 2013.
Under these capital regulations, the minimum capital ratios are: (1) a CET1common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 capital ratio of 6.0% of risk-weighted assets; (3) a total capital ratio of 8.0% of risk-weighted assets; and (4) a leverage ratio (the ratio of Tier 1 capital to average total adjusted assets) of 4.0%. CET1; (3) a Tier 1 capital ratio of 6.0% of risk-weighted assets; and (4) a total capital ratio of 8.0% of risk-weighted assets. Common equity Tier 1 generally consists of common stock; retained earnings; accumulated other comprehensive income (loss), netAOCI unless an institution elects to exclude accumulated other comprehensive income (loss), netAOCI from regulatory capital; and certain minority interests; all subject to applicable regulatory adjustments and deductions. Tier 1 capital generally consists of CET1common equity Tier 1 and noncumulative perpetual preferred stock. Tier 2 capital generally consists of other preferred stock and subordinated debt meeting certain conditions plus an amount of the allowance for loan and leasecredit losses up to 1.25% of risk-weighted assets. Total capital is the sum of Tier 1 and Tier 2 capital.
In addition to the minimum CET1,common equity Tier 1, Tier 1, leverage ratio and total capital ratios, the Company and the Bank must maintain a capital conservation buffer consisting of additional CET1common equity Tier 1 capital greater than 2.5% above
the required minimum risk-based capital levels in order to avoid limitations on paying dividends,
repurchasing shares, and paying discretionary bonuses. The new capital conservation buffer requirement began to be phased in on January 1, 2016, when requiring a buffer greater than 0.625% of risk-weighted assets, was required which amount increased 0.625% each year until the buffer requirement was fully implemented on January 1, 2019.
To be considered "well capitalized," a bank holding company must have, on a consolidated basis, a total risk-based capital ratio of 10.0% or greater and a Tier 1 risk-based capital ratio of 6.0% or greater and a total risk-based capital ratio of 10.0% or greater and must not be subject to an individual order, directive or agreement under which the Federal Reserve requires it to maintain a specific capital level. To be considered “well capitalized,” a depository institution must have a common equity Tier 1 capital ratio of at least 6.5%, a leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 8%, a total risk-based capital ratio of at least 10%, a CET1 capital ratio of at least 6.5% and a leverage ratio of at least 5% and not be subject to an individualized order, directive or agreement under which its primary federal banking regulator requires it to maintain a specific capital level. As of December 31, 2018, the Company and the Bank met the requirements to be "well capitalized" and the fully phased-in capital conservation buffer requirement.
For a complete description of theThe Company’s and the Bank's required and actual capital levels as of December 31, 2018, see2021 are listed in Note (22)(21) Regulatory Capital Requirements of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
Prompt Corrective Action
Federal statutes establish a supervisory framework for FDIC-insured institutions based on five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution’s category depends upon where its capital levels are in relation to relevant capital measures. The well capitalized category is described in the Capital Adequacy section above. An institution that is not well capitalized is subject to certain restrictions on brokered deposits, including restrictions on the rates it can offer on its deposits generally.deposits. To be considered adequately capitalized, an institution must have the minimum capital ratios described in the Capital Adequacy section above. Any institution which is neither well capitalized nor adequately capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by Heritage Banka bank to comply with applicable capital requirements would result in progressively more severe restrictions on its activities and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels and, ultimately, the appointment of the FDIC as receiver or conservator. Banking regulators will take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for their review may be dependent on compliance with capital requirements.
As of December 31, 2018,2021, the Company and the Bank met all minimum capital requirements and the requirements to be classifiedmost recent regulatory notifications categorized the Bank as “well capitalized.”well capitalized under the regulatory framework for prompt corrective action. See Note (22)(21) Regulatory Capital Requirements of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
Classification of Loans
Federal regulations require the Bank to periodically evaluate the risks inherent in its loan portfolio. In addition, the DivisionDFI and the FDIC have the authority to identify adverseadversely classified loans and, if appropriate, require them to be reclassified. There are three types of classified loans: Substandard, Doubtful, and Loss. Substandard loans have one or more defined weaknesses and are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Doubtful loans have the weaknesses of Substandard loans, with additional characteristics that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values questionable. There is a high probability of some loss in loans classified as Doubtful. A loan classified as Loss is considered uncollectible and of such little value that continuance as a loan of the institution is not warranted. If a loan or a portion of the loan is classified as Loss, the institution must charge-off this amount.
Deposit Insurance and Other FDIC Programs
The deposits of the Bank are insured up to $250,000 per separately insured category by the Deposit Insurance Fund, which is administered by the FDIC. The FDIC is an independent federal agency that insures the deposits, up to applicable limits, of depository institutions. As insurer of the Bank's deposits, the FDIC has supervisory and enforcement authority over Heritagethe Bank and this insurance is backed by the full faith and credit of the United States government. As insurer, the FDIC imposes deposit insurance premiumsassessments and is authorized to conduct examinations of and to require reporting by institutions insured by the FDIC. It also may prohibit any FDIC-insured institution from engaging in any activity determined by regulation or order to pose a serious risk to the institution and the Deposit Insurance Fund. The FDIC also has the authority to initiate enforcement actions and may terminate the deposit insurance if it determines that an institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
The Dodd-Frank Act broadened the base for FDICDeposit insurance assessments. Assessmentsassessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. In addition, the Dodd-Frank Act raised set the minimum designated reserve ratio (“DRR”) of the Deposit Insurance Fund (the “DIF”) at 1.35%, required the FDIC to set a target DRRfor the ratio each year, and eliminated the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. The FDIC has set the target DRRratio at 2.0% and adopted a plan to achieve that target ratio. The FDIC has announced that the DRR surpassed 1.35% as of September 30, 2018. Currently, total base assessment rates range-range from 1.5 to 40 basis points on an annualized basis, subject to certain adjustments. Under current regulations, the ranges of assessment rates are scheduled to decrease as the DRRratio increases in increments above 2.0%. No institution may pay a dividend if it is in default on its federal deposit insurance assessment.
The FDIC announced that the Deposit Insurance Fund ratio surpassed 1.35% as of September 30, 2018 which triggered two changes under the regulations: surcharges on large banks (total consolidated assets of $10 billion or more) ended and small banks (total consolidated assets of less than $10 billion, which includes the Bank) were awarded assessment credits for the portion of their assessments that contributed to the growth in the Reserve Ratio from 1.15% to 1.35% to be applied when
the reserve ratio is at least 1.35%. The Bank was awarded $1.2 million in small bank assessment credits of which $518,000 and $726,000 was applied against quarterly FDIC assessments during the years ended December 31, 2020 and 2019, respectively.
Other Regulatory Developments
Significant federal legislation affecting banking has been enacted in recent years. The following summarizes some of such recentthe significant federal legislation.legislation affecting banking in recent years.
The Dodd-Frank Act. The Dodd-Frank-Act imposes restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions and implements new capital regulations that we are subject to and that are discussed above under “—Capital Adequacy.”
The federal banking and securities regulators have issued final rules to implement Section 619 of the Dodd-Frank Act, commonly known as the “Volcker Rule” pursuant to the Dodd-Frank Act. Generally, subject to a transition period and certain exceptions, the Volcker Rule restricts insured depository institutions and their affiliated companies from engaging in short-term proprietary trading of certain securities, investing in funds with collateral comprised of any loans that are not registered with the SEC and from engaging in hedging activities that do not hedge a specific identified risk. In accordance with the transition period, the Volcker Rule prohibitions and restrictions apply to banking entities, including the Company and the Bank, unless an exception applies. We are continuously reviewing our investment portfolio to determine if changes to our investment strategies may be required in order to comply with the various provisions of the Volcker Rule.
In addition, among other changes, the Dodd-Frank Act requires public companies, like us, to (i) provide their shareholders with a non-binding vote (a) at least once every three years on the compensation paid to executive officers and (b) at least once every six years on whether they should have a “say on pay” vote every one, two or three years; (ii) have a separate, non-binding shareholder vote regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments; (iii) provide disclosure in annual proxy materials concerning the relationship between the executive compensation paid and the financial performance of the issuer; and (iv) amend Item 402 of Regulation S-K to require companies to disclose the ratio of the Chief Executive Officer's annual total compensation to the median annual total compensation of all other employees.
Economic Growth Act. In May 2018 the Economic Growth Regulatory Relief and Consumer Protection Act (the “Economic Growth Act”), was enacted to modify or remove certain financial reform rules and regulations, including some of those implemented under the Dodd-Frank Act. While the Economic Growth Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and for large banks with assets of more than $50 billion. Many of these changes could result in meaningful regulatory changes for community banks such as the Bank, and their holding companies.
The Economic Growth Act, among other matters, expands the definition of qualified mortgages which may be held by a financial institution and includes regulatory relief for community banks regarding regulatory examination cycles, call reports, the Volcker Rule (proprietary trading prohibitions), mortgage disclosures, risk weights for certain high-risk commercial real estate loans and simplifies the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “CommunityCommunity Bank Leverage Ratio”Ratio, which became effective January 1, 2020. The new ratio is an optional framework that is designed to reduce regulatory burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework starting in the first quarter of between 82020. Qualifying community banking organizations that elect to use the Community Bank Leverage Ratio framework and 10 percent. Any qualifyingthat maintain a leverage ratio of greater than nine percent are considered to have satisfied the risk-based and leverage capital requirements in the agencies’ generally applicable capital rule. Additionally, such insured depository institution or its holding company that exceeds the “community bank leverage ratio” will beinstitutions are considered to have met generally applicablethe well-capitalized ratio requirements for purposes of section 38 of the Federal Deposit Insurance Act. The leverage and risk-based regulatory capital requirements and any qualifying depository institution that exceedsratio required for purposes of the new framework is calculated as Tier 1 capital divided by average total consolidated assets, consistent with how banking organizations calculate their leverage ratio will be consideredunder the current rules. As of December 31, 2021, the Company and the Bank had not elected to be “well capitalized” undersubject to the prompt corrective action rules. In addition, the Economic Growth Act includes regulatory relief for community banks regarding regulatory examination cycles, call reports, the Volcker Rule (proprietary trading prohibitions), mortgage disclosures and risk weights for certain high-risk commercial real estate loans.Community Bank Leverage Ratio.
It is difficult at this time to predict when or how any new standards under the Economic Growth Act will ultimately be applied to us or what specific impact the Act and the yet-to-be-written implementing rules and regulations will have on community banks.
CECL.CECL. The Financial Accounting Standards Board has adoptedFASB issued a new accounting standard for U.S. Generally Accepted Accounting Principles that will be effective for us for our first fiscal year beginning after December 15, 2019.the Bank adopted on January 1, 2020. This standard, referred to as Current Expected Credit Loss, or CECL, requires FDIC-insured institutions and their holding companies (banking organizations) to recognize credit losses expected over the life of certain financial assets. CECL covers a broader range of assets than the currentprior method of recognizing credit losses and generally results in earlier recognition of credit losses. Upon adoption of CECL, a banking organization must record a one-time adjustment to its credit loss allowances as of the beginning of the fiscal year of adoption equal to the difference, if any, between the amount of credit loss allowances under the current methodology and the amount required under CECL. For a banking organization, implementationConcurrent with enactment of CECL is generally likely to reduce retained earnings, and to affect other items, in a manner that reduces its regulatory capital.
Thethe CARES Act, federal banking regulators (the Federal Reserve, the OCC and the FDIC) have adopted aagencies issued an interim final rule that gives adelays the estimated impact on regulatory capital resulting from the adoption of CECL. The interim final rule provides banking organizationorganizations that implement CECL before the end of 2020 the option to phase in over a three-year perioddelay for two years the day-one adverse effectsestimated impact of CECL on its regulatory capital.
Sarbanes-Oxley Act. As a public company that files periodic reports with the SEC,capital relative to regulatory capital determined under the Securities Exchange Actprior incurred loss methodology, followed by a three-year transition period to phase out the aggregate amount of 1934, Heritage is subjectcapital benefit provided during the initial two-year delay. The changes in the final rule apply only to those banking organizations that elect the Sarbanes-Oxley ActCECL transition relief provided under the rule. The Company and the Bank elected this option.
See discussion of 2002 ("Sarbanes-Oxley Act"), which addresses, among other issues, corporate governance, auditingCECL Adoption in Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and accounting, executive compensation and enhanced and timely disclosure of corporate information.
The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulationRecently Issued Accounting Pronouncements of the accounting profession, andNotes to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. Our policies and procedures have been updated to comply with the requirements of the Sarbanes-Oxley Act.Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data
Website Access to Company Reports
We post publicly available reports required to be filed with the SEC on our website, www.hf-wa.com, as soon as reasonably practicable after filing such reports. The required reports are available free of charge through our website.
Code of Ethics
We have adopted a Code of Ethics that applies to our principal executive officer, principal financial officer and controller.officers. We have posted the text of our Code of Ethics at www.hf-wa.com in the section titled Overview: Governance Documents. Any waivers of the code of ethics will be publicly disclosed to shareholders.
Competition
We compete for loans and deposits with other commercial banks, credit unions, mortgage bankers, and other providers of financial services, including finance companies, online-only banks, mutual funds, insurance companies, and more recently with financial technology (or "FinTech") companies that rely on technology to provide financial services. Many of our competitors have substantially greater resources than we do. Particularly in times of high or rising interest rates, we also face significant competition for investors’ funds from short-term money market securities and other corporate and government securities.
We compete for loans principally through the range and quality of the services we provide, interest rates and loan fees, and the locations ofrobust delivery channels for our Bank's branches.products and services. We actively solicit deposit-related clients and compete for deposits by offering depositors a variety of savings accounts, checking accounts, cash management and other services.
EmployeesHuman Capital
We had 859 full-time equivalent employees atDemographics
As of December 31, 2018. We believe that2021, the Bank employed 727 full-time and 40 part-time employees playacross Washington and
Oregon. None of these employees are represented by a vital role incollective bargaining agreement. During 2021, we hired 134 regular full-time and part-time employees. Voluntary workforce turnover (rolling 12-month attrition) was 20.76% and our average tenure was 7.6 years. Our workforce was 72% female and 28% male, and women held 70% of the bank’s management roles (including department supervisors and managers, as well as executive leadership). The average tenure of management was 10 years. The ethnicity of our workforce was 77% White, 8% Asian, 6% Hispanic, 4% Two or More Races, 2% Black, and 3% other.
Our Culture and Our People
The Company's success depends on the success of its people. As a service company. Employees are providedresult, the Company is focused on enhancing employee empowerment through human capital and talent management. Our strong culture was built upon adherence to a well-defined company mission and values, which aligns employees across all levels of the Company to a common goal and enables them to reach their full potential.
The Company views its employees as our most important assets, which makes training and professional development a worthy investment. We offer an array of learning opportunities through virtual and in-house courses via “Heritage Bank University”, as well as sponsoring courses through external providers, such as Ken Blanchard Company, Washington Bankers Association, Oregon Bankers Association and the Pacific Coast Banking School. We sponsor situational leadership training for leaders that focuses on communication and employee engagement.
The Company strives to maintain an environment of open communication with access to senior management, which includes quarterly all-employee virtual meetings, as well as New Employee Orientation hosted by the Chief Executive Officer. To further enhance our “listening culture” and foster open communications, we utilize a pulse survey platform to provide employees with a varietychance to share feedback directly with leadership throughout the year, including internal communications and COVID-19 Pandemic-related surveys. Survey results are shared with executive leadership and drive action planning. We also host Celebrate Great, an active internal peer recognition platform, where managers and employees post appreciation and recognition for co-workers and teams. The Company celebrates “Employee Appreciation Days” in the spring and fall which includes prizes, games, employee recognition and in-person events hosted by executive management. During 2021, the Puget Sound Business Journal recognized Heritage Bank as one of benefits such as medical, vision, dental and life insurance, a retirement plan, and paid vacationsthe Top 100 Best Workplaces in the Puget Sound.
In addition to vacation and sick leave. Noneleave, all employees receive at least eight hours of paid time each year specifically to use for volunteer activities of their choice in the communities where they live and work.
COVID-19
The COVID-19 Pandemic has presented a unique challenge with regard to maintaining employee safety while continuing successful operations. Currently, a portion of our employees are coveredworking remotely, however, substantially all employees are expected to return to their go-forward working environments during the three months ended March 31, 2022. The Company continues to monitor the situation and will continue to implement measures commensurate with guidance issued by the Centers for Disease Control and state/local health authorities.
Diversity, Equity, and Inclusion
We recognize and appreciate the importance of creating an environment in which all employees feel valued, included, and empowered to do their best work. We recognize that each employee's unique experiences, perspectives, and viewpoints add value to our ability to be the leading commercial community bank in the Pacific Northwest.
The Company has a collective bargaining agreement.DEI plan, a Diversity Council and a DEI Officer who has been certified by the National Diversity Council. The Company's Diversity Council is made up of a diverse group of employees that acts on behalf of the Company to promote the diversity and inclusion process and works closely with senior leaders to ensure DEI initiatives align with the Company's overall strategic goals and initiatives. Both our Chief Executive Officer and Senior Vice President Chief Human Resources Officer serve as Executive Sponsors to the Company's Diversity Council. The Company's Diversity Council is a critical driver in fostering organizational change, establishing a dedicated focus on diversity, equity, and inclusion priorities. The primary role of the Company's Diversity Council is to connect DEI activities to a broader, business-driven and results-oriented strategy. Executive management and the Company's board of directors have received instructor-led, custom DEI training. In addition, all employees receive ongoing diversity training.
The objectives of the Company's DEI plan include:
•Workforce Diversity: Recruit from a diverse, qualified group of potential applicants to secure a high-performing workforce drawn from all segments of the communities we serve.
•Workplace Inclusion: Promote a culture that encourages collaboration, flexibility and fairness to enable individuals to contribute to their full potential.
•Sustainability: Develop structures and strategies to equip leaders with the ability to manage diversity, be accountable, measure results, refine approaches on the basis of such data and foster a culture of inclusion.
Compensation and Benefits
We provide competitive compensation and benefit programs to aid us in attracting and retaining top talent in the very competitive Puget Sound and Portland, Oregon job markets where many of our offices are located. These programs include annual bonuses, equity, 401(k) Plan with an employer matching contribution, health insurance, transit passes, paid parking, and paid time off.
Executive Officers
The following table sets forth certain information with respect to the executive officers of the Company at December 31, 2018.2021:
| | | Name | | Age as of December 31, 2018 | | Position | | Has Served the Company or Heritage Bank Since | Name | | Age as of
December 31,
2021 | | Position | | Has Served
the Company or Bank Since |
| Brian L. Vance | | 64 |
| | Chief Executive Officer of Heritage | | 1996 | |
| Jeffrey J. Deuel | | 60 |
| | President of Heritage; President and Chief Executive Officer of Heritage Bank | | 2010 | Jeffrey J. Deuel | | 63 | | | Chief Executive Officer of Heritage Financial Corporation and Heritage Bank | | 2010 |
| Donald J. Hinson | | 57 |
| | Executive Vice President and Chief Financial Officer of Heritage and Heritage Bank | | 2005 | Donald J. Hinson | | 60 | | | Executive Vice President and Chief Financial Officer of Heritage Financial Corporation and Heritage Bank | | 2005 |
| David A. Spurling | | 65 |
| | Executive Vice President and Chief Credit Officer of Heritage and Heritage Bank | | 2001 | |
| Tony Chalfant | | Tony Chalfant | | 60 | | | Executive Vice President and Chief Credit Officer of Heritage Financial Corporation and Heritage Bank | | 2018 |
| Bryan McDonald | | 47 |
| | Executive Vice President and Chief Operating Officer of Heritage and Heritage Bank | | 2014 | Bryan McDonald | | 50 | | | Executive Vice President of Heritage Financial Corporation and President and Chief Operating Officer of Heritage Bank | | 2014 |
| Cindy Huntley | | Cindy Huntley | | 58 | | | Executive Vice President and Chief Banking Officer of Heritage Bank | | 1988 |
The business experience of each executive officer is set forth below.
Brian L. VanceJeffrey J. Deuel is the Chief Executive Officer of Heritage. During 2018, Mr. Vance announced his intent to retire on July 1, 2019. Upon his retirement, Mr. Vance will assume the role of Executive Board Chair of Heritage and oversee board activities. Mr. Vance was appointed President and Chief Executive Officer of HeritageBank and Heritage Bank in 2006. In 2003,Financial Corporation. Mr. VanceDeuel was appointedpromoted to President and Chief Executive Officer of Heritage Bank and in 1998, Mr. Vance was named President and Chief Operating Officer of Heritage Bank. Mr. Vance joined Heritage Bank in 1996 as its Executive Vice President and Chief Credit Officer. Prior to joining Heritage Bank, Mr. Vance was employed for 24 years with West One Bank, a bank with offices in Idaho, Utah, Oregon and Washington. Prior to leaving West One, he was Senior Vice President and Regional Manager of Banking Operations for the south Puget Sound region.
Jeffrey J. Deuel is the President of Heritage Financial Corporation effective July 2018 and President andthen promoted to Chief Executive Officer of Heritage Bank.Financial Corporation effective July 2019. Mr. Deuel was appointed President of Heritage and President and Chief Executive Officer of Heritage Bank in July 2018. Mr. Deuel was previously promoted to President and Chief Operating Officer of Heritage Bank and Executive Vice President of Heritage Financial Corporation in 2012,September 2012. In November 2010, Mr. Deuel was named Executive Vice President and Chief Operating Officer of Heritage Bank and Executive Vice President of the Company in 2010, andCompany. Mr. Deuel joined Heritage Bank in February 2010 as Executive Vice President of Corporate Strategies.President. Prior to joining Heritage, Mr. Deuel came to the Company with 28 years of banking experience and most recently held the position of Executive Vice President Commercial Operations with JPMorgan Chase, formerly Washington Mutual. Prior to joining Washington Mutual, Mr. Deuel was based in Philadelphia where he worked for Bank United, First Union Bank, CoreStates Bank, and First Pennsylvania Bank. During his career Mr. Deuel held a variety of leadership positions in commercial banking including lending, credit administration, portfolio management, retail, corporate strategies, and support services, corporate strategies, credit administration, and portfolio management.services. He earned his Bachelor’s degree at Gettysburg College.
Donald J. Hinson becamewas promoted to Executive Vice President and Chief Financial Officer of Heritage and Heritage Bank in September 2012. InFrom 2007 Mr. Hinsonto 2012, he was appointed to Senior Vice President and Chief Financial Officer of Heritage and Heritage Bank.Officer. Mr. Hinson joined Heritage Bankthe Company in 2005 as Vice President and Controller. Prior to that, he served in the banking audit practice of local and national accounting firms of Knight, Vale and Gregory and RSM McGladrey from 1994 to 2005. Mr. Hinson holds a Bachelor's of Science degree in Accounting from Central Washington University and is a licensed Certified Public Accountant.Bachelor's degree in Psychology from Western Washington University.
David A. SpurlingTony Chalfant became Executive Vice President and Chief Credit Officer of Heritage Financial Corporation and Heritage Bank in January 2014. Prior to that, he wasJuly 2020. Previously, Mr. Chalfant held the title of Senior Vice President and Deputy Chief Credit Officer of Heritage Bank beginning in 2007. Mr. Spurling joinedsince July 2019. Prior to that, he served as a Regional Credit Officer since January 2018 when Heritage Bank acquired Puget Sound Bank. Mr. Chalfant served as the Chief Credit Officer for Puget Sound Bank for 13 years. Prior to joining Puget Sound Bank, Mr. Chalfant held commercial lending and leadership positions with U.S. Bank for 11 years. Mr. Chalfant started his career with the U.S. Office of Comptroller of the Currency, working there for eight years. Mr. Chalfant obtained his Bachelor's degree in 2001 as a commercial lender, followed by a role as a commercial team leader. He began his banking career as a middle market lender at Seafirst Bank, followed by positions as a commercial lender at Bank of America in Small Business BankingFinance and as a regional manager for Bank of America’s government-guaranteed lending division. Mr. Spurling holds a Master’s Degree in Business AdministrationEconomics from theWashington State University of Washington and is Credit Risk Certified bya graduate of the Risk Management Association.Pacific Coast Banking School.
Bryan McDonald is the President and Chief Operating Officer of Heritage Bank. Mr. McDonald was appointedpromoted to Executive Vice President and Chief Operating Officer of Heritage Bank ineffective July 1, 2018 and then promoted to President and Chief Operating Officer of 2018.Heritage Bank effective July 1, 2021. Mr. McDonald becamewas promoted to Executive Vice President and Chief Lending Officer of Heritage Bank upon
completionas a result of the merger between Heritage Financial and Washington Banking MergerCompany effective on May 1, 2014. Mr. McDonald had served asPreviously, with Whidbey Island Bank he held the position of President and Chief Executive Officer of Whidbey Island Bank sincefrom January 1, 2012. Mr. McDonald2012 to May 2014. He joined Whidbey Island Bank in 2006 as Commercial Banking Manager and was promoted to Chief Operating Officer in 2010. Mr. McDonald has extensive managerial experience in various sales, credit, operations, commercial banking and residential real estate areas. Before joining the team at Whidbey Island Bank, he served as Seniorwas Snohomish and King County Business Group Manager where he was responsible for developing all aspects of Peoples Bank's commercial banking operation in King and Snohomish County.
Cindy Huntley was appointed Executive Vice President and Chief OperatingBanking Officer in September of Whidbey Island2019. Cindy has been with Heritage Bank from April 1, 2010 until his promotion to Executivesince 1988 and previously served as a Director of Retail Banking since 2006 and a Senior Vice President on August 26, 2010. Mr. McDonaldsince 2004. During her tenure with Heritage, Ms. Huntley has been serving in the banking industry since 1994,held numerous positions including regional commercial lending management roles with Washington Mutualmarketing, retail and Peoples Bank. Mr. McDonaldexecutive support positions. She holds a Bachelor's degree in Management from the University of Northern Colorado and Master’s Degree in Business Administrationgraduated from Washington State University.the Pacific Coast Banking School.
ITEM 1A. RISK FACTORS
We assume and manage a certain degree of risk in order to conduct our business strategy. The following provides a
discussion of certainmaterial risks that management believes are specific to our business. This discussion should not be viewed as an all-inclusive list or in any particular order.
Risks Related to the COVID-19 Pandemic and Associated Economic Slowdown
The outbreak of COVID-19 has adversely affected certain industries in which our customers operate and may impair their ability to fulfill their obligations to us. Further, the spread of the outbreak has disrupted banking and other financial activity in the areas in which we operate, could lead to an economic recession or other additional severe disruptions in the U.S. economy, and could potentially create business continuity issues for us.
The COVID-19 Pandemic continues to negatively impact economic and commercial activity and financial markets, both globally and within the United States. In our market areas, stay-at-home orders, travel restrictions and closure of non-essential business and similar orders imposed across the United States to restrict the spread of the COVID-19 Pandemic in 2020 resulted in significant business and operational disruptions, including business closures, supply chain disruptions and significant layoffs and furloughs. Although local jurisdictions have subsequently lifted stay-at-home orders and moved to the opening of businesses, worker shortages, vaccine and testing requirements, new variants of COVID-19 and other health and safety recommendations have impacted the ability of businesses to return to pre-pandemic levels of activity and employment. While the overall economy has improved, disruptions to supply chains continue and significant inflation has been seen in the market. If these effects continue for a prolonged period or result in sustained economic stress or recession, many of the risk factors identified in our Form 10-K could be exacerbated, including the following risks from the COVID-19 Pandemic, any of which could have a material, adverse effect on our business, financial condition, liquidity and results of operations of the Company:
•effects on key employees, including operational management personnel and those charged with preparing, monitoring and evaluating our financial reporting and internal controls;
•declines in demand for loans and other banking services and products, as well as a decline in the credit quality of our loan portfolio owing to the effects of the COVID-19 Pandemic in the markets served by us;
•if the economy is unable to remain open in an efficient manner, loan delinquencies, problem assets and foreclosures may increase, resulting in increased charge-offs and reduced income;
•collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;
•our allowance for credit losses on loans may increase if borrowers experience financial difficulties, which will adversely affect net income;
•the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments;
•as long as the Federal Reserve Board’s target federal funds rate remains near 0%, the yield on assets may decline to a greater extent than the decline in the cost of interest-bearing liabilities, reducing net interest margin and spread and reducing net income;
•higher operating costs, increased cybersecurity risks and potential loss of productivity as a result of an increase in the number of employees working remotely;
•increasing or protracted volatility in the price of the Company’s common stock, which may also impair our goodwill; and
•risks to the capital markets that may impact the performance of our investment securities portfolio as well as limit our access to capital markets and other funding sources.
Because there have been no comparable recent global pandemics that resulted in similar global impact, we do not yet know the full extent of the COVID-19 Pandemic’s effects on our business, operations or the global economy as a whole. Any future development will be highly uncertain and cannot be predicted, including the scope and duration of the pandemic, possible future virus variants, the effectiveness of our work-from-home arrangements, third party providers’ ability to support our operations and any actions taken by governmental authorities and other third parties in response to the pandemic. The uncertain future development of this crisis could materially and adversely affect our business, operations, operating results, financial condition, liquidity or capital levels.
Risks Related to our Business Strategy
Our strategy of pursuing acquisitions and de novo branching exposes us to financial and operational risks that could adversely affect us.
We are pursuing a strategy of supplementing organic growth by acquiring other financial institutions or their businesses that we believe will help us fulfill our strategic objectives and enhance our earnings. There are risks associated with this strategy, however, including the following:
•we may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks, businesses, assets and liabilities we acquire. If these issues or liabilities exceed our estimates, our results of operations and financial condition may be materially negatively affected;
•higher than expected deposit attrition;
•potential diversion of our management's time and attention;
•prices at which acquisitions are made can fluctuate with market conditions. We have experienced times during which acquisitions could not be made in specific markets at prices we considered acceptable and expect that we may continue to experience this condition in the future;
•the acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired entity into our company to make the transaction economically successful. This integration process is complicated and time consuming and can also be disruptive to the customers of the acquired business. If the integration process is not conducted successfully and with minimal effect on the acquired business and its customers, we may not realize the anticipated economic benefits of an acquisition within the expected time frame, and we may lose customers or employees of the acquired business. We may also experience greater than anticipated customer losses even if the
integration process is successful. These risks may be present in our Puget Sound Merger and Premier Merger that were completed during the first and third quarters of 2018, respectively;
•to finance an acquisition, we may borrow funds, thereby increasing our leverage and diminishing our liquidity, or raise additional capital, which could dilute the interests of our existing shareholders;
•from 2006 through 2018,2021, we completed eight acquisitions or mergers, including one acquisition in 2006, two acquisitions during 2010, two acquisitions during 2013, one merger in 2014 and two acquisitions in 2018 that enhanced our rate of growth. We may not be able to continue to sustain our past rate of growth or to grow at all in the future;
•we expect our net income will increase following our acquisitions; however, we also expect our general and administrative expenses and consequently our efficiency ratios willmay also increase. Ultimately, we would expect our efficiency ratio to improve; however, if we are not successful in our integration process, this may not occur, and our acquisitions or branching activities may not be accretive to earnings in the short or long-term; and
•to the extent our costs of an acquisition exceed the fair value of the net assets acquired, the acquisition will generate goodwill. As discussed below under “-If“-If the goodwill we have recorded in connection with acquisitions becomes impaired, our earnings and capital could be reduced,,” we are required to assess our goodwill for impairment at least annually, and any goodwill impairment charge could have a material adverse effect on our results of operations and financial condition.
condition; and
such loans. Estimating the fair value of such loans requires management to make estimates based on available information and facts and circumstances on the acquisition date. The difference between the fair value and the outstanding balance of such loans is accreted into net interest income. Thus, our net interest margins may initially increase due to accretion. The yields on our loans could decline as our acquired loan portfolio pays down or matures, and we expect downward pressure on our interest income to the extent that the runoff on our acquired loan portfolio is not replaced with comparable high-yielding loans. This could result in higher net interest margins and interest income in current periods and lower net interest rate margins and lower interest income in future periods.
Our business strategy includes significant growth plans, and our financial condition and results of operations could be negatively affected if we are not successful in executing this strategy or if we fail to grow or manage our growth effectively.
We intend to pursue a growth strategy for our business. We regularly evaluate potential acquisitions and expansion opportunities. If appropriate opportunities present themselves, we expect to engage in selected acquisitions of financial institutions in the future, including branch acquisitions, or other business growth initiatives or undertakings. There can be no assurance that we will successfully identify appropriate opportunities, that we will be able to negotiate or finance such activities or that such activities, if undertaken, will be successful.
Our growth initiatives may require us to recruit experienced personnel to assist in such initiatives, which will increase our compensation costs. In addition, the failure to identify and retain such personnel would place significant limitations on our ability to successfully execute our growth strategy. To the extent we expand our lending beyond our current market areas, we also could incur additional risk related to those new market areas. We may not be able to expand our market presence in our existing market areas or successfully enter new markets.
If we do not successfully execute our acquisition growth plan, it could adversely affect our business, financial condition, results of operations, reputation and growth prospects. In addition, if we were to conclude that the value of an acquired business had decreased and that the related goodwill had been impaired, that conclusion would result in an impairment of goodwill charge to us, which would adversely affect our results of operations. While we believe we have the executive management resources and internal systems in place to successfully manage our future growth, there can be no assurance that suitable growth opportunities will be available or that we will successfully manage our growth. See below “-If the goodwill we have recorded in connection with acquisitions becomes impaired, our earnings and capital could be reduced” and “-Our strategy of pursuing acquisitions and de novo branching exposes us to financial and operational risks that could adversely affect us” for additional risks related
Risks Related to our acquisition strategy.
The required accounting treatment of purchased loans we acquire through acquisitions could result in higher net interest margins and interest income in current periods and lower net interest margins and interest income in future periods.
Under generally accepted accounting principles ("GAAP"), we are required to record purchased loans acquired through acquisitions at fair value, which may differ from the outstanding balance of such loans. Estimating the fair value of such loans requires management to make estimates based on available information and facts and circumstances on the acquisition date. Actual performance could differ from management’s initial estimates. If these loans outperform our original fair value estimates, the difference between our original estimate and the actual performance of the loan (the “discount”) is accreted into net interest income. Thus, our net interest margins may initially increase due to the discount accretion. This accretable yield may change due to changes in expected timing and amount of future cash flows. The yields on our loans could decline as our acquired loan portfolio pays down or matures, and we expect downward pressure on our interest income to the extent that the runoff on our acquired loan portfolio is not replaced with comparable high-yielding loans. This could result in higher net interest margins and interest income in current periods and lower net interest rate margins and lower interest income in future periods.
New or changing tax, accounting, and regulatory rules and interpretations could significantly impact strategic initiatives, results of operations, cash flows, and financial condition.
The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit our stockholders. These regulations may sometimes impose significant limitations on operations. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and adequacy of an institution's allowance for loan losses. These bank regulators also have the ability to impose conditions in the approval of merger and acquisition transactions.Lending Activities
Our loan portfolio is concentrated in loans with a higher risk of loss.
Repayment of our commercial business loans, consisting of commercial and industrial loans as well as owner-occupied and non-owner occupied commercial real estate loans, is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value. We offer different types of commercial business loans to a variety of businesses with a focus onin industries such as real estate related industries and businesses in agricultural,rental and leasing, healthcare, legal,accommodation and other professions.food services, retail trade and construction. The primary types of commercial business loans offered are lines of credit, term equipment financing and term real estate loans. We also originate loans that are guaranteed by the SBA and we are a “preferred lender” of the SBA. Commercial business lending involves risks that are different from those associated with residential real estate lending. Our commercial business loans are primarily made based on our assessment of the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The borrower's cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Although these commercial
business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use, among other things. Accordingly, the repayment of commercial business loans depends primarily on the cash flow and creditworthiness of the borrower and secondarily on the underlying collateral provided by the borrower. In addition, as part of our commercial business lending activities, we originate agricultural loans. Agricultural lending involves a greater degree of risk. Payments on agricultural loans are typically dependent on the profitable operation or management of the related farm property. Theproperty and the success of the farm may be affected by many factors outside the control of the borrower, including adverse weather conditions that prevent the planting of a crop or limit crop yields (such as hail, drought and floods), loss of livestock due to disease or other factors, declines in market prices for agricultural products (both domestically and internationally), changes in the economy (such as tariffs) and the impact of
government regulations (including changes in price supports, subsidies and environmental regulations). In addition, many farms are dependent on a limited number of key individuals whose injury or death may significantly affect the successful operation of the farm. If the cash flow from a farming operation is diminished, the borrower’s ability to repay the loan may be impaired.
Consequently, agricultural loans may involve a greater degree of risk than other types of loans, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as farm equipment (some of which is highly specialized with a limited or no market for resale), or assets such as livestock or crops. In such cases, any repossessed collateral for a defaulted agricultural operating loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation or because the assessed value of the collateral exceeds the eventual realization value.
At December 31, 2018,2021, our commercial business loans totaled $2.94$3.19 billion, or approximately 80.4%83.7% of our total loan portfolio. Approximately $12.6portfolio, of which $23.1 million, or 0.4%0.7%, of our commercial business loans were nonperformingclassified as nonaccrual at December 31, 2018.2021. The majority of the nonperforming commercial business loans were secured by real estate. Within commercial and industrial loans. Ourbusiness loans, agricultural lendingloans totaled $94.3$64.7 million, or 2.6%1.7% of our total loan portfolio and 3.2%2.0% of our commercial business loans.loans at December 31, 2021. Nonaccrual agricultural loans totaled $5.1 million, or 21.5% of nonaccrual loans at December 31, 2021.
Our owner and non-owner occupied commercial real estate loans, which include five or more familymultifamily residential real estate loans, involve higher principal amounts than other loans and repayment of these loans may be dependent on factors outside our control or the control of our borrowers. We originate commercial and five or more family residential real estate loans for individuals and businesses for various purposes, which are secured by commercial properties. These loans typically involve higher principal amounts than other types of loans and repayment is dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions. For example, if the cash flow from the borrower’s project is reduced as a result of leases not being obtained or renewed, the borrower’s ability to repay the loan may be impaired.
Commercial and five or more family residential real estate loans also expose us to greater credit risk than loans secured by one-to-four family residential real estate because the collateral securing these loans typically cannot be sold as easily as one-to-four family residential real estate. In addition, many of our commercial and five or more family residential real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment, which may increase the risk of default or non-payment. If we foreclose on a commercial and five or more family residential real estate loan, our holding period for the collateral typically is longer than for one-to-four family residential real estate loans because there are fewer potential purchasers of the collateral. Additionally, commercial and five or more family residential real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, if we make any errors in judgment regarding the collectability of our commercial and five or more family residential real estate loans, any resulting charge-offs may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.
As of December 31, 2018,2021, our owner and non-owner occupied commercial real estate loans totaled $1.30$2.42 billion, or 35.7%63.6% of our total loan portfolio. Approximately $1.7portfolio, of which $12.8 million, or 0.1%0.5%, of our non-owner occupied commercial real estate loans were nonperformingclassified as nonaccrual at December 31, 2018.2021.
Our real estate construction and land development loans are based upon estimates of costs and net operating income and the related value associated with the completed project. These estimates may be inaccurate. Construction lending involves additional risks when compared with permanent commercial and residential lending because funds are advanced upon the collateral for the project based on an estimate of costs that will produce a future value at completion. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the complete project and the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the completed project loan-to-value ratio. Changes in demand for new housing and higher than
anticipated building costs may cause actual results to vary significantly from those estimated. For these reasons, this type of lending also typically involves higher loan principal amounts and may be concentrated with a small number of builders. A downturn in housing, or the real estate market, could increase delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. Some of theour borrowers are builders we deal with have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss. In addition, during the term of some of our construction loans, no payment from the borrower is required since the accumulated interest is added to the principal of the loan through an interest reserve. As a result, these loans often involve the disbursement of funds with repayment substantially dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of a completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. Because construction loans require active monitoring of the building process, including cost comparisons and on-site inspections, these loans are more difficult and more costly to monitor. Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly increasing the end-purchaser's borrowing costs, thereby possibly reducing the homeowner'sborrower's ability to finance the homeproject upon completion or the overall demand for the project. Properties under construction are often difficult to sell and typically must be completed in order to be successfully sold which also complicates the process of working ourout problem construction loans. This may require us to advance additional funds and/or contract with another builder to complete construction and assume the market risk of selling the project at a future market price, which may or may not enable us to fully recover unpaid loan funds and associated construction and liquidation costs. Furthermore, in the case of speculative construction loans, there is the added risk associated with identifying an end-tenant or end-purchaser for the finished project. Land development loans also pose additional risk because of the lack of income being produced by the property and potential illiquid nature of the collateral. These risks can be significantly impacted by supply and demand conditions.
As of December 31, 2018,2021, our real estate construction and land development loans totaled $215.5$226.9 million, or 5.9% of our total loan portfolio. Of these loans, $102.7portfolio, of which $85.5 million, or 2.8%2.2% of our total loan portfolio, were one-to-four family residential construction related and $112.7$141.3 million, or 3.1%3.7% of our total loan portfolio, were fivecommercial and multifamily construction. Within this category, $571,000, or more family residential and commercial property construction related. Approximately $899,000, or 0.4%,0.3% of our total real estate construction and land development loans, were nonperformingclassified as nonaccrual at December 31, 2018.2021.
Our allowance for loan lossesACL on loans may prove to be insufficient to absorb losses in our loan portfolio.
Lending money is a substantial part of our business. Every loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
•the cash flow of the borrower, guarantors and/or the project being financed;
•the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
•the character and creditworthiness of a particular borrower or guarantor;
•changes in economic and industry conditions; and
•the duration of the loan.
We maintain an allowance for loan losses, whichThe ACL on loans is a reserve establishedvaluation account that is deducted from the amortized cost of loans receivable to present the net amount expected to be collected. Loans are charged-off through the ACL on loans when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are recorded to the ACL on loans. The Bank records the changes in the ACL on loans through earnings as a provision for loancredit losses charged against earnings, which we believe is appropriate to absorb probable incurred losses in our loan portfolio. The amounton the Consolidated Statements of this allowance is determined by our management through a periodic comprehensive review and consideration of several factors, including, but not limited to:
our general reserve, based on our historical default and loss experience;
our specific reserve, based on our evaluation of impaired loans and their underlying collateral or discounted cash flows; and
current macroeconomic factors, regulatory requirements and management’s expectation of future events.Income.
The determination of the appropriate level of the allowance for loan lossesACL on loans inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. If our estimates are incorrect, the allowance for loan lossesACL on loans may not be sufficient to cover credit losses inherent in our loan portfolio, resulting in the need for increases in our allowance for loan lossesACL on loans through the provision for losses on loans which is charged against income.credit losses. Management also recognizes that significant new growth in loan portfolios,segments and new loan products and the refinancing of existing loans can result in portfoliosloans segments comprised of unseasoned loans that may not perform in a historical or projected manner and will increase the risk that our allowanceACL on loans may be insufficient to absorb losses without significant additional provisions.
Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses.ACL on loans. If current conditions in the housing and real estate markets weaken, we expect we will experience increased delinquencies and credit losses. In addition, bank regulatory agencies periodically review our allowance for loan lossesACL on loans and may require an increase in the provision for loancredit losses or the recognition of further loan charge-offs, based on their judgments about information available to them at the time of their examination. In addition, if charge-offs in future periods exceed the allowance for loan lossesACL on loans, we will need additional provisions to increase the allowance for loan losses.
The FASB has adopted a new accounting standard referred to as Current Expected Credit Loss ("CECL") which will require financial institutions to determine periodic estimates of lifetime expected credit lossesACL on loans and recognize the expected credit losses as allowances for credit losses. This will change the current method of providing allowances for credit losses that are probable, which may require us to increase our allowance for loan losses, and may greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for credit losses. This accounting pronouncement is expected to be applicable to us effective for our fiscal year beginning January 1, 2020. We are evaluating the impact the CECL accounting model will have on our accounting, but expect to recognize a one-time cumulative-effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective. We cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on our financial condition or results of operations. The federal banking regulators, including the Federal Reserve and the FDIC, have adopted a rule that gives a banking organization the option to phase in over a three-year period the day-one adverse effects of CECL on its regulatory capital. Any increases in the allowance for loan losses due to the one-time cumulative-effect adjustment will result in a decrease in net income and possibly capital, and may have a material adverse effect on our financial condition and results of operations.loans.
If our allowance for loan lossesACL on loans is not sufficient to cover actual loan losses our earnings could decrease.
For the year ended December 31, 20182021 we recorded a reversal of provision for loan lossescredit loss on loans of $5.1$27.3 million compared to $4.2a provision for credit loss on loans of $35.4 million for the year ended December 31, 2017. We recorded net charge-offs of loans of $2.2 million for2020 due primarily to changes in forecasted economic conditions attributable to the year ended December 31, 2018 compared to $3.2 million for the year ended December 31, 2017.COVID-19 Pandemic during each period. At December 31, 20182021 our total nonperformingnonaccrual loans were $13.7$23.8 million, or 0.37%0.62% of loans receivable, net, compared to $10.7$58.1 million, or 0.38%1.30% of loans receivable, net, at December 31, 2017.2020. Generally, our nonperformingnonaccrual loans reflect operating difficulties of individual borrowers, which may be the result of current economic conditions. If economic conditions deteriorate, we expect that we could experience significantly higher delinquencies and loan charge-offs. As a result, we may be required to make further increases in our provision for loan losses in the future, which could adversely affect our financial condition and results of operations, perhaps materially.
General economic conditions tend to impact loan segments at varying degrees. At December 31, 2018,2021, our commercial and industrial loan portfolio hadrepresented 43.3% of our nonaccrual loans, which was the greatest percentage of nonaccrual loans of 48.4%any loan category, as the borrowers are primarily business owners whose business results are influenced by current economic conditions as well as impact of the types of collateral generally securing these loans. Our owner-occupiedconditions. Owner-occupied commercial real estate loans and non-owner occupied commercial real estate loans portfolio, which contained 30.7%represented 34.4% and 12.5%19.6%, respectively, of our nonaccrual loans at December 31, 2018, generally have a large percentage of nonperforming loans because of the same reasons as the commercial and industrial loan portfolio noted above.2021.
Risks Related to Economic Conditions
The current economic condition in the market areas we serve may adversely impact our earnings and could increase the credit risk associated with our loan portfolio.
Substantially all of our loans are to businesses and individuals in the states of Washington and Oregon. A decline in the economies of our primary market areas of the Pacific Northwest in which we operate could have a material adverse effect on our business, financial condition, results of operations and prospects. Weakness in the global economy has adversely affected many businesses operating in our markets that are dependent upon international trade and it is not known how the recent changes in tariffs being imposed on international trade may also affect these businesses.
While real estate values and unemployment rates have improved, aA deterioration in economic conditions in our market areas of the Pacific Northwest as a result of the COVID-19 Pandemic or other factors could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:
•loan delinquencies, problem assets and foreclosures may increase;
•we may increase our allowanceACL on loans and provision for loancredit losses;
•the sale of foreclosed assets may be slow;
our provision for loan losses may increase;
•demand for our products and services may decline, possibly resulting in a decrease in our total loans;
•collateral for loans made may decline further in value, exposing us to increased risk of loss on existing loans;
•the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us; and
•the amount of our deposits may decrease and the composition of our deposits may be adversely affected.
A decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loans are geographically diverse. Many of the loans in our portfolio are secured by real estate. Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively affect the borrower’s ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by various
other factors, including changes in general or regional economic conditions, governmental rules or policies and natural disasters such as earthquakes and flooding. If we are required to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and profitability could be adversely affected.
Adverse changes in the regional and general economy could reduce our growth rate, impair our ability to collect loans and generally have a negative effect on our financial condition and results of operations.
IfChanges in the goodwill weUnited States government and its agencies’ monetary or fiscal policies, including stimulus enacted in response to the COVID-19 Pandemic, could adversely affect our results of operations and financial condition.
Our earnings will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The United States government and its agencies have recorded in connection with acquisitions becomes impaired, our earnings and capital could be reduced.
Accounting standards require that we account for acquisitions using the purchase method of accounting. Under purchase accounting, if the purchase price of an acquired company exceeds the fair value of its net assets, the excess is carriedimportant impact on the acquirer’s balance sheet as goodwill. In accordance with GAAP, our goodwill is evaluated for impairment on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists. The evaluation is based on a variety of factors, including the quoted price of our common stock, market prices of common stock of other banking organizations, common stock trading multiples, discounted cash flows, and data from comparable acquisitions. At December 31, 2018, we had goodwill with a carrying amount of $240.9 million.
Declines in our stock price or a prolonged weakness in the operating environment of the financial services industry may result in a future impairment charge. Any such impairment charge could have a material adverse effect on our operating results of banks through their power to implement national monetary policy, among other things, in order to curb inflation, combat a recession or react to impacts from the COVID-19 Pandemic. We cannot predict the nature or impact of future changes in such monetary and financial condition.fiscal policies, including stimulus enacted in response to the COVID-19 Pandemic.
Risks Related to Market Interest Rates
Fluctuating interest rates can adversely affect our profitability.
Our profitability is dependent to a large extent upon net interest income, which is the difference (or “spread”) between the interest earned on loans, investment securities and other interest earning assets and the interest paid on deposits, borrowings, and other interest bearing liabilities. Because of the differences in maturities and repricing characteristics of our interest earning assets and interest bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest earning assets and interest paid on interest bearing liabilities.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investmentsinvestment securities and the amount of interest we pay on deposits and borrowings, but these changes could also affect (i) our ability to originate and/or sell loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, which could negatively impact shareholders’ equity, and our ability to realize gains from the sale of such assets, (iii) our ability to obtain and retain deposits in competition with other available investment alternatives, (iv) the ability of our borrowers to repay adjustable or variable rate loans, and (v) the average duration of our investment securities portfolio and other interest-earninginterest earning assets. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if interest rates decrease as assets tend to reprice more quickly than liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially affected.
Interest rates are highly sensitive to many factors that are beyond our control, including general and forecasted economic conditions reflected in the rates offered along the yield curve and the FHLB's fixed-rate advance index, and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. In an attemptMarch 2020, in response to help the overall economy,COVID-19 Pandemic, the Federal ReserveFOMC lowered the target range for the federal funds rate 150 basis points to a range of 0.00% to 0.25%. The reduction in the targeted federal funds rate has keptresulted in a decline in overall interest rates low through its targeted Fed Funds rate. The Federal Reservewhich has steadily increasednegatively impacted our net interest income. However, the targeted Fed Funds rate overFOMC has recently indicated it expects to increase rates starting in 2022. If the last three fiscal years to 2.50% at December 31, 2018. The Federal Reserve may make additional increases in interest rates during 2019 subject to economic conditions. As the Federal ReserveFOMC increases the targeted federal funds rates,rate, overall interest rates will likelyare expected to rise, which will positively impact our net interest income, but may negatively impact both the housing marketsmarket, by reducing refinancing activity and new home purchases, and the U.S. economic recovery.economy. In addition, deflationary pressures, while possibly lowering our operational costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of collateral securing loans which could negatively affect our financial performance.
A sustained increase in market interest rates could adversely affect our earnings. As a resultis the case with many banks and saving institutions, our emphasis on increasing the development of the exceptionally low interest rate environment, an increasing percentage of ourcore deposits have been comprised of(those deposits bearing no or a relatively low rate of interest andwith no stated maturity date) has resulted in our interest bearing liabilities having a shorter duration than our assets. We would incur a higher cost of funds to retain these deposits in a rising interest rate environment. If the interest rates paid on deposits and other borrowings
increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected.
Changes in interest rates also affect the value of our interest-earninginterest earning assets and in particular our investment securities portfolio. Generally, the fair value of fixed-rate investment securities fluctuates inversely with changes in interest rates. Unrealized gains and losses on investment securities available for sale are reported as a separate component of equity, net of tax. Decreases in the fair value of investment securities available for sale resulting from increases in interest rates could have an adverse effect on stockholders’ equity.
Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet.
Uncertainty relating to the London Interbank Offered Rate ("LIBOR") calculation process and potential phasing out For further discussion of LIBOR may adversely affect our results of operations.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enactedhow changes in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, subordinated debentures, or other securities or financial arrangements, given LIBOR's role in determining market interest rates globally. Uncertainty as to the naturecould impact us and additional information about our interest rate risk management, see Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Our investment securities portfolio may be negatively impacted by fluctuations in market value and interest rates.
Our investment securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated other comprehensive income (loss), netAOCI and/or earnings. Fluctuations in market value may be caused by changes in market interest rates, rating agency actions in respect of the securities, defaults by the issuer or with respect to the underlying securities, lower market prices for securities and limited investor demand. Our investment securities portfolio is evaluated for other-than-temporary impairment. If this evaluation shows impairment toestimated credit losses and an ACL on investment securities, as appropriate, is recorded as a contra asset on the actual or projected cash flows associated with one or morefinancial statement of condition and a provision for credit loss on investment securities a potential loss to earnings may occur. Changes in interest rates can also have an adverse effect on our financial condition, as our available-for-sale securities are reported at their estimated fair value, and therefore are impacted by fluctuations in interest rates. We increase or decrease our shareholders' equity by the amount of change in the estimated fair value of the available-for-sale securities, net of taxes.through earnings. There can be no assurance that the declines in market value will not result in other-than-temporary impairments of these assets,credit losses, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.
Decreased volumesRisks Related to Laws and lower gains on sales of mortgage loans sold could adversely impact our noninterest income.
We originate and sell one-to-four family residential loans. Our mortgage banking income is a significant portion of our noninterest income. We generate gains on the sale of one-to-four family residential loans pursuant to programs currently offered by the Federal Home Loan Mortgage Corporation ("Freddie Mac") and other secondary market purchasers. Any future changes in their purchase programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of such entities could, in turn, materially adversely affect our results of operations. Further, in a rising or higher interest rate environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors. This would result in a decrease in mortgage banking revenues and a corresponding decrease in noninterest income. In addition, our results of operations are affected by the amount of noninterest expense associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment and data processing expense and other operating costs. During
periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, growth and prospects.
Liquidity is essential to our business. We rely on a number of different sources in order to meet our potential liquidity demands. We require sufficient liquidity to meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress. A tightening of the credit markets and the inability to obtain adequate funding may negatively affect our liquidity, asset growth and, consequently, our earnings capability and capital levels. In addition to any deposit growth, and the sale of loans or investment securities, maturity of investment securities and loan payments, we rely from time to time on advances from the FHLB of Des Moines, and certain other wholesale funding sources to meet liquidity demands. Our liquidity position could be significantly constrained if we were unable to access funds from the FHLB of Des Moines or other wholesale funding sources. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated, negative operating results, or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry or deterioration in credit markets. Any decline in available funding in amounts adequate to finance our activities or on terms which are acceptable could adversely impact our ability to originate loans, invest in securities, meet our expenses, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could, in turn, have a material adverse effect on our business, financial condition and results of operations.
Additionally, collateralized public funds are bank deposits of state and local municipalities. These deposits are required to be secured by certain investment grade securities to ensure repayment, which on the one hand tends to reduce our contingent liquidity risk by making these funds somewhat less credit sensitive, but on the other hand reduces standby liquidity by restricting the potential liquidity of the pledged collateral. Although these funds historically have been a relatively stable source of funds for us, availability depends on the individual municipality's fiscal policies and cash flow needs.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high; further, the resulting dilution of our equity may adversely affect the market price of our common stock.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. At some point we may need to raise additional capital to support our continued internal growth and growth through acquisitions or be required by our regulators to increase our capital resources. Our ability to raise additional capital, however, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. If we are able to raise capital it may not be on terms that are acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired and our financial condition and liquidity could be materially and adversely affected. Accordingly, we cannot make assurances that we will be able to raise additional capital when needed.
We are not restricted from issuing additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities. The market price of our common stock could decline as a result of sales of a large number of shares of common stock or preferred stock or similar securities in the market or from the perception that such sales could occur.
Our Board of Directors is authorized generally to cause us to issue additional common stock, as well as series of preferred stock, without any action on the part of our shareholders except as may be required under the listing requirements of the NASDAQ Stock Market. In addition, our Board has the power, without shareholder approval, to set the terms of any such series of preferred stock that may be issued, including voting rights, dividend rights and preferences over the common stock with respect to dividends or upon the liquidation, dissolution or winding-up of our business and other terms. Any capital we obtain may result in the dilution of the interests of existing holders of our common stock.
In addition, if we issue preferred stock in the future that has a preference over the common stock with respect to the payment of dividends or upon liquidation, dissolution or winding-up, or if we issue preferred stock with voting
rights that dilute the voting power of the common stock, the rights of holders of the common stock or the market price of the common stock could be adversely affected.Regulations
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions.
The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions. Recently several banking institutions have received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations.
Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these resultsus and could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
Our operationsRisks Related to Operational Matters
We rely on numerous external vendors.other companies to provide key components of our business infrastructure.
We rely on numerous external vendors to provide us with products and services necessary to maintain our day-to-day operations. Accordingly, our operations are exposed to the risk that these vendors will not perform in accordance with the contracted arrangements under service level agreements. The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements because of changes in the vendor's organizational structure, financial condition, level of support for existing products and services, or strategic focus or for any other reason, could be disruptive to our operations, which in turn could have a material negative impact on our financial condition and results of operations. We also could be adversely affected to the extent a service agreement is not renewed by the third partythird-party vendor or is renewed on terms less favorable to us. Additionally, the bank regulatory agencies expect financial institutions to be responsible for all aspects of our vendors’ performance, including aspects which they delegate to third parties. Disruptions or failures in the physical infrastructure or operating systems that support our business and customers, or cyber-attacks or security breaches of the networks, systems or devices that our customers use to access our products and services could result in client attrition; regulatory fines, penalties or intervention; reputational damage; reimbursement or other compensation costs and/or additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.
We are subject to certain risks in connection with our use of technology.
Our security measures may not be sufficient to mitigate the risk of a cyber-attack.cyber-attack. Communications and information systems are essential to the conduct of our business as we use such systems to manage our customer relationships, our core operating systems, our general ledger and virtually all other aspects of our business. Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems, software and networks may be vulnerable to breaches, fraudulent or unauthorized access, denial or degradation of service attacks, misuse, computer viruses, malware or other malicious code and cyber-attacks that could have a security impact. If one or more of these events occur, this could jeopardize our or our customers' confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us. We could also suffer significant reputational damage.
Security breaches in our internet banking activities could further expose us to possible liability and damage our reputation.reputation. Increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries and vulnerabilities in third partythird-party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes andand/or controls that we use to prevent fraudulent transactions and to protect data about us, our clients and underlying transactions. Any compromise of our security could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. Although we have developed and continue to invest in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, these precautions may not protect our systems from compromises or breaches of our security measures.measures and could result in losses to us or our customers, our loss of business and/or customers, damage to our reputation, the
incurrence of additional expenses, disruption to our business, our inability to grow our online services or other businesses, additional regulatory scrutiny or penalties or our exposure to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.
Our security measures may not protect us from system failures or interruptions. While we have established policies and procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance that such events will not occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects of our data processing and other operational functions to certain third-party providers. While the Company selects third-party vendors carefully, it does not control their actions. If our third-party providers encounter difficulties, including those resulting from breakdowns or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher transaction volumes, cyber-attacks and security breaches or if we otherwise have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected and our ability to deliver products and services to our customers and otherwise conduct business operations could be adversely impacted. Replacing these third-party vendors could also entail significant delay and expense. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
We cannot assure you that such breaches, failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third partiesthird-parties on which we rely. We may not be insured against all types of losses as a result of third partythird-party failures and insurance coverage may be inadequate to cover all losses resulting from breaches, system failures or other disruptions. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to identify alternative sources of such services and we cannot assure you that we could negotiate terms that are as favorable to us or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all. Further, the occurrence of any systems failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny or could expose us to legal liability. Any of these occurrences could have a material adverse effect on our financial condition and results of operations.
The board of directors oversees the risk management process, including the risk of cybersecurity, and engages with management on cybersecurity issues.
If our enterprise risk management framework is not effective at mitigating risk and loss to us, we could suffer unexpected losses and our results of operations could be materially adversely affected.
Our enterprise risk management framework seeks to achieve an appropriate balance between risk and return, which is critical to optimizing stockholder value. We have established processes and procedures intended to identify, measure, monitor, report, analyze and control the types of risk to which we are subject. These risks include liquidity risk,risk; credit risk,risk; market risk,risk; interest rate risk,risk; operational risk,risk; legal and compliance risk,risk; and reputational risk, among others. We also maintain a compliance program to identify, measure, assess and report on our adherence to applicable laws, policies and procedures. While we assess and improve these programs on an ongoing basis, there can be no assurance that our risk management or compliance programs, along with other related controls, will effectively mitigate all risk and limit losses in our business. However, as with any risk management framework, there are inherent limitations to our risk management strategies as there may exist, or develop in the future, risks that we have not appropriately anticipated or identified. If our risk management framework proves ineffective, we could suffer unexpected losses and our business, financial condition and results of operations could be materially adversely affected.
We are subject to certain risks in connection with our data management or aggregation.
We are reliant on our ability to manage data and our ability to aggregate data in an accurate and timely manner to ensure effective risk reporting and management. Our ability to manage data and aggregate data may be limited by the effectiveness of our policies, programs, processes and practices that govern how data is acquired, validated, stored, protected and processed. While we continuously update our policies, programs, processes and practices, many of our data management and aggregation processes are manual and subject to human error or system failure. Failure to manage data effectively and to aggregate data in an accurate and timely manner may limit our ability to manage current and emerging risks, as well as to manage changing business needs.
We rely on dividends from Heritage Bank for substantially all of our revenue at the holding company level.
We are an entity separate and distinct from our subsidiary, Heritage Bank, and derive substantially all of our revenue at the holding company level in the form of dividends from that subsidiary. Accordingly, we are, and will be, dependent upon dividends from Heritage Bank to pay the principal of and interest on our indebtedness, to satisfy our other cash needs and to pay dividends on our common stock. Heritage Bank's ability to pay dividends is subject to its ability to earn net income and to meet certain regulatory requirements. In the event Heritage Bank is unable to pay dividends to us, we may not be able to pay dividends on our common stock. Also, our right to participate in a distribution of assets upon a subsidiary's liquidation or reorganization is subject to the prior claims of the subsidiary's creditors.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.crimes.
Our loansThe Company and the Bank are susceptible to businesses and individuals andfraudulent activity that may be committed against us or our deposit relationships and related transactions are subjectcustomers which may result in financial losses or increased costs to exposureus or our customers, disclosure or misuse of our information or our customer’s information, misappropriation of assets, privacy breaches against our customers, litigation or damage to the risk of loss due toour reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other financial crimes.dishonest acts. Nationally, reported incidents of fraud and other financial crimes have increased. We have also experienced losses due to apparent fraud and other financial crimes, although such losses have been relatively insignificant to date. While we have policies and procedures designed to prevent such losses, there can be no assurance that such losses will not occur.
Managing reputational risk is important to attracting and maintaining customers, investors and employees.
Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies and questionable or fraudulent activities of our customers. We have policies and procedures in place to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective. Negative publicity regarding
our business, employees or customers, with or without merit, may result in the loss of customers, investors and employees,employees; costly litigation,litigation; a decline in revenues and increased governmental regulation.
We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects.
Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge of, and experience in, the community banking industry where we conduct our business. The process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel and upon the continued contributions of our management and personnel. In particular, our success has been and continues to be highly dependent upon the abilities of key executives, including our Chief Executive Officer, of Heritage, Mr. Brian L. Vance, and our Chief Executive Officer of Heritage Bank, Jeffrey J. Deuel, and certain other employees. The loss of key personnel could adversely affect our ability to successfully conduct our business.
Our ability to sustain or improve upon existing performance is dependent upon our ability to respond to technological change, and we may have fewer resources than some of our competitors to continue to invest in technological improvements.
The financial services industry is experiencing rapid technological changes with frequent introductions of new technology-driven products and services. Effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Many of our competitors have substantially greater resources to invest in technological improvements than the Company does.we do. Our future success will depend, to some degree, upon itsour ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as create additional efficiencies in our operations. We may not be able to effectively implement new technology-driven products or services or be successful in marketing these products and services. Additionally, the implementation of technological changes and upgrades to maintain current systems and integrate new ones may cause servicesservice interruptions, transaction processing errors and system conversion delays and may cause us to fail to comply with applicable laws. There can be no assurance that we will be able to successfully manage the risks associated with increased dependency on technology.
Risks Related to Accounting Matters
New or changing tax, accounting, and regulatory rules and interpretations could significantly impact strategic initiatives, results of operations, cash flows, and financial condition.
The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit our stockholders. These regulations, along with the currently existing tax, accounting, securities, insurance and monetary laws, regulations, rules, standards, policies and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies and interpretations are constantly evolving and may change significantly over time. Any new regulations or legislation, change in existing regulation or oversight, whether a change in regulatory policy or a change in a regulator's interpretation of a law or regulation, could have a material impact on our operations, increase our costs of regulatory compliance and of doing business and adversely affect our profitability. Regulatory authorities also have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and adequacy of an institution's ACL. These bank regulators also have the ability to impose conditions in the approval of merger and acquisition transactions.
If the goodwill we have recorded in connection with acquisitions becomes impaired, our earnings and capital could be reduced.
Accounting standards require that we account for acquisitions or business combinations using the purchase method of accounting. Under purchase accounting, if the purchase price of an acquired company exceeds the fair value of its net assets, the excess is carried on the acquirer’s balance sheet as goodwill. In accordance with GAAP, our goodwill is evaluated for impairment on an annual basis or more frequently if events or circumstances indicate a potential impairment exists. The evaluation may be based on a variety of quantitative factors, including the quoted price of our common stock, market prices of common stock of other banking organizations, common stock trading multiples, discounted cash flows and data from comparable acquisitions. Additionally, we may perform a qualitative assessment that takes into consideration macroeconomic conditions, industry and market conditions, cost or margin factors, and financial performance. Our evaluation of the fair value of goodwill involves a substantial amount of judgment. If our judgment was incorrect, or if events or circumstances change, and an impairment of goodwill was deemed to exist, we would be required to write down our goodwill resulting in a charge against income, which could adversely affect our results of operations and financial condition, perhaps materially; however, it would have no impact on our liquidity, operations or regulatory capital.
Other Risks Related to Our Business
We will be required to transition from the use of the London Interbank Offered Rate ("LIBOR") in the future.
FHLB advances, loans receivable, investment securities, subordinated debentures and trust preferred securities may be indexed to LIBOR to calculate the interest rate. The continued availability of the LIBOR index is not guaranteed after 2021 and LIBOR is scheduled to be eliminated entirely by June 2023. We cannot predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR (with the exception of overnight
repurchase agreements, which are expected to be based on SOFR). Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and to a lesser extent securities in our portfolio, and may impact the availability and cost of hedging instruments and borrowings, including the rates we pay on our trust preferred securities. The language in our LIBOR-based contracts and financial instruments has developed over time and may have various events that trigger when a successor rate to the designated rate would be selected. If a trigger is satisfied, contracts and financial instruments may give the calculation agent discretion over the substitute index or indices for the calculation of interest rates to be selected. The implementation of a substitute index or indices for the calculation of interest rates under our loan agreements with our borrowers or our borrowings may result in our incurring significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices and may result in disputes or litigation with clients and creditors over the appropriateness or comparability to LIBOR of the substitute index or indices, which could have an adverse effect on our results of operations.
To mitigate the uncertainty surrounding the LIBOR transition, the Bank has been utilizing specific contract language in new loan agreements that provides for changes in the index used to calculate the loan's interest rate. Additionally, effective January 25, 2021, the Company agreed to adhere to the Interbank Offered Rate Fallbacks Protocol as published by the International Swaps and Derivatives Association, Inc recommended by the Alternative Reference Rates Committee.
Decreased volumes and lower gains on sales of mortgage loans sold could adversely impact our noninterest income.
We originate and sell residential real estate loans, or mortgage loans. The related mortgage income is a significant portion of our noninterest income. We generate gains on the sale of residential real estate loans pursuant to programs currently offered by the Federal Home Loan Mortgage Corporation and other secondary market purchasers. Any future changes in these purchase programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of such entities could, in turn, materially adversely affect our results of operations. Further, in a rising or higher interest rate environment, our originations of mortgage loans may decrease resulting in fewer loans that are available to be sold to investors. This would result in a decrease in gain on loans, net and a corresponding decrease in noninterest income. In addition, our results of operations are affected by the amount of noninterest expense associated with mortgage banking activities, such as salaries and employee benefits; occupancy and equipment expense; data processing expense and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in mortgage loan originations.
Ineffective liquidity management could adversely affect our financial results and condition.
Effective liquidity management is essential to our business. We require sufficient liquidity to meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress. An inability to raise funds through deposits, borrowings, the sale of loans or investment securities and other sources could have a substantial negative effect on our liquidity. We rely on customer deposits and borrowings from the FHLB and certain other wholesale funding sources to fund our operations. Deposit flows and the prepayment of loans and mortgage-related investment securities are strongly influenced by such external factors as the direction of interest rates, whether actual or perceived, and the competition for deposits and loans in the markets we serve. Further, changes to the FHLB's underwriting guidelines for wholesale borrowings or lending policies may limit or restrict our ability to borrow and could therefore have a significant adverse impact on our liquidity. Although we have historically been able to replace maturing deposits and borrowings if desired, we may not be able to replace such funds in the future if, among other things, our financial condition, the financial condition of the FHLB or market conditions change. Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable could be impaired by factors that affect us, the financial services industry or the economy in general, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry or deterioration in credit markets. Additional factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our deposits and loans are concentrated, negative operating results or adverse regulatory action against us. Any decline in available funding in amounts adequate to finance our activities or on terms which are acceptable could adversely impact our ability to originate loans, invest in securities, pay our expenses or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could, in turn, have a material adverse effect on our business, financial condition and results of operations.
Additionally, collateralized public funds are bank deposits of state and local municipalities. These deposits are required to be secured by certain investment grade securities to ensure repayment, which on the one hand tends to reduce our contingent liquidity risk by making these funds somewhat less credit sensitive, but on the other hand reduces standby liquidity by restricting the potential liquidity of the pledged collateral. Although these funds historically have been a relatively stable source of funds for us, availability depends on the individual municipality's fiscal policies and cash flow needs.
Societal responses to climate change could adversely affect our business and performance, including indirectly through impacts on our customers.
Concerns over the long-term impacts of climate change have led and will continue to lead to governmental efforts around the world to mitigate those impacts. Consumers and businesses also may change their behavior on their own as a result of these concerns. We and our customers will need to respond to new laws and regulations as well as consumer and business preferences resulting from climate change concerns. We and our customers may face cost increases, asset value reductions and operating process changes. The impact on our customers will likely vary depending on their specific attributes, including reliance on or role in carbon intensive activities. Among the impacts to us could be a drop in demand for our products and services,
particularly in certain industry sectors. In addition, we could face reductions in creditworthiness on the part of some customers or in the value of assets securing loans. Our efforts to take these risks into account in making lending and other decisions, including by increasing our business with climate-friendly companies, may not be effective in protecting us from the negative impact of new laws and regulations or changes in consumer or business behavior.
Risk Related to Holding Our Common Stock
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high; further, the resulting dilution of our equity may adversely affect the market price of our common stock.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. At some point, we may need to raise additional capital to support our growth or replenish future losses. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. Accordingly, we cannot make assurances we will be able to raise additional capital, if needed, on terms that are acceptable to us or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired and our financial condition and liquidity could be materially and adversely affected.
In addition, any additional capital we obtain may result in the dilution of the interests of existing holders of our common stock. Further, if we are unable to raise additional capital when required by our bank regulators, we may be subject to adverse regulatory action.
We rely on dividends from the Bank for substantially all of our revenue at the holding company level.
We are an entity separate and distinct from our subsidiary, the Bank, and derive substantially all of our revenue at the holding company level in the form of dividends from that subsidiary. Accordingly, we are, and will be, dependent upon dividends from the Bank to pay the principal of and interest on our indebtedness, to satisfy our other cash needs and to pay dividends on our common stock. The Bank's ability to pay dividends is subject to its ability to earn net income and to meet certain regulatory requirements. In the event the Bank is unable to pay dividends to us, we may not be able to pay dividends on our common stock. Also, our right to participate in a distribution of assets upon a subsidiary's liquidation or reorganization is subject to the prior claims of the subsidiary's creditors.
ITEM 1B. UNRESOLVED STAFF COMMENTS
The Company has no unresolved staff comments from the SEC as it relates to the Company's financial information as reported onin the Form 10-K.
ITEM 2. PROPERTIES
Our executive offices and theThe main office of Heritagethe Company and the Bank are located in approximately 22,000 square feet of the headquarters building and adjacent office space and main branch office which are owned by Heritage Bank andis located in downtown Olympia.Olympia, Washington. In addition, the Bank owns back office locations in downtown Tacoma, Washington; Lynnwood, Washington and Burlington, Washington. The Company'sBank's branch network at December 31, 20182021 was comprised of 6449 branches located throughout Washington and Oregon. The numberOregon following the consolidation of 12 branches per county, as well as occupancy type, is detailedduring the year ended December 31, 2021. In the opinion of management, all properties are adequately covered by insurance, are in the following table.good state of repair and are adequate to meet our present and immediately foreseeable needs.
|
| | | | | | | | | | | |
| | | | | | | Occupancy Type |
| County | | State | | Number of Branches | | Owned | | Leased |
| Clark | | WA | | 2 |
| | 1 |
| | 1 |
|
| Cowlitz | | WA | | 2 |
| | 2 |
| | — |
|
Island (1) | | WA | | 7 |
| | 6 |
| | 1 |
|
Kittitas (1) | | WA | | 1 |
| | 1 |
| | — |
|
| King | | WA | | 8 |
| | 3 |
| | 5 |
|
| Mason | | WA | | 1 |
| | 1 |
| | — |
|
| Multnomah | | OR | | 2 |
| | — |
| | 2 |
|
| Pierce | | WA | | 13 |
| | 8 |
| | 5 |
|
| San Juan | | WA | | 1 |
| | — |
| | 1 |
|
Skagit (1) | | WA | | 3 |
| | 3 |
| | — |
|
| Snohomish | | WA | | 8 |
| | 6 |
| | 2 |
|
Thurston (1) | | WA | | 4 |
| | 3 |
| | 1 |
|
| Washington | | OR | | 5 |
| | 1 |
| | 4 |
|
| Whatcom | | WA | | 3 |
| | 3 |
| | — |
|
| Yakima | | WA | | 4 |
| | 4 |
| | — |
|
| Total | | | | 64 |
| | 42 |
| | 22 |
|
| |
(1)
| One Island County branch, one Skagit County branch, one Thurston County branch and the one branch in Kittitas County have land leases, which are not included in the leased section above as the building is owned. |
For additional information concerning our premises and equipment and lease obligations, see Note (7) Premises and Equipment and Note (14) Commitments and Contingencies of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
ITEM 3. LEGAL PROCEEDINGS
We, and our Bank, are not a party to any material pending legal proceedings other than ordinary routine litigation incidental to the business of the Bank.our businesses.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is traded on the NASDAQ Global Select Market under the symbol HFWA.
Holders
At December 31, 2018,2021, we had approximately 1,4391,183 shareholders of record (not including the number of persons or entities holding stock in nominee or street name through various brokerage firms) and 36,874,05535,105,779 outstanding shares of common stock. This total does not reflect the number of persons or entities who hold stock in nominee or “street” name through various brokerage firms.
Quarterly, the Company reviews the potential payment of cash dividends to common shareholders. The timing and amount of cash dividends paid on our common stock depends on the Company’s earnings, capital requirements, financial condition and other relevant factors.
The dividend activities for the years ended December 31, 2018 and 2017 and through the date of this filing are listed below:
|
| | | | | | | | |
Declared | | Cash
Dividend per Share
| | Record Date | | Paid | | |
January 25, 2017 | | $0.12 | | February 9, 2017 | | February 23, 2017 | | |
April 25, 2017 | | $0.13 | | May 10, 2017 | | May 24, 2017 | | |
July 25, 2017 | | $0.13 | | August 10, 2017 | | August 24, 2017 | | |
October 25, 2017 | | $0.13 | | November 8, 2017 | | November 22, 2017 | | |
October 25, 2017 | | $0.10 | | November 8, 2017 | | November 22, 2017 | | * |
January 24, 2018 | | $0.15 | | February 7, 2018 | | February 21, 2018 | | |
April 25, 2018 | | $0.15 | | May 10, 2018 | | May 24, 2018 | | |
July 24, 2018 | | $0.15 | | August 9, 2018 | | August 23, 2018 | | |
October 24, 2018 | | $0.17 | | November 7, 2018 | | November 21, 2018 | | |
October 24, 2018 | | $0.10 | | November 7, 2018 | | November 21, 2018 | | * |
January 23, 2019 | | $0.18 | | February 7, 2019 | | February 21, 2019 | | |
* Denotes special dividend.
The primary source for dividends paid to our shareholders are dividends paid to us from Heritage Bank. There are regulatory restrictions on the ability of the Bank to pay dividends. Under federal regulations, the dollar amount of dividends the Bank may pay depends upon its capital position and recent net income. Generally, if an institution satisfies its regulatory capital requirements, it may make dividend payments up to the limits prescribed under state law and FDIC regulations. However, an institution that has converted to the stock form of ownership, as Heritage Bank has done, may not declare or pay a dividend on, or repurchase any of, its common stock if the effect thereof would cause the regulatory capital of the institution to be reduced below the amount required for the liquidation account which was established in connection with the mutual to stock conversion.
As a bank holding company, our ability to pay dividends is subject to the guidelines of the Federal Reserve regarding capital adequacy and dividends. The Federal Reserve’s policy is that a bank holding company should pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition, and that it is inappropriate for a bank holding company experiencing serious financial problems to borrow funds to pay dividends. Under Washington law, we are prohibited from paying a dividend if, after making such dividend payment, we would be unable to pay our debts as they become due in the usual course of business, or if our total liabilities, plus the amount that would be needed, in the event we were to be dissolved at the time of the dividend payment, to satisfy preferential rights on dissolution of holders of preferred stock ranking senior in right of payment to the capital stock on which the applicable distribution is to be made exceed our total assets.
common stock.
Stock Repurchases
The Company has had various stock repurchase programs since March 1999. On October 23, 2014,Purchases of Equity Securities by the Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares, or approximately 1,513,000 shares, under the eleventh stock repurchase plan. At December 31, 2018, there were approximately 933,004 shares remaining to be purchased under the eleventh stock repurchase plan. The number, timingIssuer and price of shares repurchased will depend on business and market conditions, and other factors, including opportunities to deploy the Company's capital.
Since the inception of the eleventh plan, the Company has repurchased 579,996 shares at an average share price of $16.67. No shares were repurchased under this plan during the year ended December 31, 2018 and 2017. During the year ended December 31, 2016, the Company repurchased 138,000 shares at an average share price of $17.16.
In addition to the stock repurchases under a plan, the Company repurchases shares to pay withholding taxes on the vesting of restricted stock awards and units. The following table provides total repurchased shares for the periods indicated:
|
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
Repurchased shares to pay withholding taxes (1) | 53,256 |
| | 29,429 |
| | 29,512 |
|
| Stock repurchase to pay withholding taxes average share price | $ | 31.99 |
| | $ | 25.01 |
| | $ | 17.82 |
|
| |
(1)
| During the year ended December 31, 2018, the Company repurchased 26,741 shares related to the withholding taxes due on the accelerated vesting of the restricted stock units of Puget Sound which were converted to Heritage common stock shares with a share price of $31.80 under the terms of the Puget Sound Merger.
|
Affiliated Purchasers
The following table sets forth information about the Company’s purchases of its outstanding common stock during the quarter ended December 31, 2018.2021:
| | | | | | | | | | | | | | | | | | | | | | | |
| Period | Total Number of Shares Purchased | | Average Price Paid Per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs |
| October 1, 2021— October 31, 2021 | — | | | $ | — | | | 9,822,889 | | | 802,188 | |
| November 1, 2021— November 30, 2021 | — | | | — | | | 9,822,889 | | | 802,188 | |
| December 1, 2021— December 31, 2021 | 64,730 | | | 23.03 | | | 9,886,773 | | | 738,304 | |
| Total | 64,730 | | | $ | 23.03 | | | | | |
|
| | | | | | | | | | | | | |
| Period | | Total Number of Shares Purchased (1) | | Average Price Paid Per Share (1) | | Cumulative Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs |
| October 1, 2018— October 31, 2018 | | — |
| | $ | — |
| | 7,893,389 |
| | 935,034 |
|
| November 1, 2018—November 30, 2018 | | — |
| | — |
| | 7,893,389 |
| | 935,034 |
|
| December 1, 2018—December 31, 2018 | | 68 |
| | 31.79 |
| | 7,893,389 |
| | 935,034 |
|
| Total | | 68 |
| | $ | 31.79 |
| | | | |
| |
(1)
| All of the common shares repurchased by the Company between October 1, 2018 and December 31, 2018, were shares of restricted stock that represented the cancellation of stock to pay withholding taxes. |
Of the common shares repurchased by the Company between October 1, 2021 and December 31, 2021, 846 shares represented the cancellation of stock to pay withholding taxes on vested restricted stock units. See Note (15) Stockholders' Equity of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data for additional information on publicly announced repurchase plans or programs.
Stock Performance Graph
The following graph depictsshows the five-year comparison of the total return to shareholders of the Company’s common stock as compared to the NASDAQ Composite Index, the KBW NASDAQ Bank Index and the S&P U.S. SmallCap Banks Index during the five-year period beginning December 31, 20132016 and ending December 31, 2018.2021. The graph assumes the value of the investment in Company’s common stock and each index was $100 on December 31, 2016, and all dividends were reinvested. Total return includes appreciation or depreciation in market value of the Company’s common stock as well as actual cash and stock dividends paid to common shareholders. The graph additionally shows the five-year comparison of the total return to shareholders of the Company’s common stock as compared to the NASDAQ Composite Index and the SNL U.S. Bank NASDAQ Index. The NASDAQ Composite Index is a comparative broad equity market index comprised of all domestic and international common stocks listed on the Nasdaq Stock Market. TheDuring the year ended December 31, 2021, the previously used SNL U.S. Bank NASDAQ Index was replaced by the KBW NASDAQ Bank Index on the S&P Global Market Intelligence platform. The KBW NASDAQ Bank Index is and the previously used SNL U.S. Bank NASDAQ Index was a comparative peerpublished industry index comprised of banks and related holding companies listed on the NASDAQ Stock Market. The graph assumes thatS&P U.S. SmallCap Banks Index is also a published industry index, however, the valueindex constituents are aligned within the same market capitalization range as the Company and we will include the S&P U.S. SmallCap Banks Index in the future since it is more closely aligned with holding companies and banks of the investment in Heritage’s common stock and each of the three indices was $100 on December 31, 2013, and that all dividends were reinvested.our size.
.
.
| | | | | Years Ended December 31, | | Years Ended December 31, |
| Index | | 2013 | | 2014 | | 2015 | | 2016 | | 2017 | | 2018 | Index | 2016 | | 2017 | | 2018 | | 2019 | | 2020 | | 2021 |
| Heritage Financial Corporation | | $ | 100.00 |
| | $ | 105.74 |
| | $ | 116.98 |
| | $ | 166.45 |
| | $ | 203.56 |
| | $ | 200.82 |
| Heritage Financial Corporation | $ | 100.00 | | | $ | 122.28 | | | $ | 120.65 | | | $ | 118.22 | | | $ | 101.59 | | | $ | 109.59 | |
| NASDAQ Composite Index | | 100.00 |
| | 114.75 |
| | 122.74 |
| | 133.62 |
| | 173.22 |
| | 168.30 |
| NASDAQ Composite Index | 100.00 | | | 129.64 | | | 125.96 | | | 172.18 | | | 249.51 | | | 304.85 | |
| SNL U.S. Bank NASDAQ Index | | 100.00 |
| | 103.57 |
| | 111.80 |
| | 155.02 |
| | 163.20 |
| | 137.56 |
| |
| KBW NASDAQ Bank Index | | KBW NASDAQ Bank Index | 100.00 | | | 118.59 | | | 97.58 | | | 132.84 | | | 119.14 | | | 164.80 | |
| S&P U.S. SmallCap Banks Index | | S&P U.S. SmallCap Banks Index | 100.00 | | | 104.33 | | | 87.06 | | | 109.22 | | | 99.19 | | | 138.09 | |
*Information for the graph was provided by S&P Global Market Intelligence.
ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth certain information concerning our consolidated financial position and results of operations at and for the dates indicated and have been derived from our audited Consolidated Financial Statements. The information below is qualified in its entirety by the detailed information included elsewhere herein and should be read along with Item 7. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations and Item 8. Financial Statements And Supplementary Data.
ITEM 6. [RESERVED]
Matters affecting comparability in the five-year summary detailed below include the Washington Banking Merger in 2014, and the Premier and Puget Mergers in 2018, as discussed below.
|
| | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | 2018 | | 2017 | | 2016 | | 2015 | | 2014 |
| | | (Dollars in thousands, except per share amounts) |
| Operations Data: | | | | | | | | | | |
| Interest income | | $ | 199,359 |
| | $ | 147,709 |
| | $ | 138,512 |
| | $ | 135,739 |
| | $ | 121,106 |
|
| Interest expense | | 12,413 |
| | 8,346 |
| | 6,006 |
| | 6,120 |
| | 5,681 |
|
| Net interest income | | 186,946 |
|
| 139,363 |
|
| 132,506 |
| | 129,619 |
|
| 115,425 |
|
| Provision for loan losses | | 5,129 |
| | 4,220 |
| | 4,931 |
| | 4,372 |
| | 4,594 |
|
| Noninterest income | | 31,665 |
| | 35,579 |
| | 31,619 |
| | 32,268 |
| | 16,467 |
|
| Noninterest expense | | 149,395 |
| | 110,575 |
| | 106,473 |
| | 106,208 |
| | 99,379 |
|
Income tax expense (1) | | 11,030 |
| | 18,356 |
| | 13,803 |
| | 13,818 |
| | 6,905 |
|
| Net income | | 53,057 |
| | 41,791 |
| | 38,918 |
| | 37,489 |
|
| 21,014 |
|
| Earnings per common share | | | | | | | | | | |
| Basic | | $ | 1.49 |
| | $ | 1.39 |
| | $ | 1.30 |
| | $ | 1.25 |
| | $ | 0.82 |
|
| Diluted | | 1.49 |
| | 1.39 |
| | 1.30 |
| | 1.25 |
| | 0.82 |
|
Dividend payout ratio to common shareholders (2) | | 48.3 | % | | 43.9 | % | | 55.4 | % | | 42.4 | % | | 61.0 | % |
| Performance Ratios: | | | | | | | | | | |
Net interest spread (3) | | 4.15 | % | | 3.83 | % | | 3.89 | % | | 4.04 | % | | 4.45 | % |
Net interest margin (4) | | 4.29 |
| | 3.93 |
| | 3.96 |
| | 4.11 |
| | 4.53 |
|
Efficiency ratio (5) | | 68.34 |
| | 63.21 |
| | 64.87 |
| | 65.61 |
| | 75.35 |
|
| Noninterest expense to average assets | | 3.00 |
| | 2.78 |
| | 2.84 |
| | 3.01 |
| | 3.49 |
|
| Return on average assets | | 1.07 |
| | 1.05 |
| | 1.04 |
| | 1.06 |
| | 0.74 |
|
| Return on average common equity | | 7.72 |
| | 8.36 |
| | 8.01 |
| | 8.08 |
| | 5.61 |
|
| |
(1)
| The Tax Cuts and Jobs Act enacted December 22, 2017 decreased the federal corporate income tax rate from 35% to 21% beginning January 1, 2018 and impacted the comparability of our results. The results for the year ended December 31, 2017 included a $2.6 million increase to the income tax expense as a result of the revaluation of our deferred tax assets and liabilities to account for the tax rate change. |
| |
(2)
| Dividend payout ratio is declared dividends per common share divided by diluted earnings per common share. |
| |
(3)
| Net interest spread is the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities. |
| |
(4)
| Net interest margin is net interest income divided by average interest earning assets. |
| |
(5)
| The efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income. |
|
| | | | | | | | | | | | | | | | | | | | |
| | | December 31, |
| | | 2018 | | 2017 | | 2016 | | 2015 | | 2014 |
| | | (Dollars in thousands) |
| Balance Sheet Data: | | | | | | | | | | |
| Total assets | | $ | 5,316,927 |
| | $ | 4,113,270 |
| | $ | 3,878,981 |
| | $ | 3,650,792 |
| | $ | 3,457,750 |
|
| Total loans receivable, net | | 3,619,118 |
| | 2,816,985 |
| | 2,609,666 |
| | 2,372,296 |
| | 2,223,348 |
|
| Investment securities | | 976,095 |
| | 810,530 |
| | 794,645 |
| | 811,869 |
| | 778,660 |
|
| Goodwill and other intangible assets | | 261,553 |
| | 125,117 |
| | 126,403 |
| | 127,818 |
| | 129,918 |
|
| Deposits | | 4,432,402 |
| | 3,393,060 |
| | 3,229,648 |
| | 3,108,287 |
| | 2,906,331 |
|
| Federal Home Loan Bank advances | | — |
| | 92,500 |
| | 79,600 |
| | — |
| | — |
|
| Junior subordinated debentures | | 20,302 |
| | 20,009 |
| | 19,717 |
| | 19,424 |
| | 19,082 |
|
| Securities sold under agreement to repurchase | | 31,487 |
| | 31,821 |
| | 22,104 |
| | 23,214 |
| | 32,181 |
|
| Stockholders’ equity | | 760,723 |
| | 508,305 |
| | 481,763 |
| | 469,970 |
| | 454,506 |
|
| Financial Measures: | | | | | | | | | | |
| Book value per common share | | $ | 20.63 |
| | $ | 16.98 |
| | $ | 16.08 |
| | $ | 15.68 |
| | $ | 15.02 |
|
| Stockholders' equity to assets ratio | | 14.3 | % | | 12.4 | % | | 12.4 | % | | 12.9 | % | | 13.1 | % |
Net loans to deposits (1) | | 82.4 | % | | 84.0 | % | | 81.8 | % | | 77.3 | % | | 77.5 | % |
| Capital Ratios: | | | | | | | | | | |
| Total risk-based capital ratio | | 12.9 | % | | 12.8 | % | | 13.0 | % | | 13.7 | % | | 15.1 | % |
| Tier 1 risk-based capital ratio | | 12.1 |
| | 11.8 |
| | 12.0 |
| | 12.7 |
| | 13.9 |
|
| Leverage ratio | | 10.5 |
| | 10.2 |
| | 10.3 |
| | 10.4 |
| | 10.2 |
|
| Common equity Tier 1 capital to risk-weighted assets | | 11.7 |
| | 11.3 |
| | 11.4 |
| | 12.00 |
| | N/A |
|
| Asset Quality Ratios: | | | | | | | | | | |
| Nonperforming loans to loans receivable, net | | 0.37 | % | | 0.38 | % | | 0.41 | % | | 0.40 | % | | 0.51 | % |
| Allowance for loan losses to loans receivable, net | | 0.96 |
| | 1.13 |
| | 1.18 |
| | 1.24 |
| | 1.23 |
|
| Allowance for loan losses to nonperforming loans | | 255.73 |
| | 299.79 |
| | 284.93 |
| | 307.67 |
| | 239.62 |
|
| Nonperforming assets to total assets | | 0.30 |
| | 0.26 |
| | 0.30 |
| | 0.32 |
| | 0.43 |
|
| Net charge-off on loans to average loans receivable, net | | 0.06 |
| | 0.12 |
| | 0.14 |
| | 0.10 |
| | 0.30 |
|
| Other Data: | | | | | | | | | | |
| Number of banking offices | | 64 |
| | 59 |
| | 63 |
| | 67 |
| | 66 |
|
| Number of full-time equivalent employees | | 859 |
| | 735 |
| | 760 |
| | 717 |
| | 748 |
|
| Deposits per branch | | 69,256 |
| | 57,509 |
| | 51,264 |
| | 46,392 |
| | 44,035 |
|
| Assets per full-time equivalent | | 6,190 |
| | 5,596 |
| | 5,104 |
| | 5,092 |
| | 4,623 |
|
| |
(1)
| Loans receivable, net of deferred costs divided by deposits. |
The Company has focused on expanding its business over the past several years. In May 2014, the Company completed the merger with Washington Banking Company. In 2018, the Company completed two bank acquisitions of Puget Sound Bancorp in January 2018 and Premier Commercial Bancorp in July 2018. These acquisitions and merger, together with organic growth of the business, have significantly increased the Company's assets and liabilities.
During the period from December 31, 2014 through December 31, 2018 total assets have increased $1.86 billion, or 53.8%, to $5.32 billion as of December 31, 2018 from $3.46 billion at December 31, 2014. The total loans receivable, net of allowance for loan losses increased $1.40 billion, or 62.8%, to $3.62 billion as of December 31, 2018 from $2.22 billion at December 31, 2014. Loan increases during the five-year period are attributable primarily to the
Premier and Puget Mergers with the acquisitions of loans at fair value of $718.6 million as of the merger dates. The remaining five-year period increase in loans of $677.2 million, or 6.9% annualized growth, was due to organic growth.
Deposits increased $1.53 billion, or 52.5%, to $4.43 billion at December 31, 2018 from $2.91 billion at December 31, 2014. Deposit increases during the five-year period are also attributable to the Premier and Puget Mergers with the assumptions of deposits at fair value of $824.6 million as of the merger dates. From December 31, 2014 to December 31, 2018, non-maturity deposits (total deposits less certificate of deposit accounts), including acquired deposits, increased $1.58 billion, or 66.6%, to $3.97 billion at December 31, 2018. The percentage of certificate of deposit accounts to total deposits decreased to 10.5% at December 31, 2018 from 18.1% at December 31, 2014.
Stockholders’ equity increased by $306.2 million, or 67.4%, to $760.7 million at December 31, 2018 from $454.5 million at December 31, 2014 due primarily to a combination of earnings and issuances of common stock, partially offset by repurchases of common stock and declarations of cash dividends. Our net income increased $32.0 million, or 152.5%, to $53.1 million for the year ended December 31, 2018 from $21.0 million for the year ended December 31, 2014 as a result of growth in the Company due primarily through acquisitions and merger. Net interest income increased$71.5 million, or 62.0%, to $186.9 million for the year ended December 31, 2018 from $115.4 million during the year ended December 31, 2014. The increase in net interest income was primarily a result of an increase in interest income of $78.3 million, or 64.6%, to $199.4 million for the year ended December 31, 2018 from $121.1 million for the year ended December 31, 2014. Additionally, the increase in net income includes an increase in noninterest income of $15.2 million, or 92.3%, to $31.7 million for the year ended December 31, 2018 compared to $16.5 million for the year ended December 31, 2014. The increase in net income was partially offset by an increase in noninterest expense of $50.0 million, or 50.3%, to $149.4 million for the year ended December 31, 2018 from $99.4 million for the year ended December 31, 2014 as a result of the growth of the Company primarily through acquisitions and merger.
| |
ITEM 7. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion is intended to assist in understanding the financial condition and results of operations of the Company.Company as of and for the year ended December 31, 2021. The information contained in this section should be read together with the December 31, 20182021 audited Consolidated Financial Statements and the accompanying Notes thereto included in Item 8. Financial Statements And Supplementary Data of this Form 10-K.
Critical Accounting Policies
The Company’s ConsolidatedThis section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Statements have been preparedCondition and Results of Operations” in accordance with accounting principles generally accepted in the United States of America. Companies may apply certain critical accounting policies requiring management to make subjective or complex judgments, often as a resultPart II, Item 7 of the need to estimate the effect of matters that are inherently uncertain.
The Company considers its most critical accounting estimates to be the allowance for loan losses, estimations of expected cash flows related to purchased credit impaired loans, business combinations, other-than-temporary impairments in the fair value of investments and consideration of potential impairment of goodwill.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged against earnings. The balance of the allowance for loan losses is maintained at the amount management believes will be appropriate to absorb probable incurred credit losses in the loan portfolio at the balance sheet date. The allowance for loan losses is determined by applying estimated loss factors to the credit exposure from outstanding loans.
We assess the estimated credit losses inherent in our loan portfolio by considering a number of elements including:
historical loss experience in the loan portfolio;
impact of environmental factors, including:
| |
◦ | levels of and trends in delinquencies, classified and impaired loans; |
| |
◦ | levels of and trends in charge-offs and recoveries; |
| |
◦ | trends in volume and terms of loans; |
| |
◦ | effects of changes in risk selection and underwriting standards, and other changes in lending policies, procedures and practices; |
| |
◦ | experience, ability, and depth of lending management and other relevant staff; |
| |
◦ | national and local economic trends and conditions; |
| |
◦ | other external factors such as competition, legal and regulatory; |
| |
◦ | effects of changes in credit concentrations; and |
We calculate an appropriate allowance for loan lossesCompany’s Form 10-K for the loans in our loan portfolio by applying historical loss factors for homogeneous classes of the portfolio, adjusted for changes to the above-noted environmental factors. We may record a specific allowance for impaired loans, including loans on nonaccrual status and troubled-debt restructured ("TDR") loans, after a careful analysis of each loan’s credit and collateral factors. Our analysis of an appropriate allowance for loan losses combines the provisions made for our non-impaired loans and the specific provisions made for each impaired loan.
While we believe we use the best information available to determine the allowance for loan losses, our results of operations could be significantly affected if circumstances differ substantially from the assumptions used in determining the allowance. A decline in national and local economic conditions, or other factors, could result in a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and results of operations. In addition, the determination of the amount of the allowance for loan losses is subject to review by bank regulators, as part of their routine examination process, which may result in the establishment of additional allowance for loan losses based upon their judgment of information available to them at the time of their examination.
For additional information regarding the allowance for loan losses, its relation to the provision for loan losses, its risk related to asset quality and lending activity, see “—Results of Operations for the Years Ended December 31, 2018 and 2017—Provision for Loan Losses” and “—Consolidated Financial Condition —Allowance for Loan Losses” below, Item 1A. Risk Factors—Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio as well as Note (5) Allowance for Loan Losses of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
Estimated Expected Cash Flows related to Purchased Credit Impaired ("PCI") Loans
Loans purchased in an acquisition with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are accounted for under FASB Accounting Standards Codification ("ASC") 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. In situations where such PCI loans have similar risk characteristics, loans may be aggregated into pools to estimate cash flows. A pool is accounted for as a single asset with a single interest rate, cumulative loss rate and cash flow expectation.
The cash flows expected over the life of the PCI loan or pool are estimated using an external cash flow model that projects cash flows and calculates the carrying values, book yields, effective interest income and impairment, if any, based on loan or pool level events. Assumptions as to default rates, loss severity and prepayment speeds are utilized to calculate the expected cash flows.
Expected cash flows at the acquisition date in excess of the fair value of loans are considered to be accretable yield, which is recognized as interest income over the life of the loan or pool using a level yield method if the timing and amounts of the future cash flows of the loan or pool are reasonably estimable. Subsequent to the acquisition date, cash flows expected over the life of the PCI loan or pool are estimated quarterly using an external cash flow model that projects cash flows and calculates the carrying values of the loans or pools, book yields, effective interest income and impairment, if any, based on loan or pool level events. Any increases in cash flow over those expected at the prior quarter are recorded as interest income prospectively. Any subsequent decreases in cash flow over those expected at the prior quarter are recognized by recording an allowance for loan losses. Any disposals of loans in pools, including sales of loans, payments in full or foreclosures result in the removal of the loan from the loan pool at the carrying amount and recognition of income if the proceeds from such activity is in excess of the carrying amount removed from the pool.
Business Combinations
The Company applies the acquisition method of accounting for business combinations. Under the acquisition method, the acquiring entity in a business combination recognizes all of the identifiable assets acquired and liabilities assumed at their acquisition date fair values. Management utilizes prevailing valuation techniques appropriate for the asset or liability being measured in determining these fair values. Any excess of the purchase price over amounts allocated to assets acquired, including identifiable intangible assets, and liabilities assumed is recorded as goodwill. Where amounts allocated to assets acquired and liabilities assumed is greater than the purchase price, a bargain purchase gain is recognized. Acquisition-related costs are expensed as incurred unless they are directly attributable to the issuance of the Company's common stock in a business combination and the Company chooses to record these acquisition-related costs through stockholders' equity.
Other-Than-Temporary Impairments in the Fair Value of Investments
Unrealized losses on investment securities available for sale are evaluated at least quarterly to determine whether declines in value should be considered “other than temporary” and therefore be subject to immediate loss recognition in income. Although these evaluations involve significant judgment, an unrealized loss in the fair value of a debt security is generally deemed to be temporary when the fair value of the security is below the carrying value primarily due to changes in interest rates, there has not been significant deterioration in the financial condition of the issuer, and it is not more likely than not that the Company will be required to sell the security before the anticipated recovery of its remaining carrying value. Other factors that may be considered in determining whether a decline in the value of an investment security is “other than temporary” include ratings by recognized rating agencies; actions of commercial banks or other lenders relative to the continued extension of credit facilities to the issuer of the security; the financial condition, capital strength and near-term prospects of the issuer and recommendations of investment advisors or market analysts. Therefore, continued deterioration of market conditions could result in additional impairment losses recognized within the investment portfolio.
Goodwill
The Company’s goodwill is assigned to Heritage Bank and is evaluated for impairment at the Heritage Bank level (reporting unit). Goodwill is reviewed for impairment annually and between annual tests if an event occurs or circumstances change that might indicate the Company’s recorded value is more than its implied value. Such indicators may include, among others: a significant adverse change in legal factors or in the general business climate; significant decline in the Company’s stock price and market capitalization; unanticipated competition; and an adverse action or assessment by a regulator. Any adverse changes in these factors could have a significant impact on the recoverability of goodwill and could have a material impact on the Company’s Consolidated Financial Statements.
The goodwill impairment test involves a two-step process. The first test for goodwill impairment is done by comparing the reporting unit’s aggregate fair value to its carrying value. Absent other indicators of impairment, if the aggregate fair value exceeds the carrying value, goodwill is not considered impaired and no additional analysis is necessary. If the carrying value of the reporting unit were to exceed the aggregate fair value, a second test would be performed to measure the amount of impairment loss, if any. Alternatively, the testing for impairment may begin with an assessment of qualitative factors to determine whether the existence of events or circumstances leads to a determination that the fair value of goodwill is less than carrying value. The qualitative assessment includes adverse events or circumstances identified that could negatively affect the reporting unit's fair value as well as positive and mitigating events. To measure any impairment loss, the implied fair value would be determined in the same manner as if the reporting unit were being acquired in a business combination. If the implied fair value of goodwill is less than the recorded goodwill an impairment charge would be recorded for the difference.
For thefiscal year ended December 31, 2018, the Company completed step one of the two-step process of the goodwill impairment test. Based on the results of the test, the Company concluded that the reporting unit’s fair value was greater than its carrying value and there was no impairment of goodwill.2020.
For additional information regarding goodwill, see Note (8) Goodwill and Other Intangible Assets of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
Financial Overview
Heritage Financial Corporation is a bank holding company which primarily engages in the business activities of our wholly-owned financial institution subsidiary, Heritage Bank. We provide financial services to our local communities with an ongoing strategic focus on our commercial banking relationships, market expansion and asset quality. The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report relates primarily to the Bank’s operations.
Consolidated Financial ConditionOur business consists primarily of commercial lending and deposit relationships with small to medium sized businesses and their owners in our market areas and attracting deposits from the general public. We also make real estate construction and land development loans and consumer loans. We additionally originate for sale or for investment purposes residential real estate loans on single family properties located primarily in our markets. During the three months ended March 31, 2020, we ceased indirect auto loan originations, included in our consumer loan portfolio.
Our core profitability depends primarily on our net interest income. Net interest income is the difference between interest income, which is the income that we earn on interest earning assets, comprised primarily of loans and investment securities, and interest expense, which is the amount we pay on our interest bearing liabilities, consisting primarily of deposits. Management manages the repricing characteristics of the Company's interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve. Like most financial institutions, our net interest income is significantly affected by general and local economic conditions, particularly changes in market interest rates, and by governmental policies and actions of regulatory agencies. Net interest income is additionally affected by changes in the volume and mix of interest earning assets, interest earned on these assets, the volume and mix of interest bearing liabilities and interest paid on these liabilities.
Our net income is affected by many factors, including the provision for credit losses on loans. The provision for credit losses on loans is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan portfolio as well as prevailing economic and market conditions. Management believes that the ACL on loans reflects the amount that is appropriate to provide for current expected credit losses in our loan portfolio based on our methodology.
Net income is also affected by noninterest income and noninterest expense. Noninterest income primarily consists of service charges and other fees and other income. Noninterest expense consists primarily of compensation and employee benefits, occupancy and equipment, data processing and professional services. Compensation and employee benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits. Occupancy and equipment expenses are the fixed and variable costs of buildings and equipment and consists primarily of lease expenses, depreciation charges, maintenance and utilities. Data processing consists primarily of processing and network services related to the Bank’s core operating system, including the account processing system, electronic payments processing of products and services, internet and mobile banking channels and software-as-a-service providers. Professional services consists primarily of third-party service providers such as auditors, consultants and lawyers.
Results of operations may also be significantly affected by general and local economic and competitive conditions, governmental policies and actions of regulatory authorities, especially changes resulting from the COVID-19 Pandemic and the governmental actions taken to address it. Net income is also impacted by growth of operations through organic growth or acquisitions.
COVID-19 Pandemic Response
The Company’s total assets increased $1.20 billion, or 29.3%,Company maintains its commitment to $5.32 billionsupporting its community and customers during the COVID-19 Pandemic and remains focused on keeping its employees safe and the Bank running effectively to serve its customers. As of December 31, 2021, nearly all Bank branches are open with normal hours and substantially all employees are expected to return to their go-forward working environments during the three months ended March 31, 2022. The Bank will continue to monitor branch access and occupancy levels in relation to cases and close contact scenarios and follow governmental restrictions and public health authority guidelines.
Branch Consolidation Plan
The Company reduced the branch count to 49 from 61 branches at December 31, 2018 from $4.11 billion at2020, including the consolidation of
eight branches during the three months ended March 31, 2021 and four branches in October 2021. The Company integrated these locations into other branches within its network. These actions were the result of the Company’s increased focus on balancing physical locations and digital banking channels, driven by increased customer usage of online and mobile banking and a commitment to improve digital banking technology.
Results of Operations
Net income was $98.0 million, or $2.73 per diluted common share, for the year ended December 31, 2017. The increase was2021 compared to $46.6 million, or $1.29 per diluted common share, for the year ended December 31, 2020. Net income increased $51.5 million, or 110.5%, due primarily due to the Premier and Puget Mergers completeda reversal of provision for credit losses of $29.4 million during the year ended December 31, 2018 with acquired assets totaling $957.62021 compared to a provision for credit losses of $36.1 million atfor the respective merger dates. same period in 2020.
The asset balances atCompany’s efficiency ratio was 62.09% for the year ended December 31, 20182021 compared to 62.52% for the year ended December 31, 2020.
Average Balances, Yields and 2017Rates Paid
The following table provides relevant net interest income information for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
| | Average Balance(1) | | Interest
Earned/
Paid | | Average
Yield/
Rate | | Average Balance(1) | | Interest
Earned/
Paid | | Average
Yield/
Rate | | Average Balance(1) | | Interest
Earned/
Paid | | Average
Yield/
Rate |
| | (Dollars in thousands) |
| Interest Earning Assets: | | | | | | | | | | | | | | | | | |
Loans receivable, net (2)(3) | $ | 4,181,464 | | | $ | 189,832 | | | 4.54 | % | | $ | 4,335,564 | | | $ | 192,417 | | | 4.44 | % | | $ | 3,668,665 | | | $ | 189,515 | | | 5.17 | % |
| Taxable securities | 846,892 | | | 17,492 | | | 2.07 | | | 731,378 | | | 17,541 | | | 2.40 | | | 827,822 | | | 23,045 | | | 2.78 | |
Nontaxable securities (3) | 158,968 | | | 3,899 | | | 2.45 | | | 152,447 | | | 3,659 | | | 2.40 | | | 135,245 | | | 3,396 | | | 2.51 | |
| Interest earning deposits | 1,193,724 | | | 1,608 | | | 0.13 | | | 315,847 | | | 703 | | | 0.22 | | | 98,153 | | | 1,894 | | | 1.93 | |
| Total interest earning assets | 6,381,048 | | | 212,831 | | | 3.34 | % | | 5,535,236 | | | 214,320 | | | 3.87 | % | | 4,729,885 | | | 217,850 | | | 4.61 | % |
| Noninterest earning assets | 745,202 | | | | | | | 758,386 | | | | | | | 681,193 | | | | | |
| Total assets | $ | 7,126,250 | | | | | | | $ | 6,293,622 | | | | | | | $ | 5,411,078 | | | | | |
| | | | | | | | | | | | | | | | | |
| Interest Bearing Liabilities: | | | | | | | | | | | | | | | | | |
| Certificates of Deposit | $ | 372,279 | | | $ | 1,811 | | | 0.49 | % | | $ | 482,316 | | | $ | 5,675 | | | 1.18 | % | | $ | 512,732 | | | $ | 7,021 | | | 1.37 | % |
| Savings accounts | 598,492 | | | 367 | | | 0.06 | | | 489,471 | | | 526 | | | 0.11 | | | 506,073 | | | 2,633 | | | 0.52 | |
| Interest bearing demand and money market accounts | 2,862,504 | | | 3,982 | | | 0.14 | | | 2,491,477 | | | 6,064 | | | 0.24 | | | 2,052,573 | | | 6,695 | | | 0.33 | |
| Total interest bearing deposits | 3,833,275 | | | 6,160 | | | 0.16 | | | 3,463,264 | | | 12,265 | | | 0.35 | | | 3,071,378 | | | 16,349 | | | 0.53 | |
| Junior subordinated debentures | 21,025 | | | 742 | | | 3.53 | | | 20,730 | | | 890 | | | 4.29 | | | 20,438 | | | 1,339 | | | 6.55 | |
| Securities sold under agreement to repurchase | 45,655 | | | 140 | | | 0.31 | | | 27,805 | | | 160 | | | 0.58 | | | 28,457 | | | 175 | | | 0.61 | |
| FHLB advances and other borrowings | — | | | — | | | — | | | 1,466 | | | 8 | | | 0.55 | | | 11,899 | | | 305 | | | 2.56 | |
| Total interest bearing liabilities | 3,899,955 | | | 7,042 | | | 0.18 | % | | 3,513,265 | | | 13,323 | | | 0.38 | % | | 3,132,172 | | | 18,168 | | | 0.58 | % |
| Noninterest bearing demand deposits | 2,256,608 | | | | | | | 1,835,165 | | | | | | | 1,389,721 | | | | | |
| Other noninterest bearing liabilities | 127,620 | | | | | | | 139,612 | | | | | | | 99,683 | | | | | |
| Stockholders’ equity | 842,067 | | | | | | | 805,580 | | | | | | | 789,502 | | | | | |
| Total liabilities and stock-holders’ equity | $ | 7,126,250 | | | | | | | $ | 6,293,622 | | | | | | | $ | 5,411,078 | | | | | |
| Net interest income and spread | | | $ | 205,789 | | | 3.16 | % | | | | $ | 200,997 | | | 3.49 | % | | | | $ | 199,682 | | | 4.03 | % |
| Net interest margin | | | | | 3.23 | % | | | | | | 3.63 | % | | | | | | 4.22 | % |
(1) Average balances are calculated using daily balances.
(2) Average loan receivable, net includes loans held for sale and loans classified as nonaccrual, which carry a zero yield. Interest earned on loans receivable, net includes the amortization of net deferred loan fees of $28.4 million, $14.4 million and $776,000 for the years ended December 31, 2021, 2020, and 2019, respectively.
(3) Yields on tax-exempt loans and securities have not been stated on a tax-equivalent basis.
Net Interest Income and Margin Overview
One of the Company's key sources of earnings is net interest income. There are several factors that affect net interest income, including, but not limited to, the volume, pricing, mix and maturity of interest earning assets and interest bearing liabilities; the volume of noninterest earning assets, noninterest bearing demand deposits, other noninterest bearing liabilities and stockholders' equity; market interest rate fluctuations; and asset quality.
The following table provides the changes in thosenet interest income due to changes in average asset and liability balances are included(volume), changes in average rates (rate) and changes attributable to the combined effect of volume and interest rates allocated proportionately to the absolute value of changes due to volume and changes due to interest rates:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2021 Compared to 2020
Increase (Decrease) Due to changes in | | 2020 Compared to 2019
Increase (Decrease) Due to changes in |
| | Volume | | Rate | | Total | | Volume | | Rate | | Total |
| | (Dollars in thousands) | | (Dollars in thousands) |
| Interest Earning Assets: | | | | | | | | | | | |
| Loans receivable, net | $ | (6,934) | | | $ | 4,349 | | | $ | (2,585) | | | $ | 31,716 | | | $ | (28,814) | | | $ | 2,902 | |
| Taxable securities | 2,566 | | | (2,615) | | | (49) | | | (2,515) | | | (2,989) | | | (5,504) | |
| Nontaxable securities | 159 | | | 81 | | | 240 | | | 418 | | | (155) | | | 263 | |
| Interest earning deposits | 1,278 | | | (373) | | | 905 | | | 1,544 | | | (2,735) | | | (1,191) | |
| Total interest income | $ | (2,931) | | | $ | 1,442 | | | $ | (1,489) | | | $ | 31,163 | | | $ | (34,693) | | | $ | (3,530) | |
| | | | | | | | | | | |
| Interest Bearing Liabilities: | | | | | | | | | | | |
| Certificates of deposit | $ | (1,082) | | | $ | (2,782) | | | $ | (3,864) | | | $ | (399) | | | $ | (947) | | | $ | (1,346) | |
| Savings accounts | 100 | | | (259) | | | (159) | | | (84) | | | (2,023) | | | (2,107) | |
| Interest bearing demand and money market accounts | 803 | | | (2,885) | | | (2,082) | | | 1,265 | | | (1,896) | | | (631) | |
| Total interest bearing deposits | (179) | | | (5,926) | | | (6,105) | | | 782 | | | (4,866) | | | (4,084) | |
| Junior subordinated debentures | 12 | | | (160) | | | (148) | | | 19 | | | (468) | | | (449) | |
| Securities sold under agreement to repurchase | 75 | | | (95) | | | (20) | | | (4) | | | (11) | | | (15) | |
| FHLB advances and other borrowings | (4) | | | (4) | | | (8) | | | (157) | | | (140) | | | (297) | |
| Total interest expense | $ | (96) | | | $ | (6,185) | | | $ | (6,281) | | | $ | 640 | | | $ | (5,485) | | | $ | (4,845) | |
| Net interest income | $ | (2,835) | | | $ | 7,627 | | | $ | 4,792 | | | $ | 30,523 | | | $ | (29,208) | | | $ | 1,315 | |
Net interest income increased $4.8 million, or 2.4%, to $205.8 million for the year ended December 31, 2021 compared to $201.0 million for 2020 due primarily to the Bank decreasing deposit rates following decreases in short-term market interest rates and secondarily due to an increase in the yield of loans receivable, net, predominately from higher amortization of deferred SBA PPP loan fees recognized from forgiven SBA PPP loans and higher recoveries of interest and fees on loans classified as nonaccrual. These factors increasing net interest income were offset partially by a decrease in average loans receivable, net and a decrease in the yield on taxable securities.
Net interest margin decreased due primarily to the significant increase in low-yielding average interest earning deposits to average total earning assets of 18.7% during the year ended December 31, 2021 compared to 5.7% for the same period in 2020, reducing the yield on interest earning assets for 2021.
The following table:table presents the loan yield and the impacts of SBA PPP loans and the incremental accretion on purchased loans on this financial measure for the periods presented below:
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2021 | | 2020 |
| (Dollars in thousands) |
|
| Loan yield (GAAP) | 4.54 | % | | 4.44 | % |
| Exclude impact from SBA PPP loans | (0.20) | % | | 0.16 | % |
| Exclude impact from incremental accretion on purchased loans | (0.07) | % | | (0.08) | % |
| Loan yield excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP) | 4.27 | % | | 4.52 | % |
(1) For additional information, see the "Reconciliations of Non-GAAP Measures" section below.
|
| | | | | | | | | | | | | | |
| | December 31, 2018 | | December 31, 2017 | | Change 2018 vs. 2017 | | Percent Change 2018 vs. 2017 |
| | (Dollars in thousands) |
| Cash and cash equivalents | $ | 161,910 |
| | $ | 103,015 |
| | $ | 58,895 |
| | 57.2 | % |
| Investment securities available for sale, at fair value | 976,095 |
| | 810,530 |
| | 165,565 |
| | 20.4 |
|
| Loans held for sale | 1,555 |
| | 2,288 |
| | (733 | ) | | (32.0 | ) |
| Total loans receivable, net | 3,619,118 |
| | 2,816,985 |
| | 802,133 |
| | 28.5 |
|
| Other real estate owned | 1,983 |
| | — |
| | 1,983 |
| | — |
|
| Premises and equipment, net | 81,100 |
| | 60,325 |
| | 20,775 |
| | 34.4 |
|
| FHLB stock, at cost | 6,076 |
| | 8,347 |
| | (2,271 | ) | | (27.2 | )% |
| Bank owned life insurance | 93,612 |
| | 75,091 |
| | 18,521 |
| | 24.7 |
|
| Accrued interest receivable | 15,403 |
| | 12,244 |
| | 3,159 |
| | 25.8 |
|
| Prepaid expenses and other assets | 98,522 |
| | 99,328 |
| | (806 | ) | | (0.8 | ) |
| Other intangible assets, net | 20,614 |
| | 6,088 |
| | 14,526 |
| | 238.6 |
|
| Goodwill | 240,939 |
| | 119,029 |
| | 121,910 |
| | 102.4 |
|
| Total assets | $ | 5,316,927 |
| | $ | 4,113,270 |
| | $ | 1,203,657 |
| | 29.3 | % |
Provision for Credit Losses Overview
The aggregate of the provision for credit losses on loans and the provision for credit losses on unfunded commitments is presented on the Consolidated Statements of Income as the provision for credit losses. The ACL on unfunded commitments is included on the Consolidated Statements of Financial Condition within accrued expenses and other liabilities.
The following table presents the provision for credit losses for the periods indicated:
| | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 |
| (In thousands) |
| Provision for credit losses on loans | $ | (27,298) | | | $ | 35,433 | |
| Provision for credit losses on unfunded commitments | (2,074) | | | 673 | |
| Provision for credit losses | $ | (29,372) | | | $ | 36,106 | |
The reversal of provision for credit losses recognized during the year ended December 31, 2021 was due primarily to improvements in forecasted economic indicators used to calculate credit losses during the year ended December 31, 2021 compared to the worsening of economic indicators during the year ended December 31, 2020 stemming from the onset of the COVID-19 Pandemic.
Noninterest Income Overview
The following table presents the change in the key components of noninterest income for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
| 2021 | | 2020 | | Change | | % Change |
| (Dollars in thousands) |
| Service charges and other fees | $ | 17,597 | | | $ | 16,228 | | | $ | 1,369 | | | 8.4 | % |
| Gain on sale of investment securities, net | 29 | | | 1,518 | | | (1,489) | | | (98.1) | |
| Gain on sale of loans, net | 3,644 | | | 5,044 | | | (1,400) | | | (27.8) | |
| Interest rate swap fees | 661 | | | 1,691 | | | (1,030) | | | (60.9) | |
| Bank owned life insurance income | 2,520 | | | 4,319 | | | (1,799) | | | (41.7) | |
| Gain on sale of other assets, net | 4,405 | | | 955 | | | 3,450 | | | 361.3 | |
| Other income | 5,759 | | | 7,474 | | | (1,715) | | | (22.9) | |
| Total noninterest income | $ | 34,615 | | | $ | 37,229 | | | $ | (2,614) | | | (7.0) | % |
Noninterest income decreased due primarily to lower bank owned life insurance income as the year ended December 31, 2020 included the recognition of death benefits of $1.9 million and lower other income as last year included trust income of $1.6 million, including a termination fee of $651,000 from the divestiture of our trust department. Additionally, noninterest income was lower due to reduced gain on sale of investment securities due to fewer sales, a decrease in gain on sale of loans due primarily to lower sales volume of secondary market mortgage loans and a decline in interest rate swap fees due to fewer executions of interest rate swap contracts. Partially offsetting these decreases was an increase in gain on sale of other assets, net for the year ended December 31, 2021, including a $2.7 million gain from the sale and leaseback of the Company's headquarters in Olympia, Washington.
Noninterest Expense Overview
The following table presents changes in the key components of noninterest expense for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
| 2021 | | 2020 | | Change | | % Change |
| (Dollars in thousands) |
| Compensation and employee benefits | $ | 89,880 | | | $ | 88,106 | | | $ | 1,774 | | | 2.0 | % |
| Occupancy and equipment | 17,243 | | | 17,611 | | | (368) | | | (2.1) | |
| Data processing | 16,533 | | | 14,449 | | | 2,084 | | | 14.4 | |
| Marketing | 3,039 | | | 3,100 | | | (61) | | | (2.0) | |
| Professional services | 4,065 | | | 5,921 | | | (1,856) | | | (31.3) | |
| State/municipal business and use tax | 3,884 | | | 3,754 | | | 130 | | | 3.5 | |
| Federal deposit insurance premium | 2,106 | | | 1,789 | | | 317 | | | 17.7 | |
| Other real estate owned, net | — | | | (145) | | | 145 | | | (100.0) | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
| 2021 | | 2020 | | Change | | % Change |
| (Dollars in thousands) |
| Amortization of intangible assets | 3,111 | | | 3,525 | | | (414) | | | (11.7) | |
| Other expense | 9,408 | | | 10,830 | | | (1,422) | | | (13.1) | |
| Total noninterest expense | $ | 149,269 | | | $ | 148,940 | | | $ | 329 | | | 0.2 | % |
Noninterest expense increased slightly due primarily to an increase in data processing expense as the Bank continues to invest in technology. Additionally, noninterest expense increased due to compensation and employee benefits primarily as a result of severance payments following a strategic reduction in force and an increase in accrual for incentive payments. The increase in noninterest expense was offset partially by lower professional services expense due to costs incurred during the year ended December 31, 2020 related to the launch of the new mobile and online commercial banking platform "Heritage Direct" last year and secondarily due to the decrease in other expense from lower branch consolidation costs recognized during the year ended December 31, 2021 compared to the same period in 2020.
Income Tax Expense Overview
The following table presents the income tax expense and related metrics and the change for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
| 2021 | | 2020 | | Change | | % Change |
| (Dollars in thousands) |
| Income before income taxes | $ | 120,507 | | | $ | 53,180 | | | $ | 67,327 | | | 126.6 | % |
| Income tax expense | $ | 22,472 | | | $ | 6,610 | | | $ | 15,862 | | | 240.0 | % |
| Effective income tax rate | 18.6 | % | | 12.4 | % | | 6.2 | % | | 50.0 | % |
Income tax expense and the effective income tax rate both increased due primarily to higher pre-tax income, which decreased the impact of favorable permanent tax items such as tax-exempt investments, investments in bank owned life insurance and low-income housing tax credits, and secondarily due to a provision in the CARES Act, which permitted the Company to recognize a $1.0 million benefit from net operating losses related to prior acquisitions during the year ended December 31, 2020. Additionally, the Bank's New Market Tax Credit was fully utilized during the seven year period ending December 31, 2020 and the related entities were dissolved in May 2021. In 2021, the Bank formed HBCDE, LLC which was certified as a Community Development Entity by the Department of the Treasury Community Development Financial Institutions Fund in September 2021. The newly created entity is expected to commence funding eligible loans during the year ended December 31, 2022 and apply for New Market Tax Credits in future years.
Financial Condition Overview
The table below provides a comparison of the changes in the Company's financial condition for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 | | December 31, 2020 | | Change | | % Change |
| (Dollars in thousands) |
| Assets | | | | | | | |
| Cash and cash equivalents | $ | 1,723,292 | | | $ | 743,322 | | | $ | 979,970 | | | 131.8 | % |
| Investment securities available for sale, at fair value, net | 894,335 | | | 802,163 | | | 92,172 | | | 11.5 | |
| Investment securities held to maturity, at amortized cost, net | 383,393 | | | — | | | 383,393 | | | 100.0 | |
| Loans held for sale | 1,476 | | | 4,932 | | | (3,456) | | | (70.1) | |
| Loans receivable, net | 3,773,301 | | | 4,398,462 | | | (625,161) | | | (14.2) | |
| | | | | | | |
| Premises and equipment, net | 79,370 | | | 85,452 | | | (6,082) | | | (7.1) | |
| Federal Home Loan Bank stock, at cost | 7,933 | | | 6,661 | | | 1,272 | | | 19.1 | |
| Bank owned life insurance | 120,196 | | | 107,580 | | | 12,616 | | | 11.7 | |
| Accrued interest receivable | 14,657 | | | 19,418 | | | (4,761) | | | (24.5) | |
| Prepaid expenses and other assets | 183,543 | | | 193,301 | | | (9,758) | | | (5.0) | |
| Other intangible assets, net | 9,977 | | | 13,088 | | | (3,111) | | | (23.8) | |
| Goodwill | 240,939 | | | 240,939 | | | — | | | — | |
| Total assets | $ | 7,432,412 | | | $ | 6,615,318 | | | $ | 817,094 | | | 12.4 | % |
| | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 | | December 31, 2020 | | Change | | % Change |
| (Dollars in thousands) |
| Liabilities and Stockholders' Equity | | | | | | | |
| Deposits | $ | 6,381,337 | | | $ | 5,597,990 | | | $ | 783,347 | | | 14.0 | % |
| | | | | | | |
| Junior subordinated debentures | 21,180 | | | 20,887 | | | 293 | | | 1.4 | |
| Securities sold under agreement to repurchase | 50,839 | | | 35,683 | | | 15,156 | | | 42.5 | |
| Accrued expenses and other liabilities | 124,624 | | | 140,319 | | | (15,695) | | | (11.2) | |
| Total liabilities | 6,577,980 | | | 5,794,879 | | | 783,101 | | | 13.5 | |
| Common stock | 551,798 | | | 571,021 | | | (19,223) | | | (3.4) | |
| Retained earnings | 293,238 | | | 224,400 | | | 68,838 | | | 30.7 | |
| Accumulated other comprehensive income, net | 9,396 | | | 25,018 | | | (15,622) | | | (62.4) | |
| Total stockholders' equity | 854,432 | | | 820,439 | | | 33,993 | | | 4.1 | |
| Total liabilities and stockholders' equity | $ | 7,432,412 | | | $ | 6,615,318 | | | $ | 817,094 | | | 12.4 | % |
Total assets increased due primarily to increases in cash and cash equivalents and total investment securities due primarily to the significant increase in total deposits, which is discussed in more detail in the "Deposit Activities Overview" section below. The increase in total assets was offset partially by a decrease in loans receivable, net, which is discussed in more detail in the "Lending Activities Overview" section below.
Investment Activities Overview
Our investment policy is established by the BoardCompany's board of Directorsdirectors and monitored by the Risk Committee of the Boardboard of Directors.directors. It is designed primarily to provide and maintain liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk, and complements the Bank's lending activities. The policy dictates the criteria for classifying securities as either available for sale or held to maturity. The policy permits investment in various types of liquid assets permissible under applicable regulations, which include U.S. Treasury obligations, U.S. Government agency obligations, some certificates of deposit of insured banks, mortgage-backed and mortgage related securities, corporate notes, municipal bonds, and federal funds.regulations. Investment in non-investment grade bonds and stripped mortgage-backed securities is not permitted under the policy.
Investment securities available for sale increased $165.6 million, or 20.4%, to $976.1 million at December 31, 2018 from $810.5 million at December 31, 2017. The increase was due primarily to purchases of investment securities of $342.1 million, excluding investment securities acquired in the Premier and Puget Mergers, partially offset by sales of investment securities of $156.0 million and maturities, calls and payments of investment securities of $92.6 million during the year ended December 31, 2018. Included in the sales of investment securities was $80.4 million of investments acquired in the Puget Sound Merger which were sold shortly after the merger.
The following table provides information regarding our investment securities at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2021 | | December 31, 2020 | | |
| | Balance | | % of
Total | | Balance | | % of
Total | | Change | | % Change |
| | (Dollars in thousands) |
| Investment securities available for sale, at fair value: |
| U.S. government and agency securities | $ | 21,373 | | | 1.7 | % | | $ | 45,660 | | | 5.7 | % | | $ | (24,287) | | | (53.2) | % |
| Municipal securities | 221,212 | | | 17.3 | % | | 209,968 | | | 26.2 | % | | 11,244 | | | 5.4 | |
| | | | | | | | | | | |
| Residential CMO and MBS | 306,884 | | | 24.0 | % | | 201,872 | | | 25.2 | % | | 105,012 | | | 52.0 | |
| Commercial CMO and MBS | 315,861 | | | 24.7 | % | | 303,746 | | | 37.9 | % | | 12,115 | | | 4.0 | |
| Corporate obligations | 2,014 | | | 0.2 | % | | 11,096 | | | 1.4 | % | | (9,082) | | | (81.8) | |
| Other asset-backed securities | 26,991 | | | 2.1 | % | | 29,821 | | | 3.6 | % | | (2,830) | | | (9.5) | |
| Total | $ | 894,335 | | | 70.0 | % | | $ | 802,163 | | | 100.0 | % | | $ | 92,172 | | | 11.5 | % |
| | | | | | | | | | | |
| Investment securities held to maturity, at amortized cost: |
| U.S. government and agency securities | $ | 141,011 | | | 11.0 | % | | $ | — | | | — | % | | $ | 141,011 | | | 100.0 | % |
| Residential CMO and MBS | 24,529 | | | 1.9 | % | | — | | | — | | | 24,529 | | | 100.0 | |
| Commercial CMO and MBS | 217,853 | | | 17.1 | % | | — | | | — | | | 217,853 | | | 100.0 | |
| Total | $ | 383,393 | | | 30.0 | % | | $ | — | | | — | % | | $ | 383,393 | | | 100.0 | % |
| | | | | | | | | | | |
| Total investment securities | $ | 1,277,728 | | | 100.0 | % | | $ | 802,163 | | | 100.0 | % | | $ | 475,565 | | | 59.3 | % |
Total investment securities increased due primarily to purchases of $756.4 million, offset partially by maturities, calls and payments of investment securities of $255.9 million. Additionally, we transferred $244.8 million of investment securities available for sale at the dates indicated.to investment securities held to maturity in order to mitigate market price volatility and its impact to AOCI within stockholders' equity.
|
| | | | | | | | | | | | | | | | | | | | |
| | December 31, 2018 | | December 31, 2017 | | December 31, 2016 |
| | Fair Value | | % of Total Investments | | Fair Value | | % of Total Investments | | Fair Value | | % of Total Investments |
| | (Dollars in thousands) |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 101,603 |
| | 10.4 | % | | $ | 13,442 |
| | 1.7 | % | | $ | 1,569 |
| | 0.2 | % |
| Municipal securities | 158,864 |
| | 16.3 |
| | 250,015 |
| | 30.8 |
| | 237,256 |
| | 29.9 |
|
Mortgage-backed securities and collateralized mortgage obligations(1): | | | | | | | | | | | |
| Residential | 331,602 |
| | 34.0 |
| | 280,211 |
| | 34.5 |
| | 309,176 |
| | 38.9 |
|
| Commercial | 333,761 |
| | 34.2 |
| | 217,079 |
| | 26.8 |
| | 208,318 |
| | 26.2 |
|
| Collateralized loan obligations | — |
| | — |
| | 4,580 |
| | 0.6 |
| | 10,478 |
| | 1.3 |
|
| Corporate obligations | 25,563 |
| | 2.6 |
| | 16,770 |
| | 2.1 |
| | 16,706 |
| | 2.1 |
|
Other securities(2)(3) | 24,702 |
| | 2.5 |
| | 28,433 |
| | 3.5 |
| | 11,142 |
| | 1.4 |
|
| Total | $ | 976,095 |
| | 100.0 | % | | $ | 810,530 |
| | 100.0 | % | | $ | 794,645 |
| | 100.0 | % |
| |
| Issued and guaranteed by U.S. Government-sponsored agencies. |
| |
(2)
| Primarily asset-backed securities issued and guaranteed by U.S. Government-sponsored agencies. |
| |
(3)
| As a result of the adoption of FASB Accounting Standard Update 2016-01 on January 1, 2018, equity investments of $146,000 and $123,000 as of December 31, 2017 and 2016, respectively, are no longer classified as investment securities available for sale and their presentation is not comparable to the presentation as of December 31, 2018. |
The following table provides information regardingthe weighted average yield at December 31, 2021 calculated based upon the fair values of our investment securities available for sale by contractualand held to maturity at December 31, 2018.and excluding any income tax benefits of tax-exempt bonds:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | In one year or less | | After one year through five years | | After five years through ten years | | After ten years | | Total |
| | Fair
Value | | Yield | | Fair
Value | | Yield | | Fair
Value | | Yield | | Fair
Value | | Yield | | Fair
Value | | Yield |
| | (Dollars in thousands) | | | | |
| Investment securities available for sale: |
| U.S. government and agency securities | $ | — | | | — | % | | $ | 1,493 | | | 3.01 | % | | $ | 11,682 | | | 2.07 | % | | $ | 8,198 | | | 2.32 | % | | $ | 21,373 | | | 2.23 | % |
| Municipal securities | 7,095 | | | 3.19 | | | 25,746 | | | 2.84 | | | 58,340 | | | 2.61 | | | 130,031 | | | 2.52 | | | 221,212 | | | 2.60 | |
| Residential CMO and MBS | — | | | — | | | 10,978 | | | 2.30 | | | 34,783 | | | 2.00 | | | 261,123 | | | 1.68 | | | 306,884 | | | 1.74 | |
| Commercial CMO and MBS | 20,025 | | | 2.15 | | | 81,769 | | | 2.54 | | | 178,906 | | | 1.50 | | | 35,161 | | | 1.99 | | | 315,861 | | | 1.86 | |
| Corporate obligations | — | | | — | | | 2,014 | | | 0.94 | | | — | | | — | | | — | | | — | | | 2,014 | | | 0.94 | |
| Other asset-backed securities | — | | | — | | | 354 | | | 2.77 | | | 4,068 | | | 2.54 | | | 22,569 | | | 1.12 | | | 26,991 | | | 1.35 | |
| Total | $ | 27,120 | | | 2.42 | % | | $ | 122,354 | | | 2.56 | % | | $ | 287,779 | | | 1.82 | % | | $ | 457,082 | | | 1.93 | % | | $ | 894,335 | | | 1.99 | % |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Investment securities held to maturity: |
| U.S. government and agency securities | $ | — | | | — | % | | $ | — | | | — | % | | $ | 68,014 | | | 1.95 | % | | $ | 71,349 | | | 1.67 | % | | $ | 139,363 | | | 1.81 | % |
| Residential CMO and MBS | — | | | — | | | — | | | — | | | — | | | — | | | 24,376 | | | 1.74 | | | 24,376 | | | 1.74 | |
| Commercial CMO and MBS | — | | | — | | | — | | | — | | | 181,393 | | | 1.50 | | | 31,199 | | | 1.62 | | | 212,592 | | | 1.52 | |
| Total | $ | — | | | — | % | | $ | — | | | — | % | | $ | 249,407 | | | 1.62 | % | | $ | 126,924 | | | 1.67 | % | | $ | 376,331 | | | 1.64 | % |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | One Year or Less | | Over One to Five Years | | Over Five to Ten Years | | Over Ten Years | | Total |
| | Fair Value | | Yield(2) | | Fair Value | | Yield(2) | | Fair Value | | Yield(2) | | Fair Value | | Yield(2) | | Fair Value | | Yield(2) |
| | (Dollars in thousands) | | | | |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 15,936 |
| | 2.50 | % | | $ | 44,462 |
| | 2.98 | % | | $ | 35,190 |
| | 3.56 | % | | $ | 6,015 |
| | 2.99 | % | | $ | 101,603 |
| | 3.11 | % |
| Municipal securities | 13,587 |
| | 3.14 |
| | 25,957 |
| | 3.07 |
| | 30,601 |
| | 3.27 |
| | 88,719 |
| | 3.24 |
| | 158,864 |
| | 3.21 |
|
Mortgage-backed securities and collateralized mortgage obligations (1): | | | | | | | | | | | | | | | | | | | |
| Residential | 206 |
| | 0.94 |
| | 3,027 |
| | 2.33 |
| | 73,986 |
| | 2.49 |
| | 254,383 |
| | 2.88 |
| | 331,602 |
| | 2.78 |
|
| Commercial | 7,901 |
| | 1.56 |
| | 94,395 |
| | 2.55 |
| | 129,002 |
| | 2.80 |
| | 102,463 |
| | 2.89 |
| | 333,761 |
| | 2.72 |
|
| Corporate obligations | 848 |
| | 2.87 |
| | 24,715 |
| | 3.40 |
| | — |
| | — |
| | — |
| | — |
| | 25,563 |
| | 3.38 |
|
Other securities (3) | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 24,702 |
| | 3.81 |
| | 24,702 |
| | 3.81 |
|
| Total | $ | 38,478 |
| | 2.53 | % | | $ | 192,556 |
| | 2.82 | % | | $ | 268,779 |
| | 2.87 | % | | $ | 476,282 |
| | 3.00 | % | | $ | 976,095 |
| | 2.91 | % |
| |
(1)
| Issued and guaranteed by U.S. Government-sponsored agencies. |
| |
(2)
| Taxable equivalent weighted average yield. |
| |
(3)
| Primarily asset-backed securities issued and guaranteed by U.S. Government-sponsored agencies. |
Loan Portfolio Overview
Changes by loan type
The Bank is a full service commercial bank, which originates a wide variety of loans with a focus on commercial business loans. Total loans receivable, net of allowance for loan losses, increased $802.1 million, or 28.5%, to $3.62 billion at December 31, 2018 from $2.82 billion at December 31, 2017 primarily as a result of loans acquired in the Premier and Puget Mergers totaling $718.6 million at the respective merger dates. The year-over-year loan growth included increases in non-owner occupied commercial real estate loans which increased $317.9 million, or 32.2%, to $1.30 billion, in commercial and industrial loans which increased $208.2 million, or 32.3%, to $853.6 million and owner-occupied commercial real estate loans which increased $157.7 million, or 25.3%, to $779.8 million at December 31, 2018.
The following table provides information about our loan portfolio by type of loan at the dates indicated. These balances are priorindicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2021 | | December 31, 2020 | | | | |
| | Amortized Cost | | % of Loans Receivable | | Amortized Cost | | % of Loans Receivable | | Change | | % Change |
| | (Dollars in thousands) |
| Commercial business: |
| Commercial and industrial | $ | 621,567 | | | 16.3 | % | | $ | 733,098 | | | 16.4 | % | | $ | (111,531) | | | (15.2) | % |
| SBA PPP | 145,840 | | | 3.8 | | | 715,121 | | | 16.0 | | | (569,281) | | | (79.6) | |
| Owner-occupied CRE | 931,150 | | | 24.4 | | | 856,684 | | | 19.2 | | | 74,466 | | | 8.7 | |
| Non-owner occupied CRE | 1,493,099 | | | 39.2 | | | 1,410,303 | | | 31.5 | | | 82,796 | | | 5.9 | |
| Total commercial business | 3,191,656 | | | 83.7 | | | 3,715,206 | | | 83.1 | | | (523,550) | | | (14.1) | |
| Residential real estate | 164,582 | | | 4.3 | | | 122,756 | | | 2.7 | | | 41,826 | | | 34.1 | |
| Real estate construction and land development: |
| Residential | 85,547 | | | 2.2 | | | 78,259 | | | 1.8 | | | 7,288 | | | 9.3 | |
| Commercial and multifamily | 141,336 | | | 3.7 | | | 227,454 | | | 5.1 | | | (86,118) | | | (37.9) | |
| Total real estate construction and land development | 226,883 | | | 5.9 | | | 305,713 | | | 6.9 | | | (78,830) | | | (25.8) | |
| Consumer | 232,541 | | | 6.1 | | | 324,972 | | | 7.3 | | | (92,431) | | | (28.4) | |
| Total | $ | 3,815,662 | | | 100.0 | % | | $ | 4,468,647 | | | 100.0 | % | | $ | (652,985) | | | (14.6) | % |
Loans receivable decreased due primarily to deduction fora decrease in SBA PPP loans as a result of forgiveness payments received from the allowance forSBA in excess of SBA PPP originations and elevated prepayments of commercial and industrial loans. Additionally, the consumer loan losses.portfolio decreased due partially to continued runoff of the indirect auto loan portfolio following the cessation of this business line during the three months ended March 31, 2020. Offsetting these decreases was an increase in CRE loans which includes the transfer of several completed projects from real estate construction and land development loans.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, |
| | 2018 | | 2017 | | 2016 | | 2015 | | 2014 |
| | Balance | | % of Total(2) | | Balance | | % of Total(2) | | Balance | | % of Total(2) | | Balance | | % of Total(2) | | Balance | | % of Total(2) |
| | (Dollars in thousands) |
| Commercial business: | | | | | | | | | | | | | | | | | | | |
| Commercial and industrial | $ | 853,606 |
| | 23.4 | % | | $ | 645,396 |
| | 22.7 | % | | $ | 637,773 |
| | 24.2 | % | | $ | 596,726 |
| | 24.8 | % | | $ | 570,453 |
| | 25.3 | % |
| Owner-occupied commercial real estate | 779,814 |
| | 21.3 |
| | 622,150 |
| | 21.8 |
| | 558,035 |
| | 21.1 |
| | 572,609 |
| | 23.8 |
| | 574,687 |
| | 25.5 |
|
| Non-owner occupied commercial real estate | 1,304,463 |
| | 35.7 |
| | 986,594 |
| | 34.6 |
| | 880,880 |
| | 33.4 |
| | 753,986 |
| | 31.4 |
| | 663,935 |
| | 29.5 |
|
| Total commercial business | 2,937,883 |
| | 80.4 |
| | 2,254,140 |
| | 79.1 |
| | 2,076,688 |
| | 78.7 |
| | 1,923,321 |
| | 80.0 |
| | 1,809,075 |
| | 80.3 |
|
One-to-four family residential (1) | 101,763 |
| | 2.8 |
| | 86,997 |
| | 3.1 |
| | 77,391 |
| | 2.9 |
| | 72,548 |
| | 3.0 |
| | 69,530 |
| | 3.1 |
|
| Real estate construction and land development: | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | 102,730 |
| | 2.8 |
| | 51,985 |
| | 1.8 |
| | 50,414 |
| | 1.9 |
| | 51,752 |
| | 2.2 |
| | 49,195 |
| | 2.2 |
|
| Five or more family residential and commercial properties | 112,730 |
| | 3.1 |
| | 97,499 |
| | 3.4 |
| | 108,764 |
| | 4.1 |
| | 55,325 |
| | 2.3 |
| | 64,920 |
| | 2.9 |
|
| Total real estate construction and land development | 215,460 |
| | 5.9 |
| | 149,484 |
| | 5.2 |
| | 159,178 |
| | 6.0 |
| | 107,077 |
| | 4.5 |
| | 114,115 |
| | 5.1 |
|
| Consumer | 395,545 |
| | 10.8 |
| | 355,091 |
| | 12.5 |
| | 325,140 |
| | 12.3 |
| | 298,167 |
| | 12.4 |
| | 259,294 |
| | 11.5 |
|
| Gross loans receivable | 3,650,651 |
| | 99.9 |
| | 2,845,712 |
| | 99.9 |
| | 2,638,397 |
| | 99.9 |
| | 2,401,113 |
| | 99.9 |
| | 2,252,014 |
| | 100.0 |
|
| Net deferred loan costs (fees) | 3,509 |
| | 0.1 |
| | 3,359 |
| | 0.1 |
| | 2,352 |
| | 0.1 |
| | 929 |
| | 0.1 |
| | (937 | ) | | — |
|
| Loans receivable, net | $ | 3,654,160 |
| | 100.0 | % | | $ | 2,849,071 |
| | 100.0 | % | | $ | 2,640,749 |
| | 100.0 | % | | $ | 2,402,042 |
| | 100.0 | % | | $ | 2,251,077 |
| | 100.0 | % |
| |
(1)
| Excludes loans held for sale of $1.6 million, $2.3 million, $11.7 million, $7.7 million and $5.6 million as of December 31, 2018, 2017, 2016, 2015 and 2014, respectively.
|
| |
(2)
| Percent of loans receivable, net. |
SBA Paycheck Protection Program
The Bank has supported its community and customers during the COVID-19 Pandemic through its participation in the SBA's PPP. The SBA PPP ended on May 31, 2021.
The Bank earns 1% interest on these loans as well as a fee from the SBA to cover processing costs, which is amortized over the life of the loan and recognized fully at payoff or forgiveness. The Bank began processing loan forgiveness applications and receiving SBA PPP forgiveness payments during the three months ended December 31, 2020.
Composition of loans receivable by contractual maturity and interest type
The following table presents the amortized cost of the loan portfolio by segment and contractual maturity at December 31, 2018 (i)2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | In one year or less | | After one year through five years | | After five years through 15 years | | After 15 years | | Total |
| | (In thousands) |
| Commercial business: |
| Commercial and industrial | $ | 142,248 | | | $ | 227,589 | | | $ | 244,025 | | | $ | 7,705 | | | $ | 621,567 | |
| SBA PPP | 5,921 | | | 139,919 | | | — | | | — | | | 145,840 | |
| Owner-occupied CRE | 21,919 | | | 190,612 | | | 674,344 | | | 44,275 | | | 931,150 | |
| Non-owner occupied CRE | 78,879 | | | 398,844 | | | 981,290 | | | 34,086 | | | 1,493,099 | |
| Total commercial business | 248,967 | | | 956,964 | | | 1,899,659 | | | 86,066 | | | 3,191,656 | |
| Residential real estate | — | | | 1,045 | | | 29,067 | | | 134,470 | | | 164,582 | |
| Real estate construction and land development: |
| Residential | 65,861 | | | 2,563 | | | 8,936 | | | 8,187 | | | 85,547 | |
| Commercial and multifamily | 58,009 | | | 12,563 | | | 59,099 | | | 11,665 | | | 141,336 | |
| Total real estate construction and land development | 123,870 | | | 15,126 | | | 68,035 | | | 19,852 | | | 226,883 | |
| Consumer | 11,953 | | | 94,359 | | | 29,972 | | | 96,257 | | | 232,541 | |
| Total | $ | 384,790 | | | $ | 1,067,494 | | | $ | 2,026,733 | | | $ | 336,645 | | | $ | 3,815,662 | |
The following table presents the aggregate contractual maturitiesamortized cost of loans in the named categories of our loan portfolio by segment and (ii) the aggregate amountsinterest rate type that are due after one year at December 31, 2021:
| | | | | | | | | | | | | | | | | |
| | Have predetermined interest rates(1) | | Have floating or adjustable interest rates(1) | | Total |
| | (In thousands) |
| Commercial business: | | | | | |
| Commercial and industrial | $ | 317,892 | | | $ | 161,427 | | | $ | 479,319 | |
| SBA PPP | 139,919 | | | — | | | 139,919 | |
| Owner-occupied CRE | 453,836 | | | 455,395 | | | 909,231 | |
| Non-owner occupied CRE | 589,292 | | | 824,928 | | | 1,414,220 | |
| Total commercial business | 1,500,939 | | | 1,441,750 | | | 2,942,689 | |
Residential real estate (3) | 119,966 | | | 44,616 | | | 164,582 | |
| Real estate construction and land development: | | | | | |
| Residential | 8,181 | | | 11,505 | | | 19,686 | |
| Commercial and multifamily | 39,457 | | | 43,870 | | | 83,327 | |
| Total real estate construction and land development | 47,638 | | | 55,375 | | | 103,013 | |
| Consumer | 118,471 | | | 102,117 | | | 220,588 | |
| Total | $ | 1,787,014 | | | $ | 1,643,858 | | | $ | 3,430,872 | |
(1) Includes $2.2 million of fixed ratereal estate construction and variableland development loans with predetermined interest rates and $329.2 million of commercial business loans with floating or adjustable rate loans in the named categories.
|
| | | | | | | | | | | | | | | | |
| | | Maturing |
| | | One Year or Less | | Over One to Five Years | | Over Five Years | | Total |
| | | (In thousands) |
| Commercial business | | $ | 434,492 |
| | $ | 637,472 |
| | $ | 1,865,919 |
| | $ | 2,937,883 |
|
| One-to-four family residential | | 112 |
| | 2,337 |
| | 99,314 |
| | 101,763 |
|
| Real estate construction and land development | | 137,297 |
| | 31,313 |
| | 46,850 |
| | 215,460 |
|
| Consumer | | 19,091 |
| | 127,153 |
| | 249,301 |
| | 395,545 |
|
| Gross loans receivable | | $ | 590,992 |
| | $ | 798,275 |
| | $ | 2,261,384 |
| | $ | 3,650,651 |
|
| | | | | | | | | |
| Fixed rate loans | | $ | 96,139 |
| | $ | 573,664 |
| | $ | 642,831 |
| | $ | 1,312,634 |
|
| Variable or adjustable rate loans | | 494,853 |
| | 224,611 |
| | 1,618,553 |
| | 2,338,017 |
|
| Total | | $ | 590,992 |
| | $ | 798,275 |
| | $ | 2,261,384 |
| | $ | 3,650,651 |
|
Included in the balance of variable or adjustable rate loans with maturity over five years in the table above are certain commercial loansinterest rates in which the Bank entered into non-hedge interest rate swap contracts with the borrower and a third party.third-party. Under these derivative contract arrangements, the Bank effectively earns a variable rate of interest based on the one-month LIBOR plus various margins while the customer pays a fixed rate of interest. At December 31, 2018, the Bank had 48 separatemargin, except for interest rate swap contracts with borrowers with notional valueon construction loans that earn fixed rates until the end of $171.8 million compared to 39 separate interestthe construction period and the variable rate swap contracts with borrowers with notional value of $146.5 million at December 31, 2017.
becomes effective.
Loans classified as nonaccrual and performing TDR and nonperforming assets
The following table provides information about our nonaccrual loans, other real estate owned and performing TDR loans and nonperforming assets for the indicated dates.dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31,
2021 | | December 31, 2020 | | Change | | % Change |
| (Dollars in thousands) |
Nonaccrual loans: (1) | | | | | | | |
| Commercial business | $ | 23,107 | | | $ | 56,786 | | | $ | (33,679) | | | (59.3) | % |
| Residential real estate | 47 | | | 184 | | | (137) | | | (74.5) | |
| Real estate construction and land development | 571 | | | 1,022 | | | (451) | | | (44.1) | |
| Consumer | 29 | | | 100 | | | (71) | | | (71.0) | |
| Total nonaccrual loans | 23,754 | | | 58,092 | | | (34,338) | | | (59.1) | |
| Other real estate owned | — | | | — | | | — | | | n/a |
| Total nonperforming assets | 23,754 | | | 58,092 | | | (34,338) | | | (59.1) | % |
| | | | | | | |
| Accruing loans past due 90 days or more | $ | 293 | | | $ | — | | | $ | 293 | | | 100.0 | % |
| | | | | | | |
| Credit quality ratios: | | | | | | | |
| Nonaccrual loans to loans receivable | 0.62 | % | | 1.30 | % | | (0.68) | % | | (52.3) | % |
| Nonaccrual loans to total assets | 0.32 | | | 0.88 | | | (0.56) | | | (63.6) | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Performing TDR loans: (1) | | | | | | | |
| Commercial business | $ | 57,142 | | | $ | 49,403 | | | $ | 7,739 | | | 15.7 | % |
| Residential real estate | 358 | | | 188 | | | 170 | | | 90.4 | |
| Real estate construction and land development | 450 | | | 1,926 | | | (1,476) | | | (76.6) | |
| Consumer | 1,160 | | | 1,355 | | | (195) | | | (14.4) | |
| Total performing TDR loans | $ | 59,110 | | | $ | 52,872 | | | $ | 6,238 | | | 11.8 | % |
|
| | | | | | | | | | | | | | | | | | | | |
| | | December 31, |
| | | 2018 | | 2017 | | 2016 | | 2015 | | 2014 |
| | | (Dollars in thousands) |
| Nonaccrual loans: | | | | | | | | | | |
| Commercial business | | $ | 12,564 |
| | $ | 9,098 |
| | $ | 8,580 |
| | $ | 7,122 |
| | $ | 8,596 |
|
| One-to-four family residential | | 71 |
| | 81 |
| | 94 |
| | 38 |
| | — |
|
| Real estate construction and land development | | 899 |
| | 1,247 |
| | 2,008 |
| | 2,414 |
| | 2,831 |
|
| Consumer | | 169 |
| | 277 |
| | 227 |
| | 94 |
| | 145 |
|
Total nonaccrual loans(1) | | 13,703 |
| | 10,703 |
| | 10,909 |
| | 9,668 |
| | 11,572 |
|
| Other real estate owned | | 1,983 |
| | — |
| | 754 |
| | 2,019 |
| | 3,355 |
|
| Total nonperforming assets | | $ | 15,686 |
| | $ | 10,703 |
| | $ | 11,663 |
| | $ | 11,687 |
| | $ | 14,927 |
|
| | | | | | | | | | | |
| Allowance for loan losses | | $ | 35,042 |
| | $ | 32,086 |
| | $ | 31,083 |
| | $ | 29,746 |
| | $ | 27,729 |
|
| | | | | | | | | | | |
| Allowance for loan losses to loans receivable, net | | 0.96 | % | | 1.13 | % | | 1.18 | % | | 1.24 | % | | 1.23 | % |
| Allowance for loan losses to nonaccrual loans | | 255.73 | % | | 299.79 | % | | 284.93 | % | | 307.67 | % | | 239.62 | % |
| Nonperforming loans to loans receivable, net | | 0.37 | % | | 0.38 | % | | 0.41 | % | | 0.40 | % | | 0.51 | % |
| Nonperforming assets to total assets | | 0.30 | % | | 0.26 | % | | 0.30 | % | | 0.32 | % | | 0.43 | % |
| | | | | | | | | | | |
| Performing TDR loans: | | | | | | | | | | |
| Commercial business | | $ | 22,170 |
| | $ | 25,729 |
| | $ | 19,837 |
| | $ | 17,345 |
| | $ | 14,421 |
|
| One-to-four family residential | | 208 |
| | 218 |
| | 227 |
| | 236 |
| | 245 |
|
| Real estate construction and land development | | — |
| | 645 |
| | 2,141 |
| | 3,014 |
| | 3,927 |
|
| Consumer | | 358 |
| | 165 |
| | 83 |
| | 100 |
| | 66 |
|
| Total performing TDR loans | | $ | 22,736 |
| | $ | 26,757 |
| | $ | 22,288 |
| | $ | 20,695 |
| | $ | 18,659 |
|
| | | | | | | | | | | |
| Accruing loans past due 90 days or more | | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
|
| Potential problem loans | | 101,349 |
| | 83,543 |
| | 87,762 |
| | 110,357 |
| | 162,930 |
|
(1) At December 31, 2018, 2017, 2016, 20152021 and 2014, $6.9 million $5.2 million, $6.9 million, $6.3December 31, 2020, $1.4 million and $7.3$3.2 million of nonaccrual loans, were consideredrespectively, and $1.6 million and $1.9 million of performing TDR loans, respectively.respectively, were guaranteed by government agencies.
The following table provides the changes in nonaccrual loans during the periods indicated:
Nonaccrual Loans. Nonaccrual | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
| 2021 | | 2020 | | Change | | % Change |
| (In thousands) |
| Balance, beginning of period | $ | 58,092 | | | $ | 44,525 | | | $ | 13,567 | | | 30.5 | % |
| Additions to nonaccrual loan classification | 1,495 | | | 33,024 | | | (31,529) | | | (95.5) | |
| Net principal payments and transfers to accruing status | (14,786) | | | (6,463) | | | (8,323) | | | 128.8 | |
| Payoffs | (19,857) | | | (11,033) | | | (8,824) | | | 80.0 | |
| Charge-offs | (1,190) | | | (1,691) | | | 501 | | | (29.6) | |
| Transfer to OREO | — | | | (270) | | | 270 | | | (100.0) | |
| Balance, end of period | $ | 23,754 | | | $ | 58,092 | | | $ | (34,338) | | | (59.1) | % |
The decrease in nonaccrual loans increased $3.0 million to $13.7 million, or 0.37% of loans receivable, net, atduring the year ended December 31, 2018 from $10.7 million, or 0.38% of loans receivable, net, at December 31, 2017. The increase2021 was due primarily to payoffs, including a payoff of an agricultural business relationship of $10.7 million, which was initially classified as nonaccrual during the additionthree months ended September 30, 2019, and the return to accrual status of seven commercialan owner-occupied CRE relationship of $7.0 million. The Bank recovered $1.5 million of interest and industrial customer relationships totaling $8.9fees on loans related to the payoff of the agricultural business relationship. Additionally, the volume of additions to the nonaccrual loan classification decreased to $1.5 million during the year ended December 31, 2018. Of these additions, $5.32021 compared to $33.0 million relatedlast year which contributed to two agricultural relationships who subsequently repaid $3.4 million during the year ended December 31, 2018,lower ending balance of loans classified as includednonaccrual. The decrease in net principal payments below.nonaccrual loans improved the Bank's credit quality ratios.
The following table reflects the changes in nonaccrual loans during the years ended December 31, 2018 and 2017:
|
| | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 |
| | (In thousands) |
| Nonaccrual loans | | | |
| Balance, beginning of period | $ | 10,703 |
| | $ | 10,909 |
|
| Addition of previously classified pass graded loans | 5,469 |
| | 2,405 |
|
| Addition of previously classified potential problem loans | 5,319 |
| | 3,253 |
|
| Addition of previously classified TDR loans | 786 |
| | 1,556 |
|
| Addition of acquired loans | 130 |
| | — |
|
| Transfer of loans to accrual status | — |
| | (968 | ) |
| Charge-offs | (1,027 | ) | | (1,219 | ) |
| Net principal payments | (7,677 | ) | | (5,233 | ) |
| Balance, end of period | $ | 13,703 |
| | $ | 10,703 |
|
At December 31, 2018, nonaccrual loans of $9.5 million had related allowance for loan losses of $1.9 million and nonaccrual loans of $4.2 million had no related allowance for loan losses. At December 31, 2017 nonaccrual loans of $3.8 million had related allowance for loan losses of $720,000 and nonaccrual loans of $6.9 million had no allowance for loan losses.
At December 31, 2018, nonperforming TDR loans, included in the nonaccrual loan table above, were $6.9 million and had a related allowance for loan losses of $658,000. At December 31, 2017, nonperforming TDR loans were $5.2 million and had a related allowance for loan losses of $379,000.
Nonperforming Assets. Nonperforming assets consist of nonaccrual loans and other real estate owned. Nonperforming assets increased $5.0 million to $15.7 million, or 0.30% of total assets at December 31, 2018 from $10.7 million, or 0.26% of total assets, at December 31, 2017 due primarily to the increase in nonaccrual loans discussed above. Nonperforming assets additionally increased due to the additions of other real estate owned, primarily as a result of other real estate owned acquired in the Premier Merger of $1.8 million. There was no other real estate owned at December 31, 2017.
Troubled Debt Restructured Loans. TDR loans are considered impaired and are separately measured for impairment whether on accrual or nonaccrual status. Performing TDR loans are not considered nonperforming assets as they continue to accrue interest despite being considered impaired due to the restructured status. Our performing TDR loans decreased $4.0 million, or 15.0%, to $22.7 million at December 31, 2018 from $26.8 million at December 31, 2017.
The following table reflects the changes in performing TDR loans during the years ended December 31, 2018 and 2017:
|
| | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 |
| | (In thousands) |
| Performing TDR loans | | | |
| Balance, beginning of period | $ | 26,757 |
| | $ | 22,288 |
|
| Addition of previously classified pass graded loans | 2,165 |
| | 12,244 |
|
| Addition of previously classified potential problem loans | 9,651 |
| | 2,189 |
|
| Addition of former nonaccrual loans | — |
| | 968 |
|
| Transfers of loans to nonaccrual and troubled debt restructured status | (786 | ) | | (1,556 | ) |
| Charge-offs | — |
| | (16 | ) |
| Net principal payments | (15,051 | ) | | (9,360 | ) |
| Balance, end of period | $ | 22,736 |
| | $ | 26,757 |
|
The related allowance for loan losses on performing TDR loans was $2.3 million as of December 31, 2018 and $2.6 million as of December 31, 2017.
Potential Problem Loans. Potential problem loans increased $17.8 million, or 21.3%, to $101.3 million at December 31, 2018 from $83.5 million at December 31, 2017. The increase was due primarily to the addition of potential problem loans acquired in the Premier and Puget Mergers with an acquired total outstanding balance of $10.1 million and $4.5 million, respectively, at their respective merger dates, and totaling $12.2 million at December 31, 2018.
The following table reflects the changes in potential problem loans during the years ended December 31, 2018 and 2017:
|
| | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 |
| | (In thousands) |
| Potential problem loans | | | |
| Balance, beginning of period | $ | 83,543 |
| | $ | 87,762 |
|
| Addition of previously classified pass graded loans | 59,238 |
| | 52,039 |
|
Acquired in Premier and Puget Mergers (1) | 18,869 |
| | — |
|
| Net principal payments | (28,184 | ) | | (37,636 | ) |
| Upgrades to pass graded loan status | (16,746 | ) | | (5,245 | ) |
| Transfers of loan to nonaccrual and troubled debt restructured status | (14,970 | ) | | (6,866 | ) |
| Transfers of loans to other real estate owned | — |
| | (32 | ) |
| Transfer of loan to held for sale | — |
| | (5,779 | ) |
| Charge-offs | (401 | ) | | (700 | ) |
| Balance, end of period | $ | 101,349 |
| | $ | 83,543 |
|
(1) Represents the loan balance acquired and post-acquisition classification as potential problem loan of any loan acquired in the Premier and Puget Mergers. The period end balance of these potential problem loans is $17.8 million as of December 31, 2018 due to net principal payments subsequent to the acquisition or classification as a potential problem loan.
Allowance for LoanCredit Losses on Loans Overview
The following table provides information regarding changes in our allowance for loan losses at andACL on loans for the indicated years:years indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| | At or For the Years Ended December 31, | | | | |
| | 2021 | | 2020 | | Change | | % Change |
| | (Dollars in thousands) |
| ACL on loans at the beginning of the period | $ | 70,185 | | | $ | 36,171 | | | $ | 34,014 | | | 94.0 | % |
| Impact of CECL Adoption | — | | | 1,822 | | | (1,822) | | | (100.0) | |
| Adjusted ACL on loans, beginning of period | 70,185 | | | 37,993 | | | 32,192 | | | 84.7 | |
| Charge-offs: | | | | | | | |
| Commercial business | (1,276) | | | (3,751) | | | 2,475 | | | (66.0) | |
| | | | | | | |
| Real estate construction and land development | (1) | | | (417) | | | 416 | | | (99.8) | |
| Consumer | (669) | | | (1,454) | | | 785 | | | (54.0) | |
| Total charge-offs | (1,946) | | | (5,622) | | | 3,676 | | | (65.4) | |
| Recoveries: | | | | | | | |
| Commercial business | 816 | | | 1,530 | | | (714) | | | (46.7) | |
| Residential real estate | — | | | 3 | | | (3) | | | (100.0) | |
| Real estate construction and land development | 32 | | | 278 | | | (246) | | | (88.5) | |
| Consumer | 572 | | | 570 | | | 2 | | | 0.4 | |
| Total recoveries | 1,420 | | | 2,381 | | | (961) | | | (40.4) | |
| Net charge-offs | (526) | | | (3,241) | | | 2,715 | | | (83.8) | |
| Provision for credit losses on loans | (27,298) | | | 35,433 | | | (62,731) | | | (177.0) | |
| ACL on loans at the end of period | $ | 42,361 | | | $ | 70,185 | | | $ | (27,824) | | | (39.6) | % |
| | | | | | | |
| Credit quality ratios: | | | | | | | |
| ACL on loans to loans receivable | 1.11 | % | | 1.57 | % | | (0.46) | % | | (29.3) | % |
ACL on loans to loans receivable, excluding SBA PPP loans (1) | 1.15 | | | 1.87 | | | (0.72) | | | (38.5) | |
| ACL on loans to nonaccrual loans | 178.33 | % | | 120.82 | % | | 57.51 | % | | 47.6 | % |
| | | | | | | |
| | | | | | | |
Average balances outstanding during the period: (2) | | | | | | | |
| Commercial business | $ | 3,540,728 | | | $ | 3,569,851 | | | $ | (29,123) | | | (0.8) | % |
| Residential real estate | 123,875 | | | 131,171 | | | (7,296) | | | (5.6) | |
| Real estate construction and land development | 301,532 | | | 303,591 | | | (2,059) | | | (0.7) | |
| Consumer | 271,834 | | | 384,134 | | | (112,300) | | | (29.2) | |
| Total | $ | 4,237,969 | | | $ | 4,388,747 | | | $ | (150,778) | | | (3.4) | % |
| | | | | | | |
| Net charge-offs (recoveries) during the period to average balances outstanding during the period: |
| Commercial business | 0.01 | % | | 0.06 | % | | (0.05) | % | | (83.3) | % |
| Residential real estate | — | | | — | | | — | | | n/a |
| Real estate construction and land development | (0.01) | | | 0.05 | | | (0.06) | | | (120.0) | |
| Consumer | 0.04 | | | 0.23 | | | (0.19) | | | (82.6) | |
| Total | 0.01 | % | | 0.07 | % | | (0.06) | % | | (85.7) | % |
|
| | | | | | | | | | | | | | | | | | | | |
| | | At or For the Years Ended December 31, |
| | | 2018 | | 2017 | | 2016 | | 2015 | | 2014 |
| | | (Dollars in thousands) |
| Allowance for loan losses at beginning of the year | | $ | 32,086 |
| | $ | 31,083 |
| | $ | 29,746 |
| | $ | 27,729 |
| | $ | 28,824 |
|
| Provision for loan losses | | 5,129 |
| | 4,220 |
| | 4,931 |
| | 4,372 |
| | 4,594 |
|
| Charge-offs: | | | | | | | | | | |
| Commercial business | | (1,400 | ) | | (2,438 | ) | | (4,153 | ) | | (1,676 | ) | | (5,252 | ) |
| One-to-four family residential | | (45 | ) | | (30 | ) | | — |
| | — |
| | (31 | ) |
| Real estate construction and land development | | — |
| | (556 | ) | | (154 | ) | | (106 | ) | | (345 | ) |
| Consumer | | (2,160 | ) | | (1,814 | ) | | (1,778 | ) | | (1,700 | ) | | (969 | ) |
| Total charge-offs | | (3,605 | ) | | (4,838 | ) | | (6,085 | ) | | (3,482 | ) | | (6,597 | ) |
| Recoveries: | | | | | | | | | | |
| Commercial business | | 908 |
| | 947 |
| | 1,844 |
| | 476 |
| | 716 |
|
| One-to-four family residential | | — |
| | 2 |
| | 2 |
| | 13 |
| | 7 |
|
| Real estate construction and land development | | 11 |
| | 202 |
| | 83 |
| | 100 |
| | 43 |
|
| Consumer | | 513 |
| | 470 |
| | 562 |
| | 538 |
| | 142 |
|
| Total recoveries | | 1,432 |
| | 1,621 |
| | 2,491 |
| | 1,127 |
| | 908 |
|
| Net charge-offs | | (2,173 | ) | | (3,217 | ) | | (3,594 | ) | | (2,355 | ) | | (5,689 | ) |
| Allowance for loan losses at end of the year | | $ | 35,042 |
| | $ | 32,086 |
| | $ | 31,083 |
| | $ | 29,746 |
| | $ | 27,729 |
|
Gross loans receivable at end of the year (1) | | $ | 3,650,651 |
| | $ | 2,845,712 |
| | $ | 2,638,397 |
| | $ | 2,401,113 |
| | $ | 2,252,014 |
|
Average loans receivable during the year (1) | | 3,414,424 |
| | 2,703,934 |
| | 2,489,730 |
| | 2,316,175 |
| | 1,871,696 |
|
| Net charge-offs on loans to average loans receivable | | 0.06 | % | | 0.12 | % | | 0.14 | % | | 0.10 | % | | 0.30 | % |
| |
(1)
| Excludes loans held for sale. |
(1) The ACL on loans does not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA. See "Reconciliations of Non-GAAP Measures" section below.
(2) Average balances exclude the ACL on loans and loans held for sale, but include loans classified as nonaccrual.
The following table shows the allocation of the allowanceprovision for loancredit losses at the indicated dates. The allocation is based upon an evaluation of defined loan problems, historical loan loss ratios, and industry-wide and other factors that affect loan losses in the categories shown below:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, |
| | 2018 | | 2017 | | 2016 | | 2015 | | 2014 |
| | Allowance for Loan Losses | | % of Total (1) | | Allowance for Loan Losses | | % of Total (1) | | Allowance for Loan Losses | | % of Total (1) | | Allowance for Loan Losses | | % of Total (1) | | Allowance for Loan Losses | | % of Total (1) |
| | (Dollars in thousands) |
| Commercial business | $ | 23,711 |
| | 80.5 | % | | $ | 21,999 |
| | 79.1 | % | | $ | 22,382 |
| | 78.8 | % | | $ | 22,064 |
| | 80.1 | % | | $ | 20,186 |
| | 80.3 | % |
| One-to-four family residential | 1,203 |
| | 2.8 |
| | 1,056 |
| | 3.1 |
| | 1,015 |
| | 2.9 |
| | 1,157 |
| | 3.0 |
| | 1,200 |
| | 3.1 |
|
| Real estate construction | 2,194 |
| | 5.9 |
| | 2,052 |
| | 5.3 |
| | 2,156 |
| | 6.0 |
| | 1,871 |
| | 4.5 |
| | 2,758 |
| | 5.1 |
|
| Consumer | 6,581 |
| | 10.8 |
| | 6,081 |
| | 12.5 |
| | 5,024 |
| | 12.3 |
| | 4,309 |
| | 12.4 |
| | 2,769 |
| | 11.5 |
|
| Unallocated | 1,353 |
| | — |
| | 898 |
| | — |
| | 506 |
| | — |
| | 345 |
| | — |
| | 816 |
| | — |
|
| Total allowance for loan losses | $ | 35,042 |
| | 100.0 | % | | $ | 32,086 |
| | 100.0 | % | | $ | 31,083 |
| | 100.0 | % | | $ | 29,746 |
| | 100.0 | % | | $ | 27,729 |
| | 100.0 | % |
| |
(1)
| Represents the percent of loans receivable by loan category to total gross loans receivable. |
The allowance for loan losses increased $3.0 million, or 9.2%, to $35.0 million at December 31, 2018 from $32.1 millionat December 31, 2017. The increase was the result of provision for loan losses of $5.1 million recognizedon loans recorded during the year ended December 31, 2018, offset partially by net charge-offs of $2.2 million recorded during2021 following improvements in the year. The allowance for loan losses to loans receivable, net, decreased to 0.96%economic forecast used in the CECL model at December 31, 2018 from 1.13%2021 as compared to the economic forecast at December 31, 2017 primarily as a result2020.
The following table presents the ACL on loans by loan portfolio segment at the indicated dates:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2021 | | December 31, 2020 | | | | |
| | ACL on loans | | Percent of Total (1) | | ACL on loans | | Percent of Total (1) | | Change | | % Change |
| | (Dollars in thousands) |
| Commercial business | $ | 33,049 | | | 83.7 | % | | $ | 49,608 | | | 83.1 | % | | $ | (16,559) | | | (33.4) | % |
| Residential real estate | 1,409 | | | 4.3 | | | 1,591 | | | 2.7 | | | (182) | | | (11.4) | |
| Real estate construction and land development | 5,276 | | | 5.9 | | | 13,092 | | | 6.9 | | | (7,816) | | | (59.7) | |
| Consumer | 2,627 | | | 6.1 | | | 5,894 | | | 7.3 | | | (3,267) | | | (55.4) | |
| Total ACL on loans | $ | 42,361 | | | 100.0 | % | | $ | 70,185 | | | 100.0 | % | | $ | (27,824) | | | (39.6) | % |
(1) Represents the percent of loans acquired fromreceivable by loan category to loans receivable.
Deposits Overview
The following table summarizes the Premier and Puget Mergers with no related allowance for loan lossesCompany's deposits at the date of acquisition in accordance with GAAP. Included in the carrying value ofdates indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2021 | | December 31, 2020 | | | | |
| | Balance | | Percent of Total | | Balance | | Percent of Total | | Change | | % Change |
| | (Dollars in thousands) |
| Noninterest demand deposits | $ | 2,330,956 | | | 36.5 | % | | $ | 1,980,531 | | | 35.4 | % | | $ | 350,425 | | | 17.7 | % |
| Interest bearing demand deposits | 1,946,605 | | | 30.5 | | | 1,716,123 | | | 30.7 | | | 230,482 | | | 13.4 | |
| Money market accounts | 1,120,174 | | | 17.6 | | | 962,983 | | | 17.2 | | | 157,191 | | | 16.3 | |
| Savings accounts | 640,763 | | | 10.0 | | | 538,819 | | | 9.6 | | | 101,944 | | | 18.9 | |
| Total non-maturity deposits | 6,038,498 | | | 94.6 | | | 5,198,456 | | | 92.9 | | | 840,042 | | | 16.2 | |
| Certificates of deposit | 342,839 | | | 5.4 | | | 399,534 | | | 7.1 | | | (56,695) | | | (14.2) | |
| Total deposits | $ | 6,381,337 | | | 100.0 | % | | $ | 5,597,990 | | | 100.0 | % | | $ | 783,347 | | | 14.0 | % |
Total deposits increased due primarily to proceeds from SBA PPP loans are net discounts on loans purchased in mergers and acquisitions which may reduce the need for an allowance for loan losses on these loans because they are carried at an amount below the outstanding principal balance. The remaining net discount on purchased loans, including the related fair value discount acquired in the Premier and Puget Mergers, was $11.8 million at December 31, 2018 compared to $10.1 million at December 31, 2017.
The Company recorded charge-offs of $3.6 millionoriginated during the year ended December 31, 2018 due primarily2021 which were deposited directly into the customers' deposit accounts.
Total deposits includes uninsured deposits of $2.68 billion and $2.17 billion at December 31, 2021 and 2020, respectively, calculated in accordance with FDIC guidelines. The Bank does not hold any foreign deposits.
The following table provides the uninsured portion of certificates of deposit at December 31, 2021, by account, with a maturity of:
| | | | | |
| |
| (In thousands) |
| Three months or less | $ | 10,264 | |
| Over three months through six months | 24,102 | |
| Over six months through twelve months | 11,542 | |
| Over twelve months | 5,623 | |
| Total | $ | 51,531 | |
Stockholders' Equity Overview
The Company’s stockholders' equity to a large volumeassets ratio was 11.5% as of small charge-offs on consumer loans. December 31, 2021 and 12.4% as of December 31, 2020. The following table provides the changes to stockholders' equity during the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
| 2021 | | 2020 | | Change | | % Change |
| (In thousands) |
| Balance, beginning of period | $ | 820,439 | | | $ | 809,311 | | | $ | 11,128 | | | 1.4 | % |
Cumulative effect from change in accounting policy (1) | — | | | (5,615) | | | 5,615 | | | (100.0) | |
| | | | | | | |
| Net income | 98,035 | | | 46,570 | | | 51,465 | | | 110.5 | |
| Dividends declared | (29,197) | | | (29,029) | | | (168) | | | 0.6 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
| 2021 | | 2020 | | Change | | % Change |
| (In thousands) |
| Other comprehensive income, net of tax | (15,622) | | | 14,640 | | | (30,262) | | | (206.7) | |
| Repurchase of common stock | (22,889) | | | (19,119) | | | (3,770) | | | 19.7 | |
| Other | 3,666 | | | 3,681 | | | (15) | | | (0.4) | |
| Balance, end of period | $ | 854,432 | | | $ | 820,439 | | | $ | 33,993 | | | 4.1 | % |
(1) Effective January 1, 2020, the Bank adopted ASU 2016-13, Financial Instruments - Credit Losses.
The Company recorded recoveriesrepurchased 904,972 and 795,700 shares of $1.4 millionits common stock under the Company's stock repurchase plans during the year ended December 31, 2018, primarily as a result of small recoveries on a large volume of small dollar consumer loans.
As of December 31, 2018, the Bank identified $13.7 million of nonperforming loans2021 and $22.7 million of performing TDR loans for a total of $36.4 million of impaired loans. Of these impaired loans, $7.6 million had no allowances for loan losses as their estimated collateral value or discounted expected cash flow is equal to or exceeds their carrying costs.2020, respectively. The remaining $28.8 million of impaired loans had related allowances for loan losses totaling $4.2 million. As of December 31, 2017, the Bank identified $10.7 million of nonperforming loansrepurchases represented approximately 2.5% and $26.8 million of performing TDR loans for a total of $37.5 million of impaired loans. Of these impaired loans, $10.4 million had no allowances for loan losses. The remaining $27.1 million of impaired loans had related allowances for loan losses totaling $3.4 million.
The following table outlines the allowance for loan losses and related outstanding loan balances on loans at December 31, 2018 and 2017:
|
| | | | | | | |
| | December 31, 2018 | | December 31, 2017 |
| | (Dollars in thousands) |
| General Valuation Allowance: | | | |
| Allowance for loan losses | $ | 27,854 |
| | $ | 24,732 |
|
| Gross loans, excluding PCI and impaired loans | 3,589,305 |
| | 2,767,650 |
|
| Percentage | 0.78 | % | | 0.89 | % |
| | | | |
| PCI Allowance: | | | |
| Allowance for loan losses | $ | 3,018 |
| | $ | 3,999 |
|
| Gross PCI loans | 24,907 |
| | 40,603 |
|
| Percentage | 12.12 | % | | 9.85 | % |
| | | | |
| Specific Valuation Allowance: | | | |
| Allowance for loan losses | $ | 4,170 |
| | $ | 3,355 |
|
| Gross impaired loans | 36,439 |
| | 37,459 |
|
| Percentage | 11.44 | % | | 8.96 | % |
| | | | |
| Total Allowance for Loan Losses: | | | |
| Allowance for loan losses | $ | 35,042 |
| | $ | 32,086 |
|
| Gross loans receivable | 3,650,651 |
| | 2,845,712 |
|
| Percentage | 0.96 | % | | 1.13 | % |
Based on the Bank's established comprehensive methodology, management deemed the allowance for loan losses of $35.0 million at December 31, 2018 (0.96% of loans receivable, net and 255.73% of nonperforming loans) appropriate to provide for probable incurred credit losses based on an evaluation of known and inherent risks in the loan portfolio at that date. This compares to an allowance for loan losses at December 31, 2017 of $32.1 million (1.13% of loans receivable, net and 299.79% of nonperforming loans).
While we believe we use the best information available to determine the allowance for loan losses, our results of operations could be significantly affected if circumstances differ substantially from the assumptions used in determining the allowance. A decline in national and local economic conditions, or other factors, could result in a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and results of operations. In addition, the determination2.2% of the amount of the allowance for loan losses is subject to review by bank regulators, as part of their routine examination process, which may result in the establishment of an additional allowance for loan losses based upon their judgment of information available to themCompany's stock outstanding at the timebeginning of their examination. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is appropriate or that increased provisions will not be necessary should the quality of the loans deteriorate. Any material increase in the allowance for loan losses would adversely affect the Company’s financial condition and results of operations.
Deposits
Total deposits increased $1.04 billion, or 30.6%, to $4.43 billion at December 31, 2018 from $3.39 billion at December 31, 2017 due primarily to the deposits acquired in the Premier and Puget Mergers of $824.6 million at the respective merger dates. Non-maturity deposits as a percentage of total deposits increased to 89.5% at December 31, 2018 from 88.3% at December 31, 2017 and the percentage of certificates of deposit to total deposits decreased to 10.5% at December 31, 2018 from 11.7% at December 31, 2017.
The following table provides the balances outstanding for each major category of deposits at the dates indicated: |
| | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2018 | | December 31, 2017 | | December 31, 2016 |
| | | Amount | | Percent of Total | | Amount | | Percent of Total | | Amount | | Percent of Total |
| | | (Dollars in thousands) |
| Noninterest demand deposits | | $ | 1,362,268 |
| | 30.7 | % | | $ | 944,791 |
| | 27.8 | % | | $ | 882,091 |
| | 27.3 | % |
| Interest bearing demand deposits | | 1,317,513 |
| | 29.7 |
| | 1,051,752 |
| | 31.1 |
| | 963,821 |
| | 29.8 |
|
| Money market accounts | | 765,316 |
| | 17.3 |
| | 499,618 |
| | 14.7 |
| | 523,875 |
| | 16.2 |
|
| Savings accounts | | 520,413 |
| | 11.8 |
| | 498,501 |
| | 14.7 |
| | 502,460 |
| | 15.6 |
|
| Total non-maturity deposits | | 3,965,510 |
| | 89.5 |
| | 2,994,662 |
| | 88.3 |
| | 2,872,247 |
| | 88.9 |
|
| Certificate of deposit accounts | | 466,892 |
| | 10.5 |
| | 398,398 |
| | 11.7 |
| | 357,401 |
| | 11.1 |
|
| Total deposits | | $ | 4,432,402 |
| | 100.0 | % | | $ | 3,393,060 |
| | 100.0 | % | | $ | 3,229,648 |
| | 100.0 | % |
The following table provides the average balances outstanding and the weighted average interest rates for each major category of deposits for the years indicated:
|
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | 2018 | | 2017 | | 2016 |
| | | Average Balance | | Average Yield/Rate | | Average Balance | | Average Yield/Rate | | Average Balance | | Average Yield/Rate |
| | | (Dollars in thousands) |
| Interest bearing demand deposits and money market accounts | | $ | 1,916,319 |
| | 0.23 | % | | $ | 1,498,619 |
| | 0.17 | % | | $ | 1,464,198 |
| | 0.16 | % |
| Savings accounts | | 513,680 |
| | 0.40 |
| | 499,435 |
| | 0.26 |
| | 485,482 |
| | 0.16 |
|
| Certificate of deposit accounts | | 463,124 |
| | 0.85 |
| | 378,044 |
| | 0.59 |
| | 388,286 |
| | 0.50 |
|
| Total interest bearing deposits | | 2,893,123 |
| | 0.36 |
| | 2,376,098 |
| | 0.25 |
| | 2,337,966 |
| | 0.21 |
|
| Noninterest demand deposits | | 1,240,621 |
| | — |
| | 902,716 |
| | — |
| | 829,912 |
| | — |
|
| Total deposits | | $ | 4,133,744 |
| | 0.25 | % | | $ | 3,278,814 |
| | 0.18 | % | | $ | 3,167,878 |
| | 0.16 | % |
The following table shows the amount and maturity of certificate of deposit accounts of $100,000 or more:
|
| | | |
| | December 31, 2018 |
| | (In thousands) |
| Remaining maturity: | |
| Three months or less | $ | 88,527 |
|
| Over three months through six months | 48,781 |
|
| Over six months through twelve months | 63,878 |
|
| Over twelve months | 96,042 |
|
| Total | $ | 297,228 |
|
Borrowings
Borrowings may be used on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and match the maturity of repricing intervals of interest earning assets. The Bank also
utilizes securities sold under agreement to repurchase as a supplement to its funding sources. Our repurchase agreements are secured by available for sale investment securities. At December 31, 2018, the Bank had securities sold under agreement to repurchase of $31.5 million, a decrease of $334,000, or 1.0%, from $31.8 million at December 31, 2017. The decrease was the result of customer activity during the period.
The Company also has junior subordinated debentures with a par value of $25.0 million which pay quarterly interest based on three-month LIBOR plus 1.56%. The debentures mature in 2037. The balance of the junior subordinated debentures was $20.3 million at December 31, 2018, which reflects the fair value of the junior subordinated debentures established during the Washington Banking Merger, adjusted for the accretion of discount from purchase accounting fair value adjustment.
At December 31, 2018, the Bank maintained credit facilities with the FHLB of Des Moines for $921.7 million and credit facilities with the Federal Reserve Bank for $37.4 million. The Company had no FHLB advances outstanding at December 31, 2018 compared to $92.5 million at December 31, 2017. The average cost of the FHLB advances during the year ended December 31, 2018 and 2017 was1.98% and 1.16%, respectively. The Bank also maintains lines of credit with four correspondent banks to purchase federal funds totaling $90.0 million as of December 31, 2018. There were no federal funds purchased as of December 31, 2018 or December 31, 2017.
Stockholders' Equity and Capital
Stockholders’ equity at December 31, 2018 was $760.7 million compared to $508.3 million at December 31, 2017. The changes to stockholders' equity during the years ended December 31, 2018 and 2017 are as follows:
|
| | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 |
| | (In thousands) |
| Balance, beginning of period | $ | 508,305 |
| | $ | 481,763 |
|
| Common stock issued in the Premier and Puget Mergers | 230,043 |
| | — |
|
| Net income | 53,057 |
| | 41,791 |
|
| Dividends declared | (25,791 | ) | | (18,305 | ) |
| Other comprehensive (loss) income, net | (6,064 | ) | | 1,526 |
|
| Other | 1,173 |
| | 1,530 |
|
| Balance, end of period | $ | 760,723 |
| | $ | 508,305 |
|
The Company has historically paid cash dividends to its common shareholders. Payments of future cash dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our business, operating results and financial condition, capital requirements, current and anticipated cash needs, plans for expansion, any legal or contractual limitation on our ability to pay dividends and other relevant factors. Dividends on common stock from the Company depend substantially upon receipt of dividends from the Bank, which is the Company’s predominant source of income. On January 23, 2019,26, 2022, the Company’s Boardboard of Directorsdirectors declared a regular quarterly dividend of $0.18$0.21 per common share payable on February 21, 201923, 2022 to shareholders of record on February 7, 2019.9, 2022.
|
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| Dividends paid per common share | $ | 0.72 |
| | $ | 0.61 |
| | $ | 0.72 |
|
Dividend payout ratio (1) | 48.3 | % | | 43.9 | % | | 55.4 | % |
(1) Dividend payout ratio is declared dividends per common share divided by diluted earnings per common share.
The Company is a bank holding company under the supervision of the Federal Reserve Bank. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended,Liquidity and the regulations of the Federal Reserve. Heritage Bank is a federally insured institution and thereby is subject to the capital requirements established by the FDIC. The Federal Reserve capital requirements generally parallel the FDIC requirements. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements and operations. Management believes as of December 31, 2018, the Company and the Bank meet all capital adequacy requirements to which they are subject. For additional information
regarding the Company’s and the Bank’s regulatory capital requirements, see “Supervision and Regulation-Capital Adequacy” in Item 1. Business and Note (22) Regulatory Capital Requirements included in Item 8. Financial Statements And Supplementary Data.
Off-Balance Sheet Arrangements
In the ordinary course of business, we enter into various types of transactions that include commitments to extend credit that are not included in our Consolidated Financial Statements. We apply the same credit standards to these commitments as we use in all our lending activities and have included these commitments in our lending risk evaluations. Our exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. The Company had off-balance sheet loan commitments, including letters of credit, aggregating $990.0 million at December 31, 2018, an increase of $276.8 million, or 38.8%, from $713.2 million at December 31, 2017. For additional information, see Note (14) Commitments and Contingencies included in Item 8. Financial Statements And Supplementary Data.
Average Balances, Yields and Rates Paid for the Years Ended December 31, 2018, 2017 and 2016
Our core profitability depends primarily on our net interest income, which is the difference between the income we receive on our loan and investment portfolios, and our cost of funds, which consists of interest paid on deposits and borrowed funds. Like most financial institutions, our interest income and cost of funds are affected significantly by general economic conditions, particularly changes in market interest rates and government policies.
Changes in net interest income result from changes in volume, net interest spread, and net interest margin. Volume refers to the average dollar amounts of interest earning assets and interest bearing liabilities. Net interest spread refers to the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities. Net interest margin refers to net interest income divided by average interest earning assets and is influenced by the level and relative mix of interest earning assets and interest bearing and noninterest bearing liabilities.
The following table provides relevant net interest income information for selected periods. The average daily loan balances presented in the table are net of allowances for loan losses. Nonaccrual loans have been included in the tables as loans carrying a zero yield. Yields on tax-exempt securities and loans have not been presented on a tax-equivalent basis.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | Average Balance | | Interest Earned/ Paid | | Average Yield/ Rate | | Average Balance | | Interest Earned/ Paid | | Average Yield/ Rate | | Average Balance | | Interest Earned/ Paid | | Average Yield/ Rate |
| | (Dollars in thousands) |
| Assets: | | | | | | | | | | | | | | | | | |
| Total loans receivable, net | $ | 3,414,424 |
| | $ | 175,466 |
| | 5.14 | % | | $ | 2,703,934 |
| | $ | 129,213 |
| | 4.78 | % | | $ | 2,489,730 |
| | $ | 122,147 |
| | 4.91 | % |
| Taxable securities | 677,893 |
| | 17,602 |
| | 2.60 |
| | 570,969 |
| | 12,688 |
| | 2.22 |
| | 589,867 |
| | 11,215 |
| | 1.90 |
|
| Nontaxable securities | 190,209 |
| | 4,649 |
| | 2.44 |
| | 226,934 |
| | 5,269 |
| | 2.32 |
| | 221,708 |
| | 4,870 |
| | 2.20 |
|
| Other interest earning assets | 76,117 |
| | 1,642 |
| | 2.16 |
| | 45,949 |
| | 539 |
| | 1.17 |
| | 44,951 |
| | 280 |
| | 0.62 |
|
| Total interest earning assets | 4,358,643 |
| | 199,359 |
| | 4.57 |
| | 3,547,786 |
| | 147,709 |
| | 4.16 |
| | 3,346,256 |
| | 138,512 |
| | 4.14 |
|
| Noninterest earning assets | 615,372 |
| | | | | | 433,566 |
| | | | | | 399,279 |
| | | | |
| Total assets | $ | 4,974,015 |
| | | | | | $ | 3,981,352 |
| | | | | | $ | 3,745,535 |
| | | | |
| | | | | | | | | | | | | | | | | | |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | Average Balance | | Interest Earned/ Paid | | Average Yield/ Rate | | Average Balance | | Interest Earned/ Paid | | Average Yield/ Rate | | Average Balance | | Interest Earned/ Paid | | Average Yield/ Rate |
| | (Dollars in thousands) |
| Liabilities and Stockholders' Equity: |
| Certificate of deposit accounts | $ | 463,124 |
| | $ | 3,959 |
| | 0.85 | % | | $ | 378,044 |
| | $ | 2,244 |
| | 0.59 | % | | $ | 388,286 |
| | $ | 1,936 |
| | 0.50 | % |
| Savings accounts | 513,680 |
| | 2,056 |
| | 0.40 |
| | 499,435 |
| | 1,311 |
| | 0.26 |
| | 485,482 |
| | 756 |
| | 0.16 |
|
| Interest bearing demand and money market accounts | 1,916,319 |
| | 4,382 |
| | 0.23 |
| | 1,498,619 |
| | 2,494 |
| | 0.17 |
| | 1,464,198 |
| | 2,318 |
| | 0.16 |
|
| Total interest bearing deposits | 2,893,123 |
| | 10,397 |
| | 0.36 |
| | 2,376,098 |
| | 6,049 |
| | 0.25 |
| | 2,337,966 |
| | 5,010 |
| | 0.21 |
|
| Junior subordinated debentures | 20,145 |
| | 1,263 |
| | 6.27 |
| | 19,860 |
| | 1,014 |
| | 5.11 |
| | 19,565 |
| | 880 |
| | 4.50 |
|
| FHLB advances and other borrowings | 33,914 |
| | 671 |
| | 1.98 |
| | 105,648 |
| | 1,226 |
| | 1.16 |
| | 13,349 |
| | 74 |
| | 0.55 |
|
| Securities sold under agreement to repurchase | 31,426 |
| | 82 |
| | 0.26 |
| | 25,434 |
| | 57 |
| | 0.22 |
| | 20,392 |
| | 42 |
| | 0.21 |
|
| Total interest bearing liabilities | 2,978,608 |
| | 12,413 |
| | 0.42 |
| | 2,527,040 |
| | 8,346 |
| | 0.33 |
| | 2,391,272 |
| | 6,006 |
| | 0.25 |
|
| Demand and other noninterest bearing deposits | 1,240,621 |
| | | | | | 902,716 |
| | | | | | 829,912 |
| | | | |
| Other noninterest bearing liabilities | 67,692 |
| | | | | | 51,820 |
| | | | | | 38,474 |
| | | | |
| Stockholders’ equity | 687,094 |
| | | | | | 499,776 |
| | | | | | 485,877 |
| | | | |
| Total liabilities and stock-holders’ equity | $ | 4,974,015 |
| | | | | | $ | 3,981,352 |
| | | | | | $ | 3,745,535 |
| | | | |
| Net interest income | | | $ | 186,946 |
| | | | | | $ | 139,363 |
| | | | | | $ | 132,506 |
| | |
| Net interest spread | | | | | 4.15 | % | | | | | | 3.83 | % | | | | | | 3.89 | % |
| Net interest margin | | | | | 4.29 | % | | | | | | 3.93 | % | | | | | | 3.96 | % |
| Average interest earning assets to average interest bearing liabilities | | | | | 146.33 | % | | | | | | 140.39 | % | | | | | | 139.94 | % |
Resources
The following table provides the amount of change in our net interest income attributable to changes in volumematerial cash requirements and changes in interest rates. Changes attributable to the combined effect of volume and interest rates have been allocated proportionately for changes due specifically to volume and interest rates.
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | 2018 Compared to 2017 Increase (Decrease) Due to | | 2017 Compared to 2016 Increase (Decrease) Due to |
| | | Volume | | Rate | | Total | | Volume | | Rate | | Total |
| | | (In thousands) |
| Interest Earning Assets: | | | | | | | | | | | | |
| Loans | | $ | 36,512 |
| | $ | 9,741 |
| | $ | 46,253 |
| | $ | 10,236 |
| | $ | (3,170 | ) | | $ | 7,066 |
|
| Taxable securities | | 2,776 |
| | 2,138 |
| | 4,914 |
| | (420 | ) | | 1,893 |
| | 1,473 |
|
| Nontaxable securities | | (898 | ) | | 278 |
| | (620 | ) | | 121 |
| | 278 |
| | 399 |
|
| Other interest earning assets | | 651 |
| | 452 |
| | 1,103 |
| | 12 |
| | 247 |
| | 259 |
|
| Interest income | | $ | 39,041 |
| | $ | 12,609 |
| | $ | 51,650 |
| | $ | 9,949 |
| | $ | (752 | ) | | $ | 9,197 |
|
| Interest Bearing Liabilities: | | | | | | | | | | | | |
| Certificate of deposit accounts | | $ | 727 |
| | $ | 988 |
| | $ | 1,715 |
| | $ | (61 | ) | | $ | 369 |
| | $ | 308 |
|
| Savings accounts | | 57 |
| | 688 |
| | 745 |
| | 37 |
| | 518 |
| | 555 |
|
| Interest bearing demand and money market accounts | | 955 |
| | 933 |
| | 1,888 |
| | 57 |
| | 119 |
| | 176 |
|
| Total interest bearing deposits | | 1,739 |
| | 2,609 |
| | 4,348 |
| | 33 |
| | 1,006 |
| | 1,039 |
|
| Junior subordinated debentures | | 18 |
| | 231 |
| | 249 |
| | 15 |
| | 119 |
| | 134 |
|
| Securities sold under agreement to repurchase | | 16 |
| | 9 |
| | 25 |
| | 11 |
| | 4 |
| | 15 |
|
| FHLB advances and other borrowings | | (1,419 | ) | | 864 |
| | (555 | ) | | 1,071 |
| | 81 |
| | 1,152 |
|
| Interest expense | | $ | 354 |
| | $ | 3,713 |
| | $ | 4,067 |
| | $ | 1,130 |
| | $ | 1,210 |
| | $ | 2,340 |
|
| Net Interest Income | | $ | 38,687 |
| | $ | 8,896 |
| | $ | 47,583 |
| | $ | 8,819 |
| | $ | (1,962 | ) | | $ | 6,857 |
|
Results of Operations for the Years Ended December 31, 2018 and 2017
Earnings Summary
Net income was $53.1 million, or $1.49 per diluted common share, for the year ended December 31, 2018 compared to $41.8 million, or $1.39 per diluted common share, for the year ended December 31, 2017. Net income increased $11.3 million, or 27.0%, for the year ended December 31, 2018 compared to the year ended December 31, 2017 primarily due to an increase in net interest income of $47.6 million, or 34.1%, and the impact of utilizing a lower effective tax rate due to the Tax Cuts and Jobs Act, partially offset by an increase in noninterest expense of $38.8 million, or 35.1%. The increases in net interest income and noninterest expense during the year ended December 31, 2018 compared to the same period in 2017 were primarily the result of the Premier and Puget Mergers.
The net interest margin increased 36 basis points to 4.29% for the year ended December 31, 2018 compared to 3.93% for the same period in 2017. The increase in net interest margin was primarily due to the increases in both the average loan balance and loan yield and secondarily due to increases in both the average balances and yields on investments, offset partially by an increase in both the average balance and cost of interest bearing liabilities.
The Company’s efficiency ratio was 68.34% for the year ended December 31, 2018 compared to 63.21% for the year ended December 31, 2017. The change in the efficiency ratio for the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily attributable to acquisition-related expenses included in noninterest expense as a result of the Premier and Puget Mergers.
Net Interest Income
One of the Company's key sources of earnings is net interest income. There are several factors that affect net interest income including, but not limited to, the volume, pricing, mix and maturity of interest earning assets and interest bearing liabilities; the volume of noninterest bearing depositscapital resources from known contractual and other liabilitiesobligations and stockholders' equity; the volume of noninterest earning assets; market interest rate fluctuations; and asset quality. Net interest income increased $47.6 million, or 34.1%, to $186.9 million for the year ended December 31, 2018 compared to $139.4 million for the year ended December 31, 2017. The increase in net interest income was primarily due to increases in average interest earning assets, which increased substantially as a result of the Premier and Puget Mergers, and increases in the yield on total interest earning assets due to increasing market rates, offset partially by increases in the average cost of total interest bearing liabilities primarily as a result of rising interest rates and increases in average interest bearing liabilities, also due to the Premier and Puget Mergers.
Interest Income
Total interest income increased $51.7 million, or 35.0%, to $199.4 million for the year ended December 31, 2018 compared to $147.7 million for the same period in 2017. The balance of average interest earning assets increased $810.9 million, or 22.9%, to $4.36 billion for the year ended December 31, 2018 from $3.55 billion for the year ended December 31, 2017 and the yield on total interest earning assets increased 41 basis points to 4.57% for the year ended December 31, 2018 compared to 4.16% for the year ended December 31, 2017. The increase in the interest income was due primarily to interest income from interest and fees on loans and secondarily due to interest income on investment securities.
Interest income from interest and fees on loans increased $46.3 million, or 35.8%, to $175.5 million for the year ended December 31, 2018 from $129.2 million for the same period in 2017 due primarily to increases in both average loans receivable, net and in loan yields. Average total loans receivable, net increased $710.5 million, or 26.3%, to $3.41 billion for the year ended December 31, 2018 compared to $2.70 billion for the year ended December 31, 2017 primarily as a result of the Premier and Puget Mergers. Loan yields increased 36 basis points to 5.14% for the year ended December 31, 2018 from 4.78% for the year ended December 31, 2017 due to a combination of higher contractual loan rates as a result of the increasing interest rate environment and higher loan yields for loans acquired in the Premier and Puget Mergers as compared to the yield of legacy Heritage loans.
Incremental accretion income was $8.0 million and $6.3 million for the year ended December 31, 2018 and 2017, respectively. The increase in the incremental accretion was primarily due to the accretion of the loans acquired in the Premier and Puget Mergers. The impact on loan yield from incremental accretion on purchased loans was 0.23% for both the years ended December 31, 2018 and 2017. The incremental accretion and the impact to loan yield will change during any quarter based on the volume of prepayments, but is expected to decrease over time as the balance of the purchased loans continues to decrease. It is also expected that incremental accretion on portfolios with heavy short-term or revolving loans will experience higher accretion in the first year after the merger date.
The following table presents a reconciliation of the loan yield calculated in accordance with GAAP to the loan yield excluding the effect of the incremental accretion on purchased loans for the year ended December 31, 2018 and 2017:
|
| | | | | | | | |
| | | Year Ended December 31, |
| | | 2018 | | 2017 |
| | | (Dollars in thousands) |
| Loan yield (GAAP) | | 5.14 | % | | 4.78 | % |
Exclude impact on loan yield from incremental accretion on purchased loans(1) | | 0.23 | % | | 0.23 | % |
Loan yield, excluding incremental accretion on purchased loans (non-GAAP)(1) (2) | | 4.91 | % | | 4.55 | % |
| | | | | |
| Incremental accretion on purchased loans | | $ | 7,964 |
| | $ | 6,320 |
|
(1) As of the date of completion of each merger and acquisition transaction, purchased loans were recorded at their estimated fair value, including our estimate of future expected cash flows until the ultimate resolution of these credits. The difference between the contractual loan balance and the fair value represents the purchased discount. The purchased discount is accreted into income over the estimated remaining life of the loan or pool of loans, based upon results of the quarterly cash flow re-estimation. The incremental accretion income represents the amount of income recorded on the purchased loans in excess of the contractual stated interest rate in the individual loan notes.
(2) For additional information, see "Non-GAAP Financial Information."
Interest income on investment securities increased $4.3 million, or 23.9%, to $22.3 million during the year ended December 31, 2018 compared to $18.0 million for the year ended December 31, 2017. The increase in interest income on investment securities was the result of a combination of an increase in investment yields for the year ended December 31, 2018 compared to the same period in 2017 and an increase in the average balance of investment securities during the period. Yields on taxable securities increased 38 basis points to 2.60% for the year ended December 31, 2018 compared to 2.22% for the same period in 2017. Yields on nontaxable securities increased 12 basis points to 2.44% for the year ended December 31, 2018 from 2.32% for the same period in 2017. The average balance of investment securities increased $70.2 million, or 8.8%, to $868.1 million during the year ended December 31, 2018 from $797.9 million during the year ended December 31, 2017. The Company reduced the balance of its tax exempt securities during the year ended December 31, 2018 compared to the same period in 2017 as holding tax exempt securities was not as beneficial given the decrease in the federal corporate income tax rate in 2018. The Company has actively managed its investment securities portfolio to improve performance in the increasing rate environment.
Income on other interest earning assets increased $1.1 million, or 204.6%, to $1.6 million during the year ended December 31, 2018 compared to $539,000 during the same period in 2017 due to a combination of an increase in both the average balance and yield. Average other interest earning assets increased $30.2 million, or 65.7%, to $76.1 million for the year ended December 31, 2018 compared to $45.9 million for the year ended December 31, 2017. The increase was due primarily to an increase in interest earning deposits, as the Bank held more funds in interest earning accounts compared to the same period in 2017. The yield on other interest earning assets increased 99 basis points to 2.16% during the year ended December 31, 2018 compared to 1.17% during the same period in 2017, reflecting a rise in market rates.
Interest Expense
Total interest expense increased $4.1 million, or 48.7%, to $12.4 million for the year ended December 31, 2018 compared to $8.3 million for the same period in 2017 due primarily to an increase in the cost of funds. The cost of total interest bearing liabilities increased nine basis points to 0.42% for the year ended December 31, 2018 from 0.33% for the year ended December 31, 2017 primarily as a result of rising interest rates. The increase in interest expense was secondarily due to an increase in the total average interest bearing liabilities which increased by $451.6 million, or 17.9%, to $2.98 billion for the year ended December 31, 2018 from $2.53 billion for the year ended December 31, 2017, primarily as a result of liabilities assumed in the Premier and Puget Mergers.
The Company was able to reduce the impact of the rising market interest rates by increasing the average balance of noninterest bearing deposits at a higher growth rate than for total interest bearing deposits. The average balance of noninterest bearing deposits increased by $337.9 million, or 37.4%, during the year ended December 31,
2018 to $1.24 billion from $902.7 million for 2017, including $332.7 million acquired in the Premier and Puget Mergers at the respective merger dates. The average balance of total interest bearing deposits increased $517.0 million, or 21.8%, during the year ended December 31, 2018 to $2.89 billion from $2.38 billion for the same period in 2017. The cost of all deposit accounts increased seven basis points to 0.25% for the year ended December 31, 2018 compared to 0.18% for the year ended December 31, 2017.
Interest expense on FHLB advances and other borrowings decreased $555,000, or 45.3%, to $671,000 for the year ended December 31, 2018 from $1.2 million for the year ended December 31, 2017 due to a decrease in the average balance, partially offset by an increase in the cost. The average balance for FHLB advances and other borrowings decreased $71.7 million to $33.9 million for the year ended December 31, 2018 from $105.6 million for the same period in 2017. The Company paid off all the outstanding FHLB advances during the third quarter of 2018. The average rate of the FHLB advances and other borrowings increased 82 basis points to 1.98% for the year ended December 31, 2018 compared to 1.16% for the same period in 2017 as a result of the increase in market rates.
The average cost of the junior subordinated debentures, including the effects of accretion of the discount established as of the date of the merger with Washington Banking Company, increased 116 basis points to 6.27% for the year ended December 31, 2018 compared to 5.11% for the same period in 2017. The increase on the cost of debentures was due to an increase in the three-month LIBOR rate to 2.81% at December 31, 2018 from 1.69% on December 31, 2017.
Net Interest Margin
Net interest margin for the year ended December 31, 2018 increased 36 basis points to 4.29% from 3.93% for the same period in 2017 primarily due to the above mentioned changes in asset yields and costs of funds. The net interest spread for the year ended December 31, 2018 increased 32 basis points to 4.15% from 3.83% for the same period in 2017 primarily due to the increase in yield on total interest earning assets.
Net interest margin is impacted by the incremental accretion on purchased loans. The following table presents a reconciliation of the net interest margin calculated in accordance with GAAP to the net interest margin excluding the effect of the incremental accretion on purchased loans for the year ended December 31, 2018 and 2017:
|
| | | | | | |
| | | Year Ended December 31, |
| | | 2018 | | 2017 |
| Net interest margin (GAAP) | | 4.29 | % | | 3.93 | % |
Exclude impact on net interest margin from incremental accretion on purchased loans(1) | | 0.18 | % | | 0.18 | % |
Net interest margin, excluding incremental accretion on purchased loans (non-GAAP)(1) (2) | | 4.11 | % | | 3.75 | % |
(1) As of the date of completion of each merger and acquisition transaction, purchased loans were recorded at their estimated fair value, including our estimate of future expected cash flows until the ultimate resolution of these credits. The difference between the contractual loan balance and the fair value represents the purchased discount. The purchased discount is accreted into income over the estimated remaining life of the loan or pool of loans, based upon results of the quarterly cash flow re-estimation. The incremental accretion income represents the amount of income recorded on the purchased loans in excess of the contractual stated interest rate in the individual loan notes.
(2) For additional information, see "Non-GAAP Financial Information."
Provision for Loan Losses
The Bank has established a comprehensive methodology for determining its allowance for loan losses. The allowance for loan losses is increased by provisions for loan losses charged to expense, and is reduced by loans charged-off, net of loan recoveries or a recovery of previous provision. The amount of the provision expense recognized during the years ended December 31, 2018 and 2017 was calculated in accordance with the Bank's methodology. For additional information, see “—Critical Accounting Policies” above.
The provision for loan losses is dependent on the Bank’s ability to manage asset quality and control the level of net charge-offs through prudent underwriting standards. In addition, a decline in general economic conditions could increase future provisions for loan losses and have a material effect on the Company’s net income.
The provision for loan losses increased $909,000, or 21.5% to $5.1 million for the year ended December 31, 2018 from $4.2 million for the year ended December 31, 2017. The increase in the provision for loan losses for the year ended December 31, 2018 from the same period in 2017 was primarily the result of increases in total loan balances
during the year ended December 31, 2018. Based on a thorough review of the loan portfolio, the Bank determined that the provision for loan losses for the year ended December 31, 2018 was appropriate as it was calculated in accordance with the Bank's methodology for determining the allowance for loan losses.
Noninterest Income
Total noninterest income decreased $3.9 million, or 11.0%, to $31.7 million for the year ended December 31, 2018 compared to $35.6 million for the same period in 2017. The following table presents the change in the key components of noninterest income for the periods noted:
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | | | |
| | 2018 | | 2017 | | Change | | Percentage Change |
| | (Dollars in thousands) |
| Service charges and other fees | $ | 18,914 |
| | $ | 18,004 |
| | $ | 910 |
| | 5.1 | % |
| Gain on sale of investment securities, net | 137 |
| | 6 |
| | 131 |
| | 2,183.3 |
|
| Gain on sale of loans, net | 2,759 |
| | 7,696 |
| | (4,937 | ) | | (64.2 | ) |
| Interest rate swap fees | 564 |
| | 1,045 |
| | (481 | ) | | (46.0 | ) |
| Other income | 9,291 |
| | 8,828 |
| | 463 |
| | 5.2 |
|
| Total noninterest income | $ | 31,665 |
| | $ | 35,579 |
| | $ | (3,914 | ) | | (11.0 | )% |
Gain on sale of loans, net decreased $4.9 million, or 64.2% to $2.8 million for the year ended December 31, 2018 compared to $7.7 million for the same period in 2017 due primarily to a $3.0 million gain recognized during 2017 as a result of the sale of a previously classified purchased credit impaired loan. The decrease in gain on sale of loans, net is also due to lower originations of loans held for sale. Volume from sale of mortgage loans decreased $42.2 million, or 34.8%, to $79.2 million for the year ended December 31, 2018 from $121.5 million for the same period in 2017. Volume from sale of the guaranteed portion of SBA loans decreased $10.1 million, or 50.3%, to $10.0 million for the year ended December 31, 2018 from $20.1 million for the same period in 2017. The lower volume of sales of mortgage loans and the guaranteed portion of SBA loans is also due to originating more of these type of loans as held for investment that are retained as portfolio loans in loans receivable, net. The detail of gain on sale of loans, net is included in the following schedule:
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | |
| | 2018 | | 2017 | | Change | | Percentage Change |
| | (Dollars in thousands) |
| Gain on sale of mortgage loans, net | $ | 2,403 |
| | $ | 3,412 |
| | $ | (1,009 | ) | | (29.6 | )% |
| Gain on sale of guaranteed portion of SBA loans, net | 356 |
| | 1,286 |
| | (930 | ) | | (72.3 | ) |
| Gain on sale of other loans, net | — |
| | 2,998 |
| | (2,998 | ) | | (100.0 | ) |
| Gain on sale of loans, net | $ | 2,759 |
| | $ | 7,696 |
| | $ | (4,937 | ) | | (64.2 | )% |
Interest rate swap fees decreased $481,000, or 46.0%, to $564,000 for the year ended December 31, 2018 compared to $1.0 million for the same period in 2017 as a result of fewer borrower requests for interest rate swap transactions.
The decrease in total noninterest income was partially mitigated by an increase in service charges and other fees of $910,000, or 5.1%, to $18.9 million for the year ended December 31, 2018 compared to $18.0 million for the same period in 2017, due primarily to an increase in deposit balances from acquisition and organic growth and changes in fee structures on deposit accounts, including a business deposit consolidation process completed during the second quarter 2017.
Additionally, other income increased $463,000, or 5.2%, to $9.3 million for the year ended December 31, 2018 compared to $8.8 million for the same period in 2017, due primarily to the total gain of $798,000 on the sales of a branch and a former administrative building during the year ended December 31, 2018.
Noninterest Expense
Noninterest expense increased $38.8 million, or 35.1%, to $149.4 million during the year ended December 31, 2018 compared to $110.6 million for the year ended December 31, 2017. The following table presents changes in the key components of noninterest expense for the periods noted:
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | | | |
| | 2018 | | 2017 | | Change | | Percentage Change |
| | (Dollars in thousands) |
| Compensation and employee benefits | $ | 86,830 |
| | $ | 64,268 |
| | $ | 22,562 |
| | 35.1 | % |
| Occupancy and equipment | 19,779 |
| | 15,396 |
| | 4,383 |
| | 28.5 |
|
| Data processing | 9,888 |
| | 8,176 |
| | 1,712 |
| | 20.9 |
|
| Marketing | 3,228 |
| | 2,943 |
| | 285 |
| | 9.7 |
|
| Professional services | 9,670 |
| | 4,777 |
| | 4,893 |
| | 102.4 |
|
| State and local taxes | 3,210 |
| | 2,461 |
| | 749 |
| | 30.4 |
|
| Federal deposit insurance premium | 1,480 |
| | 1,435 |
| | 45 |
| | 3.1 |
|
| Other real estate owned, net | 106 |
| | (70 | ) | | 176 |
| | (251.4 | ) |
| Amortization of intangible assets | 3,819 |
| | 1,286 |
| | 2,533 |
| | 197.0 |
|
| Other expense | 11,385 |
| | 9,903 |
| | 1,482 |
| | 15.0 |
|
| Total noninterest expense | $ | 149,395 |
| | $ | 110,575 |
| | $ | 38,820 |
| | 35.1 | % |
The Company incurred significant acquisition-related expenses as a result of the Premier and Puget Mergers. The following table presents these expenses by key component in the following table:
|
| | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 |
| | (In thousands) |
| Compensation and employee benefits | $ | 5,455 |
| | $ | — |
|
| Occupancy and equipment | 45 |
| | 2 |
|
| Data processing | 1,365 |
| | 113 |
|
| Marketing | 24 |
| | 1 |
|
| Professional services | 3,046 |
| | 690 |
|
| Other expense | 456 |
| | 4 |
|
| Total merger related expenses | $ | 10,391 |
| | $ | 810 |
|
Compensation and employee benefits increased $22.6 million, or 35.1%, to $86.8 million during the year ended December 31, 2018 from $64.3 million during the year ended December 31, 2017 primarily as a result of additional employees, mostly due to the Premier and Puget Mergers, including increases in senior level staffing. The average full time equivalent employees increased to 840 for the year ended December 31, 2018 compared to 749 for the same period in 2017. Compensation and employee benefits additionally increased due to acquisition-related payments for change-in-control bonuses and severance related to the Premier and Puget Mergers of $5.5 million during the year ended December 31, 2018 and increases in standard salary rates.
Professional services increased $4.9 million, or 102.4%, to $9.7 million during the year ended December 31, 2018 from $4.8 million during the year ended December 31, 2017 primarily due to an increase of $2.4 million in professional services acquisition costs. The increase was additionally the result of the buy-out of a third party contract in the amount of $1.7 million during the year ended December 31, 2018. The third party assisted the Company in its deposit product realignment and was compensated based on success factors over three years subsequent to implementation. The Company assessed the contract and determined that it was advantageous to buy-out the contract prior to the system conversions relating to the Premier and Puget Mergers. The Company expects the accumulated savings in future professional services expenses to fully offset the cost of the buy-out by the end of 2019.
Occupancy and equipment increased $4.4 million, or 28.5%, to $19.8 million during the year ended December 31, 2018 from $15.4 million during the year ended December 31, 2017 due substantially to branch or other leased space expansion in the Seattle, Bellevue, Portland and other Oregon markets. The Bellevue expansion included the
lease acquired from the Puget Sound Merger and additional space leased subsequent to the merger. The Oregon expansion included five leases acquired in the Premier Merger.
Amortization of intangible assets increased $2.5 million, or 197.0%, to $3.8 million during the year ended December 31, 2018 from $1.3 million during the year ended December 31, 2017 primarily a result of additional amortization related to acquired core deposit intangibles from the Premier and Puget Mergers of $2.7 million during the year ended December 31, 2018.
Data processing increased $1.7 million, or 20.9%, to $9.9 million during the year ended December 31, 2018 from $8.2 million during the year ended December 31, 2017 primarily due to acquisition-related costs for core system conversions. The increase in the year ended December 31, 2018 compared to 2017 was additionally due to higher transactional activity as a result of the Premier and Puget Mergers and organic growth in loans and deposits.
The ratio of noninterest expense to average total assets was 3.00% for the year ended December 31, 2018, compared to 2.78% for the year ended December 31, 2017. The increase was primarily a result of increased expenses including acquisition-related costs and increases in amortization of intangible assets as a result of the Premier and Puget Mergers during the year ended December 31, 2018.
Income Tax Expense
Income tax expense decreased $7.3 million, or 39.9%, to $11.0 million for the year ended December 31, 2018 from $18.4 million for the year ended December 31, 2017. The effective tax rate was 17.2% for the year ended December 31, 2018 compared to 30.5% for the same period in 2017. The decrease in the income tax expense and effective tax rate during the year ended December 31, 2018 was primarily due to the impact of the Tax Cuts and Jobs Act enacted in December 2017 which lowered the federal corporate income tax rate from 35% to 21%. The decrease in the effective tax rate was partially offset by a change in the estimated current tax benefits form certain low income housing tax credit projects which increased income tax expense in the amount of $898,000 in 2018. Although long-term tax benefits from the projects is still expected to occur, the timing of some of the benefits was extended to future periods.
Results of Operations for the Years Ended December 31, 2017 and 2016
Earnings Summary
Net income was $41.8 million, or $1.39 per diluted common share, for the year ended December 31, 2017 compared to $38.9 million, or $1.30 per diluted common share, for the year ended December 31, 2016. The increase in net income of $2.9 million, or 7.4%, for the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily the result of an increase in net interest income of $6.9 million, or 5.2%, and an increase in total noninterest income of $4.0 million, or 12.5%, partially offset by an increase in income tax expense of $4.6 million, or 33.0%, and an increase in total noninterest expense of $4.1 million, or 3.9%.
The net interest margin decreased three basis points to 3.93% for the year ended December 31, 2017 compared to 3.96% for the same period in 2016 primarily due to a decrease in loan yields.
The Company’s efficiency ratio improved to 63.21% for the year ended December 31, 2017 from 64.87% for the year ended December 31, 2016. The improvement in the efficiency ratio for the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily attributable to the increases in net interest income and noninterest income.
Net Interest Income
Net interest income increased $6.9 million, or 5.2%, to $139.4 million for the year ended December 31, 2017 compared to $132.5 million for the year ended December 31, 2016. The increase in net interest income was primarily due to increases in average interest earning assets and yields on interest earning assets.
Interest Income
Total interest income increased $9.2 million, or 6.6%, to $147.7 million for the year ended December 31, 2017 compared to $138.5 million for the year ended December 31, 2016. The balance of average interest earning assets increased $201.5 million, or 6.0%, to $3.55 billion for the year ended December 31, 2017 from $3.35 billion for the year ended December 31, 2016. The yield on total interest earning assets increased two basis points to 4.16% for the year ended December 31, 2017 from 4.14% for the year ended December 31, 2016.
Interest income from interest and fees on loans increased $7.1 million, or 5.8%, to $129.2 million for the year ended December 31, 2017 from $122.1 million for the same period in 2016 due primarily to an increase in average
loans receivable, offset partially by a decrease in average loan yields. Average loans receivable increased $214.2 million, or 8.6%, to $2.70 billion for the year ended December 31, 2017 compared to $2.49 billion for the year ended December 31, 2016 as a result of loan growth. Average loan yields decreased 13 basis points to 4.78% for the year ended December 31, 2017 from 4.91% for the year ended December 31, 2016. While variable indexed rates had increased during 2017, loan yield, excluding incremental accretion on purchased loans, decreased seven basis points to 4.55% for the year ended December 31, 2017 compared to 4.62% for the year ended 2016 due primarily to a combination of lower consumer indirect loan yields during 2017, fewer payments in 2017 to resolve nonperforming or charged-off loans and lower prepayment penalties received in 2017 as compared to 2016. Average loan yields secondarily decreased as a result of a decrease in incremental accretion income on purchased loans, which had the impact of loan yields of 0.23% for the year ended December 31, 2017 compared to 0.29% for the year ended December 31, 2017. Incremental accretion income was $6.3 million and $7.2 million for the years ended December 31, 2017 and 2016, respectively. The decrease in the incremental accretion was primarily a result of a continued decline in the purchased loan balances and a decrease in the prepayments of purchased loans during the year ended December 31, 2017 compared to the same period in 2016. The incremental accretion and the impact to loan yield will change during any period based on the volume of prepayments, but is expected to decrease over time as the balance of the purchased loans continues to decrease.
The following table presents the average loan yield and effects of the incremental accretion on purchased loans for the year ended December 31, 2017 and 2016:
|
| | | | | | | | |
| | | Year Ended December 31, |
| | | 2017 | | 2016 |
| | | (Dollars in thousands) |
| Loan yield (GAAP) | | 4.78 | % | | 4.91 | % |
Exclude impact on loan yield from incremental accretion on purchased loans(1) | | 0.23 |
| | 0.29 |
|
Loan yield, excluding incremental accretion on purchased loans (non-GAAP)(1)(2) | | 4.55 | % | | 4.62 | % |
| | | | | |
Incremental accretion on purchased loans(1) | | $ | 6,320 |
| | $ | 7,155 |
|
(1) As of the date of completion of each merger and acquisition transaction, purchased loans were recorded at their estimated fair value, including our estimate of future expected cash flows until the ultimate resolution of these credits. The difference between the contractual loan balance and the fair value represents the purchased discount. The purchased discount is accreted into income over the estimated remaining life of the loan or pool of loans, based upon results of the quarterly cash flow re-estimation. The incremental accretion income represents the amount of income recorded on the purchased loans in excess of the contractual stated interest rate in the individual loan notes.
(2) For additional information, see "Non-GAAP Financial Information."
Total interest income increased primarily due to the increase in interest and fees on loans discussed above and secondarily due to an increase in interest income on investment securities of $1.9 million, or 11.6%, to $18.0 million during the year ended December 31, 2017 from $16.1 million for the year ended December 31, 2016. The increase in interest income on investment securities was the result of an increase in average investment yields for the year ended December 31, 2017 compared to the same period in 2016, offset partially by a decrease in the average balance of investment securities. Average yields on taxable securities increased 32 basis points to 2.22% for the year ended December 31, 2017 from 1.90% for the same period in 2016. The increase is primarily the result of the rise in interest rates on the adjustable rate investment securities. Average yields on nontaxable securities increased 12 basis points to 2.32% for the year ended December 31, 2017 from 2.20% for the same period in 2016. The average balance of investment securities decreased $13.7 million, or 1.7%, to $797.9 million during the year ended December 31, 2017 from $811.6 million during the year ended December 31, 2016. The Company has actively managed its investment securities portfolio to mitigate declines in loan yields.
Average other interest earning assets increased $1.0 million, or 2.24%, to $46.0 million for the year ended December 31, 2017 compared to $45.0 million for the year ended December 31, 2016. The increase was due primarily to an increase in interest earning deposits, as the Bank held more funds in interest earning accounts at the Federal Reserve Bank of San Francisco compared to the same period in 2016.
Interest Expense
Total interest expense increased $2.3 million, or 39.0%, to $8.3 million for the year ended December 31, 2017 compared to $6.0 million for the same period in 2016. The average cost of interest bearing liabilities increased eight basis points to 0.33% for the year ended December 31, 2017 from 0.25% for the year ended December 31, 2016. Total average interest bearing liabilities increased $135.8 million, or 5.7%, to $2.53 billion for the year ended December 31, 2017 from $2.39 billion for the year ended December 31, 2016. The increase in costs from the prior year was primarily a result of increases in market rates and the increased use of higher cost borrowings to fund asset growth.
The average cost of interest bearing deposits increased four basis points to 0.25% for the year ended December 31, 2017 from 0.21% for the same period in 2016 due primarily to an increase in the cost of savings accounts.
Interest expense on savings accounts increased $555,000, or 73.4%, to $1.3 million for the year ended December 31, 2017 from $756,000 for the same period in 2016 due to increases in both the average balance and cost of savings accounts. The average balance of savings accounts increased $14.0 million, or 2.9%, to $499.4 million for the year ended December 31, 2017 from $485.5 million for the same period in 2016. The cost of savings accounts increased ten basis points to 0.26% for the year ended December 31, 2017 from 0.16% for the same period in 2016.
Interest expense of certificate of deposit accounts increased $308,000, or 15.91%, to $2.2 million for the year ended December 31, 2017. The average balance of certificate of deposit accounts decreased $10.2 million, or 2.64%, to $378.0 million for the year ended December 31, 2017 compared to $388.3 million for the year ended December 31, 2016 while the cost of certificate of deposit accounts increased to 0.59% for the year ended December 31, 2017 from 0.50% for the same period in 2016.
Interest expense on FHLB advances and other borrowings increased to $1.2 million for the year ended December 31, 2017 from $74,000 for the year ended December 31, 2016 due to a combination of an increase in average balances and an increase in the cost of funds. The average balance for FHLB advances and other borrowings increased $92.3 million to $105.6 million for the year ended December 31, 2017 from $13.3 million for the same period in 2016, due primarily to fund loan growth. The average rate of the FHLB advances and other borrowings increased 61 basis points for the year ended December 31, 2017 to 1.16% from 0.55% for the same period in 2016.
The average rate of the junior subordinated debentures, including the effects of accretion of the discount established as of the date of the merger with Washington Banking Company, was 5.11% for the year ended December 31, 2017, an increase of 61 basis points from 4.50% for the same period in 2016. The rate increase on the debentures was due primarily to an increase in the three-month LIBOR rate to 1.69% at December 31, 2017 from 1.00% on December 31, 2016.
Net Interest Margin
Net interest margin for the year ended December 31, 2017 decreased three basis points to 3.93% from 3.96% for the same period in 2016 primarily due to the above mentioned decrease in the loan yields (both including and excluding the impact of incremental accretion on purchased loans) and increase in cost of funds, offset partially by the increase in average loan receivable balances and the increase in yields on taxable and nontaxable securities. The net interest spread for the year ended December 31, 2017 decreased six basis points to 3.83% from 3.89% for the same period in 2016.
Net interest margin is impacted by the incremental accretion on purchased loans. The following table presents the net interest margin and effects of the incremental accretion on purchased loans for the year ended December 31, 2017 and 2016:
|
| | | | | | |
| | | Year Ended December 31, |
| | | 2017 | | 2016 |
| | | (Dollars in thousands) |
| Net interest margin (GAAP) | | 3.93 | % | | 3.96 | % |
Exclude impact on net interest margin from incremental accretion on purchased loans(1) | | 0.18 |
| | 0.21 |
|
Net interest margin, excluding incremental accretion on purchased loans (non-GAAP)(1) (2) | | 3.75 | % | | 3.75 | % |
(1) As of the date of completion of each merger and acquisition transaction, purchased loans were recorded at their estimated fair value, including our estimate of future expected cash flows until the ultimate resolution of these credits. The difference between the contractual loan balance and the fair value represents the purchased discount. The purchased discount is accreted into income over the estimated remaining life of the loan or pool of loans, based upon results of the quarterly
cash flow re-estimation. The incremental accretion income represents the amount of income recorded on the purchased loans in excess of the contractual stated interest rate in the individual loan notes.
(2) For additional information, see "Non-GAAP Financial Information."
Provision for Loan Losses
The amount of the provision expense recognized during the years ended December 31, 2017 and 2016 was calculated in accordance with the Bank's methodology. For additional information, see “—Critical Accounting Policies” above. The provision for loan losses decreased $711,000, or 14.4% to $4.2 million for the year ended December 31, 2017 from $4.9 million for the year ended December 31, 2016. The decrease in the provision for loan losses for the year ended December 31, 2017 from the same period in 2016 was primarily the result of continued improvements in our asset quality, changes in the volume and mix of loans, changes in certain environmental factors and improvements in certain historical loss factors, partially offset by the impact of loan growth. Based on a thorough review of the loan portfolio, the Bank determined that the provision for loan losses for the year ended December 31, 2017 was appropriate as it was calculated in accordance with the Bank's methodology for determining the allowance for loan losses.
Noninterest Income
Total noninterest income increased $4.0 million, or 12.5%, to $35.6 million for the year ended December 31, 2017 compared to $31.6 million for the year ended December 31, 2016. The following table presents the change in the key components of noninterest income for the periods noted:
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | | | |
| | 2017 | | 2016 | | Change 2017 vs. 2016 | | Percentage Change |
| | (Dollars in thousands) |
| Service charges and other fees | $ | 18,004 |
| | $ | 14,354 |
| | $ | 3,650 |
| | 25.4 | % |
| Gain on sale of investment securities, net | 6 |
| | 1,315 |
| | (1,309 | ) | | (99.5 | ) |
| Gain on sale of loans, net | 7,696 |
| | 6,994 |
| | 702 |
| | 10.0 |
|
| Interest rate swap fees | 1,045 |
| | 1,854 |
| | (809 | ) | | (43.6 | ) |
| Other income | 8,828 |
| | 7,102 |
| | 1,726 |
| | 24.3 |
|
| Total noninterest income | $ | 35,579 |
| | $ | 31,619 |
| | $ | 3,960 |
| | 12.5 | % |
Service charges and other fees increased $3.7 million, or 25.4% to $18.0 million for the year ended December 31, 2017 compared to $14.4 million for the same period in 2016, due primarily to an increase in deposit balances and changes in fee structures on deposit accounts, including a consumer deposit account consolidation process completed at the end of 2016 and a business deposit consolidation process completed during second quarter 2017.
Other income increased $1.7 million, or 24.3%, to $8.8 million for the year ended December 31, 2017 compared to $7.1 million for the same period in 2016, due primarily to net gain on sales of two former Heritage Bank branches held for sale of $682,000 recognized during the year ended December 31, 2017 and increases in recoveries of zero balance purchased loan notes which were charged-off prior to the consummation of the related merger acquisition.
Gain on sale of loans, net increased $702,000, or 10.0% to $7.7 million for the year ended December 31, 2017 compared to $7.0 million for the same period in 2016, due primarily to an increase in gain on sale of other loans of $743,000. During both years ended December 31, 2017 and 2016, the Bank sold one loan previously classified as purchased credit impaired for gain on sale. Secondarily, gain on sale of guaranteed portion of SBA loans, net increased $270,000 due primarily to an increase in proceeds from sale of the guaranteed portion of SBA loans of $3.3 million, or 19.4%, to $20.1 million for the year ended December 31, 2017 compared to $16.8 million for the same period in 2016. The detail of gain on sale of loans, net is included in the following schedule:
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | | | |
| | 2017 | | 2016 | | Change 2017 vs. 2016 | | Percentage Change |
| | (Dollars in thousands) |
| Gain on sale of mortgage loans, net | $ | 3,412 |
| | $ | 3,723 |
| | $ | (311 | ) | | (8.4 | )% |
| Gain on sale of guaranteed portion of SBA loans, net | 1,286 |
| | 1,016 |
| | 270 |
| | 26.6 |
|
| Gain on sale of other loans, net | 2,998 |
| | 2,255 |
| | 743 |
| | 32.9 |
|
| Gain on sale of loans, net | $ | 7,696 |
| | $ | 6,994 |
| | $ | 702 |
| | 10.0 | % |
The increase in noninterest income was partially offset by a decrease in gain on sale of investment securities, net to $6,000 for the year ended December 31, 2017 from $1.3 million for the year ended December 31, 2016. The decrease was primarily the result of fewer sales as the Bank actively managed its investment portfolio. The proceeds from sale of investment securities was $31.0 million for the year ended December 31, 2017 compared to $140.4 million for the same period in 2016.
Noninterest Expense
Noninterest expense increased $4.1 million, or 3.9%, to $110.6 million for the year ended December 31, 2017 compared to $106.5 million for the year ended December 31, 2016. The following table presents changes in the key components of noninterest expense for the periods noted:
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | | | |
| | 2017 | | 2016 | | Change 2016 vs. 2015 | | Percentage Change |
| | (Dollars in thousands) |
| Compensation and employee benefits | $ | 64,268 |
| | $ | 61,405 |
| | $ | 2,863 |
| | 4.7 | % |
| Occupancy and equipment | 15,396 |
| | 15,763 |
| | (367 | ) | | (2.3 | ) |
| Data processing | 8,176 |
| | 7,312 |
| | 864 |
| | 11.8 |
|
| Marketing | 2,943 |
| | 2,835 |
| | 108 |
| | 3.8 |
|
| Professional services | 4,777 |
| | 3,606 |
| | 1,171 |
| | 32.5 |
|
| State and local taxes | 2,461 |
| | 2,616 |
| | (155 | ) | | (5.9 | ) |
| Federal deposit insurance premium | 1,435 |
| | 1,620 |
| | (185 | ) | | (11.4 | ) |
| Other real estate owned, net | (70 | ) | | 334 |
| | (404 | ) | | (121.0 | ) |
| Amortization of intangible assets | 1,286 |
| | 1,415 |
| | (129 | ) | | (9.1 | ) |
| Other expense | 9,903 |
| | 9,567 |
| | 336 |
| | 3.5 |
|
| Total noninterest expense | $ | 110,575 |
| | $ | 106,473 |
| | $ | 4,102 |
| | 3.9 | % |
Compensation and employee benefits increased $2.9 million, or 4.7%, to $64.3 million during the year ended December 31, 2017 from $61.4 million during the year ended December 31, 2016. The increase in the year ended December 31, 2017 compared to 2016 was primarily due to senior level staffing increases, including the addition of the new Portland, Oregon lending team members who started in May 2017, and standard salary increases.
Professional services increased $1.2 million, or 32.5%, to $4.8 million during the year ended December 31, 2017 from $3.6 million during the year ended December 31, 2016. The increase in the year ended December 31, 2017 compared to 2016 was primarily due to due to benefit-based consulting fees related to the consumer deposit account consolidation process, which correspondingly generated an increase in service charges and other fees. Professional services also increased as a result of Trust-related expenses based on a renegotiated contract for 2017, which also increased other noninterest income, and costs incurred in the Puget Sound Merger of $690,000 during the year ended December 31, 2017.
Data processing increased $864,000, or 11.8%, to $8.2 million during the year ended December 31, 2017 from $7.3 million during the year ended December 31, 2016 primarily due to higher transactional activity in the core operating system and internet banking as a result of the growth in loans and deposits and costs incurred in the Puget Sound Merger of $113,000 during the year ended December 31, 2017.
Other real estate owned, net decreased $404,000 or 121.0%, to income of $70,000 during the year ended December 31, 2017 compared to expense of $334,000 during the year ended December 31, 2016. The Bank had no other real estate owned at year ended December 31, 2017 compared to $754,000 at year ended December 31, 2016. The income recorded during the year ended December 31, 2017 was due to gain on sale of properties of $144,000, partially offset by maintenance expense of $75,000. For the year ended December 31, 2016, the Bank recorded a valuation adjustment of $383,000 and maintenance expense of $124,000, which was partially offset by the gain on sale of properties of $173,000.
The ratio of noninterest expense to average assets was 2.78% for the year ended December 31, 2017, compared to 2.84% for the year ended December 31, 2016. The decrease was primarily a result of an increase in assets and cost efficiencies gained through efforts by the Company to manage discretionary expenses.
Income Tax Expense
Income tax expense increased by $4.6 million, or 33.0%, to $18.4 million for the year ended December 31, 2017 from $13.8 million for the year ended December 31, 2016. The increase in the income tax expense during the year ended December 31, 2017 was primarily due to higher pre-tax net income and the Tax Cuts and Jobs Actenacted December 22, 2017, which required a revaluation of deferred tax assets and liabilities to account for the future impact of the decrease in the federal corporate income tax rate to 21% from 35% and other provisions of the legislation. The estimated revaluation of the net deferred tax asset increased income tax expense by $2.6 million for the year ended December 31, 2017. Certain amounts of the revaluation are considered reasonable estimates of the impact of the legislationsources as of December 31, 2017.2021:
The effective tax rate was 30.5% for | | | | | | | | | | | | | | | | | | | | | | | |
| | One Year or Less | | Over One Year | | Other (1) | | Total |
| | (Dollars in thousands) |
| Cash requirements: | | | | | | | |
| Unfunded commitments - loans and letters of credits | $ | 1,125,960 | | | $ | — | | | $ | — | | | $ | 1,125,960 | |
| Maturing certificates of deposit | 290,497 | | | 52,342 | | | — | | | 342,839 | |
| Unfunded commitment of LIHTCs | 10,648 | | | 30,835 | | | — | | | 41,483 | |
| Operating leases | 4,750 | | | 26,571 | | | — | | | 31,321 | |
| Junior subordinated debentures | — | | | 25,000 | | | — | | | 25,000 | |
| Non-maturity deposits | — | | | — | | | 6,038,498 | | | 6,038,498 | |
| Securities sold under agreement to repurchase | — | | | — | | | 50,839 | | | 50,839 | |
| Total cash requirements | $ | 1,431,855 | | | $ | 134,748 | | | $ | 6,089,337 | | | $ | 7,655,940 | |
| | | | | | | |
| Capital resources: | | | | | | | |
| Unrestricted cash and cash equivalents | $ | 1,713,474 | | | $ | — | | | $ | — | | | $ | 1,713,474 | |
FHLB and FRB borrowing availability (2) | 1,113,208 | | | — | | | — | | | 1,113,208 | |
| Unencumbered investment securities available for sale | 737,454 | | | — | | | — | | | 737,454 | |
| Loans receivable scheduled repayments, by contractual maturity date | 384,790 | | | 3,430,872 | | | — | | | 3,815,662 | |
| Fed funds line borrowing availability | 215,000 | | | — | | | — | | | 215,000 | |
| Investment securities held to maturity, by contractual maturity date | — | | | 367,331 | | | — | | | 367,331 | |
| Total capital resources | $ | 4,163,926 | | | $ | 3,798,203 | | | $ | — | | | $ | 7,962,129 | |
(1)Represents the year endedundefined maturity of non-maturity deposits, including noninterest bearing demand deposits, interest bearing demand deposits, money market accounts and savings accounts, and securities sold under agreement to repurchase, which can generally both be withdrawn on demand.
(2)Includes FHLB borrowing availability of $1.06 billion at December 31, 2017 compared to 26.2% for the same period in 2016. The increase in the effective tax rate during the year ended December 31, 2017 compared to the same period in 2016 was due primarily to the revaluation of net deferred tax asset as a result2021 based on pledged assets, however, maximum credit capacity is 45% of the Tax CutsBank's total assets one quarter in arrears or $3.26 billion.
We maintain sufficient cash and Jobs Actcash equivalents and a lower proportioninvestment securities to meet short-term liquidity needs and actively monitor our long-term liquidity position to ensure the availability of tax-exempt incomecapital resources for contractual obligations, strategic loan growth objectives and to total pre-tax income. For additional information, see Note (21) Income Taxes of the Notesfund operations. Our funding strategy has been to Consolidated Financial Statements included in “Item 8. Financial Statementsacquire non-maturity deposits from our retail accounts, acquire noninterest bearing demand deposits from our commercial customers and Supplementary Data.”
Non-GAAP Financial Information
This report contains certain financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America. These measures include net interest income, interest and fees on loans, and loan yield and net interest margin excluding the effect of the incremental accretion on purchased loans acquired through mergers. Our management uses these non-GAAP measures, together with the related GAAP measures, in its analysis ofuse our performance and in making business decisions. Management also uses these measures for peer comparisons. Management believes that presenting loan yield and net interest margin excluding the effect of the acquisition accounting discount accretion on loans acquired through mergers is useful in assessing the impact of acquisition accounting on loan yield and net interest margin, as the effect of loan discount accretion is expectedborrowing availability to decrease as the acquired loans mature or roll off our balance sheet. These disclosures should not be viewed as substitutes for the results determined to be in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.
Reconciliationsfund growth in assets. We may also acquire brokered deposits when the cost of the GAAP and non-GAAP financial measuresfunds is advantageous to other funding sources. Borrowings may be used on net interest income, interest and fees on loans, loan yield and net interest margin are presented below:
|
| | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | 2018 | | 2017 | | 2016 |
| | | (Dollars in thousands) |
| Net interest income and interest and fees on loans: |
| Net interest income (GAAP) | | $ | 186,946 |
| | $ | 139,363 |
| | $ | 132,506 |
|
| Exclude incremental accretion on purchased loans | | 7,964 |
| | 6,320 |
| | 7,155 |
|
| Adjusted net interest income (non-GAAP) | | $ | 178,982 |
| | $ | 133,043 |
| | $ | 125,351 |
|
| | | | | | | |
| Average total interest earning assets, net | | $ | 4,358,643 |
| | $ | 3,547,786 |
| | $ | 3,346,256 |
|
| Net interest margin, annualized (GAAP) | | 4.29 | % | | 3.93 | % | | 3.96 | % |
| Net interest margin, excluding incremental accretion on purchased loans, annualized (non-GAAP) | | 4.11 | % | | 3.75 | % | | 3.75 | % |
| | | | | | | |
| Interest and fees on loans (GAAP) | | $ | 175,466 |
| | $ | 129,213 |
| | $ | 122,147 |
|
| Exclude incremental accretion on purchased loans | | 7,964 |
| | 6,320 |
| | 7,155 |
|
| Adjusted interest and fees on loans (non-GAAP) | | $ | 167,502 |
| | $ | 122,893 |
| | $ | 114,992 |
|
| | | | | | | |
| Average total loans receivable, net | | $ | 3,414,424 |
| | $ | 2,703,934 |
| | $ | 2,489,730 |
|
| Loan yield, annualized (GAAP) | | 5.14 | % | | 4.78 | % | | 4.91 | % |
| Loan yield, excluding incremental accretion on purchased loans, annualized (non-GAAP) | | 4.91 | % | | 4.55 | % | | 4.62 | % |
Liquidity and Capital Resources
Our primarya short-term basis to compensate for reductions in other sources of funds are customer(such as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and local government deposits, loan principal and interest payments, loan sales, interest earned on and proceeds from sales and maturitiesmatch the maturity of investment securities. These funds, together with retained earnings, equity and other borrowed funds, are used to make loans, acquire investment securities and other assets, and fund continuing operations.repricing intervals of assets. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and loan prepayments are greatly influenced by the level of interest rates, economic conditions and competition.competition so we adhere to internal management targets assigned to the loan to deposit ratio, liquidity ratio, net short-term non-core funding ratio and non-core liabilities to total assets ratio to ensure an appropriate liquidity position.
The Company pays dividends to our shareholders and the primary source of the Company's liquidity is cash obtained from dividends from the Bank. We must maintain anexpect to continue our current practice of paying quarterly cash dividends on our common stock subject to our board of directors’ discretion to modify or terminate this practice at any time and for any reason without prior notice. Our current quarterly common stock dividend rate is $0.21 per share, as approved by our board of directors, which we believe is a dividend rate per share which enables us to balance our multiple objectives of managing and investing in the Bank and returning a substantial portion of our cash to our shareholders. Assuming continued payment during 2022 at this rate of $0.21 per share, our average total dividend paid each quarter would be approximately $7.4 million based on the number of our current outstanding shares (which assumes no increases or decreases in the number of shares).
Management believes the capital sources are adequate to meet all reasonably foreseeable short-term and intermediate-term cash requirements.
Critical Accounting Policies
Critical accounting estimates are those estimates made in accordance with generally accepted accounting principles that involve a significant level of liquidityestimation uncertainty and have had or are reasonably likely to ensurehave a material impact on the availabilityfinancial condition or results of sufficient fundsoperations of the registrant. The Company considers its critical accounting estimates to fund loan originations and deposit withdrawals, satisfy other financial commitments, and fund operations. We generally maintain sufficient cash and investments to meet short-term liquidity needs. At December 31, 2018, cash and cash equivalents totaled $161.9 million, or 3.0%, of total assets. be as follows:
ACL on Investment Securities
Investment securities available for sale totaled $976.1 million at December 31, 2018,issued by the U.S. government and its agencies are either explicitly or implicitly guaranteed by the U.S. government, highly rated by major credit rating agencies and have a long history of which $264.7 millionno credit losses and therefore management concluded any declines in fair value were pledgedattributable to secure public deposits, borrowing arrangements or repurchase agreements. Management considers unpledged investment securities available for salechanges in interest rates relative to be a viable source of liquidity.where these investments fall within the yield curve and individual characteristics. The fair valueremainder of investment securities available for sale were issued by municipal or corporate issuers. Management examined the combination of credit ratings, at the individual security level, and an analysis of historical defaults by credit rating for municipal and corporate securities since 1970 and determined the probability and magnitude of loss was insignificant.
Management's reliance on credit ratings and an analysis of historical defaults is subjective and these historical inputs may not be suitable predictors of future performance. Unanticipated changes in the credit ratings or the historical defaults could have a significant impact on our financial condition and results of operations.
For additional information regarding the ACL on investment securities, see Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements and Note (2) Investment Securities of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
ACL on Loans
Management's estimate of the ACL on loans relies on the identification, stratification and separate estimates of loss for loans individually evaluated for loss and loans collectively evaluated for loss. The estimate of loss for loans collectively evaluated for loss particularly involves a significant level of estimation uncertainty due to its complexity and quantity of inputs including: management's determination of baseline loss rate multipliers based on a third-party forecast of economic conditions, an estimate of the reasonable and supportable forecast period, an estimate of the baseline loss rate lookback period, an estimate of the reversion period from the reasonable and supportable forecast period to the baseline loss rate, and an estimate of the prepayment rate and related lookback period. Additionally, management considers other qualitative risk factors to further adjust the estimated ACL on loans through a qualitative allowance.
Management's estimates for these inputs are based on past events and current conditions, are inherently subjective, and are susceptible to significant revision as more information becomes available. While management utilizes its best judgment and information available to recognize credit losses on loans, future additions to the allowance may be necessary based on declines in local and national economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s ACL on loans. Such agencies may require the Bank to make adjustments to the allowance based on their judgments about information available to them at the time of their examinations. Unanticipated changes in any of these inputs could have a significant impact on our financial condition and results of operations.
For additional information regarding the ACL on loans, its relation to the provision for credit losses, its risk related to asset quality and lending activity, see Item 1A. Risk Factors—Our ACL on loans may prove to be insufficient to absorb losses in our loan portfolio as well as Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements and Note (4) Allowance for Credit Losses on Loans of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
ACL on Unfunded Commitments
The allowance methodology for unfunded commitments is similar to the ACL on loans, but additionally includes considerations of the current utilization of the commitment, an estimate of the future utilization, an estimate of utilization of construction loans prior to completion and an estimate of construction loan advance rates as determined appropriate by historical commitment utilization and the Bank's estimates of future utilization given current economic forecasts. Unanticipated changes in loss rates estimated in the ACL on loans, as utilized in the methodology for the ACL on unfunded commitments, or the expected utilization of unfunded commitments could have a significant impact on our financial condition and results of operations.
For additional information regarding the ACL on unfunded commitments, see Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements and Note (20) Commitments and Contingencies of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
Goodwill
The Company performed its annual goodwill impairment test during the fourth quarter of 2021 and determined, based on a qualitative assessment utilizing the Company's market capitalization, that wereit is more likely than not pledged to secure public deposits, borrowing arrangements or repurchase agreements totaled $711.4 million, or 13.4%, of total assets at December 31, 2018. Thethat the fair value of investment securities availablethe reporting unit exceeded the carrying value, such that the Company's goodwill was not considered impaired for sale with maturities of onethe year or less amounted to $38.5 million, or 0.72%, of total assets. Atended December 31, 2018,2021. Changes in the Bank maintained credit facilitieseconomic environment, operations of the reporting unit or other adverse events, including as a result of COVID-19, could result in future impairment charges which could have a material adverse impact on the Company’s operating results.
For additional information regarding goodwill, see Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements and Note (7) Goodwill and Other Intangible Assets of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
Reconciliations of Non-GAAP Measures
This Form 10-K contains certain financial measures not presented in accordance with GAAP in addition to financial measures presented in accordance with GAAP. The Company has presented these non-GAAP financial measures in this Form 10-K because it believes that they provide useful and comparative information to assess trends in the Company’s performance and asset quality and to facilitate comparison of its performance with the FHLBperformance of Des Moinesits peers. These non-GAAP measures have inherent limitations, are not required to be uniformly applied and are not audited. They should not be considered in isolation or as a substitute for $921.7 million,financial measures presented in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Reconciliations of which there were nothe GAAP and non-GAAP financial measures are presented in the tables below.
The Company believes presenting loan yield excluding the effect of borrowings outstandingdiscount accretion on purchased loans is useful in assessing the impact of acquisition accounting on loan yield as the effect of December 31, 2018,loan discount accretion is expected to decrease as the acquired loans mature or roll off its balance sheet. Incremental accretion on purchased loans represents the amount of interest income recorded on purchased loans in excess of the contractual stated interest rate in the individual loan notes due to incremental accretion of purchased discount or premium. Purchased discount or premium is the difference between the contractual loan balance and credit facilities with the Federal Reserve Bankfair value of San Francisco for $37.4 million,acquired loans at the acquisition date, or as modified by the adoption of which there were no borrowings outstanding asASU 2016-13. The purchased discount is accreted into income over the remaining life of December 31, 2018.the loan. The Bank also maintains advance lines with Wells Fargo Bank, US Bank, The Independent Bankers Bank and Pacific Coast Bankers’ Bank to purchase federal funds totaling $90.0 million asimpact of December 31, 2018. As of December 31, 2018, there were no overnight federal funds purchased.
Our strategy has been to acquire core deposits (which we define to include all deposits except public funds, brokered certificate of deposit accounts and other wholesale deposits) from our retail accounts, acquire noninterest bearing demand deposits from our commercial customers and use our available borrowing capacity to fund growth in assets. We anticipate that weincremental accretion on loan yield will continue to relychange during any period based on the same sourcesvolume of fundsprepayments, but it is expected to decrease over time as the balance of the purchased loans decreases. Similarly, presenting loan yield excluding the effect of SBA PPP loans is useful in assessing the future and use those funds primarilyimpact of these special program loans that are anticipated to make loans and purchase investment securities.substantially decrease within a short time frame.
| | | | | | | | | | | | | |
| Year Ended December 31, |
| | 2021 | | 2020 | | |
| (Dollars in thousands) | | |
| Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans: | | |
| Interest and fees on loans (GAAP) | $ | 189,832 | | | $ | 192,417 | | | |
| Exclude SBA PPP loan interest and fees | (32,109) | | | (19,472) | | | |
| Exclude incremental accretion on purchased loans | (2,638) | | | (3,446) | | | |
| Adjusted interest and fees on loans (non-GAAP) | $ | 155,085 | | | $ | 169,499 | | | |
| | | | | |
| Average loans receivable, net (GAAP) | $ | 4,181,464 | | | $ | 4,335,564 | | | |
| Exclude average SBA PPP loans | (549,422) | | | (589,635) | | | |
| Adjusted average loans receivable, net (non-GAAP) | $ | 3,632,042 | | | $ | 3,745,929 | | | |
| | | | | |
| Loan yield (GAAP) | 4.54 | % | | 4.44 | % | | |
| Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP) | 4.27 | % | | 4.52 | % | | |
Contractual Obligations
The following table providesCompany considers presenting the amountsratio of ACL on loans to loans receivable, excluding SBA PPP loans, to be a useful measurement in evaluating the adequacy of the Company's ACL on loans as the balance of SBA PPP loans is significant to the loan portfolio, and since SBA PPP loans are guaranteed by the SBA, the Company has not provided an ACL on loans for SBA PPP loans.
| | | | | | | | | | | | | |
| December 31,
2021 | | December 31, 2020 | | |
| (Dollars in thousands) | | |
| ACL on loans to loans receivable, excluding SBA PPP loans |
| Allowance for credit losses on loans | $ | 42,361 | | | $ | 70,185 | | | |
| | | | | |
| Loans receivable (GAAP) | $ | 3,815,662 | | | $ | 4,468,647 | | | |
| Exclude SBA PPP loans | 145,840 | | | 715,121 | | | |
| Loans receivable, excluding SBA PPP (non-GAAP) | $ | 3,669,822 | | | $ | 3,753,526 | | | |
| | | | | |
| ACL on loans to loans receivable (GAAP) | 1.11 | % | | 1.57 | % | | |
| ACL on loans to loans receivable, excluding SBA PPP loans (non-GAAP) | 1.15 | % | | 1.87 | % | | |
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss due under specified contractual obligations forto changes in market values of assets and liabilities. We incur market risk in the periods indicated asnormal course of December 31, 2018:
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2018 |
| | | One Year or Less | | One to Three Years | | Over Three to Five Years | | Over Five Years | | Other (1) | | Total |
| | | (In thousands) |
| Contractual payments by period: | | | | | | | | | | | | |
| Deposits | | $ | 313,830 |
| | $ | 108,283 |
| | $ | 44,761 |
| | $ | 18 |
| | $ | 3,965,510 |
| | $ | 4,432,402 |
|
| Junior subordinated debentures | | — |
| | — |
| | — |
| | 25,000 |
| | — |
| | 25,000 |
|
| Operating leases | | 4,766 |
| | 6,728 |
| | 3,272 |
| | 1,788 |
| | — |
| | 16,554 |
|
| Total contractual obligations | | $ | 318,596 |
| | $ | 115,011 |
| | $ | 48,033 |
| | $ | 26,806 |
| | $ | 3,965,510 |
| | $ | 4,473,956 |
|
| |
(1)
| Represents interest bearing and noninterest bearing checking, money market and checking accounts which can generally be withdrawn on demand and thereby have an undefined maturity. |
Asset/Liability Management
Our primary financial objective is to achieve long-term profitability while controllingbusiness through our exposure to fluctuationsmarket interest rates, equity prices and credit spreads. Our primary market risk is interest rate risk, which is the risk of loss of net interest income or net interest margin resulting from changes in market interest rates. To accomplish this objective, we have formulated anInterest rate risk results primarily from the traditional banking activities in which the Bank engages, such as gathering deposits and extending loans. Many factors, including economic and financial conditions, movements in interest rates and consumer preferences, affect the difference between the interest earned on our assets and the interest paid on our liabilities. Management regularly reviews our exposure to changes in interest rates. Among the factors considered are changes in the mix of interest earning assets and interest bearing liabilities, interest rate spreads and repricing periods. The risk committee of the board of directors oversees market risk management, including the monitoring of risk measures and limits and policy guidelines, for the amount of interest rate risk management policyand its effect on net interest income and capital.
On July 27, 2017, the United Kingdom's Financial Conduct Authority, which regulates LIBOR, publicly announced that attemptsit intends to managestop persuading or compelling banks to submit LIBOR rates after 2021. The market transition away from LIBOR to an alternative reference rates is complex and could have a range of adverse effects on our business, consolidated financial condition and consolidated results of operations. For more information, see Item 1A. Risk Factors--Other Risks Related to Our Business.
Neither we, nor the mismatch between asset and liability maturities while maintaining an acceptable interest rate sensitivity position. The principal strategies whichBank, maintain a trading account for any class of financial instrument, nor do we, employor the Bank, engage in hedging activities or purchase high risk derivative instruments. Moreover, neither we, nor the Bank, are subject to control our interest rate sensitivity are: originating certain commercial business loans and real estate construction and land development loans at variable interest rates repricing for terms generally one year or less; and offering noninterest bearing demand deposit accounts to businesses and individuals. The longer-term objective is to increase the proportion of noninterest bearing demand deposits, low-rate interest bearing demand deposits, money market accounts, and savings deposits relative to certificate of deposit accounts to reduce our overall cost of funds.
A number of measures are used to monitor and manage interestforeign currency exchange rate risk includingor commodity price risk.
Net interest income simulations, interest sensitivity (gap) analysis and economic value of equity sensitivity. simulation
An income simulation model is the primary tool usedwe use to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Modeling the sensitivity of net interest income is highly dependent on numerous assumptions incorporated into the modeling process. Key assumptions in the model include prepayment speeds on loans and investment securities, decay rates on non-maturity deposits, and pricing on investment securities, loans, deposits and borrowings. In order to measure the interest rate risk sensitivity as of December 31, 2018,2021, this simulation model uses a “no balance sheet growth” assumption and assumes an instantaneous and sustained uniform change in market interest rates at all maturities. These assumptions are inherently uncertain and, as a result, the net interest income projections should be viewed as an estimate of the net interest income sensitivity at the time of the analysis. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.
Based on the results of the simulation model, as of December 31, 2018, we would expect increasesthe following table presents the change in our net interest income as a result of $8.0 million and $14.3 million in year one and year two, respectively, ifparallel rate shock scenarios for the presented periods after the dates shown:
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 | | December 31, 2020 |
| Amount | | % Change in Net Interest Income | | Amount | | % Change in Net Interest Income |
| (Dollars in thousands) |
| Modeled increase in market interest rates of 100 basis points |
| Increase in net interest income in Year 1 | $ | 21,554 | | | 11.8 | % | | $ | 15,281 | | | 7.7 | % |
| Increase in net interest income in Year 2 | 28,307 | | | 15.9 | | | 26,839 | | | 14.3 | |
| Modeled increase in market interest rates of 200 basis points |
| Increase in net interest income in Year 1 | 40,762 | | | 22.4 | | | 28,507 | | | 14.4 | |
| Increase in net interest income in Year 2 | 53,779 | | | 30.1 | | | 51,021 | | | 27.1 | |
| Modeled decrease in market interest rates of 100 basis points |
| Decrease in net interest income in Year 1 | (6,445) | | | (3.5) | | | (3,014) | | | (1.5) | |
| Decrease in net interest income in Year 2 | (18,261) | | | (10.2) | | | (7,034) | | | (3.7) | |
These scenarios are based on market interest rates increased from current ratesas of the last day of a reporting period published by 100 basis points. We would expect an increaseindependent sources that are actively traded in net interest incomethe open market. Given the overall level of $16.1 million and $28.7 million in year one and year two, respectively, ifmarket interest rates increased from current rates by 200 basis points. If interest rates decreased by 100 basis points, we would expect decreases of $8.3 million and $14.7 million in year one and year two, respectively.
Our asset and liability management strategies have resulted in a negative less than 3 month “gap” of 34.1% as ofat December 31, 2018. This “gap” measures the difference between the dollar amount of our interest earning assets and interest bearing liabilities that mature or reprice within the designated period (three months or less) as a percentage of total interest earning assets, based on certain estimates and assumptions as discussed below. We2021, we do not believe that the implementation of our operating strategies has reduced the potential effects of changes in market interest rates on
our results of operations.the "Down 200" analysis provide meaningful output and therefore have been excluded. For the "Down 100" scenario, the Bank's modeling assumption is that all deposit rates are floored to one or two basis points and new loan production is recalibrated to incorporate a chosen net interest spread over index. The negative gap forsimulations used to manage market risk are based on numerous assumptions regarding the less than three month period indicates that decreases in market interest rates may favorably affect our results over that period.
The following table provides the estimated maturity or repricing and the resulting interest rate sensitivity gapeffect of our interest earning assets and interest bearing liabilities at December 31, 2018. We used certain assumptions in presenting this data so the amounts may not be consistent with other financial information prepared in accordance with generally accepted accounting principles. The amounts in the tables also could be significantly affected by external factors, such as changes in prepayment assumptions, early withdrawal of deposits and competition.
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2018 |
| | | Estimated Maturity or Repricing Within |
| | | Three Months or Less | | Over Three Months to 12 Months | | Over One to Five Years | | Over Five to 15 Years | | Over 15 Years | | Total |
| | | (Dollars in thousands) |
| Interest Earnings Assets: | | | | | | | | | | | | |
Loans receivable (1) | | $ | 938,334 |
| | $ | 234,894 |
| | $ | 1,737,157 |
| | $ | 655,536 |
| | $ | 84,730 |
| | $ | 3,650,651 |
|
| Investment securities | | 167,513 |
| | 74,657 |
| | 220,039 |
| | 303,035 |
| | 210,851 |
| | 976,095 |
|
| Interest earning deposits | | 69,206 |
| | — |
| | — |
| | — |
| | — |
| | 69,206 |
|
| Total interest earning assets | | $ | 1,175,053 |
| | $ | 309,551 |
| | $ | 1,957,196 |
| | $ | 958,571 |
| | $ | 295,581 |
| | $ | 4,695,952 |
|
| | | | | | | | | | | | | |
| Percentage of interest earning assets | | 25.0 | % | | 6.6 | % | | 41.7 | % | | 20.4 | % | | 6.3 | % | | 100.0 | % |
| | | | | | | | | | | | | |
| Interest Bearing Liabilities: | | | | | | | | | | | | |
Total interest bearing deposits (2) | | $ | 2,722,519 |
| | $ | 193,211 |
| | $ | 154,326 |
| | $ | 78 |
| | $ | — |
| | $ | 3,070,134 |
|
| Junior subordinated debentures | | 20,302 |
| | — |
| | — |
| | — |
| | — |
| | 20,302 |
|
| Securities sold under agreement to repurchase | | 31,487 |
| | — |
| | — |
| | — |
| | — |
| | 31,487 |
|
| Total interest bearing liabilities | | $ | 2,774,308 |
| | $ | 193,211 |
| | $ | 154,326 |
| | $ | 78 |
| | $ | — |
| | $ | 3,121,923 |
|
| | | | | | | | | | | | | |
| Interest bearing liabilities, as a percentage of total interest earning assets | | 59.1 | % | | 4.1 | % | | 3.3 | % | | — | % | | — | % | | 66.5 | % |
| | | | | | | | | | | | | |
| Interest rate sensitivity gap | | $ | (1,599,255 | ) | | $ | 116,340 |
| | $ | 1,802,870 |
| | $ | 958,493 |
| | $ | 295,581 |
| | $ | 1,574,029 |
|
| Interest rate sensitivity gap, as a percentage of total interest earning assets | | (34.1 | )% | | 2.5 | % | | 38.4 | % | | 20.4 | % | | 6.3 | % | | 33.5 | % |
| Cumulative interest rate sensitivity gap | | $ | (1,599,255 | ) | | $ | (1,482,915 | ) | | $ | 319,955 |
| | $ | 1,278,448 |
| | $ | 1,574,029 |
| | |
| Cumulative interest rate sensitivity gap, as a percentage of total interest earning assets | | (34.1 | )% | | (31.6 | )% | | 6.8 | % | | 27.2 | % | | 33.5 | % | | |
| |
(1)
| Excludes net deferred loan costs and allowance for loan losses. |
| |
(2)
| Adjustable-rate liabilities are included in the period in which interest rates are next scheduled to adjust rather than in the period they are due to mature. Although regular savings, demand, NOW, and money market deposit accounts are subject to immediate withdrawal, based on historical experience management considers a substantial amount of such accounts to be core deposits having significantly longer maturities. |
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on some types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market interest rates. Additionally, some assets, such as adjustable rate mortgages, have features, which restrict changes in
the interest rates of those assets both on a short-term basis and over the lives of such assets. Further, if a change in market interest rates occurs, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability of many borrowers to service their adjustable rate debt may decrease if market interest rates increase substantially.
The table below provides information about our financial instruments that are sensitive to changes in interest rates ason the timing and extent of December 31, 2018. The table presents principalreprice characteristics, future cash flows and related weighted averagecustomer behavior. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest rates by expected maturity dates. The expected maturity isincome or precisely predict the contractual maturityimpact of higher or earlier call datelower net interest income. Actual results will differ from simulated results due to the timing, magnitude and frequency of the instrument. The datainterest rate changes as well as changes in this table may not be consistent with the amounts in the preceding table, which represents amounts by the estimated repricing date or maturity date, whichever occurs sooner.market condition, customer behavior and management strategies, among other factors.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | By Expected Maturity Date |
| | | Year Ended December 31, 2018 |
| | | Three Months or Less | | Over Three Months to 12 Months | | Over One Year to Five Years | | Over Five Years to 15 Years | | Over 15 Years | | Total | | Fair Value |
| | | (Dollars in thousands) |
| Investment Securities | | | | | | | | | | | | | | |
| Amounts maturing: | | | | | | | | | | | | | | |
| Fixed rate | | $ | 58,389 |
| | $ | 60,650 |
| | $ | 179,649 |
| | $ | 300,244 |
| | $ | 210,851 |
| | $ | 809,783 |
| | |
| Weighted average interest rate | | 3.13 | % | | 2.81 | % | | 2.79 | % | | 2.85 | % | | 2.81 | % | | 2.84 | % | | |
| Adjustable rate | | $ | 4,141 |
| | $ | 207 |
| | $ | 11,926 |
| | $ | 45,338 |
| | $ | 104,700 |
| | $ | 166,312 |
| | |
| Weighted average interest rate | | 3.65 | % | | 0.94 | % | | 3.88 | % | | 3.04 | % | | 3.21 | % | | 3.22 | % | | |
| Total | | $ | 62,530 |
| | $ | 60,857 |
| | $ | 191,575 |
| | $ | 345,582 |
| | $ | 315,551 |
| | $ | 976,095 |
| | $ | 976,095 |
|
Loans (1) | | | | | | | | | | | | | | |
| Amounts maturing: | | | | | | | | | | | | | | |
| Fixed rate | | $ | 30,154 |
| | $ | 65,986 |
| | $ | 573,664 |
| | $ | 558,100 |
| | $ | 84,730 |
| | $ | 1,312,634 |
| | |
| Weighted average interest rate | | 5.37 | % | | 5.31 | % | | 4.65 | % | | 4.44 | % | | 4.50 | % | | 4.60 | % | | |
| Adjustable rate | | $ | 184,381 |
| | $ | 310,472 |
| | $ | 224,609 |
| | $ | 1,401,867 |
| | $ | 216,688 |
| | $ | 2,338,017 |
| | |
| Weighted average interest rate | | 6.20 | % | | 6.06 | % | | 5.55 | % | | 4.71 | % | | 5.09 | % | | 5.13 | % | | |
| Total | | $ | 214,535 |
| | $ | 376,458 |
| | $ | 798,273 |
| | $ | 1,959,967 |
| | $ | 301,418 |
| | $ | 3,650,651 |
| | $ | 3,614,348 |
|
| Certificate of Deposit Accounts | | | | | | | | | | | | | | |
| Amounts maturing: | | | | | | | | | | | | | | |
| Fixed rate | | $ | 122,420 |
| | $ | 191,410 |
| | $ | 153,044 |
| | $ | 18 |
| | $ | — |
| | $ | 466,892 |
| | $ | 470,222 |
|
| Weighted average interest rate | | 0.80 | % | | 0.96 | % | | 1.52 | % | | 0.78 | % | | — | % | | 1.10 | % | | |
| Junior Subordinated Debentures | | | | | | | | | | | | | | |
| Amounts maturing: | | | | | | | | | | | | | | |
| Adjustable rate | | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 20,302 |
| | $ | 20,302 |
| | $ | 20,500 |
|
Weighted average interest rate (2) | | — | % | | — | % | | — | % | | — | % | | 6.27 | % | | 6.27 | % | | |
| |
(1)
| Excludes deferred loan costs (fees), net and allowance for loan losses. |
| |
(2)
| The contractual interest rate of the junior subordinated debentures was 4.37% at December 31, 2018. The weighted average interest rate includes the effects of the discount accretion for the Washington Banking Merger purchase accounting adjustment. |
Impact of Inflation and Changing Prices
Inflation affects our operations by increasing operating costs and indirectly by affecting the operations and cash flow of our customers. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, changes in interest rates generally have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction or the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to interest rate risk through our lending and deposit gathering activities. For a discussion of how this exposure is managed and the nature of changes in our interest rate risk profile during the past year, see Item 7. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations.
Neither we, nor the Bank, maintain a trading account for any class of financial instrument, nor do we, or the Bank, engage in hedging activities or purchase high risk derivative instruments. Moreover, neither we, nor the Bank, are subject to foreign currency exchange rate risk or commodity price risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
StockholdersShareholders and the Board of Directors of Heritage Financial Corporation
Olympia, Washington
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated statementsConsolidated Statements of financial conditionFinancial Condition of Heritage Financial Corporation and subsidiariesSubsidiaries (the "Company") as of December 31, 20182021 and 2017,2020, the related consolidated statementsConsolidated Statements of income, comprehensive income, stockholders’ equity,Income, Comprehensive Income, Stockholders’ Equity, and cash flowsCash Flows for each of the years in the three-year period ended December 31, 2018,2021, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2018,2021, based on criteria established in the 2013 Internal Control -– Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)(“COSO”).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 20182021 and 2017,2020, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 20182021 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018,2021, based on criteria established in the 2013 Internal Control -– Integrated Framework issued by COSO.
Change in Accounting Principle
As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for allowance for credit losses effective January 1, 2020 due to the adoption of Financial Accounting Standards Board Accounting Standards Codification No 326, Financial Instruments – Credit Losses (ASC 326). The Company adopted the new current expected credit loss standard using the modified retrospective method such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. As permitted, the Company has excluded the operations of Premier Community Bank and Puget Sound Bank both acquired during 2018, which is described in Note 2 of the consolidated financial statements, from the scope of management’s report on internal control over financial reporting. As such, it has also been excluded from the scope of our audit of internal control over financial reporting. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Credit Losses on Loans – Qualitative Allowance
As described in Note 1, “Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements” and Note 4, “Allowance for Credit Losses (“ACL”) on Loans” to the consolidated financial statements, the Company’s consolidated allowance for credit losses on loans was $42.4 million at December 31, 2021 and reversal of provision for credit losses on loans was $27.3 million for the year then ended. The ACL on loans evaluation is inherently subjective, as it utilizes estimates that require a high degree of judgment relating to risk characteristics of loan segments, macroeconomic variables used in forecasting, and other qualitative risk factors. Changes in these judgments and estimates could have a material effect on the Company’s financial results.
The Company primarily uses a historic loss, open pool credit loss methodology to calculate the ACL on loans, which the Company has applied to identified loan segments with similar risk characteristics. The allowance for collectively evaluated loans is comprised of the baseline loss allowance, the macroeconomic allowance, and the qualitative allowance. The baseline loss allowance begins with the baseline loss rates calculated using average quarterly historical loss information for an economic cycle. The baseline loss rates are applied to each loan's estimated cash flows over the life of the loan under the remaining life method to determine the baseline loss estimate for each loan. The macroeconomic methodology incorporates a macroeconomic sensitive model which calculates multipliers for each loan segment to account for the current and forecasted conditions that adjust the baseline historical loss rates over a reasonable and supportable forecast period. Management also considers other qualitative risk factors to further adjust the estimated ACL on loans through a qualitative allowance. These adjustments are subjectively selected by management and are based on established metrics to estimate risk.
The subjective nature of the qualitative risk factor adjustments requires significant judgment by management both in the selection of qualitative factors to apply, if any, and the magnitude of the adjustment once selected. The audit procedures over the qualitative allowance utilized in management’s methodology involved especially challenging and subjective auditor judgment, including the use of more experienced audit personnel. Therefore, we identified auditing the ACL qualitative allowance as a critical audit matter.
Our audit procedures to address this critical audit matter primarily included the following:
•Tested the operating effectiveness of controls over application of the macroeconomic sensitive model and related factors including:
◦The Company’s ACL committee’s review and approval of the qualitative risk factor adjustments used to derive the qualitative allowance for the ACL on loans, and the relevance and reliability of the data used therein.
◦Management’s controls over the completeness and accuracy of the data utilized in the qualitative allowance for the ACL on loans.
•Substantively tested management’s application of the macroeconomic sensitive model and related factors including:
◦Evaluated the reasonableness of management’s judgments used in the determination of the qualitative risk factor adjustments by loan segment and the resulting allocation to the qualitative allowance for the ACL on loans.
◦Evaluated the reliability and relevancy of data used as a basis for the qualitative risk factor adjustments.
◦Tested the completeness and accuracy of the data utilized in management’s ACL methodology to derive the qualitative allowance for the ACL on loans.
/s/ Crowe LLP
We have served as the Company's auditor since 2012.
Sacramento, CaliforniaDenver, Colorado
March 1, 2019
February 24, 2022
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except shares)
| | | | | | | | | | | |
| December 31, 2021 | | December 31, 2020 |
| ASSETS | | | |
| Cash on hand and in banks | $ | 61,377 | | | $ | 91,918 | |
| Interest earning deposits | 1,661,915 | | | 651,404 | |
| Cash and cash equivalents | 1,723,292 | | | 743,322 | |
| Investment securities available for sale, at fair value, net (amortized cost of $883,832 and $770,195, respectively) | 894,335 | | | 802,163 | |
| Investment securities held to maturity, at amortized cost, net (fair value of $376,331 and $0, respectively) | 383,393 | | | — | |
| Total investment securities | 1,277,728 | | | 802,163 | |
| Loans held for sale | 1,476 | | | 4,932 | |
| Loans receivable | 3,815,662 | | | 4,468,647 | |
| Allowance for credit losses on loans | (42,361) | | | (70,185) | |
| Loans receivable, net | 3,773,301 | | | 4,398,462 | |
| Other real estate owned | — | | | — | |
| Premises and equipment, net | 79,370 | | | 85,452 | |
| Federal Home Loan Bank stock, at cost | 7,933 | | | 6,661 | |
| Bank owned life insurance | 120,196 | | | 107,580 | |
| Accrued interest receivable | 14,657 | | | 19,418 | |
| Prepaid expenses and other assets | 183,543 | | | 193,301 | |
| Other intangible assets, net | 9,977 | | | 13,088 | |
| Goodwill | 240,939 | | | 240,939 | |
| Total assets | $ | 7,432,412 | | | $ | 6,615,318 | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | |
| Deposits | $ | 6,381,337 | | | $ | 5,597,990 | |
| | | |
| Junior subordinated debentures | 21,180 | | | 20,887 | |
| Securities sold under agreement to repurchase | 50,839 | | | 35,683 | |
| Accrued expenses and other liabilities | 124,624 | | | 140,319 | |
| Total liabilities | 6,577,980 | | | 5,794,879 | |
| Stockholders’ equity: | | | |
| Preferred stock, no par value, 2,500,000 shares authorized; no shares issued and outstanding, respectively | — | | | — | |
| Common stock, no par value, 50,000,000 shares authorized; 35,105,779 and 35,912,243 shares issued and outstanding, respectively | 551,798 | | | 571,021 | |
| Retained earnings | 293,238 | | | 224,400 | |
| Accumulated other comprehensive income, net | 9,396 | | | 25,018 | |
| Total stockholders’ equity | 854,432 | | | 820,439 | |
| Total liabilities and stockholders’ equity | $ | 7,432,412 | | | $ | 6,615,318 | |
|
| | | | | | | |
| | December 31, 2018 | | December 31, 2017 |
| ASSETS | | | |
| Cash on hand and in banks | $ | 92,704 |
| | $ | 78,293 |
|
| Interest earning deposits | 69,206 |
| | 24,722 |
|
| Cash and cash equivalents | 161,910 |
| | 103,015 |
|
| Investment securities available for sale, at fair value | 976,095 |
| | 810,530 |
|
| Loans held for sale | 1,555 |
| | 2,288 |
|
| Loans receivable, net | 3,654,160 |
| | 2,849,071 |
|
| Allowance for loan losses | (35,042 | ) | | (32,086 | ) |
| Total loans receivable, net | 3,619,118 |
| | 2,816,985 |
|
| Other real estate owned | 1,983 |
| | — |
|
| Premises and equipment, net | 81,100 |
| | 60,325 |
|
| Federal Home Loan Bank stock, at cost | 6,076 |
| | 8,347 |
|
| Bank owned life insurance | 93,612 |
| | 75,091 |
|
| Accrued interest receivable | 15,403 |
| | 12,244 |
|
| Prepaid expenses and other assets | 98,522 |
| | 99,328 |
|
| Other intangible assets, net | 20,614 |
| | 6,088 |
|
| Goodwill | 240,939 |
| | 119,029 |
|
| Total assets | $ | 5,316,927 |
|
| $ | 4,113,270 |
|
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | |
| Deposits | $ | 4,432,402 |
| | $ | 3,393,060 |
|
| Federal Home Loan Bank advances | — |
| | 92,500 |
|
| Junior subordinated debentures | 20,302 |
| | 20,009 |
|
| Securities sold under agreement to repurchase | 31,487 |
| | 31,821 |
|
| Accrued expenses and other liabilities | 72,013 |
| | 67,575 |
|
| Total liabilities | 4,556,204 |
| | 3,604,965 |
|
| Stockholders’ equity: | | | |
| Preferred stock, no par value, 2,500,000 shares authorized; no shares issued and outstanding at December 31, 2018 and 2017 | — |
| | — |
|
| Common stock, no par value, 50,000,000 shares authorized; 36,874,055 and 29,927,746 shares issued and outstanding at December 31, 2018 and 2017, respectively | 591,806 |
| | 360,590 |
|
| Retained earnings | 176,372 |
| | 149,013 |
|
| Accumulated other comprehensive loss, net | (7,455 | ) | | (1,298 | ) |
| Total stockholders’ equity | 760,723 |
| | 508,305 |
|
| Total liabilities and stockholders’ equity | $ | 5,316,927 |
| | $ | 4,113,270 |
|
See accompanying Notes to Consolidated Financial Statements.
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)amounts and shares outstanding)
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 | | 2019 |
| INTEREST INCOME: | | | | | |
| Interest and fees on loans | $ | 189,832 | | | $ | 192,417 | | | $ | 189,515 | |
| Taxable interest on investment securities | 17,492 | | | 17,541 | | | 23,045 | |
| Nontaxable interest on investment securities | 3,899 | | | 3,659 | | | 3,396 | |
| Interest on interest earning deposits | 1,608 | | | 703 | | | 1,894 | |
| Total interest income | 212,831 | | | 214,320 | | | 217,850 | |
| INTEREST EXPENSE: | | | | | |
| Deposits | 6,160 | | | 12,265 | | | 16,349 | |
| Junior subordinated debentures | 742 | | | 890 | | | 1,339 | |
| Other borrowings | 140 | | | 168 | | | 480 | |
| Total interest expense | 7,042 | | | 13,323 | | | 18,168 | |
| Net interest income | 205,789 | | | 200,997 | | | 199,682 | |
| (Reversal of) provision for credit losses | (29,372) | | | 36,106 | | | 4,311 | |
| Net interest income after (reversal of) provision for credit losses | 235,161 | | | 164,891 | | | 195,371 | |
| NONINTEREST INCOME: | | | | | |
| Service charges and other fees | 17,597 | | | 16,228 | | | 18,712 | |
| Gain on sale of investment securities, net | 29 | | | 1,518 | | | 330 | |
| Gain on sale of loans, net | 3,644 | | | 5,044 | | | 2,424 | |
| Interest rate swap fees | 661 | | | 1,691 | | | 1,232 | |
| Bank owned life insurance income | 2,520 | | | 4,319 | | | 2,160 | |
| Gain on sale of other assets, net | 4,405 | | | 955 | | | 246 | |
| Other income | 5,759 | | | 7,474 | | | 7,358 | |
| Total noninterest income | 34,615 | | | 37,229 | | | 32,462 | |
| NONINTEREST EXPENSE: | | | | | |
| Compensation and employee benefits | 89,880 | | | 88,106 | | | 87,568 | |
| Occupancy and equipment | 17,243 | | | 17,611 | | | 17,644 | |
| Data processing | 16,533 | | | 14,449 | | | 13,022 | |
| Marketing | 3,039 | | | 3,100 | | | 3,481 | |
| Professional services | 4,065 | | | 5,921 | | | 5,192 | |
| State/municipal business and use taxes | 3,884 | | | 3,754 | | | 3,754 | |
| Federal deposit insurance premium | 2,106 | | | 1,789 | | | 725 | |
| Other real estate owned, net | — | | | (145) | | | 352 | |
| Amortization of intangible assets | 3,111 | | | 3,525 | | | 4,001 | |
| Other expense | 9,408 | | | 10,830 | | | 11,049 | |
| Total noninterest expense | 149,269 | | | 148,940 | | | 146,788 | |
| Income before income taxes | 120,507 | | | 53,180 | | | 81,045 | |
| Income tax expense | 22,472 | | | 6,610 | | | 13,488 | |
| Net income | $ | 98,035 | | | $ | 46,570 | | | $ | 67,557 | |
| Basic earnings per share | $ | 2.75 | | | $ | 1.29 | | | $ | 1.84 | |
| Diluted earnings per share | $ | 2.73 | | | $ | 1.29 | | | $ | 1.83 | |
| Dividends declared per share | $ | 0.81 | | | $ | 0.80 | | | $ | 0.84 | |
| Average number of basic shares outstanding | 35,677,851 | | | 36,014,445 | | | 36,758,230 | |
| Average number of diluted shares outstanding | 35,973,386 | | | 36,170,066 | | | 36,985,766 | |
|
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| INTEREST INCOME: | | | | | |
| Interest and fees on loans | $ | 175,466 |
| | $ | 129,213 |
| | $ | 122,147 |
|
| Taxable interest on investment securities | 17,602 |
| | 12,688 |
| | 11,215 |
|
| Nontaxable interest on investment securities | 4,649 |
| | 5,269 |
| | 4,870 |
|
| Interest on other interest earning assets | 1,642 |
| | 539 |
| | 280 |
|
| Total interest income | 199,359 |
|
| 147,709 |
| | 138,512 |
|
| INTEREST EXPENSE: | | | | | |
| Deposits | 10,397 |
| | 6,049 |
| | 5,010 |
|
| Junior subordinated debentures | 1,263 |
| | 1,014 |
| | 880 |
|
| Other borrowings | 753 |
| | 1,283 |
| | 116 |
|
| Total interest expense | 12,413 |
|
| 8,346 |
| | 6,006 |
|
| Net interest income | 186,946 |
| | 139,363 |
| | 132,506 |
|
| Provision for loan losses | 5,129 |
| | 4,220 |
| | 4,931 |
|
| Net interest income after provision for loan losses | 181,817 |
|
| 135,143 |
| | 127,575 |
|
| NONINTEREST INCOME: | | | | | |
| Service charges and other fees | 18,914 |
| | 18,004 |
| | 14,354 |
|
| Gain on sale of investment securities, net | 137 |
| | 6 |
| | 1,315 |
|
| Gain on sale of loans, net | 2,759 |
| | 7,696 |
| | 6,994 |
|
| Interest rate swap fees | 564 |
| | 1,045 |
| | 1,854 |
|
| Other income | 9,291 |
| | 8,828 |
| | 7,102 |
|
| Total noninterest income | 31,665 |
|
| 35,579 |
| | 31,619 |
|
| NONINTEREST EXPENSE: | | | | | |
| Compensation and employee benefits | 86,830 |
| | 64,268 |
| | 61,405 |
|
| Occupancy and equipment | 19,779 |
| | 15,396 |
| | 15,763 |
|
| Data processing | 9,888 |
| | 8,176 |
| | 7,312 |
|
| Marketing | 3,228 |
| | 2,943 |
| | 2,835 |
|
| Professional services | 9,670 |
| | 4,777 |
| | 3,606 |
|
| State and local taxes | 3,210 |
| | 2,461 |
| | 2,616 |
|
| Federal deposit insurance premium | 1,480 |
| | 1,435 |
| | 1,620 |
|
| Other real estate owned, net | 106 |
| | (70 | ) | | 334 |
|
| Amortization of intangible assets | 3,819 |
| | 1,286 |
| | 1,415 |
|
| Other expense | 11,385 |
| | 9,903 |
| | 9,567 |
|
| Total noninterest expense | 149,395 |
|
| 110,575 |
| | 106,473 |
|
| Income before income taxes | 64,087 |
| | 60,147 |
| | 52,721 |
|
| Income tax expense | 11,030 |
| | 18,356 |
| | 13,803 |
|
| Net income | $ | 53,057 |
|
| $ | 41,791 |
|
| $ | 38,918 |
|
| Basic earnings per common share | $ | 1.49 |
| | $ | 1.39 |
| | $ | 1.30 |
|
| Diluted earnings per common share | $ | 1.49 |
| | $ | 1.39 |
| | $ | 1.30 |
|
| Dividends declared per common share | $ | 0.72 |
| | $ | 0.61 |
| | $ | 0.72 |
|
See accompanying Notes to Consolidated Financial Statements.
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 | | 2019 |
| Net income | $ | 98,035 | | | $ | 46,570 | | | $ | 67,557 | |
| Change in fair value of investment securities available for sale, net of tax of $(4,298), $4,506 and $4,834, respectively | (15,472) | | | 15,828 | | | 18,094 | |
| Reclassification adjustment for net gain from sale of investment securities available for sale included in income, net of tax of $(6), $(330) and $(69), respectively | (23) | | | (1,188) | | | (261) | |
| Amortization of net unrealized gain for the reclassification of investment securities available for sale to held to maturity, net of tax of $(35), $0 and $0, respectively | (127) | | | — | | | — | |
| Other comprehensive (loss) income | (15,622) | | | 14,640 | | | 17,833 | |
| Comprehensive income | $ | 82,413 | | | $ | 61,210 | | | $ | 85,390 | |
|
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| Net income | $ | 53,057 |
| | $ | 41,791 |
| | $ | 38,918 |
|
| Change in fair value of investment securities available for sale, net of tax of $(1,591), $826 and $(2,316), respectively | (5,956 | ) | | 1,530 |
| | (4,311 | ) |
| Reclassification adjustment for net gain from sale of investment securities available for sale included in income, net of tax of $(29), $(2) and $(461), respectively | (108 | ) | | (4 | ) | | (854 | ) |
| Other comprehensive (loss) income | (6,064 | ) | | 1,526 |
| | (5,165 | ) |
| Comprehensive income | $ | 46,993 |
| | $ | 43,317 |
| | $ | 33,753 |
|
See accompanying Notes to Consolidated Financial Statements.
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except shares and per share amounts)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2021 |
| Number of
common
shares | | Common
stock | | Retained
earnings | | AOCI | | Total
stockholders’
equity |
| Balance at December 31, 2020 | 35,912,243 | | | $ | 571,021 | | | $ | 224,400 | | | $ | 25,018 | | | $ | 820,439 | |
| | | | | | | | | |
| Restricted stock units vested | 125,377 | | | — | | | — | | | — | | | — | |
| | | | | | | | | |
| Stock-based compensation expense | — | | | 3,666 | | | — | | | — | | | 3,666 | |
| Common stock repurchased | (931,841) | | | (22,889) | | | — | | | — | | | (22,889) | |
| Net income | — | | | — | | | 98,035 | | | — | | | 98,035 | |
| Other comprehensive loss, net of tax | — | | | — | | | — | | | (15,622) | | | (15,622) | |
| | | | | | | | | |
| Cash dividends declared on common stock ($0.81 per share) | — | | | — | | | (29,197) | | | — | | | (29,197) | |
| Balance at December 31, 2021 | 35,105,779 | | | $ | 551,798 | | | $ | 293,238 | | | $ | 9,396 | | | $ | 854,432 | |
|
| | | | | | | | | | | | | | | | | | |
| | Number of common shares | | Common stock | | Retained earnings | | Accumulated other comprehensive income (loss), net | | Total stock- holders’ equity |
| Balance at December 31, 2015 | 29,975 |
| | $ | 359,451 |
| | $ | 107,960 |
| | $ | 2,559 |
| | $ | 469,970 |
|
| Restricted stock awards granted, net of forfeitures | 110 |
| | — |
| | — |
| | — |
| | — |
|
| Exercise of stock options (including excess tax benefits from nonqualified stock options) | 38 |
| | 560 |
| | — |
| | — |
| | 560 |
|
| Stock-based compensation expense | — |
| | 1,840 |
| | — |
| | — |
| | 1,840 |
|
| Net excess tax benefits from vesting of restricted stock | — |
| | 103 |
| | — |
| | — |
| | 103 |
|
| Common stock repurchased | (168 | ) | | (2,894 | ) | | — |
| | — |
| | (2,894 | ) |
| Net income | — |
| | — |
| | 38,918 |
| | — |
| | 38,918 |
|
| Other comprehensive loss, net of tax | — |
| | — |
| | — |
| | (5,165 | ) | | (5,165 | ) |
| Cash dividends declared on common stock ($0.72 per share) | — |
| | — |
| | (21,569 | ) | | — |
| | (21,569 | ) |
| Balance at December 31, 2016 | 29,955 |
| | 359,060 |
| | 125,309 |
| | (2,606 | ) | | 481,763 |
|
| Restricted stock awards forfeited | (10 | ) | | — |
| | — |
| | — |
| | — |
|
| Exercise of stock options | 13 |
| | 164 |
| | — |
| | — |
| | 164 |
|
| Stock-based compensation expense | — |
| | 2,103 |
| | — |
| | — |
| | 2,103 |
|
| Common stock repurchased | (30 | ) | | (737 | ) | | — |
| | — |
| | (737 | ) |
| Net income | — |
| | — |
| | 41,791 |
| | — |
| | 41,791 |
|
| Other comprehensive income, net of tax | — |
| | — |
| | — |
| | 1,526 |
| | 1,526 |
|
| Cash dividends declared on common stock ($0.61 per share) | — |
| | — |
| | (18,305 | ) | | — |
| | (18,305 | ) |
| ASU 2018-02 Implementation | — |
| | — |
| | 218 |
| | (218 | ) | | — |
|
| Balance at December 31, 2017 | 29,928 |
| | 360,590 |
| | 149,013 |
| | (1,298 | ) | | 508,305 |
|
| Restricted stock units vested, net of restricted stock awards forfeited | 29 |
| | — |
| | — |
| | — |
| | — |
|
| Exercise of stock options | 10 |
| | 133 |
| | — |
| | — |
| | 133 |
|
| Stock-based compensation expense | — |
| | 2,744 |
| | — |
| | — |
| | 2,744 |
|
| Common stock repurchased | (53 | ) | | (1,704 | ) | | — |
| | — |
| | (1,704 | ) |
| Net income | — |
| | — |
| | 53,057 |
| | — |
| | 53,057 |
|
| Other comprehensive loss, net of tax | — |
| | — |
| | — |
| | (6,064 | ) | | (6,064 | ) |
| Common stock issued in business combinations | 6,960 |
| | 230,043 |
| | — |
| | — |
| | 230,043 |
|
| Cash dividends declared on common stock ($0.72 per share) | — |
| | — |
| | (25,791 | ) | | — |
| | (25,791 | ) |
| ASU 2016-01 Implementation | — |
| | — |
| | 93 |
| | (93 | ) | | — |
|
| Balance at December 31, 2018 | 36,874 |
|
| $ | 591,806 |
|
| $ | 176,372 |
|
| $ | (7,455 | ) |
| $ | 760,723 |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2020 |
| Number of
common
shares | | Common
stock | | Retained
earnings | | AOCI | | Total
stockholders’
equity |
| Balance at December 31, 2019 | 36,618,729 | | | $ | 586,459 | | | $ | 212,474 | | | $ | 10,378 | | | $ | 809,311 | |
Cumulative effect from change in accounting policy (1) | — | | | — | | | (5,615) | | | — | | | (5,615) | |
| Restricted stock units vested | 109,853 | | | — | | | — | | | — | | | — | |
| Exercise of stock options | 8,248 | | | 122 | | | — | | | — | | | 122 | |
| Stock-based compensation expense | — | | | 3,559 | | | — | | | — | | | 3,559 | |
| Common stock repurchased | (824,587) | | | (19,119) | | | — | | | — | | | (19,119) | |
| Net income | — | | | — | | | 46,570 | | | — | | | 46,570 | |
| Other comprehensive income, net of tax | — | | | — | | | — | | | 14,640 | | | 14,640 | |
| | | | | | | | | |
| Cash dividends declared on common stock ($0.80 per share) | — | | | — | | | (29,029) | | | — | | | (29,029) | |
| Balance at December 31, 2020 | 35,912,243 | | | $ | 571,021 | | | $ | 224,400 | | | $ | 25,018 | | | $ | 820,439 | |
(1) Effective January 1, 2020, the Bank adopted ASU 2016-13, Financial Instruments - Credit Losses.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2019 |
| Number of
common
shares | | Common
stock | | Retained
earnings | | AOCI | | Total
stockholders’
equity |
| Balance at December 31, 2018 | 36,874,055 | | | $ | 591,806 | | | $ | 176,372 | | | $ | (7,455) | | | $ | 760,723 | |
Cumulative effect from change in accounting policy (1) | — | | | — | | | (399) | | | — | | | (399) | |
| Restricted stock units vested, net of forfeitures of restricted stock awards | 61,964 | | | — | | | — | | | — | | | — | |
| Exercise of stock options | 3,901 | | | 58 | | | — | | | — | | | 58 | |
| Stock-based compensation expense | — | | | 3,231 | | | — | | | — | | | 3,231 | |
| Common stock repurchased | (321,191) | | | (8,636) | | | — | | | — | | | (8,636) | |
| Net income | — | | | — | | | 67,557 | | | — | | | 67,557 | |
| Other comprehensive loss, net of tax | — | | | — | | | — | | | 17,833 | | | 17,833 | |
| | | | | | | | | |
| Cash dividends declared on common stock ($0.84 per share) | — | | | — | | | (31,056) | | | — | | | (31,056) | |
| Balance at December 31, 2019 | 36,618,729 | | | $ | 586,459 | | | $ | 212,474 | | | $ | 10,378 | | | $ | 809,311 | |
(1) Effective January 1, 2019, the Bank adopted ASU 2016-02, Leases.
See accompanying Notes to Consolidated Financial Statements.
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 | | 2019 |
| Cash flows from operating activities: | | | | | |
| Net income | $ | 98,035 | | | $ | 46,570 | | | $ | 67,557 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
| Depreciation, amortization and accretion | (21,739) | | | (3,612) | | | 14,113 | |
| (Reversal of) provision for credit losses | (29,372) | | | 36,106 | | | 4,311 | |
| Stock-based compensation expense | 3,666 | | | 3,559 | | | 3,231 | |
| Amortization of intangible assets | 3,111 | | | 3,525 | | | 4,001 | |
| Origination of mortgage loans held for sale | (86,443) | | | (136,979) | | | (72,216) | |
| Proceeds from sale of mortgage loans held for sale | 93,543 | | | 142,624 | | | 70,397 | |
| Bank owned life insurance income | (2,520) | | | (4,319) | | | (2,160) | |
| (Gain) loss on sale of other real estate owned | — | | | (179) | | | 227 | |
| Gain on sale of mortgage loans held for sale, net | (3,644) | | | (5,044) | | | (2,424) | |
| Gain on sale of investment securities available for sale, net | (29) | | | (1,518) | | | (330) | |
| Gain on sale of other assets, net | (4,405) | | | (955) | | | (246) | |
| Impairment of assets held for sale | 145 | | | 630 | | | 102 | |
| Impairment of ROU asset | 160 | | | 655 | | | 117 | |
| Other | 19,022 | | | (10,732) | | | 5,810 | |
| Net cash provided by operating activities | 69,530 | | | 70,331 | | | 92,490 | |
| Cash flows from investing activities: | | | | | |
| Loan repayments (originations), net | 699,107 | | | (692,720) | | | (126,142) | |
| Maturities and repayments of investment securities available for sale | 254,668 | | | 264,223 | | | 242,348 | |
| Maturities and repayments of investment securities held to maturity | 1,255 | | | — | | | — | |
| Purchase of investment securities available for sale | (616,123) | | | (152,618) | | | (242,776) | |
| Purchase of investment securities held to maturity | (140,288) | | | — | | | — | |
| Proceeds from sales of investment securities available for sale | 1,248 | | | 55,030 | | | 43,962 | |
| Purchase of premises and equipment | (3,018) | | | (6,997) | | | (13,041) | |
| Proceeds from sales of other loans | — | | | — | | | 3,562 | |
| Proceeds from sales of other real estate owned | — | | | 1,290 | | | 864 | |
| Proceeds from sales of assets held for sale | 10,556 | | | 2,407 | | | 1,664 | |
| Proceeds from redemption of Federal Home Loan Bank stock | — | | | 2,560 | | | 18,032 | |
| Purchases of Federal Home Loan Bank stock | (1,272) | | | (2,844) | | | (18,333) | |
| Proceeds from sales of premises and equipment | 65 | | | 554 | | | 96 | |
| Purchases of bank owned life insurance | (10,166) | | | (3,641) | | | (8,053) | |
| Proceeds from bank owned life insurance death benefit | — | | | 1,324 | | | — | |
| Cash received from return of New Market Tax Credit equity method investment | 9,642 | | | — | | | — | |
| Capital contributions to low-income housing tax credit partnerships | (41,911) | | | (7,117) | | | (27,485) | |
| | | | | |
| Net cash provided (used) by investing activities | 163,763 | | | (538,549) | | | (125,302) | |
|
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| Cash flows from operating activities: | | | | | |
| Net income | $ | 53,057 |
| | $ | 41,791 |
| | $ | 38,918 |
|
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
| Depreciation of premises and equipment, amortization of securities available for sale, and amortization of discount of junior subordinated debentures | 9,808 |
| | 10,704 |
| | 12,709 |
|
| Changes in net deferred loan costs, net of amortization | (150 | ) | | (1,007 | ) | | (1,422 | ) |
| Provision for loan losses | 5,129 |
| | 4,220 |
| | 4,931 |
|
| Net change in accrued interest receivable, prepaid expenses and other assets, accrued expenses and other liabilities | 10,195 |
| | 11,634 |
| | 2,147 |
|
| Stock-based compensation expense | 2,744 |
| | 2,103 |
| | 1,840 |
|
| Net excess tax benefit from exercise of stock-based compensation | — |
| | — |
| | (123 | ) |
| Amortization of intangible assets | 3,819 |
| | 1,286 |
| | 1,415 |
|
| Origination of loans held for sale | (76,101 | ) | | (108,696 | ) | | (145,107 | ) |
| Proceeds from sale of loans | 79,237 |
| | 121,482 |
| | 148,121 |
|
| Earnings on bank owned life insurance | (1,753 | ) | | (1,424 | ) | | (1,460 | ) |
| Valuation adjustment on other real estate owned | 49 |
| | — |
| | 383 |
|
| Gain on sale of loans, net | (2,759 | ) | | (7,696 | ) | | (6,994 | ) |
| Gain on sale of investment securities, net | (137 | ) | | (6 | ) | | (1,315 | ) |
| Gain on sale of assets held for sale | (798 | ) | | (747 | ) | | — |
|
| Loss on sale of other real estate owned | — |
| | (144 | ) | | (173 | ) |
| Impairment of assets held for sale | 75 |
| | — |
| | — |
|
| Loss on sale or write-off of furniture, equipment and leasehold improvements | 32 |
| | 13 |
| | 110 |
|
| Net cash provided by operating activities | 82,447 |
|
| 73,513 |
|
| 53,980 |
|
| Cash flows from investing activities: | | | | | |
| Loans originated, net of principal payments | (98,563 | ) | | (235,154 | ) | | (263,387 | ) |
| Maturities of other interest earning deposits | — |
| | — |
| | 6,709 |
|
| Maturities, calls and payments of investment securities available for sale | 92,563 |
| | 98,894 |
| | 129,408 |
|
| Purchase of investment securities available for sale | (342,141 | ) | | (149,914 | ) | | (267,657 | ) |
| Purchase of premises and equipment | (23,265 | ) | | (3,063 | ) | | (6,722 | ) |
| Proceeds from sales of other loans | 9,993 |
| | 28,874 |
| | 21,077 |
|
| Proceeds from sales of other real estate owned | 198 |
| | 930 |
| | 2,486 |
|
| Proceeds from sales of investment securities available for sale | 156,014 |
| | 31,028 |
| | 140,373 |
|
| Proceeds from sales of assets held for sale | 1,908 |
| | 1,849 |
| | — |
|
| Proceeds from redemption of Federal Home Loan Bank stock | 26,538 |
| | 30,018 |
| | 23,732 |
|
| Purchases of Federal Home Loan Bank stock | (22,524 | ) | | (30,801 | ) | | (27,148 | ) |
| Proceeds from sales of premises and equipment | 28 |
| | — |
| | 659 |
|
| Purchase of bank owned life insurance | (54 | ) | | (4,394 | ) | | (8,000 | ) |
| Proceeds from BOLI death benefit | — |
| | 1,101 |
| | — |
|
| Capital contributions to low-income housing tax credit partnerships and new market tax credit partnerships, net | (8,303 | ) | | (10,762 | ) | | (4,456 | ) |
| Net cash received from acquisitions | 105,974 |
| | — |
| | — |
|
| Net cash used in investing activities | (101,634 | ) |
| (241,394 | ) |
| (252,926 | ) |
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 | | 2019 |
| Cash flows from financing activities: | | | | | |
| Net increase in deposits | 783,347 | | | 1,015,314 | | | 150,274 | |
| Federal Home Loan Bank advances | — | | | 64,000 | | | 445,800 | |
| Repayment of Federal Home Loan Bank advances | — | | | (64,000) | | | (445,800) | |
| Common stock cash dividends paid | (28,937) | | | (28,859) | | | (30,908) | |
| Net increase (decrease) in securities sold under agreement to repurchase | 15,156 | | | 15,514 | | | (11,318) | |
| Proceeds from exercise of stock options | — | | | 122�� | | | 58 | |
| Repurchase of common stock | (22,889) | | | (19,119) | | | (8,636) | |
| Net cash provided by financing activities | 746,677 | | | 982,972 | | | 99,470 | |
| Net increase in cash and cash equivalents | 979,970 | | | 514,754 | | | 66,658 | |
| Cash and cash equivalents at beginning of period | 743,322 | | | 228,568 | | | 161,910 | |
| Cash and cash equivalents at end of period | $ | 1,723,292 | | | $ | 743,322 | | | $ | 228,568 | |
| | | | | |
| Supplemental disclosures of cash flow information: | | | | | |
| Cash paid for interest | $ | 6,790 | | | $ | 13,136 | | | $ | 17,867 | |
| Cash paid for income taxes, net of refunds | 9,888 | | | 13,432 | | | 7,528 | |
| | | | | |
| Supplemental non-cash disclosures of cash flow information: | | | | | |
| Transfer of investment securities available for sale to held to maturity | 244,778 | | | — | | | — | |
| Investment in low-income housing tax credit partnership and related funding commitment | 29,551 | | | 10,237 | | | 46,677 | |
| Loans received from return of New Market Tax Credit equity method investment | 15,596 | | | — | | | — | |
| ROU assets obtained in exchange for new operating lease liabilities | 13,966 | | | 1,265 | | | 1,505 | |
| Transfers of properties classified as held for sale to prepaid expenses and other assets from premises and equipment, net | 3,556 | | | 3,243 | | | 1,533 | |
Cumulative effect from change in accounting policy (1) | — | | | 7,175 | | | 29,754 | |
| Transfer of bank owned life insurance to prepaid expenses and other assets due to death benefit accrued, but not paid | — | | | 2,672 | | | 209 | |
| Transfers of loans receivable to other real estate owned | $ | — | | | $ | 270 | | | $ | — | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
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| | | | | |
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| | | | | |
| | | | | |
|
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| Cash flows from financing activities: | | | | | |
| Net increase in deposits | 214,740 |
| | 163,412 |
| | 121,361 |
|
| Federal Home Loan Bank advances | 554,950 |
| | 763,350 |
| | 660,900 |
|
| Repayments of Federal Home Loan Bank advances | (663,450 | ) | | (750,450 | ) | | (581,300 | ) |
| Common stock cash dividends paid | (25,791 | ) | | (18,305 | ) | | (21,569 | ) |
| Net (decrease)/increase in securities sold under agreement to repurchase | (796 | ) | | 9,717 |
| | (1,110 | ) |
| Proceeds from exercise of stock options | 133 |
| | 164 |
| | 540 |
|
| Net excess tax benefit from exercise of stock-based compensation | — |
| | — |
| | 123 |
|
| Repurchase of common stock | (1,704 | ) | | (737 | ) | | (2,894 | ) |
| Net cash provided by financing activities | 78,082 |
|
| 167,151 |
|
| 176,051 |
|
| Net increase (decrease) in cash and cash equivalents | 58,895 |
|
| (730 | ) |
| (22,895 | ) |
| Cash and cash equivalents at beginning of year | 103,015 |
| | 103,745 |
| | 126,640 |
|
| Cash and cash equivalents at end of year | $ | 161,910 |
|
| $ | 103,015 |
|
| $ | 103,745 |
|
| | | | | | |
| Supplemental disclosures of cash flow information: | | | | | |
| Cash paid for interest | $ | 12,385 |
| | $ | 8,399 |
| | $ | 5,998 |
|
| Cash paid for income taxes | 5,634 |
| | 2,045 |
| | 11,500 |
|
| | | | | | |
| Supplemental non-cash disclosures of cash flow information: | | | | | |
| Transfers of loans receivable to other real estate owned | $ | 434 |
| | $ | 32 |
| | $ | 1,431 |
|
| Transfers of properties held for sale recorded in premises and equipment, net to prepaid expenses and other assets | 1,836 |
| | 2,687 |
| | — |
|
| Transfer of BOLI to prepaid expenses and other assets | 421 |
| | — |
| | — |
|
| Investment in low income housing tax credit partnership and related funding commitment | — |
| | 33,171 |
| | 19,663 |
|
| Business Combinations: | | | | | |
| Common stock issued for business combinations | $ | 230,043 |
| | $ | — |
| | $ | — |
|
| Assets acquired (liabilities assumed) in acquisitions: | | | | | |
| Investment securities available for sale | 84,846 |
| | — |
| | — |
|
| Loans receivable | 718,620 |
| | — |
| | — |
|
| Other real estate owned | 1,796 |
| | — |
| | — |
|
| Premises and equipment | 3,785 |
| | — |
| | — |
|
| Federal Home Loan Bank stock | 1,743 |
| | — |
| | — |
|
| Accrued interest receivable | 2,454 |
| | — |
| | — |
|
| Bank owned life insurance | 17,116 |
| | — |
| | — |
|
| Prepaid expenses and other assets | 2,957 |
| | — |
| | — |
|
| Other intangible assets | 18,345 |
| | — |
| | — |
|
| Goodwill | 121,910 |
| | — |
| | — |
|
| Deposits | (824,602 | ) | | — |
| | — |
|
| Federal Home Loan Bank advances | (16,000 | ) | | — |
| | — |
|
| Securities sold under agreement to repurchase | (462 | ) | | — |
| | — |
|
| Accrued expenses and other liabilities | (8,439 | ) | | — |
| | — |
|
See accompanying Notes to Consolidated Financial Statements.
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2018, 20172021, 2020 and 20162019
(1)Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements | |
(1) | Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements |
(a) Description of Business
Heritage Financial Corporation ("Heritage" or the “Company”) is a bank holding company that was incorporated in the State of Washington in August 1997. The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, Heritage Bank (the “Bank”). The Bank is a Washington-chartered commercial bank and its deposits are insured by the FDIC.Bank. The Bank is headquartered in Olympia, Washington and conducts business from its 6449 branch offices located throughout Washington State and the greater Portland, Oregon area. The Bank’s business consists primarily of commercial lending and deposit relationships with small and medium-sized businesses and their owners in its market areas and attracting deposits from the general public. The Bank also makes real estate construction and land development loans, consumer loans and originates first mortgage loans on residential properties primarily located in its market areas. The Bank's deposits are insured by the FDIC.
Effective January 16, 2018, the Company completed the acquisition of Puget Sound Bancorp, Inc. (“Puget Sound”), the holding company for Puget Sound Bank, both of Bellevue, Washington (“Puget Sound Merger”) and on July 2, 2018, the Company completed the acquisition of Premier Commercial Bancorp ("Premier Commercial"), the holding company for Premier Community Bank, both of Hillsboro, Oregon ("Premier Merger"). See Note (2) Business Combinations for additional information on the Puget Sound Merger and the Premier Merger (collectively the "Premier and Puget Mergers").
(b) Basis of Presentation
The accountingaccompanying audited Consolidated Financial Statements have been prepared in accordance with GAAP for annual financial information and reporting policiespursuant to the rules and regulations of the Company and its subsidiaries conform to U.S. Generally Accepted Accounting Principles (“GAAP”). In preparingSEC. To prepare the audited Consolidated Financial Statements in conformity with GAAP, management makes estimates and assumptions thatbased on available information. These estimates and assumptions affect the amounts reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date ofin the financial statements and the reported amountsdisclosures provided. Management believes that the judgments, estimates, and assumptions used in the preparation of incomethe Consolidated Financial Statements are appropriate based on the facts and expenses duringcircumstances at the reporting periods.time. Actual results, however, could differ significantly from thesethose estimates. Material estimates that are particularly susceptible to significant change relate to management's estimate of the ACL on investment securities, management's estimate of the ACL on loans, management's estimate of the ACL on unfunded commitments, management's evaluation of goodwill impairment and management's estimate of the fair value of financial instruments.
The accompanying Consolidated Financial Statements include the accounts of the Company and its wholly ownedwholly-owned subsidiary, the Bank. All significant intercompany balances and transactions among the Company and the Bank have been eliminated in consolidation.
Certain prior year amounts in the Consolidated Statements of Income have been reclassified to conform to the current year’s presentation. Reclassifications had no effect on the prior years'year's net income or stockholders’ equity.
(c) Significant Accounting Policies
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and due fromin banks and interest-bearing balancesinterest earning deposits due substantially from the Federal Reserve Bank. Cash equivalents have a maturity of 90 days or less at the time of purchase.
Investment Securities
The Company identifies investments as heldInvestment securities for which the Bank has the positive intent and ability to hold to maturity or available for sale at the time of acquisition. Securities are classified as held to maturity whenand are carried at amortized cost. Investment securities held primarily for the Company haspurpose of selling in the abilitynear term are classified as trading securities and positive intentare reported at fair value, with unrealized gains and losses included in income. Investment securities not classified as held to hold them to maturity. Securitiesmaturity or trading are classified as available for sale and are available for future liquidity requirementsreported at fair value with unrealized gains and may be sold prior to maturity. Aslosses, net of December 31, 2018income taxes, as a separate component of other comprehensive income. The Bank determines the appropriate classification of investment securities at the time of purchase and December 31, 2017reassesses the Bank does not hold anyclassification at each reporting date. Any subsequent reassessment of classification and transfer of investment securities classified as held to maturity. See Note (3) Investment Securities for additional information.
Securities available for sale to held to maturity are carriedcompleted at fair value. Interest income includes amortizationthe amortized cost basis plus or minus the amount of purchase premiumsany remaining unrealized holding gain or accretionloss reported in AOCI of purchase discountsthe individual investment securities available for sale. The unrealized holding gain or loss at the date of the transfer continues to be recognized in AOCI, but that gain or loss is amortized over the remaining life of the security using the interest method. Unrealized gainsWhen the Company acquires another entity, all investment securities are recorded at fair value and losses on securitiesclassified as available for sale are generally excluded from earnings and are reported in other comprehensive income (loss), net of related income taxes. at the acquisition date.
Realized gains and losses on sales of investment securities are recorded on the trade date in gain on sale of investment securities, are computednet on the Consolidated Statements of Income and determined using the specific identification method. Transfers ofPremiums and discounts on investment securities between the available for sale and held to maturity categories are accountedamortized or accreted into income using the interest method. An investment security available for sale or held to maturity is placed on nonaccrual status at fair value.the time any principal or payments become more than 90 days delinquent and classified as past due after 30 days of nonpayment. Interest accrued, but not received for an investment security classified as nonaccrual is reversed against interest income during the period that the investment security is placed on nonaccrual status.
ACL on Investment Securities Available for Sale
Management evaluates the need for an ACL on investment securities available for other-than-temporary impairmentsale on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Although these evaluations involve significant judgment, For investment securities available for sale in
an unrealized loss inposition, the fair value of a debt security is generally deemedCompany first assesses whether it intends to be temporary when a) the fair value of the security is below the carrying value primarily due to changes in interest rates; b) there has not been significant deterioration in the financial condition of the issuer; and, c)sell or it is not more likely than not that the Companyit will be required to, nor does it have the intent to sell the security before the anticipated recovery of its remaining carrying value.amortized cost basis. If anyeither of thesethe criteria regarding intent or requirement to sell is not met, the impairmentsecurity’s amortized cost basis is split into two components as follows: 1) other-than-temporary impairmentwritten down to fair value through a provision for credit loss against income. For investment securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and adverse conditions specifically related to credit loss, which must be recognized in the income statement and 2) other-than-temporary impairment related tosecurity, among other factors, which is recognized in other comprehensive income (loss).factors. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For debt securities with other-than-temporary impairment,If the previous amortized cost basis less the other-than-temporary impairment recognized in earnings shall be the new amortized cost basispresent value of the security. In subsequent periods, the Company accretes into interest income the difference between the new amortized cost basis and cash flows expected to be collected prospectivelyis less than the amortized cost basis, a credit loss exists and an ACL on investment securities available for sale is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any unrealized decline in fair value that has not been recorded through an ACL on investment securities available for sale is recognized in other comprehensive income.
Accrued interest receivable on investment securities available for sale is excluded from the estimate of expected credit losses. Changes in the ACL on investment securities available for sale are recorded as provision for credit losses expense. Losses are charged against the ACL when management believes the uncollectability of an investment security available for sale is confirmed or when either of the criteria regarding intent or requirement to sell is met.
ACL on Investment Securities Held to Maturity
The Company measures expected credit losses on investment securities held to maturity on a pooled, collective basis by major investment security type with similar risk characteristics. A historical lifetime probability of default and severity of loss in the event of default is derived or obtained from external sources and adjusted for the expected effects of reasonable and supportable forecasts over the lifeexpected lives of the debt security. Continued deteriorationinvestment securities on those historical credit losses. Expected credit losses on investment securities in the held to maturity portfolio that do not share similar risk characteristics with any of market conditions could result in additional impairment losses recognized withinthe pools are individually measured based on net realizable value, or the difference between the discounted value of the expected future cash flows, based on the original effective interest rate, and the recorded amortized cost basis of the investment portfolio.securities.
Other factors that may be considered in determining whether a declineAccrued interest receivable on investment securities held to maturity is excluded from the estimate of expected credit losses. Changes in the valueACL on investment securities held to maturity are recorded as provision for credit losses expense. Losses are charged against the ACL when management believes the uncollectability of a debtan investment security held to maturity is “other-than-temporary” include ratings by recognized rating agencies; actions of commercial banks or other lenders relative to the continued extension of credit facilities to the issuer of the security; the financial condition, capital strength and near-term prospects of the issuer and recommendations of investment advisors or market analysts.confirmed.
Loans Held for Sale
Mortgage loans held for sale are carried at the lower of amortized cost or fair value. Any loan that management does not have the intent and ability to hold for the foreseeable future or until maturity or payoff is classified as held for sale at the time of origination, purchase, or securitization or when such decision is made. Unrealized losses on such loans held for sale are recorded as a valuation allowance and included in income.other expense on the Consolidated Statements of Income.
Loans Receivable and Loan Commitments
Loans receivable includeincludes loans originated, indirect loans purchased by the Bank as well asand loans acquired in business combinations. Loans acquired in a business combination are designated as “purchased” loans. These loans are recordedcombinations that management has the intent and ability to hold for the foreseeable future or until maturity or payoff and is reported at their fair value at acquisition date, factoring in credit losses expected to be incurred overamortized cost. Amortized cost is the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date.
Loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are accounted for under FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. These loans are identified as purchased credit impaired ("PCI") loans. In situations where such loans have similar risk characteristics, loans may be aggregated into pools to estimate cash flows. A pool is accounted for as a single asset with a single interest rate, cumulative loss rate and cash flow expectation. Expected cash flows at the acquisition date in excess of the fair value of loan or pool are considered to be accretable yield, which is recognized as interest income over the life of the loan or pool using a level yield method if the timing and amount of the future cash flows of the loan or pool is reasonably estimable.
The cash flows expected over the life of the PCI loan or pool are estimated quarterly using an external cash flow model that projects cash flows and calculates the carrying values of the loans or pools, book yields, effective interest income and impairment, if any, based on loan or pool level events. Assumptions as to default rates, loss severity and prepayment speeds are utilized to calculate the expected cash flows. To the extent actual or projected cash flows are less than previously estimated, additional provisions for loan losses on the purchased loan portfolios will be recognized immediately into earnings. To the extent actual or projected cash flows are more than previously estimated, the increase in cash flows is recognized immediately as a recapture of provision for loan losses up to the amount of any provision previously recognized for that loan or pool, if any, then prospectively recognized in interest income as a yield adjustment. Any disposals of a loan in a pool, including sale of a loan, payment in full or foreclosure results in the removal of the loan from the loan pool at the carrying amount.
Loans accounted for under FASB ASC 310-30 are generally considered accruing and performing loans as the loans accrete interest income over the estimated life of the loan when cash flows are reasonably estimable. Accordingly, PCI loans that are contractually past due are still considered to be accruing and performing loans. If the timing and amount of cash flows is not reasonably estimable, the loans may be classified as nonaccrual loans and interest income may be recognized on a cash basis or all cash payments may be accounted for a as a reduction of the principal amount outstanding.
Loans purchased that are not accounted for under FASB ASC 310-30 are accounted for under FASB ASC 310-20, Receivables—Nonrefundable fees and Other Costs. These loans are identified as non-PCI loans, and are
initially recorded at their fair value, which is estimated using an external cash flow model and assumptions similar to the FASB ASC 310-30 loans. The difference between the estimated fair value and the unpaid principal balance at acquisition date is recognized as interest income over the life of the loan using an effective interest method for non-revolving credits or a straight-line method, which approximates the effective interest method, for revolving credits. Any unrecognized discount for a loan that is subsequently repaid in full will be recognized immediately into income.
Loans are generally recorded at the unpaidoutstanding principal balance, net of purchased premiums unearnedand discounts and net deferred loan origination fees and costs. The premiums and unearned discounts may include values determined in purchase accounting. Interest on loans is calculated using the simple interest method based on the daily balance of the principal amount outstanding and is credited to interest income as earned. Accrued interest receivable for loans receivable is reported within accrued interest receivable on the Consolidated Statements of Financial Condition. The Company's policies for loans receivable generally do not differ by loan segments or classes unless specified in the following policies.
Acquired Loans:
Acquired loans are recorded at their fair value at acquisition date net of an ACL on loans expected to be incurred over the life of the loan. The initial ACL on purchased loans is determined using the same methodology as originated loans. For non-PCD loans, the initial ACL on loans is recorded through earnings as a provision for credit losses. For PCD loans, the initial ACL is incorporated into the calculation of the fair value of net assets acquired on the merger date and the net of the PCD loan purchase price and the initial ACL becomes the initial amortized cost basis. The difference between the initial amortized cost basis and the par value of PCD loans is the noncredit discount or premium for PCD loans. The noncredit discount or premium for PCD loans and both the noncredit and credit discount or premium for non-PCD loans are accreted through the interest and fees on loans line item on the Consolidated Statements of Income over the life of the loan using the interest method for non-revolving credits or the straight-line method, which approximates the effective interest method, for revolving credits. Any unrecognized discount or premium for a purchased loan that is subsequently repaid in full is recognized immediately into income. Subsequent changes to the ACL on loans for purchased loans are recorded through earnings as a provision for credit losses.
Delinquent Loans:
Loans are considered past due or delinquent when principal or interest payments are past due 30 days or more. Delinquent loans may generally remain on accrual status between 30 days and 89 days past due.
The Company's policies for determiningBank did not designate loans with payment deferrals granted due to the COVID-19 Pandemic as past due or delinquency status, placing loans on nonaccrual status, recording payments received on nonaccrual loans, resuming accrual of interest, and charging off uncollectible loans generally do not differ by loan segments or classes. Any differences are denotedduring their modification period in the applicable sections below.
Delinquent Loans:
Commercial loans are serviced by the relationship manger assigned to the account. System generated delinquency reports are provided to all relationship managers monthly, and relationship managers take follow up action as needed, including contacting the borrower and transferring seriously delinquent loans to the Bank’s Special Assets Department for collection. Consumer loans are monitored by the Bank’s Consumer Collections Department, with initial delinquency notices sent after 15 days, with follow up notices at 30 and 45 days. The Consumer Collections Department attempts to make direct contactaccordance with the borrower to establish a plan to bring the loan current. Consumer loans that become 90 days delinquent are charged off.CARES Act and related regulatory guidance.
Nonaccrual and Charged-off Loans:
Loans onfor which the accrual of interest has been discontinued are designated as nonaccrual loans. Delinquent loans may remain on accrual status between 30 days and 89 days past due. The accrual of interest is generally discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. Loans are placed on nonaccrual at an earlier date if collection of the contractual principal or interest is doubtful. All interest accrued, but not collected, on loans deemed nonaccrual during the period is reversed against interest income in that period. The interestInterest payments received on nonaccrual loans are generally accounted for on the cost-recovery method whereby the interest payment is applied to the principal balances. Loans may be returned to accrual status when improvements in credit quality eliminate the doubt as to the full collectability of both interest and principal and a period of sustained performance has occurred. Substantially all loans that are
Due to the short-term nature of the forbearance and other relief programs we were offering as a result of the COVID-19 Pandemic, borrowers granted relief under these programs generally were not reported as nonaccrual are also considered impaired. Income recognition on impaired loans conforms to that used on nonaccrual loans.during the deferral period.
Loans are generally charged-offcharged off to their net realizable value if collection of the contractual principal or interest as scheduled in the loan agreement is doubtful. Credit card loans and other consumerConsumer loans are typically charged-offcharged off no later than 18090 days past due.
Impaired Loans:
The Bank routinely tests its classified loans for potential impairment. Classified loans that may be impaired are identified using the Bank's normal loan review procedures, which include post-approval reviews, quarterly reviews by credit administration of criticized loan reports, scheduled internal reviews, underwriting during extensions and renewals, and the analysis of information routinely received on a borrower’s financial performance. A loan is considered impaired when, based on current information and events, it is probable the Bank will be unable to collect the scheduled payments of principal or interest when due according to the original contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrowers, including length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amounts of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, or as a practical expedient the loan’s observable market price or the fair value of the collateral (less cost to sell) if the loan is collateral dependent. Income recognition on impaired loans conforms to that used on nonaccrual loans.
Subsequent to an initial measure of impairment and based on new information received, if there is a significant change in the amount or timing of a loan’s expected future cash flows or a change in the value of collateral or market
price of a loan, the impairment is recalculated. However, the net carrying value of a loan never exceeds the recorded investment in the loan.
Troubled Debt Restructures:
A troubled debt restructured loan (“TDR”)TDR is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider. These concessions may include changes ofto the interest rate, forbearance of the outstanding principal or accrued interest, extension of the maturity date, delay in the timing of the regular payment or any other actions intended to minimize potential losses. The Bank does not generally forgive principal foras part of a majority of its TDRs,TDR, but in those situations where principal is forgiven, the entire amount of such principal forgiveness is immediately charged off to the extent not done so prior to the modification. The Bank also considers insignificant delays in payments when determining if a loan should be classified as a TDR.
The Company has implemented more stringent definitions of concessions and impairment measures for PCI loans which are not in pools as these loans have known credit deteriorations and are generally accreting income at a lower discounted rate as compared to the contractual note rate based on the guidance of FASB ASC 310-30. Modifications of PCI loans which are not in pools are considered TDRs if they result in a decrease in expected cash flows when compared to the pre-modification expected cash flows, without any other changes to the agreement to consider.
A loan that has been placed on nonaccrual status that is subsequently restructured will usually remain on nonaccrual status until the borrower is able to demonstrate repayment performance in compliance with the restructured terms for a sustained period, typically for six months. A restructured loan may return to accrual status sooner based on other significant events or mitigating circumstances. A loan that has not been placed on nonaccrual status may be restructured and such loan may remain on accrual status after such restructuring. In these circumstances, the borrower has made payments before the restructuring and is expected to continue to perform after the restructuring. Generally, this type of restructuring involves a reduction in the loan interest rate and/or a change to interest-only payments for a period of time. The restructured loan is considered impaired despite the accrual status and a specific valuation allowance, if any, is calculated in the manner previously described.
A TDR is considered defaulted if, during the 12-month period after the restructure, the loan has not performed in accordance to the restructured terms. Defaults generally include loans whose payments are 90 days or more past due and loans whose revised maturity date passed and no further modifications will be granted for that borrower.
A loan may subsequently be excluded from the TDR disclosures if: (i) the restructured interest rate was greater than or equal to the interest rate of a new loan with comparable risk at the time of the restructure, and (ii) the loan is no longer impaired based on the terms of the restructured agreement. The Bank's policy is that the borrower must demonstrate a sustained period, typically six consecutive months, of payments in accordance with the modified loan before it can be reviewed for removal from the TDR disclosure under the second criteria. However, the loan must be reported as a TDR in at least one annual report on Form 10-K. Once a loan has beenis classified as a TDR loan, it will continuegenerally continues to be disclosedreported as an impaired loansuch until it is paid off or charged-off, even ifcharged off.
During 2020, the loan subsequently is no longer disclosedCARES Act and regulatory agencies provided guidance around the modification of loans as a TDR.
Unfunded Loan Commitments:
Unfunded loan commitments are generally related to the unused portionresult of the total commitmentCOVID-19 Pandemic and outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined by the CARES Act and related regulatory guidance prior to any relief are not TDRs. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of a loanrepayment terms, or providing credit facilities to clientsother delays in payment that are insignificant. Borrowers are considered current if they were less than 30 days past due on the contractual payments as of December 31, 2019 under the CARES Act, which the Bank determined was the implementation date of its modification program under related regulatory guidance. The CA Act extended relief offered under the CARES Act through January 1, 2022 or 60 days after the end of the national emergency declared by the President, whichever is earlier. The Bank elected to apply the temporary relief under the applicable guidance to certain eligible short-term modifications and aredid not actively traded financial instruments. These unfunded commitments are disclosedclassify the modifications as financial instruments with off-balance sheet risk in Note (14) Commitments and Contingencies and Note (18) Fair Value Measurements inTDRs for accounting or disclosure purposes. However, COVID Modifications whose payment deferral exceeded 180 days following the Notes to Consolidated Financial Statements.loans' initial modification were classified as TDRs based on the Bank's internal policy.
Deferred Loan Origination Fees and Costs
LoanDirect loan origination fees and certain direct origination costs on originated loans and premiums and discounts on acquired loans are deferred and subsequently amortized or accreted as ana yield adjustment over the expected life of the yields ofloan without prepayment considerations utilizing the loans over their contractual lives, adjusted for prepayment of the loans, using the effective interest method, orexcept revolving loans for which the straight-line method which approximatesis used. When a loan is paid off prior to maturity, the effectiveremaining net deferred balance is immediately recognized into interest method.income. In the event loans are sold, the unamortized net deferred loan origination fees or costs arebalance is recognized as a component of the gain or loss on the sale of loans.
Allowance for Loan Losses
Allowance for Loan Losses:ACL on Loans
The allowance for loan lossesACL on loans is a reserve established through a provision for loan losses chargedvaluation account that is deducted from the amortized cost of loans receivable to expense, which represents management’s best estimate of probable losses that have been incurred withinpresent the existing portfolio of loans. Loan lossesnet amount expected to be collected. Loans are chargeddebited against the allowanceACL on loans when management believes the uncollectibility of a loan balance is confirmed. Subsequentconfirmed and subsequent recoveries, if any, are credited to the allowance. ACL on loans. The Bank records the changes in the ACL on loans through earnings as a provision for credit losses on the Consolidated Statements of Income.
Management has adopted a historic loss, open pool CECL methodology to calculate the ACL on loans. Under this methodology, loans are either collectively evaluated if they share similar risk characteristics, including performing TDR loans, or individually evaluated if they do not share similar risk characteristics, including nonaccrual loans.
The allowance for loan losses on loans designated as non-PCIindividually evaluated loans is similarcalculated using either the collateral value method, which considers the likely source of repayment as the value of the collateral less estimated costs to sell, or the methodology described below except that for non-PCI loans,net present value method, which considers the remaining unaccreted discounts resultingcontractual principal and interest terms and estimated cash flows available from the fair value adjustments recorded atborrower to satisfy the time thedebt.
Nonaccrual TDR loans were purchased are additionally factored into the allowance methodology. The allowance for loan losses on PCI loans is described in the “Allowance for Loan Losses on Purchased Credit Impaired Loans” section below.
The allowance, in the judgment of management, is necessary to reserve for estimated loan losses from risks inherent in the loan portfolio. The Company’s allowance for loan losses methodology includes allowance allocations calculated in accordance with FASB ASC 310, Receivables and allowance allocations calculated in accordance with FASB ASC 450, Contingencies. Accordingly, the methodology is based on historical loss experience by type of credit, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to nonaccrual loans, past due loans, classified loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects all actions taken on all loans for a particular period. Therefore, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in specific valuation allowances for impaired loans or loan pools.
The level of the allowance reflects management’s continuing evaluation of known and inherent risks in the loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, could be charged off.
Loans which management determines are impaired are individually evaluated for impairment, and specific valuation allowances are recorded, if any, on these loans based oncredit loss except the methodology previously described. Loans that are determinedoriginal interest rate is used to discount the expected cash flows, not to meet management's definition of impaired are collectively evaluated for impairment based on (i) historical loss factors determined in accordance with FASB ASC 450 based on historical loan loss experience for similar loans with similar characteristics and trends; and (ii) environmental loss factors that reflect the impact of current conditions, as determined in accordance with FASB ASC 450 based on general economic conditions and other qualitative risk factors both internal and external to the Company. The historical loss factors and environmental loss factors are combined and multiplied against the unguaranteed outstanding principal balances of loans in pools of similar loans with similar characteristics.
The Company evaluates specific loans for credit quality indicators and performs regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the loan officer level for all loans. When a loan is performing, but has an assigned risk grade other than pass, the loan officer analyzes the loan to determine an appropriate monitoring and collection strategy. When a loan is nonperforming or has been classified as a nonaccrual loan, a member from the special assets department will analyze the loan to determine if it is impaired. If the loan is considered impaired, the special assets department will evaluate the need for a specific valuation allowance on the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies and economic conditions affecting the borrower’s industry, among other things.
Historical loss factors are calculated based on the historical loss experience and recovery experience of specific classes of loans. The Company calculates historical loss ratios for the classes of loans based on the proportion of actual charge-offs and recoveries experienced to the total loansrate specified in the pool for a rolling twelve-quarter average.
Environmental loss factors are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) levels of and trends in delinquencies, classified and impaired loans; (ii) levels of and trends in charge-offs and recoveries; (iii) trends in volume and terms of loans (iv) effects of changes in risk selection and underwriting standards, and other changes in lending policies, procedures, and practices; (v) experience, ability, and depth of lending management and other relevant staff; (vi) national and local economic trends and conditions; (vii) other external factors such as competition, legal, and regulatory; (viii) effects of changes in credit concentrations, and (ix) other factors. Management evaluates the degree of risk that each one of these components has on the quality of the loan
portfolio on a quarterly basis. Each component is determined to be on a scale of risk. The results are then utilized in a matrix to determine an appropriate environmental loss factor for each class of loan.restructuring.
The allowance for collectively evaluated loans is comprised of the baseline loss allowance, the macroeconomic allowance and the qualitative allowance. The baseline loss allowance begins with the baseline loss rates calculated using the Bank's average quarterly historical loss information for an economic cycle. The Bank evaluates the historical period on a quarterly basis with the assumption that economic cycles have historically lasted between 10 and 15 years. The baseline loss rates are applied to each loan's estimated cash flows over the life of the loan under the remaining life method to determine the baseline loss estimate for each loan. Estimated cash flows consider the principal and interest in accordance with the contractual term of the loan and estimated prepayments. Contractual cash flows are based on the amortized cost and are adjusted for balances guaranteed by governmental entities, such as SBA or USDA, resulting in the unguaranteed amortized cost. The contractual term excludes expected extensions, renewals and modifications unless either of the following applies: 1) management has a reasonable expectation at the reporting date that a TDR will be executed with an individual borrower or 2) the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company. Prepayments are established for each segment based on rolling historical averages for the segment, which management believes is an accurate representation of future prepayment activity. Management reviews the adequacy of the prepayment assumption on a quarterly basis.
The macroeconomic allowance includes consideration of the forecasted direction of the economic and business environment and its likely impact on the estimated allowance as compared to the historical losses over the reasonable and supportable time frame. Economic forecast models for the current period are uploaded to the model, which targets 16 forecasted macroeconomic factors, such as unemployment rate, gross domestic product, housing price index, commercial real estate price index, disposable income growth, mortgage rates and certain rate indices. Macroeconomic factor multipliers are determined through regression analysis and applied to loss rates for each segment of loans with similar risk characteristics. Each of the forecasted segment balances is impacted by a mix of these macroeconomic factors. Further, each of the macroeconomic factors is utilized differently by segment, including the application of lagged factors and various transformations such as percent change year over year. A macroeconomic sensitive model is developed for each segment given the current and forecasted conditions and a macroeconomic multiplier is calculated for each forecast period considering the forecasted losses as compared to the long-term average actual losses of the dataset. The impact of those macroeconomic factors on each segment, both positive or negative, using the reasonable and supportable period, are added to the calculated baseline loss allowance. After the reasonable and supportable period, forecasted loss rates revert to historical baseline loss levels over the predetermined reversion period on a straight-lined basis.
The Bank’s ACL model also includes adjustments for qualitative factors, where appropriate. Since historical information (such as historical net losses and economic cycles) may not always, by themselves, provide a sufficient basis for determining future expected credit losses, the Bank periodically considers the need for qualitative adjustments to the ACL. The Bank has a bias for minimal qualitative risk factors unless internal or external factors indicate otherwise. Qualitative adjustments may be related to and include, but not limited to, factors such as: (i) management’s assessment of economic forecasts used in the model and how those forecasts align with management’s overall evaluation of current and expected economic conditions, (ii) organization specific risks such as credit concentrations, collateral or industry specific risks, regulatory risks, and external factors that may ultimately impact credit quality, (iii) other limitations associated with factors such as underwriting changes, acquisition of new portfolios, changes in portfolio segmentation, and (iv) management’s overall assessment of the adequacy of the ACL, including an assessment of model data inputs used to determine the ACL. The Bank has established metrics to estimate the qualitative risk factors by segment based on the identified risk.
In general, management's estimate of the ACL on loans uses relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. The evaluation of ACL on loans is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. While management utilizes its best judgment and information available to recognize estimated losses on loans, future additions to the allowance may be necessary based on further declines in local and national economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses.ACL on loans. Such agencies may require the Bank to make adjustments to the allowance based on their judgments about information available to them at the time of their examinations. The Company believes the allowance for loan lossesACL on loans is appropriate given all of the above considerations.
Allowance for Loan Losses on Purchased Credit Impaired Loans:
The PCI loans acquired in the Company's mergers and acquisitions are subject to the Company’s internal and external credit review. Under the accounting guidance of FASB ASC 310-30, the allowance for loan losses on PCI loans is measured at each financial reporting period, or measurement date, based on expected cash flows. If and when credit deterioration, or decreases in expected cash flows previously estimated, occurs subsequent to the acquisition date, a provision for loan losses will be charged to earnings as of the measurement date.
Allowance for LossesACL on Unfunded Commitments:Commitments
The Bank is also party to financial instruments withestimates expected credit losses on unfunded, off-balance sheet commitments over the contractual period in which the Bank is exposed to credit risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitmentsfrom a contractual obligation to extend credit, and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess ofunless the disbursed amounts recognized inobligation is unconditionally cancellable by the Consolidated Statements of Financial Condition. Bank.
The Company has a policy in which it evaluates the risk on a quarterly basis, and providesallowance methodology for an allowance for credit losses, as necessary. The methodologyunfunded commitments is similar to the allowance for loan losses,ACL on loans, but additionally includes considerations of the current utilization of the commitment and includes an estimate of the probabilityfuture utilization as determined appropriate by historical commitment utilization and the Bank's estimates of drawdown of the loan commitment. Based on its analysis, the Company hasfuture utilization given current economic forecasts.
The ACL for unfunded commitments is recorded an allowance for off-balance sheet financial instruments of $306,000 and $170,000 as of December 31, 2018 and 2017, respectively. This allowance is reported withinin accrued expenses and other liabilities on the Company's Consolidated Statements of Financial Condition.Condition and changes are recognized through earnings in the provision for credit losses on the Consolidated Statements of Income.
Mortgage Banking Operations
The Bank originates and sells one-to-four familycertain residential real estate loans on a servicing-released basis. The Bank recognizes a gain or loss on sale to the extent that the sale proceeds of the loan sold differs from the net book value at the time of sale.
Income from one-to-four family residential real estate loans brokered to other lenders is recognized into income on date of loan closing.
Commitments to fund residential real estate loans and commitments to subsequently sell one-to-four family residential real estate loans are made primarily during the period between the taking of the loan application and the closing of the loan. The timing of making these sale commitments is dependent upon the timing of the borrower’s election to lock-in the mortgage interest rate and fees prior to loan closing. MostThe Company enters into forward commitments for the future delivery of theseresidential real estate loans when interest rate locks are entered into in order to hedge the interest rate risk resulting from its commitments to fund the loans. These sale commitments are typically made on a best-efforts basis whereby the Bank is only obligated to sell the loan if the loan is approved and closed by the Bank. Commitments to fund one-to-four family residential real estate loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these loans are accounted for as free standing derivatives. Fair values of these mortgagefree-standing derivatives, are estimated based on changes in mortgage interest rates between the date the interest on the loan was locked and the balance sheet date. The Company enters into forward commitments for the future delivery of one-to-four family residential loans when interest rate locks are entered into, in order to hedge the interest rate risk resulting from its commitments to fund the loans. Changes inhowever, the fair values of these freestanding derivatives are included in other income. The fair value of these derivative instruments waswere not significant at December 31, 20182021 or December 31, 2020.
Commercial Loan Sales, Servicing, and 2017.Commercial Servicing Asset
The Company, on a limited basis, sells the guaranteed portion of SBA and USDA loans, with servicing retained, for cash proceeds and records a related servicing asset. The Company does not sell loans with servicing retained unless it retains a participating interest. A servicing asset is recorded at fair value upon sale which is estimated by discounting estimated net future cash flows from servicing using discount rates that approximate current market rates and using estimated prepayment rates. Subsequent to initial recognition, all classes of servicing rights are carried at the lower of amortized cost or fair value and are amortized in proportion to and over the period of the estimated net servicing income. The servicing asset is reported within prepaid expenses and other assets on the Consolidated Statements of Financial Condition.
For purposes of evaluating and measuring impairment, the fair value of servicing rights is measured using a discounted estimated net future cash flow model as described above at least annually. Impairment is determined by stratifying rights into groupings based on predominant risk characteristics including investor type, loan type and maturity and recognized through a valuation allowance for an individual stratum to the extent fair value is less than the carrying amount. If the Company later determines all or a portion of the impairment no longer exists for a particular stratum, a reduction of the allowance may be recorded as an increase to income. Changes in valuation allowances are reported within other noninterest income on the Consolidated Statements of Income.
In connection with the loan sales, the Bank typically makes representations and warranties about the underlying loans conforming to specified guidelines. If the underlying loans do not conform to the specifications, the Bank may have an obligation to repurchase the loans or indemnify the purchaser against any loss. The Bank believes the potential for material loss under these arrangements was remote at December 31, 2021, December 31, 2020 and December 31, 2019.
Servicing fee income is recorded for fees earned for servicing loans and reported as other noninterest income on the Consolidated Statements of Income. The fees are based on a contractual percentage of the outstanding principal and are recorded as income when earned. The amortization of mortgage servicing rights is netted against servicing fee income. Late fees and ancillary fees related to loan servicing were not material for the years ended December 31, 2021, 2020, and 2019.
A premium over the adjusted carrying value is received upon the sale of the guaranteed portion of a SBA or USDA loan. The Bank's investment in an SBA or USDA loan is allocated among the sold and retained portions of the loan based on the relative fair value of each portion at the time of loan origination, adjusted for payments and other activities. Because the portion retained does not carry a SBA or USDA guarantee, part of the gain recognized on the sold portion of the loan is deferred and amortized as a yield enhancement on the retained portion in order to obtain a market equivalent yield. The balance of the deferred gain was immaterial at December 31, 2021, December 31, 2020 and December 31, 2019.
Other Real Estate Owned
Other real estate acquired by the Company in partial or full satisfaction of a loan obligation is classified as held for sale. When acquired, the propertyowned is recorded at the estimated fair value (less the costs to sell) at the date of acquisition, not to exceed net realizable value, and any resulting write-down is charged toagainst the allowance for loan losses.ACL on loans. Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the properly to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement.
After acquisition, all costs incurred in maintaining the property are expensed except for costs relating to the development and improvement of the property which are capitalized to the extent of the property’s net realizable value. If the estimated realizable value of the other real estate owned property declines after the acquisition date, the valuation adjustment is charged to other real estate owned, expense, net on the Consolidated Statements of Income.
Premises and Equipment
Premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the lease period, whichever is shorter. The estimated useful lives used to compute depreciation and amortization for buildings and building improvements, including lease improvements, is 15 to 39 years; and for furniture, fixtures and equipment is three to seven years. The Company reviews buildings,premises and equipment, including leasehold improvements, and equipment for impairment whenever events or changes in the circumstances indicate that the undiscounted cash flows for the property are less than its carrying value. If identified, an impairment loss is recognized through a charge to earnings based on the fair value of the property.
Bank Owned Life Insurance
The Company's bank owned life insurance (“BOLI”)BOLI policies insure the lives of certain current or former Bank officers and name the Bank as beneficiary. Noninterest income is generated tax-free (subject to certain limitations) from the increase in the policies' underlying
investments made by the insurance company. The Bank utilizes BOLI to partially offset costs associated with employee compensation and benefit programs with the earnings on the BOLI. The Company records BOLI at the amount that can be realized under the insurance contract at the statement of financial condition date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
ACL on Accrued Interest Receivable
Accrued interest receivable on investment securities and loans receivable are excluded from their estimates of credit losses. Additionally, no allowance has been established for accrued interest receivable on investment securities and loans receivable as interest accrued, but not received, is reversed timely in accordance with the policies stated above.
Other Intangible Assets
The otherOther intangible assets represents the Core Deposit Intangible (“CDI”)represent core deposit intangibles acquired in business combinations. The fair value of the CDIcore deposit intangible stemming from any given business combination is based on the present value of the expected cost savings attributable to the core deposit funding, relative to an alternative source of funding. The CDI iscore deposit intangibles are amortized on an accelerated basis following a pattern of the economic benefits of the core deposit intangible over an estimated useful life which approximatesof the existing deposit relationships acquired on an accelerated method.acquired. The Company evaluates such identifiable intangibles for impairment annually or more frequently if an indication of impairment exists.
Goodwill
The Company’s goodwill represents the excess of the purchase price over the fair value of net assets acquired in certain mergers and acquisitions. Goodwill is assigned to Heritagethe Bank and is evaluated for impairment at the Bank level (reporting(single reporting unit) on an annual basis or more frequently if an indication of impairment exists between the annual tests. Factors to consider may include, among others: a significant change in legal factors or in the general business climate; significant change in the Company’s stock price and market capitalization; unanticipated competition; and an action or assessment by a regulator.
For the goodwill impairment assessment, the Company has the option, prior to the two-step process, to firsteither assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more-likely-than-not that the fair value of athe reporting unit is less than its carrying value. The Company optedvalue and a quantitative test is needed or opts to bypass the qualitative assessment for its 2018analysis and 2017 annual goodwill impairment testing and proceed directly to the two-step goodwill impairment test.
performs a quantitative analysis only. The goodwill impairment two-step processquantitative analysis requires the Company to make assumptions and judgments regarding fair value. The first step of the goodwill impairment test is performed by comparing the reporting unit’s aggregate fair value to its carrying value. Absent other indicators of impairment, if the aggregate fair value exceeds the carrying value, goodwill is not considered impaired and no additional analysis is necessary. If the carrying value of the reporting unit were to exceed the aggregate fair value, a second step would be performed to measure the amount of impairment loss, if any. To measure any impairment loss the implied fair value would be determined in the same manner as if the reporting unit were being acquired in a business combination.unit. If the implied fair value of goodwill is less than the recorded goodwill, an impairment charge would be recorded for the difference.
For additional information relating to goodwill, see Note (8) Goodwill and Other Intangible Assets.
Income Taxes
The Company and the Bank file a United States consolidated federal income tax return and an Oregon State income tax return. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates applicable to taxable income in the periods in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date. A valuation allowance, if needed, reduces deferred tax assets to the amounts expected to be realized.
A tax position is recognized as a benefit only if it is “more"more likely than not”not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
The Company’s policy is to recognize interest and penalties on unrecognized tax benefits in “income taxes”income tax expense in the Consolidated Statements of Income as the amounts are generally insignificant each year.
Operating Leases
The Company has only identified leases classified as operating leases. Operating leases are recorded as ROU assets and ROU liabilities within prepaid expenses and other assets and accrued expenses and other liabilities, respectively, in the Consolidated Statements of Financial Condition. ROU assets represent the Company's right to use an underlying asset for the lease term and ROU liabilities represent the Company's obligation to make lease payments arising from the lease. Operating lease ROU assets and ROU liabilities are recognized at the lease agreement commencement date based on the present value of lease payments over the lease term. The lease term incorporates options to extend the lease when it is reasonably certain that the Company will exercise that option. As the Company's leases typically do not provide an implicit rate; the Company uses its incremental borrowing rate based on the information available at the operating lease commencement date in determining the present value of lease payments. The operating lease ROU asset is further reduced by any lease pre-payments made and lease incentives. The leases may contain various provisions for increases in rental rates based either on changes in the published Consumer Price Index or a predetermined escalation schedule and such variable lease payments are recognized as lease expense as they are incurred. The majority of the Company's leases include variable lease payments such as real estate taxes, maintenance, insurance and other similar costs in addition to the base rent. Lease expense for lease payments is recognized on a straight-line basis over the lease term.
The Company does not separate non-lease components from lease components and excludes operating leases with a term of twelve months or less from being capitalized as ROU assets and ROU liabilities. The Company follows a policy to capitalize lease agreements with total contractual lease payments of $25,000 or more. The Company does not account for any leases at a portfolio level.
Stock-Based Compensation
The Company maintains a number of stock-based incentive programs, which are discussed in more detail in Note (19) (17)
Stock-Based Compensation. Compensation cost is recognized for stock options, restricted stock awards and restricted stock units issued to employees and directors based on the fair value of these awards at the date of grant. Compensation cost is generally recognized over the requisite service period, generally defined as the vesting period, on a straight-line basis. Compensation cost for restricted stock units with market-based vesting is recognized over the service period to the extent the restricted stock units are expected to vest. Forfeitures are recognized as they occur.
The market price of the Company’s common stock at the date of grant is used to determine the fair value of the restricted stock awards and restricted stock units. The fair value of stock options granted is estimated based on the date of grant using the Black-Scholes-Merton option pricing model. Certain restricted stock unit grants are subject to performance-based vesting as well as other approved vesting conditions and cliff-vest based on those conditions, and the fair value is estimated using a Monte Carlo simulation pricing model. The assumptions used in the Black-Scholes-Merton option pricing model and the Monte Carlo simulation pricing model include the expected term based on the valuation date and the remaining contractual term of the award; the risk-free interest rate based on the U.S. Treasury curve at the valuation date of the award; the expected dividend yield based on expected dividends being payable to the holders; and the expected stock price volatility over the expected term based on the historical volatility over the equivalent historical term.
Low Income Housing Tax Credit Investments
The Company has 2 equity investments in LIHTC partnerships, which are indirect federal subsidies that finance low-income housing projects. As a limited liability investor in these partnerships, the Company receives tax benefits in the form of tax deductions from partnership operating losses and federal income tax credits. The federal income tax credits are earned over a 10-year period as a result of the investment properties meeting certain criteria and are subject to recapture for noncompliance with such criteria over a 15-year period. The Company accounts for the LIHTCs under the proportional amortization method and amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance on the Consolidated Statements of Income as a component of income tax expense. The Company reports the carrying value of the equity investments in the unconsolidated LIHTCs as prepaid expenses and other assets on the Company’s Statements of Financial Condition.
The maximum exposure to loss in the LIHTCs is the amount of equity invested and credit extended by the Company. Loans to these entities are underwritten in substantially the same manner as other loans and are secured. The Company has evaluated the variable interests held by the Company in each LIHTC investment and determined the Company does not have controlling financial interests in such investments and is not the primary beneficiary.
New Market Tax Credit Investments
Through May 2021, the Company held $25.0 million of qualified equity investments in 3 certified development entities eligible to receive NMTC. The NMTC program provides federal tax incentives to investors to make investments in distressed communities and promotes economic improvements through the development of successful businesses in these communities. The NMTC is available to investors over a seven-year period and is subject to recapture if certain events occur during such period. The Company is required to fund 85% of a tranche by a predetermined deadline to claim the entire tax credit. The Company funded its tranche before the deadline.
The Company dissolved the NMTC investment during the year ended December 31, 2021 after gross tax credits related to the Company's certified development entities totaling $9.8 million were utilized during the seven year period ending December 31, 2020. Prior to dissolution, the Company accounted for its NMTC on the equity method and reported the investment balance in prepaid expenses and other assets on the Consolidated Statements of Financial Condition and the related investment income was recognized in other income on the Consolidated Statements of Income.
Deferred Compensation Plans
The Company has a Deferred Compensation Plan and has entered into similar arrangements with certain executive officers. Under the Deferred Compensation Plan, participants are permitted to elect to defer compensation and the Company has the discretion to make additional contributions to the Deferred Compensation Plan on behalf of any participant based on a number of factors. Such discretionary contributions are generally approved by the Compensation Committee of the Company's Boardboard of Directors.directors. The notional account balances of participants under the Deferred Compensation Plan earn interest on an annual basis. The applicable interest rate is the Moody’s Seasoned Aaa Corporate Bond Yield as of January 1 of each year. Generally, a participant’s account is payable upon the earliest of the participant’s separation from service with the Company, the participant’s death or disability, or a specified date that is elected by the participant in accordance with applicable rules of the Internal Revenue Code.Code, as amended.
Additionally, in conjunction with the Company's merger with Premier Merger,Commercial Bancorp in 2018, the Company assumed thea Salary Continuation Plan. The Salary Continuation Plan is an unfunded non-qualified deferred compensation plan for select former Premier Commercial executive officers, some of which are current HeritageCompany officers. Under the Salary Continuation Plan, the Company will pay each participant, or their beneficiary, specified amounts over specified periods beginning with the individual's termination of service due to retirement subject to early termination provisions.
The Company’s obligation to make payments under the Deferred Compensation Plan and the Salary Continuation Plan is a general obligation of the Company and is to be paid from the Company’s general assets. As such, participants are general unsecured creditors of the Company with respect to their participation under both plans. The Company records a liability within accrued expenses and other liabilities on the Consolidated Statements of Financial Condition and records compensation and employee benefitsexpense on the Consolidated Statements of Income in a systematic and rational manner. Since the amounts earned under the Deferred Compensation Plan are generally based on the Company’s annual performance, the Company
records deferred compensation expense each year for an amount calculated based on that year’s financial performance.
Earnings per Share
The two-class method is used in the calculation of basic and diluted earnings per common share. Basic earnings per common share is net income allocated to common shareholders divided by the weighted average number of common shares outstanding during the period. All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities for this calculation. Dividends and undistributed earnings allocated to participating securities are excluded from net income allocated to common shareholders and participating securities are excluded from weighted average common shares outstanding. Diluted earnings per common share is calculated using the treasury stock method and includes the dilutive effect of additional potential common
shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements.
Derivative Financial Instruments
The commitments to originate mortgage loans held for sale and the related forward delivery contracts are considered derivatives. The Company also utilizes interest rate swap derivative contracts to facilitate the needs of its commercial customers whereby it enters into an interest rate swap with a customer while at the same time entering into an offsetting interest rate swap with another financial institution. In connection with each swap transaction, the Company agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, the Company agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the Company’s customer to effectively convert a variable rate loan to a fixed rate.rate and the Company recognizes immediate income based upon the difference in the bid/ask spread of the underlying transactions with its customers and the third-party. Because the Company acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact the Company’s results of operations. These interest rate swaps are not designated as hedging instruments.
The Company is exposed to credit-related losses in the event of nonperformance by the counterparty to these agreements. Credit risk for derivatives with the customer is controlled through the credit approval process, amount limits, and monitoring procedures and is concentrated within our primary market areas. Credit risk for derivatives with third-parties is concentrated among four well-known broker dealers.
Fee income related to interest rate swap derivative contract transactions is recorded in interest rate swap fees on the Consolidated Statements of Income. The fair value of derivative positions outstanding is included in prepaidPrepaid expenses and other assets and accruedAccrued expenses and other liabilities in the Company's Consolidated Statements of Financial Condition and the net change in each of these financial statement line items is included in the Consolidated Statements of Cash Flows. For non-hedging derivative instruments,Condition. The gains and losses due to changes in fair value and all cash flows are included in other noninterestOther income in the Company's Consolidated Statements of Income, but typically net to zero for the years ended December 31, 2018 and 2017 based on the identical back-to-back interest rate swaps.swaps unless a credit valuation adjustment is recorded to appropriately reflect nonperformance risk in the fair value measurement. Various factors impact changes in the credit valuation adjustments over time, including changes in the risk ratings of the parties to the contracts, as well as changes in market rates and volatilities, which affect the total expected exposure of the derivative instruments.
Advertising Expenses
Advertising costs are expensed as incurred. Costs related to production of advertising are considered incurred when the advertising is first used.
Provision for Credit Losses
The provision for credit losses as presented in the Consolidated Statements of Income includes the provision for credit losses on loans, the provision for credit losses on unfunded commitments and the provision for credit losses on investment securities.
Operating Segments
While the Company’s chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Operating segments are aggregated into onebasis as operating results for all segments are similar. Accordingly, all of the financial service operations are considered by management to be aggregated in one1 reportable operating segment.
Revenue from Contracts with Customers
The Company's revenues are primarily composed of interest income on financial instruments, such as loans and investment securities, whichsecurities. The Company's revenue derived from contracts with customers are excluded from the scope of ASC 606. Descriptions of the Company's revenue-generating activities that are within the scope ASC 606, which aregenerally presented in Service Chargesservice charges and Other Feesother fees and Other Incomeother income on the Company’s Consolidated Statement of Income are as follows:and includes the following:
•Service Charges on Deposit Accounts: The Company earns fees from its deposit customers from a variety of deposit products and services. Non-transaction based fees such as account maintenance fees and monthly statement fees are considered to be provided to the customer under a day-to-day contract with ongoing renewals. Revenues for these non-transaction fees are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Transaction-based fees such as non-sufficient fund charges, stop payment charges and wire fees are recognized at the time the transaction is executed as the contract duration does not extend beyond the service performed.
•Wealth Management and Trust Services:Management: The Company earns fees from contracts with customers for fiduciary and brokerage activities. Revenues are generally recognized on a monthly basis and are generally based on a percentage of the customer’s
assets under management or based on investment or insurance solutions that are implemented for the customer.
•Merchant Processing Services and Debit and Credit Card Fees: The Company earns fees from cardholder transactions conducted through third partythird-party payment network providers which consist of (i) interchange fees earned from the payment network as a debit card issuer, (ii) referral fee income, and (iii) ongoing merchant fees earned for referring customers to the payment processing provider. These fees are recognized when the transaction occurs, but may settle on a daily or monthly basis.
(d) Recently Issued or Adopted Accounting Pronouncements
FASB ASU 2014-09, Revenue from Contracts with Customers, (as amended by FASB ASU 2015-14; FASB ASU 2016-08; FASB ASU 2016-10 and FASB ASU 2016-12), was issued in May 2014. Under this Accounting Standard Update ("ASU" or "Update"), the Financial Accounting Standards Board ("FASB") created a new Topic 606 which is in response to a joint initiative of FASB and the International Accounting Standards Board to clarify the principles for
recognizing revenue and to develop a common revenue standard for U.S. GAAP and international financial reporting standards that would:
Remove inconsistencies and weaknesses in revenue requirements.
Provide a more robust framework for addressing revenue issues.
Improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets.
Provide more useful information to users of financial statements through improved disclosure requirements.
Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.
The Company adopted the revenue recognition guidance, as amended, on January 1, 2018 using the modified retrospective approach. A significant amount of the Company’s revenues are derived from interest income on financial assets, which are excluded from the scope of the amended guidance. With respect to noninterest income and related disclosures, the Company has identified and evaluated the revenue streams and underlying revenue contracts within the scope of the guidance. The Company did not identify any significant changes in the timing of revenue recognition when considering the amended accounting guidance. The adoption of the Update did not have a material impact on the Company's Consolidated Financial Statements, but the adoption did change certain disclosure requirements as described in Significant Accounting Policies above.
FASB ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10), was issued in January 2016, to enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information. This Update contains several provisions, including but not limited to (1) requiring equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income; (2) simplifying the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (3) eliminating the requirement to disclose the method(s) and significant assumptions used to estimate fair value; and (4) requiring separate presentation of financial assets and liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements. The Update also changes certain financial statement disclosure requirements, including requiring disclosures of the fair value of financial instruments be made on the basis of exit price. The Company adopted this Update effective January 1, 2018 using the cumulative catch-up transition method. This change resulted in a cumulative adjustment of $93,000 from accumulated other comprehensive loss, net to retained earnings for the unrealized gain related to the Company's equity security. The Company's processes and procedures utilized to estimate the fair value of loans receivable and certificate of deposit accounts for disclosure requirements were additionally changed due to adoption of this Update. Previously, the Company valued these items using an entry price notion. This ASU emphasized that these instruments be measured using the exit price notion; accordingly, the Company refined its calculation as part of adopting this Update. Prior period information has not been updated to conform with the new guidance. See the Consolidated Statements of Stockholders' Equity and Note (18) Fair Value Measurements.
FASB ASU 2016-02, Leases (Topic 842), as amended by ASU 2017-13, 2018-01, 2018-10, 2018-11 and ASU 2018-20,2018-11 and ASU 2019-01, was originally issued in February 2016, to increase transparency and comparability of leases among organizations and to disclose key information about leasing arrangements. The UpdateASU sets out the principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. The UpdateASU requires lessees to apply a dual approach, classifying leases as either a finance or operating lease. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-useROU asset and a lease liability for all leases with a term greater than 12 months regardless of their classification. All cash payments will beare classified within operating activities in the statement of cash flows. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The Update isASU was effective for public entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. During 2018, management developed its methodology to estimate the right-of use assets and lease liabilities and selected a vendor to assist with implementation and calculation of the impact under the modified retrospective approach. The Company adopted the UpdateASU on January 1, 2019 and elected an exclusion accounting policy for lease assets and lease liabilities forof leases with a term of twelve months or less. The adoption of this ASU resulted in the recognition of operating lease ROU assets and liabilities of approximately $29.3 million and $30.2 million, respectively.respectively, in prepaid expenses and other assets and accrued expenses and other liabilities in the Consolidated Statements of Financial Condition. This change also resulted in a cumulative-effect adjustment to beginning retained earnings of $399,000, net of tax, under the modified retrospective approach.
FASB ASU 2016-13, Financial Instruments:Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended by ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, and ASU 2020-02, was originally issued in June 2016. CommonlyThis ASU replaced the incurred loss methodology with an expected loss methodology, which is commonly referred to as the current"CECL" methodology. The measurement of expected credit loss model ("CECL"), this Updatelosses under the CECL methodology is applicable to financial assets measured at amortized cost, including loans receivable. It also applies to off-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments. In addition, CECL Adoption made changes to the accounting for credit losses on investment securities available for sale. This ASU requires financial assets measured at amortized cost basis to be
presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses is based on relevant information about past events including historical experience, current conditions and reasonable and supportable forecasts that affect the collectibility of the reported amount. The amendment affects loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables and any other financial asset not excluded from the scope that have the contractual right to receive cash. The Update replaces the incurred loss impairment methodology, which generally only considered past events and current conditions, with a methodology that reflects the expected credit losses and required consideration of a broader range of reasonable and supportable information to estimate all expected credit losses. The Update additionally addresses purchased assets and introduces the purchased financial asset with a more-than-insignificant amount of credit deterioration since origination ("PCD"). The accounting for these PCD assets is similar to the existing accounting guidance of FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, for PCI assets, except the subsequent improvements in estimated cash flows will be immediately recognized into income, similar to the immediate recognition of subsequent deteriorations in cash flows. Current guidance only allows for the prospective recognition of these cash flow improvements. Because the terminology has been changed to a "more-than-insignificant" amount of credit deterioration, the presumption is that more assets might qualify for this accounting under the Update than those under current guidance. For public business entities, the Update isthis ASU was effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years with early adoption permitted for fiscal years after December 15, 2018. An entity will apply the Update through2018, and can be delayed under a cumulative-effect adjustment to retained earnings asprovision of the beginningCARES Act until the end of the first reporting periodofficial health emergency declaration. The Company adopted ASU 2016-13 on January 1, 2020 using the modified retrospective method for all financial assets measured at amortized cost, investment securities available for sale and unfunded commitments. At adoption, the Bank elected not to measure an ACL on accrued interest receivable on loans receivable or accrued interest receivable on investment securities available for sale as Bank policy is to reverse interest income for uncollectible accrued interest receivable balances in a timely manner. The Significant Accounting Policies section above reflects the policies after adoption. The CECL Adoption had the following impacts:
Investment Securities
As of December 31, 2019, the Company only held investment securities available for sale, had no historical charge-off or recovery history and did not have any investment securities available for sale outstanding at the adoption date for which an other-than-temporary impairment was previously recorded. At the guidance is adopted. A prospectiveadoption date of ASU 2016-13, the unrealized losses present in the portfolio of investment securities available for sale were primarily due to decreases in market interest rates on floating rate investment securities since the purchase of the securities and the fair value of these securities was expected to recover as the securities approach their maturity dates. The basis of management’s conclusion was that at December 31, 2019, 83.5% of the investment securities were issued by or guaranteed by the United States government or its agencies, 14.0% were issued and guaranteed by State and local governments and the remainder of the portfolio was invested in at least investment-grade securities. As a result of the analysis, no ACL on investment securities available for sale was recorded upon adoption.
Loan Receivable
ASU 2016-13 replaced the allowance for loan losses with the ACL on loans on the Consolidated Statements of Financial Condition and replaced the related provision for loan losses with the provision for credit losses as presented on the Consolidated Statements of Income, which now additionally includes the provision for credit losses on unfunded commitments discussed below.
The adoption was completed in a specific order beginning with the transition approach is requiredof PCI loans to PCD loans. The Bank elected to account for debt securities. An entitythe PCD loans individually, terminating the pools of loans that haswere previously appliedaccounted for under ASC 310-30. First, an ACL on loans was determined for each PCI loan. The ACL on PCI loans was added to the guidance of FASB ASC 310-30 will prospectively applyloan's carrying amount to establish a PCD loan at its amortized cost basis. The difference between the guidance in this Update for PCD assets. A prospective transition approach should be used for PCD assets where upon adoption,outstanding principal balance and the amortized cost basis should be adjusted to reflect the addition of the PCD loan is a noncredit premium or discount, which is amortized into interest income over the remaining life of the PCD loan. The PCI to PCD transition did not have an impact on
beginning retained earnings; however, it did have the effect of reducing the existing allowance for PCI loans by $1.6 million under the CECL methodology as compared to the previous ASC 310-10 methodology.
Following the PCI to PCD transition, the Bank recorded a pretax increase to the ACL on loans of $3.4 million to increase the reserve to the estimated credit losses.losses at January 1, 2020 based on its CECL methodology as part of the cumulative-effect adjustment to beginning retained earnings. The Company is anticipating adoptingpretax increase to the UpdateACL on loans of $3.4 million and the reduction in ACL on loans due to the PCI to PCD transition of $1.6 million resulted in an increase in the ACL on loans of $1.8 million at January 1, 2020. Upon adoption, the Company expects a change in the processes, internal controls and procedures to calculate the allowance for loan losses, including changes in assumptions and estimates to consider expected credit losses over the lifeadjusted beginning balance of the loan versusACL on loans as a percentage of loans receivable was 1.01% as compared to 0.96% at December 31, 2019 under the current accounting practice that utilizes theprior incurred loss model. methodology.
The new guidance may resultPCI to PCD transition also resulted in a net discount of $4.3 million for PCD loans, or an increase in the allowancenet discount for loan losses which will also reflectPCD loans of $1.6 million. Following the new requirementtransition, the total net discount for purchased loans increased to include$10.0 million at January 1, 2020 compared to $8.4 million as of December 31, 2019.
Unfunded Commitments
ASU 2016-13 replaced the nonaccretable principal differences on PCI loans; however, the Company is still in the process of determining the magnitude of the increase and its impact on the Consolidated Financial Statements. In addition, the current accounting policy and proceduresreserve for other-than-temporary impairment on investment securities available for sale will be replaced with an allowance approach. During 2017, the Company's management created a CECL steering committee to ensure it is fully compliantunfunded commitments with the amendments at the adoption date. During 2018, the CECL steering committee selected a vendor to assist the CompanyACL on unfunded commitments as included in the adoption, completed the implementation discovery sessions,Accrued liabilities and selected appropriate methodologies. The CECL steering committee is in the process of refining key data to process through its CECL models and developing formal CECL processes and procedures. The Company anticipates running parallel existing ALLL and CECL models by second quarter 2019.
FASB ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, was issued in August 2016. The Update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. For public business entities, the guidance was effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, and must be applied using a retrospective transitional method to each period presented. The Company adopted this Updateother expenses on January 1, 2018. The adoption did not have a significant impact on its Consolidated Financial Statements as cash proceeds received from the settlement of bank-owned life insurance policies and cash payments for premiums on bank-owned life insurance policies were previously classified as cash inflows and outflows, respectively, from investing activities in the Consolidated Statements of Cash Flows.Financial Condition and replaced the provision for unfunded commitments which was previously recorded in Other expense with the provision for credit losses as presented on the Consolidated Statements of Income, which now additionally includes the provision for credit losses on loans discussed above. Upon adoption, the Bank recorded a pretax increase in the beginning ACL on unfunded commitments of $3.7 million.
Overall CECL Adoption Impact
The adoption of ASU 2016-13, including the above mentioned increase to the ACL on loans of $3.4 million and the increase to the ACL on unfunded commitments of $3.7 million, resulted in a pretax cumulative-effect adjustment of $7.1 million. The impact of this adjustment to beginning retained earnings on January 1, 2020 was $5.6 million, net of tax.
FASB ASU 2017-042020-04, GoodwillReference Rate Reform (Topic 350)848), as amended by ASU 2021-01, was issued in January 2017March 2020 and eliminates Step 2 fromprovides optional guidance for a limited period of time to ease the goodwill impairment test. Underpotential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. The amendments an entity should perform its goodwill impairment testin this ASU are effective for all entities as of March 12, 2020 through December 31, 2022. The amendments are elective, apply to all entities, and provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by comparingreference rate reform if certain criteria are met. The Bank’s interest rate swap-related transactions are the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The loss recognized, however, should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amountmajority of the reporting unit when measuringCompany's LIBOR exposure. Effective January 25, 2021, the goodwill impairment loss, if applicable. The Update is effective for annual periods or any interim goodwill impairment tests beginning after December 15, 2019 using a prospective transition methodCompany adhered to the Interbank Offered Rate Fallbacks Protocol as published by the International Swaps and early adoption is permitted.Derivatives Association, Inc. and recommended by the Alternative Reference Rates Committee. The Company does not expect the Update willthis ASU to have a material impact on its business operations and the Condensed Consolidated Financial Statements.
FASB ASU 2017-08, Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt
(2)Investment Securities was issued in March 2017 and changes the accounting for certain
purchased callable debt securities held at a premium to shorten the amortization period for the premium to the earliest call date rather than to the maturity date. Accounting for purchased callable debt securities held at a discount does not change. The discount would continue to amortize to the maturity date. The Update is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. The Company adopted this Update in January 2018. The adoption did not have a material impact on its Consolidated Financial Statements as the Company had been accounting for premiums as prescribed under this guidance.
FASB ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting was issued in May 2017 to provide clarity as to when to apply modification accounting when there is a change in the terms or conditions of a share-based payment award. According to this Update, an entity should account for the effects of a modification unless the fair value, vesting conditions and balance sheet classification of the award is the same after the modification as compared to the original award prior to the modification. The Update was effective for reporting periods beginning after December 15, 2017. The Company adopted the Update on January 1, 2018. The adoption did not have a material impact on its Consolidated Financial Statements because no share-based payment award was modified during the year ended December 31, 2018. The Company will apply this Update prospectively for any subsequent modifications of share-based payment awards.
FASB ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income was issued to address the income tax accounting treatment of the stranded tax effects within other comprehensive income due to the prohibition of backward tracing due to an income tax rate change that was initially recorded in other comprehensive income. This issue came about from the enactment of the Tax Cuts and Jobs Act on December 22, 2017 ("Tax Cuts and Jobs Act") that changed the Company’s income tax rate from 35% to 21%. The Update changed current accounting whereby an entity may elect to reclassify the stranded tax effect from accumulated other comprehensive income (loss) to retained earnings. The Update is effective for periods beginning after December 15, 2018 and early adoption was permitted. The Company early adopted ASU 2018-02 effective December 31, 2017 and elected a portfolio policy to reclassify the stranded tax effects of the change in the federal corporate tax rate of the net unrealized gains on its available-for-sale investment securities of $218,000 from accumulated other comprehensive loss, net to retained earnings. See the Consolidated Statements of Stockholders' Equity.
FASB ASU 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 was issued to provide guidance on the income tax accounting implications of the Tax Cuts and Jobs Act, and allows for entities to report provisional amounts for specific income tax effects of the Tax Cuts and Jobs Act for which the accounting under ASC Topic 740 was not yet complete but a reasonable estimate could be determined. A measurement period of one-year is allowed to complete the accounting effects under ASC Topic 740 and revise any previous estimates reported. Any provisional amounts or subsequent adjustments included in an entity’s financial statements during the measurement period should be included in income from continuing operations as an adjustment to tax expense in the reporting period the amounts are determined. The Company adopted this Update with the provisional adjustments as reported in the Consolidated Financial Statements on Form 10-K as of December 31, 2017. As of December 31, 2018, the Company did not incur any adjustments to the provisional recognition.
FASB ASU 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, was issued in August 2018 and modifies the disclosure requirements on fair value measurements in Topic 820. The amendments in this Update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company does not expect the Update will have a material impact on its Consolidated Financial Statements.
During the year ended December 31, 2018, the Company completed the acquisitions of Puget Sound Bancorp and Premier Commercial Bancorp. There were no acquisitions completed during the year ended December 31, 2017.
Puget Sound Merger:
On July 26, 2017, the Company, along with the Bank, and Puget Sound Bancorp, Inc. and its wholly owned subsidiary bank, Puget Sound Bank, jointly announced the signing of a definitive agreement. The Puget Sound Merger was effective on January 16, 2018. As of the acquisition date, Puget Sound merged into Heritage and Puget Sound Bank merged into Heritage Bank.
Pursuant to the terms of the Puget Sound Merger, all outstanding Puget Sound restricted stock awards became immediately vested on the acquisition date of the Puget Sound Merger. Puget Sound shareholders received 1.1688 shares of Heritage common stock per share of Puget Sound stock. Heritage issued an aggregate of 4,112,258 shares of its common stock based on the January 12, 2018 closing price of Heritage Common stock of $31.80 for total fair
value of common shares issued of $130.8 million and paid cash of $3,000 for fractional shares in the transaction for total consideration paid of $130.8 million. Total consideration includes $851,000 representing 26,741 shares which were forfeited by the Puget Sound shareholders to pay applicable taxes.
The Company incurred acquisition-related costs of approximately $5.4 million and $810,000 for the year ended December 31, 2018 and 2017, respectively, for the Puget Sound Merger.
Premier Merger:
On March 24, 2018, the Company, along with the Bank, and Premier Commercial Bancorp and its wholly owned subsidiary bank, Premier Community Bank, jointly announced the signing of a definitive agreement. The Premier Merger was effective on July 2, 2018. As of the acquisition date, Premier merged into Heritage and Premier Commercial Bank merged into Heritage Bank.
Pursuant to the terms of the Premier Merger, Premier Commercial shareholders received 0.4863 shares of Heritage common stock in exchange for each share of Premier Commercial common stock based on the closing date price per share of Heritage common stock on June 29, 2018 of $34.85. Heritage issued an aggregate of 2,848,579 shares of its common stock and paid cash of $2,000 for fractional shares in the transaction for total consideration paid of $99.3 million.
The Company incurred acquisition-related costs of approximately $4.9 million for the year ended December 31, 2018 for the Premier Merger.
Business Combination Accounting:
The Premier Merger and Puget Sound Merger resulted in $53.4 million and $68.5 million, respectively, of goodwill. This goodwill is not deductible for tax purposes.
The primary reason for the Premier and Puget Mergers was to create depth in the Company's geographic footprint consistent with its ongoing growth strategy, focused heavily on metro markets, and to achieve operational scale and realize efficiencies of a larger combined organization. The mergers constitute business acquisitions as defined by FASB ASC 805, Business Combinations. FASB ASC 805 establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired and the liabilities assumed. Heritage was considered the acquirer in these transactions. Accordingly, the preliminary estimates of fair values of Premier Commercial and Puget Sound assets, including the identifiable intangible assets, and the assumed liabilities, were measured and recorded as of the respective acquisition dates. Fair values on the acquisition dates are preliminary and represent management’s best estimates based on available information and facts and circumstances in existence on the acquisition date. Fair values are subject to refinement for up to one year after the closing date of the acquisitions as additional information regarding the closing date fair values becomes available. The Company finalized the purchase price allocation for both mergers as of December 31, 2018 and recorded an adjustment to the Premier Commercial fair values of total loans receivable, prepaid expenses and other assets and accrued expenses and other liabilities during the quarter end December 31, 2018 with a net impact to goodwill acquired of $102,000.
The fair value estimates of the assets acquired and liabilities assumed in the Premier and Puget Mergers were as follows:
|
| | | | | | | |
| | Premier Merger | | Puget Sound Merger |
| | (In thousands) |
| Assets | | | |
| Cash and cash equivalents | $ | 22,534 |
| | $ | 25,889 |
|
| Interest earning deposits | 3,309 |
| | 54,247 |
|
| Investment securities available for sale | 4,493 |
| | 80,353 |
|
Loans receivable (1) | 330,158 |
| | 388,462 |
|
| Other real estate owned | 1,796 |
| | — |
|
| Premises and equipment, net | 3,053 |
| | 732 |
|
| Federal Home Loan Bank stock, at cost | 1,120 |
| | 623 |
|
| Bank owned life insurance | 10,852 |
| | 6,264 |
|
| Accrued interest receivable | 1,006 |
| | 1,448 |
|
| Prepaid expenses and other assets | 1,603 |
| | 1,354 |
|
| Other intangible assets | 7,075 |
| | 11,270 |
|
| Total assets acquired | $ | 386,999 |
| | $ | 570,642 |
|
| Liabilities | | | |
| Deposits | $ | 318,717 |
| | $ | 505,885 |
|
| Federal Home Loan Bank advances | 16,000 |
| | — |
|
| Securities sold under agreement to repurchase | 462 |
| | — |
|
| Accrued expenses and other liabilities | 5,935 |
| | 2,504 |
|
| Total liabilities acquired | $ | 341,114 |
| | $ | 508,389 |
|
| | | | |
| Fair value of net assets acquired | $ | 45,885 |
| | $ | 62,253 |
|
| |
(1)
| The outstanding loan balance acquired in the Premier Merger and Puget Sound Merger was $335.4 million and $392.7 million, respectively, at the acquisition date. |
A summary of the net assets purchased and the estimated fair value adjustments and resulting goodwill recognized from the Premier and Puget Sound Mergers are presented in the following tables. Goodwill represents the excess of the consideration transferred over the estimated fair value of the net assets acquired and liabilities assumed.
|
| | | | | | | |
| | Premier Merger | | Puget Sound Merger |
| | (In thousands) |
| Consideration transferred | $ | 99,275 |
| | $ | 130,773 |
|
| | | | |
| Cost basis of net assets on merger date | $ | 40,629 |
| | $ | 54,405 |
|
| Fair value adjustments: | | | |
| Investment securities | (135 | ) | | (348 | ) |
| Total loans receivable, net | (111 | ) | | 1,400 |
|
| Other real estate owned | (1,017 | ) | | — |
|
| Premises and equipment | 1,312 |
| | (121 | ) |
| Other intangible assets | 7,075 |
| | 9,207 |
|
| Prepaid expenses and other assets | (1,912 | ) | | (2,282 | ) |
| Deposits | (310 | ) | | (62 | ) |
| Accrued expenses and other liabilities | 354 |
| | 54 |
|
| Fair value of net assets on merger date | $ | 45,885 |
| | $ | 62,253 |
|
| | | | |
| Goodwill recognized from the mergers | $ | 53,390 |
| | $ | 68,520 |
|
The operating results of the Company for the year ended December 31, 2018 include the operating results produced by the net assets acquired in the Premier and Puget Mergers since the July 2, 2018 and January 16, 2018 merger dates. The Company has considered the requirement of FASB ASC 805 related to the contribution of the Premier and Puget Mergers to the Company’s results of operations. The table below presents only the significant results for the acquired businesses since the July 2, 2018 and January 16, 2018 merger dates:
|
| | | | | | | | | | | |
| | Premier Merger (1) | | Puget Sound Merger (1) | | Total |
| | Year ended December 31, 2018 |
| | (In thousands) |
Interest income: Interest and fees on loans (2) | $ | 10,462 |
| | $ | 21,898 |
| | $ | 32,360 |
|
Interest income: Interest and fees on investments (3) | 76 |
| | 59 |
| | 135 |
|
| Interest income: Other interest earning assets | 174 |
| | 113 |
| | 287 |
|
| Interest expense | (445 | ) | | (682 | ) | | (1,127 | ) |
| Provision for loan losses for loans | (700 | ) | | (850 | ) | | (1,550 | ) |
| Noninterest income | 125 |
| | 472 |
| | 597 |
|
Noninterest expense (4) | (7,558 | ) | | (11,230 | ) | | (18,788 | ) |
| Net effect, pre-tax | $ | 2,134 |
| | $ | 9,780 |
| | $ | 11,914 |
|
(1) The Premier Merger was completed on July 2, 2018. The Puget Sound Merger was completed on January 16, 2018.
(2) Includes the accretion of the discount on the purchased loans of $4.1 million during the year ended December 31, 2018.
(3) All securities acquired in the Puget Sound Merger were sold with trade date of January 16, 2018 and settlement dates on or before February 14, 2018.
(4) Excludes certain compensation and employee benefits for management as it is impracticable to determine due to the integration of the operations for this merger. Also includes certain acquisition-related costs incurred by the Company.
The following table presents certain pro forma information, for illustrative purposes only, for the years ended December 31, 2018 and 2017 as if the Premier and Puget Mergers had occurred on January 1, 2017. The estimated pro forma information combines the historical results of Premier Commercial and Puget Sound with the Company's consolidated historical results and includes certain adjustments reflecting the estimated impact of certain fair value adjustments for the respective periods. The pro forma information is not indicative of what would have occurred had the Premier and Puget Mergers occurred on January 1, 2017. In particular, the pro forma information does not consider any changes to the provision for loan losses resulting from recorded loans at fair value. Additionally, Heritage expects to achieve further operating savings and other business synergies, including interest income growth, as a result of the Premier and Puget Mergers which are not reflected in the pro forma amounts in the following table. As a result, actual amounts will differ from the pro forma information presented.
|
| | | | | | | |
| | Pro Forma for the Year Ended December 31, |
| | 2018 | | 2017 |
| | (Dollars in thousands, except per share amounts) |
| Net interest income | $ | 194,989 |
| | $ | 174,190 |
|
| Net income | 69,515 |
| | 41,551 |
|
| Basic earnings per common share | $ | 1.88 |
| | $ | 1.12 |
|
| Dilutive Earnings per common share | $ | 1.87 |
| | $ | 1.12 |
|
The Company believes that the historical Premier Commercial and Puget Sound operating results, individually or collectively, are not considered of enough significance to be meaningful to the Company’s results of operations.
The Company’s investment policy is designed primarily to provide and maintain liquidity, generate a favorable return on assets without incurring undue interest rate and credit risk and complement the Bank’s lending activities.
As a result ofDuring the adoption of FASB ASU 2016-01 on January 1, 2018, equity investments (except for investments accounted for underthree months ended September 30, 2021, the equity method of accounting) are now measuredCompany reassessed and transferred, at fair value, with changes in fair value recognized in earnings. These investments were previously measured at fair value, with changes in fair value
recognized in accumulated other comprehensive income (loss). Accordingly, theseU.S. government and agency securities are no longer classified as investment securitiesfrom the available for sale and their presentation is not comparableclassification to the presentation asheld to maturity classification. The net unrealized after tax gain of December 31, 2017. See Note (1) Description$1.3 million remained in AOCI to be amortized over the remaining life of Business, Basisthe securities, offsetting the related amortization of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements, as well asdiscount or premium on the Equity Securities section discussed below.
Available for sale investment securities
(a) Securities by Type and Maturity
The amortized cost, gross unrealizedtransferred securities. No gains gross unrealizedor losses and fair values of investment securities available for salewere recognized at the dates indicated were as follows:time of the transfer.
|
| | | | | | | | | | | | | | | |
| | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
| | (In thousands) |
| December 31, 2018 | | | | | | | |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 101,595 |
| | $ | 155 |
| | $ | (147 | ) | | $ | 101,603 |
|
| Municipal securities | 158,461 |
| | 1,209 |
| | (806 | ) | | 158,864 |
|
Mortgage-backed securities and collateralized mortgage obligations (1): | | | | | | |
|
| Residential | 337,295 |
| | 426 |
| | (6,119 | ) | | 331,602 |
|
| Commercial | 338,250 |
| | 1,035 |
| | (5,524 | ) | | 333,761 |
|
| Corporate obligations | 25,662 |
| | 36 |
| | (135 | ) | | 25,563 |
|
| Other asset-backed securities | 24,278 |
| | 424 |
| | — |
| | 24,702 |
|
| Total | $ | 985,541 |
|
| $ | 3,285 |
|
| $ | (12,731 | ) |
| $ | 976,095 |
|
| | | | | | | | |
| December 31, 2017 | | | | | | | |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 13,460 |
| | $ | 6 |
| | $ | (24 | ) | | $ | 13,442 |
|
| Municipal securities | 247,358 |
| | 3,720 |
| | (1,063 | ) | | 250,015 |
|
Mortgage-backed securities and collateralized mortgage obligations (1): | | | | | | |
|
| Residential | 282,724 |
| | 422 |
| | (2,935 | ) | | 280,211 |
|
| Commercial | 219,696 |
| | 444 |
| | (3,061 | ) | | 217,079 |
|
| Collateralized loan obligations | 4,561 |
| | 19 |
| | — |
| | 4,580 |
|
| Corporate obligations | 16,594 |
| | 220 |
| | (44 | ) | | 16,770 |
|
Other securities (2) | 27,781 |
| | 652 |
| | — |
| | 28,433 |
|
| Total | $ | 812,174 |
|
| $ | 5,483 |
|
| $ | (7,127 | ) |
| $ | 810,530 |
|
| |
(1)
| Issued and guaranteed by U.S. Government-sponsored agencies. |
| |
(2)
| Primarily asset-backed securities. |
There were no investment securities classified as trading at December 31, 2021 or December 31, 2020. There were no investment securities classified as held to maturity at December 31, 2018 or December 31, 2017.2020.
(a) Investment Securities by Classification Type and Maturity
The following tables present the amortized cost and fair value of investment securities at the dates indicated and the corresponding amounts of gross unrealized gains and losses, including the corresponding amounts of gross unrealized gains and losses on investment securities available for sale recognized in AOCI:
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
| (In thousands) |
| Investment securities available for sale: | | | | | | | |
| U.S. government and agency securities | $ | 21,494 | | | $ | 55 | | | $ | (176) | | | $ | 21,373 | |
| Municipal securities | 213,158 | | | 8,908 | | | (854) | | | 221,212 | |
| Residential CMO and MBS | 307,366 | | | 2,111 | | | (2,593) | | | 306,884 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
| (In thousands) |
| Commercial CMO and MBS | 313,169 | | | 3,891 | | | (1,199) | | | 315,861 | |
| Corporate obligations | 2,007 | | | 7 | | | — | | | 2,014 | |
| Other asset-backed securities | 26,638 | | | 369 | | | (16) | | | 26,991 | |
| Total | $ | 883,832 | | | $ | 15,341 | | | $ | (4,838) | | | $ | 894,335 | |
| | | | | | | |
| Investment securities held to maturity: | | | | | | | |
| U.S. government and agency securities | $ | 141,011 | | | $ | 120 | | | $ | (1,768) | | | $ | 139,363 | |
| | | | | | | |
| Residential CMO and MBS | 24,529 | | | — | | | (153) | | | 24,376 | |
| Commercial CMO and MBS | 217,853 | | | — | | | (5,261) | | | 212,592 | |
| | | | | | | |
| | | | | | | |
| Total | $ | 383,393 | | | $ | 120 | | | $ | (7,182) | | | $ | 376,331 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2020 |
| Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | | | Fair
Value |
| (In thousands) |
| Investment securities available for sale: | | | | | | | | | |
| U.S. government and agency securities | $ | 44,713 | | | $ | 947 | | | $ | — | | | | | $ | 45,660 | |
| Municipal securities | 197,634 | | | 12,561 | | | (227) | | | | | 209,968 | |
| Residential CMO and MBS | 196,956 | | | 5,125 | | | (209) | | | | | 201,872 | |
| Commercial CMO and MBS | 290,638 | | | 13,198 | | | (90) | | | | | 303,746 | |
| Corporate obligations | 10,971 | | | 125 | | | — | | | | | 11,096 | |
| Other asset-backed securities | 29,283 | | | 565 | | | (27) | | | | | 29,821 | |
| Total | $ | 770,195 | | | $ | 32,521 | | | $ | (553) | | | | | $ | 802,163 | |
The amortized cost and fair value of investment securities available for sale at December 31, 2018,2021, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
| | | | | | | | | | | | | | | | | | | | | | | |
| Securities Available for Sale | | Securities Held to Maturity |
| Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value |
| (In thousands) |
| Due in one year or less | $ | 7,009 | | | $ | 7,095 | | | $ | — | | | $ | — | |
| Due after one year through five years | 28,441 | | | 29,608 | | | — | | | — | |
| Due after five years through ten years | 71,319 | | | 74,089 | | | 68,210 | | | 68,014 | |
| Due after ten years | 156,528 | | | 160,798 | | | 72,801 | | | 71,349 | |
| | | | | | | |
| Total investment securities due at a single maturity date | 263,297 | | | 271,590 | | | 141,011 | | | 139,363 | |
Mortgage-backed securities (1) | 620,535 | | | 622,745 | | | 242,382 | | | 236,968 | |
| Total | $ | 883,832 | | | $ | 894,335 | | | $ | 383,393 | | | $ | 376,331 | |
|
| | | | | | | |
| | Amortized Cost | | Fair Value |
| | (In thousands) |
| Due in one year or less | $ | 38,547 |
| | $ | 38,478 |
|
| Due after one year through five years | 193,191 |
| | 192,556 |
|
| Due after five years through ten years | 272,408 |
| | 268,779 |
|
| Due after ten years | 481,395 |
| | 476,282 |
|
| Total | $ | 985,541 |
|
| $ | 976,095 |
|
There were no holdings of investment securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders’ equity at December 31, 2021 and December 31, 2020.
(b) Unrealized Losses and Other-Than-Temporary Impairmentson Investment Securities Available for Sale
The following table showstables show the gross unrealized losses and fair value of the Company'sCompany’s investment securities available for sale that arefor which an ACL on investment securities available for sale has not deemed to be other-than-temporarily impaired,been recorded, aggregated by investment category
and length of time that the individual securities have been in a continuous unrealized loss positions as of December 31, 2018 and December 31, 2017:position at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Less than 12 Months | | 12 Months or Longer | | Total |
| Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses |
| (In thousands) |
| U.S. government and agency securities | $ | 14,828 | | | $ | (176) | | | $ | — | | | $ | — | | | $ | 14,828 | | | $ | (176) | |
| Municipal securities | 29,774 | | | (619) | | | 9,351 | | | (235) | | | 39,125 | | | (854) | |
| Residential CMO and MBS | 204,039 | | | (2,470) | | | 19,862 | | | (123) | | | 223,901 | | | (2,593) | |
| Commercial CMO and MBS | 83,283 | | | (1,161) | | | 1,936 | | | (38) | | | 85,219 | | | (1,199) | |
| | | | | | | | | | | |
| Other asset-backed securities | 2,763 | | | (9) | | | 1,118 | | | (7) | | | 3,881 | | | (16) | |
| Total | $ | 334,687 | | | $ | (4,435) | | | $ | 32,267 | | | $ | (403) | | | $ | 366,954 | | | $ | (4,838) | |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| | Less than 12 Months | | 12 Months or Longer | | Total |
| | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses |
| | (In thousands) |
| December 31, 2018 | | | | | | | | | | | |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 46,992 |
| | $ | (58 | ) | | $ | 7,350 |
| | $ | (89 | ) | | $ | 54,342 |
| | $ | (147 | ) |
| Municipal securities | 31,157 |
| | (159 | ) | | 38,792 |
| | (647 | ) | | 69,949 |
| | (806 | ) |
Mortgage-backed securities and collateralized mortgage obligations (1): | | | | | | | | |
| |
|
| Residential | 66,620 |
| | (247 | ) | | 193,726 |
| | (5,872 | ) | | 260,346 |
| | (6,119 | ) |
| Commercial | 43,531 |
| | (272 | ) | | 190,585 |
| | (5,252 | ) | | 234,116 |
| | (5,524 | ) |
| Corporate obligations | 13,736 |
| | (87 | ) | | 1,951 |
| | (48 | ) | | 15,687 |
| | (135 | ) |
| Total | $ | 202,036 |
|
| $ | (823 | ) |
| $ | 432,404 |
|
| $ | (11,908 | ) |
| $ | 634,440 |
|
| $ | (12,731 | ) |
| | | | | | | | | | | | |
| December 31, 2017 | | | | | | | | | | | |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 11,436 |
| | $ | (24 | ) | | $ | — |
| | $ | — |
| | $ | 11,436 |
| | $ | (24 | ) |
| Municipal securities | 39,298 |
| | (384 | ) | | 26,509 |
| | (679 | ) | | 65,807 |
| | (1,063 | ) |
Mortgage-backed securities and collateralized mortgage obligations (1): | | | | | | | | | | | |
| Residential | 175,847 |
| | (1,296 | ) | | 66,380 |
| | (1,639 | ) | | 242,227 |
| | (2,935 | ) |
| Commercial | 75,121 |
| | (700 | ) | | 90,822 |
| | (2,361 | ) | | 165,943 |
| | (3,061 | ) |
| Corporate obligations | 3,472 |
| | (44 | ) | | — |
| | — |
| | 3,472 |
| | (44 | ) |
| Total | $ | 305,174 |
|
| $ | (2,448 | ) |
| $ | 183,711 |
|
| $ | (4,679 | ) |
| $ | 488,885 |
|
| $ | (7,127 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2020 |
| Less than 12 Months | | 12 Months or Longer | | Total |
| Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses |
| (In thousands) |
| | | | | | | | | | | |
| Municipal securities | $ | 10,264 | | | $ | (227) | | | $ | — | | | $ | — | | | $ | 10,264 | | | $ | (227) | |
| | | | | | | | | | | |
| Residential CMO and MBS | — | | | — | | | 25,293 | | | (209) | | | 25,293 | | | (209) | |
| Commercial CMO and MBS | 11,404 | | | (29) | | | 7,499 | | | (61) | | | 18,903 | | | (90) | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Other asset-backed securities | — | | | — | | | 4,570 | | | (27) | | | 4,570 | | | (27) | |
| Total | $ | 21,668 | | | $ | (256) | | | $ | 37,362 | | | $ | (297) | | | $ | 59,030 | | | $ | (553) | |
(1) Issued and guaranteed by U.S. Government-sponsored agencies.
(c) ACL on Investment Securities
The Company has evaluated these investment securities available for sale as of December 31, 20182021 and December 31, 20172020 and has determined that the declineany declines in their value is not other-than-temporary. The unrealized losses are primarily due to increases in market interest rates. The fair value were attributable to changes in interest rates relative to where these investments fall within the yield curve and individual characteristics. Management monitors published credit ratings for adverse changes for all rated investment securities and none of these securities is expected to recover as the securities approach their maturity date. None of the underlying issuers of the municipal securities and corporate obligations had credit ratings that werea below investment grade levels atcredit rating as of both December 31, 2018 or2021 and December 31, 2017. The2020. In addition, the Company hasdoes not intend to sell these securities nor does the ability and intentCompany consider it more likely than not that it will be required to holdsell these securities before the investments until recovery of the securities' amortized cost basis, which may be upon maturity. Therefore, no ACL on investment securities available for sale was recorded as of December 31, 2021 and December 31, 2020.
The Company also evaluated investment securities held to maturity for current expected credit losses. There were no investment securities held to maturity classified as nonaccrual or past due as of December 31, 2021 and all were issued by the U.S. government and its agencies and either explicitly or implicitly guaranteed by the U.S. government, highly rated by major credit rating agencies and have a long history of no credit losses. Accordingly, the Company did not measure expected credit losses on investment securities held to maturity datesince the historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment of the securities.
For the years endedamortized cost basis is zero. Therefore, no ACL on investment securities held to maturity was recorded as of December 31, 2018, 2017 and 2016 there were no other-than-temporary charges recorded to net income.2021.
(c)(d) Realized Gains and Losses
The following table presents the gross realized gains and losses on the sale of investment securities available for sale for the years ended December 31, 2018, 20172021, December 31, 2020 and 2016:December 31, 2019:
| | | | | | | | | | | | | | | | | |
| Year ended December 31, |
| 2021 | | 2020 | | 2019 |
| (In thousands) |
| Gross realized gains | $ | 29 | | | $ | 1,537 | | | $ | 558 | |
| Gross realized losses | — | | | (19) | | | (228) | |
| Net realized gains | $ | 29 | | | $ | 1,518 | | | $ | 330 | |
|
| | | | | | | | | | | |
| | Year ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | (In thousands) |
| Gross realized gains | $ | 273 |
| | $ | 193 |
| | $ | 1,518 |
|
| Gross realized losses | (136 | ) | | (187 | ) | | (203 | ) |
| Net realized gains | $ | 137 |
| | $ | 6 |
| | $ | 1,315 |
|
(d)(e) Pledged Securities
The following table summarizes the amortized cost and fair value of investment securities available for sale that are pledged as collateral for the following obligations at December 31, 2018 and December 31, 2017:
|
| | | | | | | | | | | | | | | |
| | December 31, 2018 | | December 31, 2017 |
| | Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value |
| | (In thousands) |
| Washington and Oregon state to secure public deposits | $ | 199,026 |
| | $ | 196,786 |
| | $ | 206,377 |
| | $ | 206,425 |
|
| Repurchase agreements | 48,173 |
| | 47,407 |
| | 48,750 |
| | 48,237 |
|
| Other securities pledged | 20,778 |
| | 20,482 |
| | 12,484 |
| | 12,498 |
|
| Total | $ | 267,977 |
|
| $ | 264,675 |
|
| $ | 267,611 |
|
| $ | 267,160 |
|
(e) Equity Securities
The Company holds an equity security with a readily determinable fair value of $114,000 and $146,000 as of December 31, 20182021 and December 31, 2017, respectively. As a result of2020:
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 | | December 31, 2020 |
| Amortized
Cost | | Fair
Value | | Amortized
Cost | | Fair
Value |
| (In thousands) |
| Washington and Oregon state public deposits | $ | 128,216 | | | $ | 130,217 | | | $ | 119,652 | | | $ | 124,228 | |
| Federal Reserve Bank credit facility | 61,057 | | | 59,674 | | | — | | | — | |
| Securities sold under agreement to repurchase | 59,887 | | | 59,655 | | | 38,630 | | | 39,945 | |
| Other securities pledged | 56,419 | | | 55,633 | | | 29,665 | | | 30,717 | |
| Total | $ | 305,579 | | | $ | 305,179 | | | $ | 187,947 | | | $ | 194,890 | |
(f) Accrued Interest Receivable
Accrued interest receivable excluded from the adoption of FASB ASU 2016-01, this security is no longer classified as anamortized cost on investment securitysecurities available for sale totaled $3.5 million and has been reclassified to prepaid expenses and other assets on the Company's Consolidated Statements of Financial Condition as of$3.6 million at December 31, 2018. As such, its presentation is not comparable to the presentation as of2021 and December 31, 2017. The Company recorded2020, respectively. Accrued interest receivable excluded from the tax-effected unrealized gainamortized cost on the equity security through an adjustmentinvestment securities held to accumulated other comprehensivematurity totaled $1.1 million at December 31, 2021.
No amounts of accrued interest receivable on investment securities available for sale or held to maturity were reversed against interest income (loss), net and retained earnings in the Consolidated Statement of Stockholders' Equityon investment securities available for sale during the yearyears ended December 31, 2018.2021, 2020, and 2019.
(3)Loans Receivable
The CompanyBank originates loans in the ordinary course of business and has also acquired loans through mergers and acquisitions. Disclosures related toAccrued interest receivable was excluded from disclosures presenting the Company's recorded investment inBank's amortized cost of loans receivable generally exclude accrued interest receivable and net deferred fees or costs as they wereit was deemed insignificant.
(a) Loan Origination/Risk Management
The CompanyBank categorizes the individual loans in one of the four segments of the total loan portfolio:portfolio into 4 segments: commercial business, one-to-four familybusiness; residential real estate; real estate construction and land developmentdevelopment; and consumer. Within these segments
are classes of loans for which management monitors and assesses credit risk in the loan portfolios. risk.
The CompanyBank has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and criticized loans. The CompanyBank also conducts internal loan reviews and validates the credit risk assessment on a periodic basis and presents the results of these reviews to management. The loan review process complements and reinforces the risk identification and assessment decisions made by loan officers and credit personnel, as well aspersonnel.
The amortized cost of loans receivable, net of ACL on loans at December 31, 2021 and December 31, 2020 consisted of the Company’s policiesfollowing portfolio segments and procedures.classes:
| | | | | | | | | | | |
| December 31, 2021 | | December 31, 2020 |
| (In thousands) |
| Commercial business: | | | |
| Commercial and industrial | $ | 621,567 | | | $ | 733,098 | |
| SBA PPP | 145,840 | | | 715,121 | |
| Owner-occupied CRE | 931,150 | | | 856,684 | |
| Non-owner occupied CRE | 1,493,099 | | | 1,410,303 | |
| Total commercial business | 3,191,656 | | | 3,715,206 | |
| Residential real estate | 164,582 | | | 122,756 | |
| Real estate construction and land development: | | | |
| Residential | 85,547 | | | 78,259 | |
| Commercial and multifamily | 141,336 | | | 227,454 | |
| Total real estate construction and land development | 226,883 | | | 305,713 | |
| Consumer | 232,541 | | | 324,972 | |
| Loans receivable | 3,815,662 | | | 4,468,647 | |
| | | | | | | | | | | |
| December 31, 2021 | | December 31, 2020 |
| (In thousands) |
| Allowance for credit losses on loans | (42,361) | | | (70,185) | |
| Loans receivable, net | $ | 3,773,301 | | | $ | 4,398,462 | |
| | | |
| Balances included in the amortized cost of loans receivable: | | | |
| Unamortized net discount on acquired loans | $ | (3,938) | | | $ | (6,575) | |
| Unamortized net deferred fee | $ | (7,952) | | | $ | (15,458) | |
A discussion of the risk characteristics of each loan portfolio segment is as follows:
Commercial Business:
There are threefour significant classes of loans in the commercial business portfolio segment: commercial and industrial, owner-occupied commercial real estate and non-owner occupied commercial real estate. The owner and non-owner occupied commercial real estate classes are both considered commercial real estate loans. As the commercial and industrial loans carry different risk characteristics than the commercial real estate loans, they aresegment discussed separately below.below:
Commercial and industrial. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may include a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Commercial and industrial loans carry more risk than other loans because the borrowers’ cash flow is less predictable and in the event of a default the amount of loss is potentially greater and more difficult to quantify because the value of the collateral securing these loans may fluctuate, may be uncollectible or may be obsolete or of limited use, among other things.
Commercial real estate.SBA PPP. The CompanyBank began originating SBA PPP loans following the enactment of the CARES Act in April 2020. SBA PPP loans are fully guaranteed by the SBA, intended for businesses impacted by the COVID-19 Pandemic and designed to provide near term relief to help small businesses sustain operations. These loans have either a two-year or five-year maturity date and earn interest at 1%. The Bank also earns a fee based on the size of the loan, which is recognized over the life of the loan.
Owner-occupied and non-owner occupied CRE. The Bank originates commercial real estateCRE loans primarily within its primary market areas. These loans are subject to underwriting standards and processes similar to commercial and industrial loans in that these loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate properties. Commercial real estateCRE lending typically involves higher loan principal amounts and payments on loans and repayment is dependent on successful operation and management of the properties. The value of the real estate securing these loans can be adversely affected by conditions in the real estate market or the economy. There is little difference insome common risk betweencharacteristics with owner-occupied commercial real estateCRE loans and non-owner occupied commercial real estateCRE loans. However, owner-occupied CRE loans are generally considered to have a slightly lower risk profile as we typically have the guarantee of the owner-occupant and can underwrite risk using the complete financial information on the entity that occupies the property.
One-to-Four Family Residential Real Estate:
The majority of the Company’s one-to-four familyBank’s residential real estate loans are secured by single-familyone-to-four family residences located in its primary market areas. The Company’s underwriting standards require that single-familyresidential real estate loans maintained in the portfolio loans generally are owner-occupied and do not exceed 80% of the lower of appraised value at origination or cost of the underlying collateral. Terms of maturity typically range from 15 to 30 years. The CompanyBank sells mosta portion of its single-familyoriginated residential real estate loans in the secondary market and retains a smaller portion in its loan portfolio.market.
Real Estate Construction and Land Development:
The CompanyBank originates construction loans for one-to-four family residential and for five or more family residentialcommercial and commercialmultifamily properties. The one-to-four family residential construction loans generally include construction of custom single-family homes whereby the home buyerowner is the borrower. The CompanyBank also provides financing to builders for the construction of pre-sold residential homes and, in selected cases, to builders for the construction of speculative single-family residential property. Substantially all construction loans are short-term in nature and priced with variable rates of interest. Construction lending can involve a higher level of risk than other types of lending because funds are advanced partially based upon the value of the project, which is uncertain prior to the project’s completion. Because of the uncertainties inherent in estimating construction costs as well as the market value of a completed project and the effects of governmental regulation of real property, the Company’sBank’s estimates with regard to the total funds required to complete a project and the related loan-to-value ratio may vary from actual results. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness. If the Company’sBank’s estimate of the value of a project at completion proves to be overstated, it may have inadequate security for repayment of the loan and may incur a loss if the borrower does not repay the loan. Sources of repayment for these types of loans may
be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the CompanyBank until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being dependent upon successful completion of the construction project, market interest rate changes, government
regulation of real property, general economic conditions and the availability of long-term financing.
Consumer:
The CompanyBank originates consumer loans and lines of credit that are both secured and unsecured. The underwriting process for these loans ensures a qualifying primary and secondary source of repayment. Underwriting standards for home equity loans are significantly influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. The majority of consumer loans are for relatively small amounts disbursed among many individual borrowers which reduces the overall credit risk for this type of loan.segment. To further reduce the risk, trend reports are reviewed by management on a regular basis.
The CompanyBank also originatespurchased indirect consumer loans. These indirect consumer loans are forwere secured by new and used automobile and recreational vehicles that areand were originated indirectly by selectedestablished and well-known dealers located in the Company'sour market areas. The Company has limited its purchase ofIn addition, the indirect loans primarilypurchased were made to dealerships that are established and well-knownonly prime borrowers. The Bank ceased indirect auto loan originations in their market areas and to applicants that are not classified as sub-prime.
Loans receivable at December 31, 2018 and December 31, 2017 consisted of the following portfolio segments and classes:
|
| | | | | | | |
| | December 31, 2018 | | December 31, 2017 |
| | (In thousands) |
| Commercial business: | | | |
| Commercial and industrial | $ | 853,606 |
| | $ | 645,396 |
|
| Owner-occupied commercial real estate | 779,814 |
| | 622,150 |
|
| Non-owner occupied commercial real estate | 1,304,463 |
| | 986,594 |
|
| Total commercial business | 2,937,883 |
|
| 2,254,140 |
|
| One-to-four family residential | 101,763 |
| | 86,997 |
|
| Real estate construction and land development: | | | |
| One-to-four family residential | 102,730 |
| | 51,985 |
|
| Five or more family residential and commercial properties | 112,730 |
| | 97,499 |
|
| Total real estate construction and land development | 215,460 |
|
| 149,484 |
|
| Consumer | 395,545 |
| | 355,091 |
|
| Gross loans receivable | 3,650,651 |
|
| 2,845,712 |
|
| Net deferred loan costs | 3,509 |
| | 3,359 |
|
| Loans receivable, net | 3,654,160 |
|
| 2,849,071 |
|
| Allowance for loan losses | (35,042 | ) | | (32,086 | ) |
| Total loans receivable, net | $ | 3,619,118 |
|
| $ | 2,816,985 |
|
(b) Concentrations of Credit
Most of the Company’sBank’s lending activity occurs within its primary market areas which are concentrated along the I-5 corridor from Whatcom County to Clark County in Washington State and Multnomah County and Washington County in Oregon, as well as other contiguous markets. The majority of the Company’smarkets and represents a geographic concentration. Additionally, our loan portfolio consists of (in order of balances at December 31, 2018) non-owner occupiedis concentrated in commercial loans, including commercial business loans and commercial and multifamily real estate construction and land development loans. Commercial loans are generally viewed as having more inherent risk of default than residential real estate loans or other consumer loans. Also, the commercial loan balance per borrower is typically larger than that for residential real estate loans and industrial and owner-occupied commercial real estate. As of December 31, 2018 and December 31, 2017, there were no concentrations ofconsumer loans, related to any single industry in excess of 10% of the Company’s total loans.
implying higher potential losses on an individual loan basis.
(c) Credit Quality Indicators
As part of the on-going monitoring of the credit quality of the Company’sBank’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) nonperforming loans, (v) past due status and (v)(vi) the general economic conditions of the United States of America, and specifically the states of Washington and Oregon. The CompanyBank utilizes a risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 1 to 10. A description of the general characteristics of the risk grades is as follows:
•Grades 1 to 5: These grades are considered “pass grade”“Pass” and include loans with negligible to above average, but acceptable, risk. These borrowers generally have strong to acceptable capital levels and consistent earnings and debt service capacity. Loans with the higher grades within the “pass”“Pass” category may include borrowers who are experiencing unusual operating difficulties, but have acceptable payment performance to date. Increased monitoring of financial information and/or collateral may be appropriate. Loans with this grade show no immediate loss exposure.
•Grade 6: This grade includes "Watch" loans and is considered a “pass grade”.loans. The grade is intended to be utilized on a temporary basis for pass grade borrowers where a potentially significant risk-modifying action is anticipated in the near term.
•Grade 7: This grade includes “Other Assets Especially Mentioned” (“OAEM”"Special Mention" ("SM") loans in accordance with regulatory guidelines, and is intended to highlight loans withdeemed by management to have some elevated risks.risks that deserve management's close attention. Loans with this grade show signs of deteriorating profits and capital and the borrower might not be strong enough to sustain a major setback. The borrower is typically higher than normally leveraged and outside support might be modest and likely illiquid. The loan is at risk of further credit decline unless active measures are taken to correct the situation.
•Grade 8: This grade includes “Substandard” ("SS") loans in accordance with regulatory guidelines, which the Company has determined have a high credit risk. These loans also have well-defined weaknesses which make payment default or principal exposure likely, butand are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not yet certain.corrected. The borrower may have shown serious negative trends in financial ratios and performance. Such loans may be dependent upon collateral liquidation, a secondary source of repayment or an event outside of the normal course of business. Loans with this grade can be placed on accrual or nonaccrual status based on the Company’s accrual policy.
•Grade 9: This grade includes “Doubtful” loans in accordance with regulatory guidelines and the CompanyBank has determined these loans to have excessive credit risk. Such loans are placed on nonaccrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Additionally, these loans generally have a specific valuation allowance or have been partially charged-offcharged off for the amount considered uncollectible.
•Grade 10: This grade includes “Loss” loans in accordance with regulatory guidelines and the CompanyBank has determined these loans have the highest risk of loss. Such loans are charged-offcharged off or charged-downcharged down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.
Numerical loan grades for loans are established at the origination of the loan. LoanChanges to loan grades are reviewed onconsidered at the time new information about the performance of a quarterly basis, or more frequently if necessary, byloan becomes available, including the credit department.receipt of updated financial information from the borrower, results of annual term loan reviews and scheduled loan reviews. For consumer loans, the Bank follows the FDIC’s Uniform Retail Credit Classification and Account Management Policy for subsequent classification in the event of payment delinquencies or default. Typically, an individual loan grade will not be changed from the prior period unless there is a
specific indication of credit deterioration or improvement. Credit deterioration is evidenced by delinquency, direct communications with the borrower or other borrower information that becomes known to management. Credit improvements are evidenced by known facts regarding the borrower or the collateral property.
The loanLoan grades relate to the likelihood of losses in that the higher the grade, the greater the loss potential. Loans with a pass grade may have some estimated inherent losses, but to a lesser extent than the other loan grades. The OAEMSM loan grade is transitory in that the CompanyBank is waiting on additional information to determine the likelihood and extent of the potential loss. The likelihood of loss for OAEMSM graded loans, however, is greater than Watch graded loans because there has been measurable credit deterioration. Loans with a SubstandardSS grade are generally accrual loans for which the Company has individually analyzed for potential impairment.at risk of being classified as nonaccrual loans and includes all of our loans classified as nonaccrual. For Doubtful and Loss graded loans, the CompanyBank is almost certain of the losses and the outstanding principal balances are generally charged-offcharged off to the realizable value.
the deferral. Due to the short-term nature of the forbearance and other relief programs the Bank was offering as a result of the COVID-19 Pandemic, borrowers granted relief under these programs were generally not reported as nonaccrual during the deferral period.
The following tables presenttable presents the balanceamortized cost of the loans receivable by credit quality indicatorrisk grade as of December 31, 20182021 and December 31, 2017.2020:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 | | Revolving Loans | | Revolving Loans Converted to Term Loans (1) | | Loans Receivable |
| Term Loans
Amortized Cost Basis by Origination Year | | | |
| 2021 | | 2020 | | 2019 | | 2018 | | 2017 | | Prior | | | |
| (In thousands) |
| Commercial business: |
| Commercial and industrial |
| Pass | $ | 95,960 | | | $ | 100,193 | | | $ | 94,657 | | | $ | 54,707 | | | $ | 28,558 | | | $ | 77,294 | | | $ | 127,651 | | | $ | 1,035 | | | $ | 580,055 | |
| SM | 326 | | | 884 | | | 5,998 | | | 1,425 | | | 2,223 | | | 2,401 | | | 2,048 | | | 353 | | | 15,658 | |
| SS | 1,443 | | | 1,287 | | | 5,912 | | | 2,809 | | | 2,526 | | | 6,907 | | | 4,402 | | | 568 | | | 25,854 | |
| | | | | | | | | | | | | | | | | |
| Total | 97,729 | | | 102,364 | | | 106,567 | | | 58,941 | | | 33,307 | | | 86,602 | | | 134,101 | | | 1,956 | | | 621,567 | |
| SBA PPP |
| Pass | 139,253 | | | 6,587 | | | — | | | — | | | — | | | — | | | — | | | — | | | 145,840 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Owner-occupied CRE |
| Pass | 182,742 | | | 90,609 | | | 188,380 | | | 73,714 | | | 66,039 | | | 273,518 | | | — | | | 72 | | | 875,074 | |
| SM | 264 | | | — | | | 3,079 | | | 7,521 | | | 3,937 | | | 16,724 | | | — | | | — | | | 31,525 | |
| SS | — | | | 1,332 | | | — | | | 3,787 | | | 3,014 | | | 16,418 | | | — | | | — | | | 24,551 | |
| | | | | | | | | | | | | | | | | |
| Total | 183,006 | | | 91,941 | | | 191,459 | | | 85,022 | | | 72,990 | | | 306,660 | | | — | | | 72 | | | 931,150 | |
| Non-owner occupied CRE |
| Pass | 187,860 | | | 185,650 | | | 244,863 | | | 149,090 | | | 144,896 | | | 499,486 | | | — | | | — | | | 1,411,845 | |
| SM | — | | | — | | | 5,674 | | | — | | | 15,482 | | | 2,400 | | | — | | | — | | | 23,556 | |
| SS | — | | | — | | | — | | | 3,379 | | | — | | | 54,319 | | | — | | | — | | | 57,698 | |
| | | | | | | | | | | | | | | | | |
| Total | 187,860 | | | 185,650 | | | 250,537 | | | 152,469 | | | 160,378 | | | 556,205 | | | — | | | — | | | 1,493,099 | |
| Total commercial business |
| Pass | 605,815 | | | 383,039 | | | 527,900 | | | 277,511 | | | 239,493 | | | 850,298 | | | 127,651 | | | 1,107 | | | 3,012,814 | |
| SM | 590 | | | 884 | | | 14,751 | | | 8,946 | | | 21,642 | | | 21,525 | | | 2,048 | | | 353 | | | 70,739 | |
| SS | 1,443 | | | 2,619 | | | 5,912 | | | 9,975 | | | 5,540 | | | 77,644 | | | 4,402 | | | 568 | | | 108,103 | |
| | | | | | | | | | | | | | | | | |
| Total | 607,848 | | | 386,542 | | | 548,563 | | | 296,432 | | | 266,675 | | | 949,467 | | | 134,101 | | | 2,028 | | | 3,191,656 | |
| Residential real estate |
| Pass | 85,089 | | | 27,090 | | | 23,295 | | | 5,672 | | | 6,141 | | | 16,891 | | | — | | | — | | | 164,178 | |
| | | | | | | | | | | | | | | | | |
| SS | — | | | — | | | — | | | — | | | — | | | 404 | | | — | | | — | | | 404 | |
| | | | | | | | | | | | | | | | | |
| Total | 85,089 | | | 27,090 | | | 23,295 | | | 5,672 | | | 6,141 | | | 17,295 | | | — | | | — | | | 164,582 | |
| Real estate construction and land development: |
| Residential |
| Pass | 44,892 | | | 23,728 | | | 12,266 | | | 2,921 | | | 389 | | | 1,351 | | | — | | | — | | | 85,547 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
|
| | | | | | | | | | | | | | | | | | | |
| | December 31, 2018 |
| | Pass | | OAEM | | Substandard | | Doubtful/Loss | | Total |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 788,395 |
| | $ | 16,168 |
| | $ | 49,043 |
| | $ | — |
| | $ | 853,606 |
|
| Owner-occupied commercial real estate | 741,227 |
| | 27,724 |
| | 10,863 |
| | — |
| | 779,814 |
|
| Non-owner occupied commercial real estate | 1,283,077 |
| | 9,438 |
| | 11,948 |
| | — |
| | 1,304,463 |
|
| Total commercial business | 2,812,699 |
| | 53,330 |
| | 71,854 |
| | — |
| | 2,937,883 |
|
| One-to-four family residential | 100,401 |
| | — |
| | 1,362 |
| | — |
| | 101,763 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 101,519 |
| | 258 |
| | 953 |
| | — |
| | 102,730 |
|
| Five or more family residential and commercial properties | 112,678 |
| | 52 |
| | — |
| | — |
| | 112,730 |
|
| Total real estate construction and land development | 214,197 |
| | 310 |
| | 953 |
| | — |
| | 215,460 |
|
| Consumer | 390,808 |
| | — |
| | 4,213 |
| | 524 |
| | 395,545 |
|
| Gross loans receivable | $ | 3,518,105 |
| | $ | 53,640 |
| | $ | 78,382 |
| | $ | 524 |
| | $ | 3,650,651 |
|
|
| | | | | | | | | | | | | | | | | | | |
| | December 31, 2017 |
| | Pass | | OAEM | | Substandard | | Doubtful/Loss | | Total |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 597,697 |
| | $ | 19,536 |
| | $ | 28,163 |
| | $ | — |
| | $ | 645,396 |
|
| Owner-occupied commercial real estate | 595,455 |
| | 12,668 |
| | 14,027 |
| | — |
| | 622,150 |
|
| Non-owner occupied commercial real estate | 955,450 |
| | 10,494 |
| | 20,650 |
| | — |
| | 986,594 |
|
| Total commercial business | 2,148,602 |
| | 42,698 |
| | 62,840 |
| | — |
| | 2,254,140 |
|
| One-to-four family residential | 85,762 |
| | — |
| | 1,235 |
| | — |
| | 86,997 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 49,925 |
| | 537 |
| | 1,523 |
| | — |
| | 51,985 |
|
| Five or more family residential and commercial properties | 96,404 |
| | 707 |
| | 388 |
| | — |
| | 97,499 |
|
| Total real estate construction and land development | 146,329 |
| | 1,244 |
| | 1,911 |
| | — |
| | 149,484 |
|
| Consumer | 349,590 |
| | — |
| | 4,976 |
| | 525 |
| | 355,091 |
|
| Gross loans receivable | $ | 2,730,283 |
| | $ | 43,942 |
| | $ | 70,962 |
| | $ | 525 |
| | $ | 2,845,712 |
|
Potential problem loans are loans classified as OAEM or worse that are currently accruing interest and are not considered impaired, but which management is closely monitoring because the financial information of the borrower causes concern as to their ability to meet their loan repayment terms. Potential problem loans may include PCI loans as these loans continue to accrete loan discounts established at acquisition based on the guidance of FASB ASC 310-30. Potential problem loans as of December 31, 2018 and December 31, 2017 were $101.3 million and $83.5 million, respectively.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 | | Revolving Loans | | Revolving Loans Converted to Term Loans (1) | | Loans Receivable |
| Term Loans
Amortized Cost Basis by Origination Year | | | |
| 2021 | | 2020 | | 2019 | | 2018 | | 2017 | | Prior | | | |
| Commercial and multifamily |
| Pass | 56,448 | | | 41,616 | | | 34,117 | | | 5,794 | | | 710 | | | 1,379 | | | — | | | — | | | 140,064 | |
| SM | — | | | — | | | 68 | | | — | | | — | | | 213 | | | — | | | — | | | 281 | |
| SS | — | | | 571 | | | — | | | — | | | — | | | 420 | | | — | | | — | | | 991 | |
| | | | | | | | | | | | | | | | | |
| Total | 56,448 | | | 42,187 | | | 34,185 | | | 5,794 | | | 710 | | | 2,012 | | | — | | | — | | | 141,336 | |
| Total real estate construction and land development |
| Pass | 101,340 | | | 65,344 | | | 46,383 | | | 8,715 | | | 1,099 | | | 2,730 | | | — | | | — | | | 225,611 | |
| SM | — | | | — | | | 68 | | | — | | | — | | | 213 | | | — | | | — | | | 281 | |
| SS | — | | | 571 | | | — | | | — | | | — | | | 420 | | | — | | | — | | | 991 | |
| | | | | | | | | | | | | | | | | |
| Total | 101,340 | | | 65,915 | | | 46,451 | | | 8,715 | | | 1,099 | | | 3,363 | | | — | | | — | | | 226,883 | |
| Consumer |
| Pass | 1,286 | | | 15,737 | | | 46,041 | | | 29,819 | | | 15,068 | | | 13,026 | | | 108,492 | | | 120 | | | 229,589 | |
| | | | | | | | | | | | | | | | | |
| SS | — | | | 181 | | | 657 | | | 476 | | | 542 | | | 1,043 | | | 36 | | | 17 | | | 2,952 | |
| | | | | | | | | | | | | | | | | |
| Total | 1,286 | | | 15,918 | | | 46,698 | | | 30,295 | | | 15,610 | | | 14,069 | | | 108,528 | | | 137 | | | 232,541 | |
| Loans receivable |
| Pass | 793,530 | | | 491,210 | | | 643,619 | | | 321,717 | | | 261,801 | | | 882,945 | | | 236,143 | | | 1,227 | | | 3,632,192 | |
| SM | 590 | | | 884 | | | 14,819 | | | 8,946 | | | 21,642 | | | 21,738 | | | 2,048 | | | 353 | | | 71,020 | |
| SS | 1,443 | | | 3,371 | | | 6,569 | | | 10,451 | | | 6,082 | | | 79,511 | | | 4,438 | | | 585 | | | 112,450 | |
| | | | | | | | | | | | | | | | | |
| Total | $ | 795,563 | | | $ | 495,465 | | | $ | 665,007 | | | $ | 341,114 | | | $ | 289,525 | | | $ | 984,194 | | | $ | 242,629 | | | $ | 2,165 | | | $ | 3,815,662 | |
(1) Represents the loans receivable balance at December 31, 2021 which was converted from a revolving loan to an amortizing loan during the year ended December 31, 2021.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2020 | | Revolving Loans | | Revolving Loans Converted to Term Loans (1) | | Loans Receivable | | |
| Term Loans
Amortized Cost Basis by Origination Year | | | | | |
| 2020 | | 2019 | | 2018 | | 2017 | | 2016 | | Prior | | | | | |
| (In thousands) |
| Commercial business: | | |
| Commercial and industrial | | |
| Pass | $ | 118,971 | | | $ | 127,919 | | | $ | 70,766 | | | $ | 44,231 | | | $ | 37,658 | | | $ | 95,958 | | | $ | 121,440 | | | $ | 819 | | | $ | 617,762 | | | |
| SM | 14,430 | | | 9,162 | | | 10,878 | | | 4,171 | | | 5,700 | | | 3,579 | | | 11,790 | | | 814 | | | 60,524 | | | |
| SS | 2,199 | | | 11,835 | | | 3,416 | | | 9,348 | | | 1,052 | | | 7,651 | | | 15,484 | | | 3,827 | | | 54,812 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 135,600 | | | 148,916 | | | 85,060 | | | 57,750 | | | 44,410 | | | 107,188 | | | 148,714 | | | 5,460 | | | 733,098 | | | |
| SBA PPP | | |
| Pass | 715,121 | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | 715,121 | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Owner-occupied CRE | | |
| Pass | 89,224 | | | 167,095 | | | 94,830 | | | 80,138 | | | 74,902 | | | 254,864 | | | — | | | — | | | 761,053 | | | |
| SM | 6,146 | | | 4,540 | | | 16,386 | | | 11,231 | | | 5,464 | | | 12,105 | | | — | | | — | | | 55,872 | | | |
| SS | — | | | — | | | 114 | | | 7,320 | | | 3,313 | | | 29,012 | | | — | | | — | | | 39,759 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 95,370 | | | 171,635 | | | 111,330 | | | 98,689 | | | 83,679 | | | 295,981 | | | — | | | — | | | 856,684 | | | |
| Non-owner-occupied CRE | | |
| Pass | 197,548 | | | 173,153 | | | 148,830 | | | 172,438 | | | 240,614 | | | 406,817 | | | — | | | — | | | 1,339,400 | | | |
| SM | — | | | 1,979 | | | 357 | | | 2,448 | | | 6,210 | | | 3,539 | | | — | | | — | | | 14,533 | | | |
| SS | — | | | — | | | 3,623 | | | — | | | 35,455 | | | 17,292 | | | — | | | — | | | 56,370 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 197,548 | | | 175,132 | | | 152,810 | | | 174,886 | | | 282,279 | | | 427,648 | | | — | | | — | | | 1,410,303 | | | |
| Total commercial business | | |
| Pass | 1,120,864 | | | 468,167 | | | 314,426 | | | 296,807 | | | 353,174 | | | 757,639 | | | 121,440 | | | 819 | | | 3,433,336 | | | |
| SM | 20,576 | | | 15,681 | | | 27,621 | | | 17,850 | | | 17,374 | | | 19,223 | | | 11,790 | | | 814 | | | 130,929 | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| SS | 2,199 | | | 11,835 | | | 7,153 | | | 16,668 | | | 39,820 | | | 53,955 | | | 15,484 | | | 3,827 | | | 150,941 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 1,143,639 | | | 495,683 | | | 349,200 | | | 331,325 | | | 410,368 | | | 830,817 | | | 148,714 | | | 5,460 | | | 3,715,206 | | | |
| Residential real estate | | |
| Pass | 30,141 | | | 41,829 | | | 15,730 | | | 10,362 | | | 7,322 | | | 16,825 | | | — | | | — | | | 122,209 | | | |
| | | | | | | | | | | | | | | | | | | |
| SS | — | | | — | | | — | | | 59 | | | — | | | 488 | | | — | | | — | | | 547 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 30,141 | | | 41,829 | | | 15,730 | | | 10,421 | | | 7,322 | | | 17,313 | | | — | | | — | | | 122,756 | | | |
| Real estate construction and land development: | | |
| Residential | | |
| Pass | 33,801 | | | 36,697 | | | 2,725 | | | 1,097 | | | 971 | | | 1,042 | | | — | | | — | | | 76,333 | | | |
| | | | | | | | | | | | | | | | | | | |
| SS | — | | | — | | | — | | | 1,926 | | | — | | | — | | | — | | | — | | | 1,926 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 33,801 | | | 36,697 | | | 2,725 | | | 3,023 | | | 971 | | | 1,042 | | | — | | | — | | | 78,259 | | | |
| Commercial and multifamily | | |
| Pass | 27,423 | | | 151,020 | | | 38,682 | | | 5,660 | | | 689 | | | 1,407 | | | — | | | — | | | 224,881 | | | |
| SM | 67 | | | 1,011 | | | — | | | — | | | — | | | 29 | | | — | | | — | | | 1,107 | | | |
| SS | 572 | | | 450 | | | — | | | — | | | — | | | 444 | | | — | | | — | | | 1,466 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 28,062 | | | 152,481 | | | 38,682 | | | 5,660 | | | 689 | | | 1,880 | | | — | | | — | | | 227,454 | | | |
| Total real estate construction and land development |
| Pass | 61,224 | | | 187,717 | | | 41,407 | | | 6,757 | | | 1,660 | | | 2,449 | | | — | | | — | | | 301,214 | | | |
| SM | 67 | | | 1,011 | | | — | | | — | | | — | | | 29 | | | — | | | — | | | 1,107 | | | |
| SS | 572 | | | 450 | | | — | | | 1,926 | | | — | | | 444 | | | — | | | — | | | 3,392 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 61,863 | | | 189,178 | | | 41,407 | | | 8,683 | | | 1,660 | | | 2,922 | | | — | | | — | | | 305,713 | | | |
| Consumer | | |
| Pass | 43,742 | | | 77,083 | | | 53,195 | | | 30,559 | | | 13,443 | | | 15,453 | | | 87,547 | | | 315 | | | 321,337 | | | |
| | | | | | | | | | | | | | | | | | | |
| SS | 34 | | | 404 | | | 684 | | | 648 | | | 420 | | | 1,319 | | | 78 | | | 48 | | | 3,635 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | 43,776 | | | 77,487 | | | 53,879 | | | 31,207 | | | 13,863 | | | 16,772 | | | 87,625 | | | 363 | | | 324,972 | | | |
| Loans receivable | | |
| Pass | 1,255,971 | | | 774,796 | | | 424,758 | | | 344,485 | | | 375,599 | | | 792,366 | | | 208,987 | | | 1,134 | | | 4,178,096 | | | |
| SM | 20,643 | | | 16,692 | | | 27,621 | | | 17,850 | | | 17,374 | | | 19,252 | | | 11,790 | | | 814 | | | 132,036 | | | |
| SS | 2,805 | | | 12,689 | | | 7,837 | | | 19,301 | | | 40,240 | | | 56,206 | | | 15,562 | | | 3,875 | | | 158,515 | | | |
| | | | | | | | | | | | | | | | | | | |
| Total | $ | 1,279,419 | | | $ | 804,177 | | | $ | 460,216 | | | $ | 381,636 | | | $ | 433,213 | | | $ | 867,824 | | | $ | 236,339 | | | $ | 5,823 | | | $ | 4,468,647 | | | |
(1) Represents the loans receivable balance at December 31, 2020 which was converted from a revolving loan to an amortizing loan during the year ended December 31, 2020.
(d) Nonaccrual Loans
NonaccrualThe following table presents the amortized cost of nonaccrual loans segregated by segments and classesfor the dates indicated:
| | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Nonaccrual without ACL | | Nonaccrual with ACL | | Total Nonaccrual |
| (In thousands) |
| Commercial business: | | | | | |
| Commercial and industrial | $ | 6,454 | | | $ | 3,827 | | | $ | 10,281 | |
| Owner-occupied CRE | 3,036 | | | 5,138 | | | 8,174 | |
| Non-owner occupied CRE | 1,273 | | | 3,379 | | | 4,652 | |
| Total commercial business | 10,763 | | | 12,344 | | | 23,107 | |
| Residential real estate | — | | | 47 | | | 47 | |
| Real estate construction and land development: | | | | | |
| | | | | |
| Commercial and multifamily | — | | | 571 | | | 571 | |
| | | | | |
| Consumer | — | | | 29 | | | 29 | |
| Total | $ | 10,763 | | | $ | 12,991 | | | $ | 23,754 | |
| | | | | | | | | | | | | | | | | | | |
| December 31, 2020 | | |
| Nonaccrual without ACL | | Nonaccrual with ACL | | Total Nonaccrual | | |
| (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 22,039 | | | $ | 9,208 | | | $ | 31,247 | | | |
| Owner-occupied CRE | 4,693 | | | 13,700 | | | 18,393 | | | |
| Non-owner occupied CRE | 3,424 | | | 3,722 | | | 7,146 | | | |
| Total commercial business | 30,156 | | | 26,630 | | | 56,786 | | | |
| Residential real estate | 67 | | | 117 | | | 184 | | | |
| Real estate construction and land development: | | | | | | | |
| | | | | | | |
| Commercial and multifamily | 572 | | | 450 | | | 1,022 | | | |
| | | | | | | |
| Consumer | 31 | | | 69 | | | 100 | | | |
| Total | $ | 30,826 | | | $ | 27,266 | | | $ | 58,092 | | | |
The following table presents the reversal of interest income on loans due to the write-off of accrued interest receivable upon the initial classification of loans were as follows asnonaccrual loans and the interest income recognized due to payment in full of previously classified nonaccrual loans during the following periods:
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 | | December 31, 2020 |
| Interest Income Reversed | | Interest Income Recognized | | Interest Income Reversed | | Interest Income Recognized |
| (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | (10) | | | $ | 2,295 | | | $ | (95) | | | $ | 434 | |
| Owner-occupied CRE | — | | | 117 | | | (238) | | | 89 | |
| Non-owner occupied CRE | — | | | 601 | | | (208) | | | 67 | |
| Total commercial business | (10) | | | 3,013 | | | (541) | | | 590 | |
| Residential real estate | — | | | — | | | (2) | | | 2 | |
| Real estate construction and land development: | | | | | | | |
| Residential | — | | | 71 | | | — | | | — | |
| Commercial and multifamily | — | | | — | | | (11) | | | — | |
| Total real estate construction and land development | — | | | 71 | | | (11) | | | — | |
| Consumer | (1) | | | 52 | | | (1) | | | 47 | |
| Total | $ | (11) | | | $ | 3,136 | | | $ | (555) | | | $ | 639 | |
For the years ended December 31, 20182021 and December 31, 2017:
|
| | | | | | | |
| | December 31, 2018 | | December 31, 2017 |
| | (In thousands) |
| Commercial business: | | | |
| Commercial and industrial | $ | 6,639 |
| | $ | 3,110 |
|
| Owner-occupied commercial real estate | 4,212 |
| | 4,090 |
|
| Non-owner occupied commercial real estate | 1,713 |
| | 1,898 |
|
| Total commercial business | 12,564 |
|
| 9,098 |
|
| One-to-four family residential | 71 |
| | 81 |
|
| Real estate construction and land development: | | | |
| One-to-four family residential | 899 |
| | 1,247 |
|
| Total real estate construction and land development | 899 |
|
| 1,247 |
|
| Consumer | 169 |
| | 277 |
|
| Nonaccrual loans | $ | 13,703 |
|
| $ | 10,703 |
|
PCI loans are not included2020, no interest income was recognized subsequent to a loan’s classification as nonaccrual, except as indicated in the nonaccrual loan tabletables above because these loans are accounted for under FASB ASC 310-30, which provides that accretable yield is calculated based on a loan's expected cash flow even if the loan is not performing under its contractual terms.due to payment in full.
(e) Past due loans
The CompanyBank performs an aging analysis of past due loans using policies consistent with regulatory reporting requirements with categories of 30-89 days past due and 90 or more days past due.
The balancesamortized cost of past due loans, segregated by segments and classes of loans as of December 31, 20182021 and December 31, 20172020 were as follows:
|
| | | | | | | | | | | | | | | | | | | |
| | December 31, 2018 |
| | 30-89 Days | | 90 Days or Greater | | Total Past Due | | Current | | Total |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 2,988 |
| | $ | 2,281 |
| | $ | 5,269 |
| | $ | 848,337 |
| | $ | 853,606 |
|
| Owner-occupied commercial real estate | 563 |
| | 600 |
| | 1,163 |
| | 778,651 |
| | 779,814 |
|
| Non-owner occupied commercial real estate | 5,347 |
| | 1,461 |
| | 6,808 |
| | 1,297,655 |
| | 1,304,463 |
|
| Total commercial business | 8,898 |
| | 4,342 |
| | 13,240 |
| | 2,924,643 |
| | 2,937,883 |
|
| One-to-four family residential | 227 |
| | — |
| | 227 |
| | 101,536 |
| | 101,763 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 665 |
| | 234 |
| | 899 |
| | 101,831 |
| | 102,730 |
|
| Five or more family residential and commercial properties | — |
| | — |
| | — |
| | 112,730 |
| | 112,730 |
|
| Total real estate construction and land development | 665 |
| | 234 |
| | 899 |
| | 214,561 |
| | 215,460 |
|
| Consumer | 2,568 |
| | — |
| | 2,568 |
| | 392,977 |
| | 395,545 |
|
| Gross loans receivable | $ | 12,358 |
| | $ | 4,576 |
| | $ | 16,934 |
| | $ | 3,633,717 |
| | $ | 3,650,651 |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| 30-89 Days | | 90 Days
or Greater | | Total Past
Due | | Current | | Loans Receivable |
| (In thousands) |
| Commercial business: |
| Commercial and industrial | $ | 1,858 | | | $ | 6,821 | | | $ | 8,679 | | | $ | 612,888 | | | $ | 621,567 | |
| SBA PPP | 223 | | | 293 | | | 516 | | | 145,324 | | | 145,840 | |
| Owner-occupied CRE | 2,397 | | | 112 | | | 2,509 | | | 928,641 | | | 931,150 | |
| Non-owner occupied CRE | — | | | — | | | — | | | 1,493,099 | | | 1,493,099 | |
| Total commercial business | 4,478 | | | 7,226 | | | 11,704 | | | 3,179,952 | | | 3,191,656 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| 30-89 Days | | 90 Days
or Greater | | Total Past
Due | | Current | | Loans Receivable |
| (In thousands) |
| Residential real estate | 420 | | | 10 | | | 430 | | | 164,152 | | | 164,582 | |
| Real estate construction and land development: |
| Residential | 792 | | | — | | | 792 | | | 84,755 | | | 85,547 | |
| Commercial and multifamily | 3,474 | | | 571 | | | 4,045 | | | 137,291 | | | 141,336 | |
| Total real estate construction and land development | 4,266 | | | 571 | | | 4,837 | | | 222,046 | | | 226,883 | |
| Consumer | 1,026 | | | — | | | 1,026 | | | 231,515 | | | 232,541 | |
| Total | $ | 10,190 | | | $ | 7,807 | | | $ | 17,997 | | | $ | 3,797,665 | | | $ | 3,815,662 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2020 |
| 30-89 Days | | 90 Days or
Greater | | Total Past
Due | | Current | | Loans Receivable |
| (In thousands) |
| Commercial business: |
| Commercial and industrial | $ | 4,621 | | | $ | 8,082 | | | $ | 12,703 | | | $ | 720,395 | | | $ | 733,098 | |
| SBA PPP | — | | | — | | | — | | | 715,121 | | | 715,121 | |
| Owner-occupied CRE | 991 | | | 403 | | | 1,394 | | | 855,290 | | | 856,684 | |
| Non-owner occupied CRE | 412 | | | 1,970 | | | 2,382 | | | 1,407,921 | | | 1,410,303 | |
| Total commercial business | 6,024 | | | 10,455 | | | 16,479 | | | 3,698,727 | | | 3,715,206 | |
| Residential real estate | 765 | | | 16 | | | 781 | | | 121,975 | | | 122,756 | |
| Real estate construction and land development: |
| Residential | — | | | — | | | — | | | 78,259 | | | 78,259 | |
| Commercial and multifamily | 2,225 | | | — | | | 2,225 | | | 225,229 | | | 227,454 | |
| Total real estate construction and land development | 2,225 | | | — | | | 2,225 | | | 303,488 | | | 305,713 | |
| Consumer | 1,407 | | | 30 | | | 1,437 | | | 323,535 | | | 324,972 | |
| Total | $ | 10,421 | | | $ | 10,501 | | | $ | 20,922 | | | $ | 4,447,725 | | | $ | 4,468,647 | |
|
| | | | | | | | | | | | | | | | | | | |
| | December 31, 2017 |
| | 30-89 Days | | 90 Days or Greater | | Total Past Due | | Current | | Total |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 2,993 |
| | $ | 1,172 |
| | $ | 4,165 |
| | $ | 641,231 |
| | $ | 645,396 |
|
| Owner-occupied commercial real estate | 1,277 |
| | 1,225 |
| | 2,502 |
| | 619,648 |
| | 622,150 |
|
| Non-owner occupied commercial real estate | 870 |
| | 3,314 |
| | 4,184 |
| | 982,410 |
| | 986,594 |
|
| Total commercial business | 5,140 |
| | 5,711 |
| | 10,851 |
| | 2,243,289 |
| | 2,254,140 |
|
| One-to-four family residential | 513 |
| | — |
| | 513 |
| | 86,484 |
| | 86,997 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 84 |
| | 1,331 |
| | 1,415 |
| | 50,570 |
| | 51,985 |
|
| Five or more family residential and commercial properties | 40 |
| | — |
| | 40 |
| | 97,459 |
| | 97,499 |
|
| Total real estate construction and land development | 124 |
| | 1,331 |
| | 1,455 |
| | 148,029 |
| | 149,484 |
|
| Consumer | 1,939 |
| | 687 |
| | 2,626 |
| | 352,465 |
| | 355,091 |
|
| Gross loans receivable | $ | 7,716 |
| | $ | 7,729 |
| | $ | 15,445 |
| | $ | 2,830,267 |
| | $ | 2,845,712 |
|
There was one SBA PPP loan 90 days or more past due that was still accruing interest as of December 31, 2021 with an amortized cost of $293,000. There were no loans 90 days or more past due that were still accruing interest as of December 31, 2018 or December 31, 2017, excluding PCI loans.
2020.
(f) ImpairedCollateral-dependent Loans
The type of collateral securing loans
Impaired loans include nonaccrual loans individually evaluated for credit losses and performing TDR loans. The balancesfor which the repayment was expected to be provided substantially through the operation or sale of impaired loansthe collateral as of December 31, 20182021 and December 31, 20172020 were as follows, with balances representing the amortized cost of the loan classified by the primary collateral category of each loan if multiple collateral sources secure the loan:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| CRE | | Farmland | | Residential Real Estate | | Other | | Total |
| (In thousands) |
| Commercial business: |
| Commercial and industrial | $ | 1,499 | | | $ | 4,362 | | | $ | 1,036 | | | $ | 245 | | | $ | 7,142 | |
| Owner-occupied CRE | 3,035 | | | — | | | — | | | — | | | 3,035 | |
| Non-owner occupied CRE | 1,273 | | | — | | | — | | | — | | | 1,273 | |
| Total commercial business | 5,807 | | | 4,362 | | | 1,036 | | | 245 | | | 11,450 | |
| | | | | | | | | |
| Real estate construction and land development: |
| | | | | | | | | |
| Commercial and multifamily | 571 | | | — | | | — | | | — | | | 571 | |
| | | | | | | | | |
| | | | | | | | | |
| Total | $ | 6,378 | | | $ | 4,362 | | | $ | 1,036 | | | $ | 245 | | | $ | 12,021 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2020 |
| CRE | | Farmland | | Residential Real Estate | | | | Other | | Total |
| (In thousands) |
| Commercial business: |
| Commercial and industrial | $ | 1,893 | | | $ | 18,738 | | | $ | 584 | | | | | $ | 1,405 | | | $ | 22,620 | |
| Owner-occupied CRE | 4,693 | | | — | | | — | | | | | — | | | 4,693 | |
| Non-owner occupied CRE | 3,424 | | | — | | | — | | | | | — | | | 3,424 | |
| Total commercial business | 10,010 | | | 18,738 | | | 584 | | | | | 1,405 | | | 30,737 | |
| Residential real estate | — | | | — | | | 67 | | | | | — | | | 67 | |
| Real estate construction and land development: |
| | | | | | | | | | | |
| Commercial and multifamily | 572 | | | — | | | — | | | | | — | | | 572 | |
| | | | | | | | | | | |
| Consumer | — | | | — | | | 30 | | | | | — | | | 30 | |
| Total | $ | 10,582 | | | $ | 18,738 | | | $ | 681 | | | | | $ | 1,405 | | | $ | 31,406 | |
There have been no significant changes to the collateral securing loans individually evaluated for credit losses and for which repayment was expected to be provided substantially through the operation or sale of the collateral during the year ended December 31, 2021, except changes due to additions or removals of loans in this classification.
(g) Troubled Debt Restructured Loans
Loans that were modified as TDR loans are set forth in the following tables:tables for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 | | 2019 |
| Number of
Contracts | | Amortized Cost (1) (2) | | Number of
Contracts | | Amortized Cost (1) (2) | | Number of
Contracts | | Amortized Cost (1) (2) |
| (Dollars in thousands) |
| Commercial business: | | | | | | | | | | | |
| Commercial and industrial | 31 | | | $ | 9,710 | | | 75 | | | $ | 36,118 | | | 44 | | | $ | 31,122 | |
| Owner-occupied CRE | 7 | | | 16,565 | | | 14 | | | 19,326 | | | 4 | | | 1,695 | |
| Non-owner occupied CRE | 4 | | | 17,640 | | | 9 | | | 25,728 | | | 4 | | | 2,208 | |
| Total commercial business | 42 | | 43,915 | | | 98 | | | 81,172 | | | 52 | | | 35,025 | |
| Residential real estate | 1 | | | 178 | | | 1 | | | 22 | | | — | | | — | |
| Real estate construction and land development: |
| Residential | — | | | — | | | 4 | | | 1,926 | | | 1 | | | 237 | |
| Commercial and multifamily | 1 | | | 450 | | | 1 | | | 450 | | | — | | | — | |
| Total real estate construction and land development | 1 | | | 450 | | | 5 | | | 2,376 | | | 1 | | | 237 | |
| Consumer | 22 | | | 511 | | | 48 | | | 1,198 | | | 12 | | | 157 | |
| Total | 66 | | | $ | 45,054 | | | 152 | | | $ | 84,768 | | | 65 | | | $ | 35,419 | |
|
| | | | | | | | | | | | | | | | | | | |
| | December 31, 2018 |
| | Recorded Investment With No Specific Valuation Allowance | | Recorded Investment With Specific Valuation Allowance | | Total Recorded Investment | | Unpaid Contractual Principal Balance | | Related Specific Valuation Allowance |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 2,523 |
| | $ | 20,119 |
| | $ | 22,642 |
| | $ | 24,176 |
| | $ | 2,607 |
|
| Owner-occupied commercial real estate | 816 |
| | 5,000 |
| | 5,816 |
| | 6,150 |
| | 1,142 |
|
| Non-owner occupied commercial real estate | 3,352 |
| | 2,924 |
| | 6,276 |
| | 6,414 |
| | 206 |
|
| Total commercial business | 6,691 |
| | 28,043 |
| | 34,734 |
| | 36,740 |
| | 3,955 |
|
| One-to-four family residential | — |
| | 279 |
| | 279 |
| | 293 |
| | 76 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 899 |
| | — |
| | 899 |
| | 1,662 |
| | — |
|
| Total real estate construction and land development | 899 |
| | — |
| | 899 |
| | 1,662 |
| | — |
|
| Consumer | — |
| | 527 |
| | 527 |
| | 538 |
| | 139 |
|
| Total | $ | 7,590 |
| | $ | 28,849 |
| | $ | 36,439 |
| | $ | 39,233 |
| | $ | 4,170 |
|
(2) As the Bank did not forgive any principal or interest balance as part of the loan modifications, the Bank’s amortized cost in each loan at the date of modification (pre-modification) did not change as a result of the modification (post-modification).
|
| | | | | | | | | | | | | | | | | | | |
| | December 31, 2017 |
| | Recorded Investment With No Specific Valuation Allowance | | Recorded Investment With Specific Valuation Allowance | | Total Recorded Investment | | Unpaid Contractual Principal Balance | | Related Specific Valuation Allowance |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 2,127 |
| | $ | 9,872 |
| | $ | 11,999 |
| | $ | 12,489 |
| | $ | 1,326 |
|
| Owner-occupied commercial real estate | 2,452 |
| | 4,356 |
| | 6,808 |
| | 7,054 |
| | 621 |
|
| Non-owner occupied commercial real estate | 4,722 |
| | 11,297 |
| | 16,019 |
| | 16,172 |
| | 1,222 |
|
| Total commercial business | 9,301 |
| | 25,525 |
| | 34,826 |
| | 35,715 |
| | 3,169 |
|
| One-to-four family residential | — |
| | 299 |
| | 299 |
| | 308 |
| | 93 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 938 |
| | 309 |
| | 1,247 |
| | 2,200 |
| | 2 |
|
| Five or more family residential and commercial properties | — |
| | 645 |
| | 645 |
| | 645 |
| | 37 |
|
| Total real estate construction and land development | 938 |
| | 954 |
| | 1,892 |
| | 2,845 |
| | 39 |
|
| Consumer | 160 |
| | 282 |
| | 442 |
| | 466 |
| | 54 |
|
| Total | $ | 10,399 |
| | $ | 27,060 |
| | $ | 37,459 |
| | $ | 39,334 |
| | $ | 3,355 |
|
The average recorded investment of impaired$3.1 million, $7.5 million and $1.0 million at December 31, 2021, December 31, 2020, and December 31, 2019, respectively, related to these TDR loans forwhich were restructured during the year ended December 31, 2018, 20172021, 2020 and 2016 are set forth in the following table:
|
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | (In thousands) |
| Commercial business: | | | | | |
| Commercial and industrial | $ | 16,773 |
| | $ | 11,310 |
| | $ | 10,207 |
|
| Owner-occupied commercial real estate | 11,312 |
| | 5,401 |
| | 4,540 |
|
| Non-owner occupied commercial real estate | 9,465 |
| | 12,162 |
| | 11,709 |
|
| Total commercial business | 37,550 |
|
| 28,873 |
|
| 26,456 |
|
| One-to-four family residential | 290 |
| | 309 |
| | 279 |
|
| Real estate construction and land development: | | | | | |
| One-to-four family residential | 1,091 |
| | 2,315 |
| | 3,305 |
|
| Five or more family residential and commercial properties | 129 |
| | 903 |
| | 1,656 |
|
| Total real estate construction and land development | 1,220 |
|
| 3,218 |
|
| 4,961 |
|
| Consumer | 428 |
| | 351 |
| | 645 |
|
| Total | $ | 39,488 |
|
| $ | 32,751 |
|
| $ | 32,341 |
|
For the years ended December 31, 2018, 2017 and 2016, no interest income was recognized subsequent to a loan’s classification as nonaccrual. For the years ended December 31, 2018, 2017 and 2016, the Bank recorded $1.4 million, $1.2 million and $651,000, respectively, of interest income related to performing TDR loans.
(g) Troubled Debt Restructured Loans
The majority of the Bank’s TDR loans are a result of granting extensions of maturity on troubled credits which have already been adversely classified. The Bank grants such extensions to reassess the borrower’s financial status and to develop a plan for repayment. The second most prevalent concessions are certain modifications with extensions that also include interest rate reductions. Certain TDR loans were additionally re-amortized over a longer period of
time. These modifications would all be considered a concession for a borrower that could not obtain similar financing terms from another source other than from the Bank.
The financial effects of each modification will vary based on the specific restructure. For the majority of the Bank’s TDR loans, the loans were interest-only with a balloon payment at maturity. If the interest rate is not adjusted and the modified terms are consistent with other similar credits being offered, the Bank may not experience any loss associated with the restructure. If, however, the restructure involves forbearance agreements or interest rate modifications, the Bank may not collect all the principal and interest based on the original contractual terms. The Bank estimates the necessary allowance for loan losses on TDR loans using the same guidance as used for other impaired loans.
The recorded investment balance and related allowance for loan losses of performing and nonaccrual TDR loans as of December 31, 2018 and December 31, 2017 were as follows:
|
| | | | | | | | | | | | | | | |
| | December 31, 2018 | | December 31, 2017 |
| | Performing TDRs | | Nonaccrual TDRs | | Performing
TDRs | | Nonaccrual
TDRs |
| | (In thousands) |
| TDR loans | $ | 22,736 |
| | $ | 6,943 |
| | $ | 26,757 |
| | $ | 5,193 |
|
| Allowance for loan losses on TDR loans | 2,257 |
| | 658 |
| | 2,635 |
| | 379 |
|
2019, respectively.
The unfunded commitment to borrowers related to TDR loans was $943,000$5.7 million and $1.2$2.6 million at December 31, 20182021 and December 31, 2017,2020, respectively.
The following tables present loans that were modified asin a TDR and subsequently defaulted within twelve months from the modification date during the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 | | 2019 |
| Number of Contracts (1) | | Amortized Cost (1) | | Number of Contracts (1) | | Amortized Cost (1) | | Number of Contracts (1) | | Amortized Cost (1) |
| (Dollars in thousands) |
| Commercial business: | | | | | | | | | | | |
| Commercial and industrial | 6 | | | $ | 1,379 | | | 4 | | | $ | 2,136 | | | 13 | | | $ | 12,854 | |
| Owner-occupied CRE | — | | | — | | | 2 | | | 1,369 | | | 3 | | | 1,142 | |
| Non-owner occupied CRE | — | | | — | | | 2 | | | 1,811 | | | 1 | | | 52 | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Total | 6 | | | $ | 1,379 | | | 8 | | | $ | 5,316 | | | 17 | | | $ | 14,048 | |
(1)Number of contracts and amortized cost represent TDR loans which have balances as of period end, net of subsequent payments after modifications. Certain TDR loans may have been paid-down or charged-off during the years ended December 31, 2018, 20172021, 2020 and 2016 are set forth in the following table:2019.
|
| | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | Number of Contracts (1) | | Recorded Investment (1) (2) | | Number of Contracts (1) | | Recorded Investment (1) (2) | | Number of Contracts (1) | | Recorded Investment (1) (2) |
| | (Dollars in thousands) |
| Commercial business: | | | | | | | | | | | |
| Commercial and industrial | 31 |
| | $ | 16,129 |
| | 19 |
| | $ | 7,212 |
| | 19 |
| | $ | 7,398 |
|
| Owner-occupied commercial real estate | 4 |
| | 2,521 |
| | 3 |
| | 1,366 |
| | 2 |
| | 569 |
|
| Non-owner occupied commercial real estate | 3 |
| | 2,944 |
| | 4 |
| | 9,574 |
| | 2 |
| | 2,121 |
|
| Total commercial business | 38 |
|
| 21,594 |
|
| 26 |
|
| 18,152 |
| | 23 |
| | 10,088 |
|
| Real estate construction and land development: | | | | | | | | | | | |
| One-to-four family residential | 2 |
| | 665 |
| | 2 |
| | 938 |
| | 5 |
| | 2,206 |
|
| Five or more family residential and commercial properties | — |
| | — |
| | — |
| | — |
| | 1 |
| | 1,078 |
|
| Total real estate construction and land development | 2 |
|
| 665 |
|
| 2 |
|
| 938 |
| | 6 |
| | 3,284 |
|
| Consumer | 13 |
| | 236 |
| | 8 |
| | 110 |
| | 6 |
| | 66 |
|
| Total TDR loans | 53 |
| | $ | 22,495 |
| | 36 |
| | $ | 19,200 |
| | 35 |
| | $ | 13,438 |
|
| |
(1)
| Number of contracts and outstanding principal balance represent loans which have balances as of period end as certain loans may have been paid-down or charged-off during the years ended December 31, 2018, 2017 and 2016. |
| |
(2)
| Includes subsequent payments after modifications and reflects the balance as of period end. As the Bank did not forgive any principal or interest balance as part of the loan modification, the Bank’s recorded investment in each loan at the date of modification (pre-modification) did not change as a result of the modification (post-modification), except when the modification was the initial advance on a one-to-four family residential real estate construction and land development loan under a master guidance line. There were no advances on these types of loans during the years ended December 31, 2018, 2017 and 2016. |
The related specific valuation allowance at December 31, 2018 for loans that were modified as TDR loans during the year ended December 31, 2018 was $2.3 million. The related specific valuation allowance at December 31, 2017 for loans that were modified as TDR loans during the year ended December 31, 2017 was $1.8 million. Certain loans included in the tables above may have been previously reported as TDR loans. The Bank typically grants shorter extension periods to continually monitor these TDR loans despite the fact that the extended date might not be the date the Bank expects sufficient cash flow from these borrowers. The Bank does not consider these modifications a subsequent default of a TDR as new loan terms, specifically new maturity dates, were granted. The potential losses related to these loans would have been considered in the period the loan was first reported as a TDR loan and are adjusted, as necessary, in the current period based on more recent information.
Loans that were modified during the previous twelve months that subsequently defaulted duringDuring the years ended December 31, 2018, 20172021, 2020, and 2016 are included in the following table:
|
| | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | Number of Contracts | | Recorded Investment (1) | | Number of
Contracts | | Recorded Investment (1) | | Number of
Contracts | | Recorded Investment (1) |
| | (Dollars in thousands) |
| Commercial business: | | | | | | | | | | | |
| Commercial and industrial | 5 |
| | $ | 1,890 |
| | 1 |
| | $ | 283 |
| | — |
| | $ | — |
|
| Owner-occupied commercial real estate | 1 |
| | 65 |
| | 1 |
| | 80 |
| | 1 |
| | 488 |
|
| Total commercial business | 6 |
|
| 1,955 |
|
| 2 |
|
| 363 |
| | 1 |
| | 488 |
|
| Real estate construction and land development: | | | | | | | | | | | |
| One-to-four family residential | 2 |
| | 665 |
| | 2 |
| | 938 |
| | 2 |
| | 1,143 |
|
| Total real estate construction and land development | 2 |
|
| 665 |
|
| 2 |
|
| 938 |
| | 2 |
| | 1,143 |
|
| Consumer | — |
| | — |
| | 1 |
| | 7 |
| | — |
| | — |
|
| Total | 8 |
|
| $ | 2,620 |
|
| 5 |
|
| $ | 1,308 |
| | 3 |
| | $ | 1,631 |
|
| |
(1)
| Number of contracts and outstanding principal balance represent loans which have balances as of period end as certain loans may have been paid-down or charged-off during the years ended December 31, 2018, 2017 and 2016. |
During the year ended December 31, 2018, one commercial2019, 6, 8 and industrial loan totaling $882,000 defaulted due to being greater than 90 days past due the modified terms during the year ended December 31, 2018. The remaining seven11 TDR loans defaulted because they wereeach was past theirits modified maturity dates,date and the borrowers haveborrower had not subsequently repaid the credits. The Bank has chosenchose not to further extend the maturitiesmaturity date on these loans.The Bank had a specific valuation allowance of $260,000 at December 31, 2018 related to the credits which defaulted duringTDR loans. The remaining 6 TDR loans for the year ended December 31, 2018.
During2019 defaulted because the year ended December 31, 2017, one consumer loan defaulted due to being greaterborrower was more than 90 days past due the modified terms, but thedelinquent on their scheduled loan became current as of December 31, 2017. The remaining four loans defaulted as they were past their modified maturity dates, and the borrowers had not repaid the credits. The Bank has chosen not to extend the maturities on these loans. During the year ended December 31, 2016, all three loans defaulted because they were past their modified maturity dates, and the borrowers had not repaid the credits. At December 31, 2016, the Bank was in the process of granting addition extensions on these loans.payments. The Bank had a specific valuation allowance of $1,000 and $111,000 at December 31, 2017 and 2016, respectively, related to the creditsan ACL on loans for these TDR loans which defaulted during the related year ends.
(h) Purchased Credit Impaired Loans
The Company acquired certain loansyears of $111,000, $229,000, and designated them as PCI loans, which are accounted for under FASB ASC 310-30. No loans acquired in the Premier and Puget Mergers were considered PCI.
The following table reflects the outstanding principal balance and recorded investment of the PCI loans$88,000 at December 31, 20182021, 2020, and December 31, 2017:2019.
|
| | | | | | | | | | | | | | | |
| | December 31, 2018 | | December 31, 2017 |
| | Outstanding Principal | | Recorded Investment | | Outstanding Principal | | Recorded Investment |
| | (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 6,319 |
| | $ | 3,433 |
| | $ | 8,818 |
| | $ | 2,912 |
|
| Owner-occupied commercial real estate | 7,830 |
| | 7,215 |
| | 12,230 |
| | 11,515 |
|
| Non-owner occupied commercial real estate | 8,685 |
| | 7,059 |
| | 14,295 |
| | 13,342 |
|
| Total commercial business | 22,834 |
| | 17,707 |
| | 35,343 |
| | 27,769 |
|
| One-to-four family residential | 3,169 |
| | 3,315 |
| | 4,120 |
| | 5,255 |
|
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 67 |
| | 380 |
| | 841 |
| | 89 |
|
| Five or more family residential and commercial properties | 188 |
| | 43 |
| | 2,361 |
| | 2,035 |
|
| Total real estate construction and land development | 255 |
| | 423 |
| | 3,202 |
| | 2,124 |
|
| Consumer | 2,203 |
| | 3,462 |
| | 3,974 |
| | 5,455 |
|
| Gross PCI loans | $ | 28,461 |
| | $ | 24,907 |
| | $ | 46,639 |
| | $ | 40,603 |
|
On the acquisition dates, the amount by which the undiscounted expected cash flows of the PCI loans exceeded the estimated fair value of the loan is the “accretable yield.” The accretable yield is then measured at each financial reporting date and represents the difference between the remaining undiscounted expected cash flows and the current carrying value of the PCI loans.
The following table summarizes the accretable yield on the PCI loans for the years ended December 31, 2018, 2017 and 2016.
|
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | (In thousands) |
| Balance at the beginning of the year | $ | 11,224 |
| | $ | 13,860 |
| | $ | 17,592 |
|
| Accretion | (2,674 | ) | | (3,471 | ) | | (4,962 | ) |
| Disposal and other | (2,871 | ) | | (2,758 | ) | | (3,329 | ) |
| Reclassification from (to) nonaccreatable difference | 3,814 |
| | 3,593 |
| | 4,559 |
|
| Balance at the end of the year | $ | 9,493 |
|
| $ | 11,224 |
| | $ | 13,860 |
|
(i)(h) Related Party Loans
In the ordinary course of business, the Company has granted loans to certain directors, executive officers and their affiliates (collectively referred to as “related parties”).
affiliates. Activity in related party loans forduring the years ended December 31, 2018, 2017 and 2016periods indicated was as follows:
| | | | | Year Ended December 31, | | Year Ended December 31, |
| | | 2018 | | 2017 | | 2016 | | 2021 | | 2020 | | 2019 |
| | | (in thousands) | | (In thousands) |
| Balance outstanding at the beginning of year | | $ | 8,460 |
| | $ | 19,917 |
| | $ | 20,775 |
| Balance outstanding at the beginning of year | $ | 7,694 | | | $ | 8,144 | | | $ | 8,367 | |
| Elimination of outstanding loan balance due to change in related party status | | — |
| | (10,930 | ) | | — |
| |
| | Principal additions | | 211 |
| | — |
| | 738 |
| Principal additions | — | | | 199 | | | — | |
| | Principal reductions | | (304 | ) | | (527 | ) | | (1,596 | ) | Principal reductions | (572) | | | (649) | | | (223) | |
| Balance outstanding at the end of year | | $ | 8,367 |
| | $ | 8,460 |
| | $ | 19,917 |
| Balance outstanding at the end of year | $ | 7,122 | | | $ | 7,694 | | | $ | 8,144 | |
The Company had $592,000$255,000 and $750,000$545,000 of unfunded commitments to related parties and all related party loans were performing in accordance with the underlying loan agreements as of December 31, 20182021 and 2017, respectively. The Company did not have any borrowings from related parties at December 31, 2018 or 2017.2020.
(j) Mortgage Banking Activities(i) Residential Real Estate Loan Sales
The Bank originates one-to-four family residential loans. Areal estate loans; a portion of these loanswhich are sold on the secondary market. The Bank does not retain servicing on loans sold in the secondary market. At December 31, 20182021 and 2017,December 31, 2020, the balance of loans held for sale was $1.6$1.5 million and $2.3$4.9 million, respectively.
The following table presents information concerning the origination and sale of the Bank's one-to-four family residential real estate loans and the gains from their sale during the periods indicated:
| | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
| | (In thousands) |
| | | | | |
Originated (1) | $ | 190,734 | | | $ | 191,207 | | | $ | 150,030 | |
| Sold | 89,899 | | | 137,580 | | | 68,238 | |
Gain on sale of loans, net (2) | 3,644 | | | 5,044 | | | 2,159 | |
(1) Includes loans originated for sale of loans as a result ofin the secondary market or for the Bank's mortgage banking activities:loan portfolio.
(2) Excludes net gains on sales of SBA and other loans.
|
| | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | 2018 | | 2017 | | 2016 |
| | | (In thousands) |
| One-to-four family residential loans: | | | | | | |
Originated (1) | | $ | 121,998 |
| | $ | 144,066 |
| | $ | 178,169 |
|
| Sold | | 76,834 |
| | 113,786 |
| | 141,127 |
|
Gain on sale of loans, net (2) | | 2,403 |
| | 3,412 |
| | 3,723 |
|
| |
(1)
| Includes loans originated for sale in the secondary market or for the Bank's loan portfolio. |
| |
(2)
| Excludes net gains on sales of SBA and other loans. |
The Bank may additionally make commitments to fund one-to-four family residential loans (interest rate locks) to be sold into the secondary market. The contractual amounts of commitments to sell and fund with off-balance sheet risk at December 31, 2018 and 2017 were as follows:
|
| | | | | | | | |
| | | December 31, 2018 | | December 31, 2017 |
| | | (In thousands) |
| Commitments to sell mortgage loans | | $ | 3,910 |
| | $ | 10,140 |
|
| | | | | |
| Commitments to fund mortgage loans (at interest rates approximating market rates) for portfolio or for sale: | | | | |
| Fixed rate | | $ | 6,593 |
| | $ | 10,894 |
|
| Variable or adjustable rate | | 1,008 |
| | 56 |
|
| Total commitments to fund mortgage loans | | $ | 7,601 |
| | $ | 10,950 |
|
The fair values of freestanding derivatives related to the commitments to fund mortgage loans and sell at locked interest rates were not significant at December 31, 2018 or 2017.
(k) SBA(j) Commercial Loan Sales, Servicing, and Commercial Servicing Asset
The Company may choose to sell the conditionally guaranteed portion of certain loans guaranteed by the Small Business Administration or the U.S. Department of Agriculture (collectively referred to as "SBA loans") and retain a participating interest in the unguaranteed portion of the loans and the servicing of the loans. The retained unguaranteed portions of these loans are carried at cost net of discounts related to accounting for the sold and retained portions of the loans using the allocation of their carrying amounts based on their relative fair values. The Company does not sell SBA loans with servicing retained unless it retains a participating interest. Details of certain SBA loans serviced for others are as follows:
| | | | | | | | | | | |
| | December 31, 2021 | | December 31, 2020 |
| | (In thousands) |
| Loans serviced for others with participating interest, gross loan balance | $ | 30,852 | | | $ | 32,131 | |
Loans serviced for others with participating interest, participation balance owned by Bank (1) | 7,088 | | | 7,842 | |
|
| | | | | | | | |
| | | December 31, 2018 | | December 31, 2017 |
| | | (In thousands) |
| SBA loans serviced for others with participating interest, gross loan balance | | $ | 54,335 |
| | $ | 53,809 |
|
SBA loans serviced for others with participating interest, participation balance owned by Bank (1) | | 12,715 |
| | 12,394 |
|
(1) Included in the balancesbalance of total loans receivable net on the Company's Consolidated Statements of Financial Condition.
The Company recognized $506,000, $467,000$320,000, $423,000 and $460,000$532,000 of servicing fee income and fees from SBA loans serviced for others for the years ended December 31, 2018, 20172021, 2020 and 2016,2019, respectively. Servicing fee income is reported in other income
The Company's servicing asset at December 31, 2021 and December 31, 2020 was $343,000 and $583,000, respectively. There was no valuation allowance on the Company's Consolidated Statementsservicing asset as of Income.December 31, 2021 and December 31, 2020.
(k) Accrued interest receivable on loans receivable
Accrued interest receivable on loans receivable totaled $10.1 million and $15.8 million at December 31, 2021 and December 31, 2020, respectively. It is excluded from the calculation of the ACL on loans as interest accrued, but not received, is reversed timely. | |
(5) | Allowance for Loan Losses |
The
(4)Allowance for Credit Losses on Loans
Effective January 1, 2020, the Bank adopted ASU 2016-13. CECL Adoption replaced the allowance for loan losses is maintained at a level deemed appropriate by management to providewith the ACL on loans and replaced the related provision for probable incurredloan losses with the provision for credit losses on loans.
The baseline loss rates used to calculate the ACL on loans at December 31, 2021 utilized the Bank's average quarterly historical loss information from December 31, 2012 through the balance sheet date. There were no changes to this assumption during the year ended December 31, 2021. The Bank believes the historic loss rates are viable inputs to the current CECL model as the Bank's lending practice and business has remained relatively stable throughout the periods. While the Bank's assets have grown, the credit culture has stayed relatively consistent.
Prepayments included in the loan portfolio.CECL model at December 31, 2021 were based on the 48-month rolling historical averages for each segment, which management believes is an accurate representation of future prepayment activity. There were no changes to this assumption during the year ended December 31, 2021.
The reasonable and supportable period and subsequent reversion period used in the CECL model was five quarters and two quarters at December 31, 2021. There were no changes to these assumptions during the year ended December 31, 2021. Management believes forecasts beyond this seven quarter time period tend to diverge in economic assumptions and may be less comparable to actual future events. As the length of the reasonable and supportable period increases, the degree of judgment involved in estimating the allowance increases.
During the year ended December 31, 2021, the ACL on loans decreased $27.8 million, or 39.6%, due primarily to a reversal of provision for credit losses on loans of $27.3 million. The reversal of provision for credit losses was primarily driven by improvements in the economic forecast used in the CECL model at December 31, 2021 as compared to the forecast used in the CECL model at December 31, 2020.
The ACL on loans at December 31, 2021 and December 31, 2020 did not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA.
A summary of the changes in the allowance for loan lossesACL on loans during the years ended December 31, 2018, 20172021, December 31, 2020 and 2016December 31, 2019 is as follows:
| | | | Year Ended December 31, | | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 | | 2021 | | 2020 | | 2019 |
| | (In thousands) | | (In thousands) |
| Balance at the beginning of the year | $ | 32,086 |
| | $ | 31,083 |
| | $ | 29,746 |
| Balance at the beginning of the year | $ | 70,185 | | | $ | 36,171 | | | $ | 35,042 | |
| Impact of CECL Adoption | | Impact of CECL Adoption | — | | | 1,822 | | | — | |
| Balance at the beginning of the year, as adjusted | | Balance at the beginning of the year, as adjusted | 70,185 | | | 37,993 | | | 35,042 | |
| Charge-offs | (3,605 | ) | | (4,838 | ) | | (6,085 | ) | Charge-offs | (1,946) | | | (5,622) | | | (4,989) | |
| Recoveries of loans previously charged-off | 1,432 |
| | 1,621 |
| | 2,491 |
| Recoveries of loans previously charged-off | 1,420 | | | 2,381 | | | 1,807 | |
| Provision for loan losses | 5,129 |
| | 4,220 |
| | 4,931 |
| |
| (Reversal of) provision for credit losses on loans | | (Reversal of) provision for credit losses on loans | (27,298) | | | 35,433 | | | 4,311 | |
| Balance at the end of the year | $ | 35,042 |
|
| $ | 32,086 |
| | $ | 31,083 |
| Balance at the end of the year | $ | 42,361 | | | $ | 70,185 | | | $ | 36,171 | |
The following tables detail the activity in the ACL on loans by segment and class for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2021 |
| Beginning Balance | | | | | | Charge-offs | | Recoveries | | Reversal of Provision for Credit Losses | | Ending Balance |
| (In thousands) |
| Commercial business: | | | | | | | | | | | | | |
| Commercial and industrial | $ | 30,010 | | | | | | | $ | (917) | | | $ | 791 | | | $ | (12,107) | | | $ | 17,777 | |
| | | | | | | | | | | | | |
| Owner-occupied CRE | 9,486 | | | | | | | (359) | | | 25 | | | (2,741) | | | 6,411 | |
| Non-owner occupied CRE | 10,112 | | | | | | | — | | | — | | | (1,251) | | | 8,861 | |
| Total commercial business | 49,608 | | | | | | | (1,276) | | | 816 | | | (16,099) | | | 33,049 | |
| Residential real estate | 1,591 | | | | | | | — | | | — | | | (182) | | | 1,409 | |
| Real estate construction and land development: |
| Residential | 1,951 | | | | | | | — | | | 32 | | | (679) | | | 1,304 | |
| Commercial and multifamily | 11,141 | | | | | | | (1) | | | — | | | (7,168) | | | 3,972 | |
| Total real estate construction and land development | 13,092 | | | | | | | (1) | | | 32 | | | (7,847) | | | 5,276 | |
| Consumer | 5,894 | | | | | | | (669) | | | 572 | | | (3,170) | | | 2,627 | |
| Total | $ | 70,185 | | | | | | | $ | (1,946) | | | $ | 1,420 | | | $ | (27,298) | | | $ | 42,361 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2020 |
| Beginning Balance | | Impact of CECL Adoption | | Beginning Balance,
as Adjusted | | Charge-offs | | Recoveries | | Provision (Reversal of Provision) for Credit Losses | | Ending Balance |
| (In thousands) |
| Commercial business: | | | | | | | | | | | | | |
| Commercial and industrial | $ | 11,739 | | | $ | (1,348) | | | $ | 10,391 | | | $ | (3,616) | | | $ | 1,513 | | | $ | 21,722 | | | $ | 30,010 | |
| | | | | | | | | | | | | |
| Owner-occupied CRE | 4,512 | | | 452 | | | 4,964 | | | (135) | | | 17 | | | 4,640 | | | 9,486 | |
| Non-owner occupied CRE | 7,682 | | | (2,039) | | | 5,643 | | | — | | | — | | | 4,469 | | | 10,112 | |
| Total commercial business | 23,933 | | | (2,935) | | | 20,998 | | | (3,751) | | | 1,530 | | | 30,831 | | | 49,608 | |
| Residential real estate | 1,458 | | | 1,471 | | | 2,929 | | | — | | | 3 | | | (1,341) | | | 1,591 | |
| Real estate construction and land development: |
| Residential | 1,455 | | | (571) | | | 884 | | | — | | | 278 | | | 789 | | | 1,951 | |
| Commercial and multifamily | 1,605 | | | 7,240 | | | 8,845 | | | (417) | | | — | | | 2,713 | | | 11,141 | |
| Total real estate construction and land development | 3,060 | | | 6,669 | | | 9,729 | | | (417) | | | 278 | | | 3,502 | | | 13,092 | |
| Consumer | 6,821 | | | (2,484) | | | 4,337 | | | (1,454) | | | 570 | | | 2,441 | | | 5,894 | |
| Unallocated | 899 | | | (899) | | | — | | | — | | | — | | | — | | | — | |
| Total | $ | 36,171 | | | $ | 1,822 | | | $ | 37,993 | | | $ | (5,622) | | | $ | 2,381 | | | $ | 35,433 | | | $ | 70,185 | |
The following table details the activity in the allowance for loan losses disaggregated by segment and class for the year ended December 31, 2018:period indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2019 |
| Beginning Balance | | Charge-offs | | Recoveries | | Provision for Loan Losses | | Ending Balance |
| (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 11,343 | | | $ | (2,692) | | | $ | 166 | | | $ | 2,922 | | | $ | 11,739 | |
| Owner-occupied CRE | 4,898 | | | — | | | 50 | | | (436) | | | 4,512 | |
| Non-owner occupied CRE | 7,470 | | | — | | | 441 | | | (229) | | | 7,682 | |
| Total commercial business | 23,711 | | | (2,692) | | | 657 | | | 2,257 | | | 23,933 | |
| Residential real estate | 1,203 | | | (60) | | | — | | | 315 | | | 1,458 | |
|
| | | | | | | | | | | | | | | | | | | |
| | Balance at Beginning of Year | | Charge-offs | | Recoveries | | Provision for Loan Losses | | Balance at End of Year |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 9,910 |
| | $ | (1,250 | ) | | $ | 901 |
| | $ | 1,782 |
| | $ | 11,343 |
|
| Owner-occupied commercial real estate | 3,992 |
| | (1 | ) | | 7 |
| | 900 |
| | 4,898 |
|
| Non-owner occupied commercial real estate | 8,097 |
| | (149 | ) | | — |
| | (478 | ) | | 7,470 |
|
| Total commercial business | 21,999 |
| | (1,400 | ) |
| 908 |
|
| 2,204 |
|
| 23,711 |
|
| One-to-four family residential | 1,056 |
| | (45 | ) | | — |
| | 192 |
| | 1,203 |
|
| Real estate construction and land development: | | | | | | |
| | |
| One-to-four family residential | 862 |
| | — |
| | 11 |
| | 367 |
| | 1,240 |
|
| Five or more family residential and commercial properties | 1,190 |
| | — |
| | — |
| | (236 | ) | | 954 |
|
| Total real estate construction and land development | 2,052 |
| | — |
|
| 11 |
|
| 131 |
|
| 2,194 |
|
| Consumer | 6,081 |
| | (2,160 | ) | | 513 |
| | 2,147 |
| | 6,581 |
|
| Unallocated | 898 |
| | — |
| | — |
| | 455 |
| | 1,353 |
|
| Total | $ | 32,086 |
| | $ | (3,605 | ) |
| $ | 1,432 |
|
| $ | 5,129 |
|
| $ | 35,042 |
|
The following table details the allowance for loan losses disaggregated on the basis of the Company's impairment method as of December 31, 2018:
|
| | | | | | | | | | | | | | | |
| | Loans Individually Evaluated for Impairment | | Loans Collectively Evaluated for Impairment | | PCI Loans | | Total Allowance for Loan Losses |
| | (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 2,607 |
| | $ | 7,913 |
| | $ | 823 |
| | $ | 11,343 |
|
| Owner-occupied commercial real estate | 1,142 |
| | 3,063 |
| | 693 |
| | 4,898 |
|
| Non-owner occupied commercial real estate | 206 |
| | 6,630 |
| | 634 |
| | 7,470 |
|
| Total commercial business | 3,955 |
| | 17,606 |
| | 2,150 |
| | 23,711 |
|
| One-to-four family residential | 76 |
| | 1,015 |
| | 112 |
| | 1,203 |
|
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | — |
| | 1,040 |
| | 200 |
| | 1,240 |
|
| Five or more family residential and commercial properties | — |
| | 875 |
| | 79 |
| | 954 |
|
| Total real estate construction and land development | — |
| | 1,915 |
| | 279 |
| | 2,194 |
|
| Consumer | 139 |
| | 5,965 |
| | 477 |
| | 6,581 |
|
| Unallocated | — |
| | 1,353 |
| | — |
| | 1,353 |
|
| Total | $ | 4,170 |
|
| $ | 27,854 |
|
| $ | 3,018 |
|
| $ | 35,042 |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2019 |
| Beginning Balance | | Charge-offs | | Recoveries | | Provision for Loan Losses | | Ending Balance |
| Real estate construction and land development: |
| Residential | 1,240 | | | (133) | | | 637 | | | (289) | | | 1,455 | |
| Commercial and multifamily | 954 | | | — | | | — | | | 651 | | | 1,605 | |
| Total real estate construction and land development | 2,194 | | | (133) | | | 637 | | | 362 | | | 3,060 | |
| Consumer | 6,581 | | | (2,104) | | | 513 | | | 1,831 | | | 6,821 | |
| Unallocated | 1,353 | | | — | | | — | | | (454) | | | 899 | |
| Total | $ | 35,042 | | | $ | (4,989) | | | $ | 1,807 | | | $ | 4,311 | | | $ | 36,171 | |
The following table details the recorded investment balance of the loan receivables disaggregated on the basis of the Company’s impairment method as of December 31, 2018:
|
| | | | | | | | | | | | | | | |
| | Loans Individually Evaluated for Impairment | | Loans Collectively Evaluated for Impairment | | PCI Loans | | Total Gross Loans Receivable |
| | (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 22,642 |
| | $ | 827,531 |
| | $ | 3,433 |
| | $ | 853,606 |
|
| Owner-occupied commercial real estate | 5,816 |
| | 766,783 |
| | 7,215 |
| | 779,814 |
|
| Non-owner occupied commercial real estate | 6,276 |
| | 1,291,128 |
| | 7,059 |
| | 1,304,463 |
|
| Total commercial business | 34,734 |
|
| 2,885,442 |
|
| 17,707 |
|
| 2,937,883 |
|
| One-to-four family residential | 279 |
| | 98,169 |
| | 3,315 |
| | 101,763 |
|
| Real estate construction and land development: | | | | | | |
|
| One-to-four family residential | 899 |
| | 101,451 |
| | 380 |
| | 102,730 |
|
| Five or more family residential and commercial properties | — |
| | 112,687 |
| | 43 |
| | 112,730 |
|
| Total real estate construction and land development | 899 |
|
| 214,138 |
|
| 423 |
|
| 215,460 |
|
| Consumer | 527 |
| | 391,556 |
| | 3,462 |
| | 395,545 |
|
| Total | $ | 36,439 |
|
| $ | 3,589,305 |
|
| $ | 24,907 |
|
| $ | 3,650,651 |
|
The following table details the activity in the allowance for loan losses disaggregated by segment and class for the year ended December 31, 2017:
|
| | | | | | | | | | | | | | | | | | | |
| | Balance at Beginning of Year | | Charge-offs | | Recoveries | | Provision for Loan Losses | | Balance at End of Year |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 10,968 |
| | $ | (859 | ) | | $ | 792 |
| | $ | (991 | ) | | $ | 9,910 |
|
| Owner-occupied commercial real estate | 3,661 |
| | (1,579 | ) | | 155 |
| | 1,755 |
| | 3,992 |
|
| Non-owner occupied commercial real estate | 7,753 |
| | — |
| | — |
| | 344 |
| | 8,097 |
|
| Total commercial business | 22,382 |
| | (2,438 | ) | | 947 |
| | 1,108 |
| | 21,999 |
|
| One-to-four family residential | 1,015 |
| | (30 | ) | | 2 |
| | 69 |
| | 1,056 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 797 |
| | (556 | ) | | 202 |
| | 419 |
| | 862 |
|
| Five or more family residential and commercial properties | 1,359 |
| | — |
| | — |
| | (169 | ) | | 1,190 |
|
| Total real estate construction and land development | 2,156 |
| | (556 | ) | | 202 |
| | 250 |
| | 2,052 |
|
| Consumer | 5,024 |
| | (1,814 | ) | | 470 |
| | 2,401 |
| | 6,081 |
|
| Unallocated | 506 |
| | — |
| | — |
| | 392 |
| | 898 |
|
| Total | $ | 31,083 |
| | $ | (4,838 | ) | | $ | 1,621 |
| | $ | 4,220 |
| | $ | 32,086 |
|
The following table details the allowance for loan losses disaggregated on the basis of the Company's impairment method as of December 31, 2017:
|
| | | | | | | | | | | | | | | |
| | Loans Individually Evaluated for Impairment | | Loans Collectively Evaluated for Impairment | | PCI Loans | | Total Allowance for Loan Losses |
| | (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 1,326 |
| | $ | 7,558 |
| | $ | 1,026 |
| | $ | 9,910 |
|
| Owner-occupied commercial real estate | 621 |
| | 2,557 |
| | 814 |
| | 3,992 |
|
| Non-owner occupied commercial real estate | 1,222 |
| | 5,919 |
| | 956 |
| | 8,097 |
|
| Total commercial business | 3,169 |
|
| 16,034 |
|
| 2,796 |
|
| 21,999 |
|
| One-to-four family residential | 93 |
| | 798 |
| | 165 |
| | 1,056 |
|
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 2 |
| | 635 |
| | 225 |
| | 862 |
|
| Five or more family residential and commercial properties | 37 |
| | 1,064 |
| | 89 |
| | 1,190 |
|
| Total real estate construction and land development | 39 |
|
| 1,699 |
|
| 314 |
|
| 2,052 |
|
| Consumer | 54 |
| | 5,303 |
| | 724 |
| | 6,081 |
|
| Unallocated | — |
| | 898 |
| | — |
| | 898 |
|
| Total | $ | 3,355 |
|
| $ | 24,732 |
|
| $ | 3,999 |
|
| $ | 32,086 |
|
The following table details the recorded investment balance of the loan receivables disaggregated on the basis of the Company’s impairment method as of December 31, 2017:
|
| | | | | | | | | | | | | | | |
| | Loans Individually Evaluated for Impairment | | Loans Collectively Evaluated for Impairment | | PCI Loans | | Total Gross Loans Receivable |
| | (In thousands) |
| Commercial business: | | | | | | | |
| Commercial and industrial | $ | 11,999 |
| | $ | 630,485 |
| | $ | 2,912 |
| | $ | 645,396 |
|
| Owner-occupied commercial real estate | 6,808 |
| | 603,827 |
| | 11,515 |
| | 622,150 |
|
| Non-owner occupied commercial real estate | 16,019 |
| | 957,233 |
| | 13,342 |
| | 986,594 |
|
| Total commercial business | 34,826 |
|
| 2,191,545 |
|
| 27,769 |
|
| 2,254,140 |
|
| One-to-four family residential | 299 |
| | 81,443 |
| | 5,255 |
| | 86,997 |
|
| Real estate construction and land development: | | | | | | | |
| One-to-four family residential | 1,247 |
| | 50,649 |
| | 89 |
| | 51,985 |
|
| Five or more family residential and commercial properties | 645 |
| | 94,819 |
| | 2,035 |
| | 97,499 |
|
| Total real estate construction and land development | 1,892 |
|
| 145,468 |
|
| 2,124 |
|
| 149,484 |
|
| Consumer | 442 |
| | 349,194 |
| | 5,455 |
| | 355,091 |
|
| Total | $ | 37,459 |
|
| $ | 2,767,650 |
|
| $ | 40,603 |
|
| $ | 2,845,712 |
|
The following table details the activity in the allowance for loan losses disaggregated by segment and class for the year ended December 31, 2016:
|
| | | | | | | | | | | | | | | | | | | |
| | Balance at Beginning of Year | | Charge-offs | | Recoveries | | Provision for Loan Losses | | Balance at End of Year |
| | (In thousands) |
| Commercial business: | | | | | | | | | |
| Commercial and industrial | $ | 9,972 |
| | $ | (3,265 | ) | | $ | 1,844 |
| | $ | 2,417 |
| | $ | 10,968 |
|
| Owner-occupied commercial real estate | 4,370 |
| | (538 | ) | | — |
| | (171 | ) | | 3,661 |
|
| Non-owner occupied commercial real estate | 7,722 |
| | (350 | ) | | — |
| | 381 |
| | 7,753 |
|
| Total commercial business | 22,064 |
| | (4,153 | ) | | 1,844 |
| | 2,627 |
| | 22,382 |
|
| One-to-four family residential | 1,157 |
| | — |
| | 2 |
| | (144 | ) | | 1,015 |
|
| Real estate construction and land development: | | | | | | | | | |
| One-to-four family residential | 1,058 |
| | (100 | ) | | 83 |
| | (244 | ) | | 797 |
|
| Five or more family residential and commercial properties | 813 |
| | (54 | ) | | — |
| | 600 |
| | 1,359 |
|
| Total real estate construction and land development | 1,871 |
| | (154 | ) | | 83 |
| | 356 |
| | 2,156 |
|
| Consumer | 4,309 |
| | (1,778 | ) | | 562 |
| | 1,931 |
| | 5,024 |
|
| Unallocated | 345 |
| | — |
| | — |
| | 161 |
| | 506 |
|
| Total | $ | 29,746 |
| | $ | (6,085 | ) | | $ | 2,491 |
| | $ | 4,931 |
| | $ | 31,083 |
|
| |
(6) | Other Real Estate Owned |
Changes in other real estate owned during the years ended December 31, 2018, 2017 and 2016periods indicated were as follows:
| | | | Year Ended December 31, | | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 | | 2021 | | 2020 | | 2019 |
| | (In thousands | | (In thousands) |
| Balance at the beginning of the year | $ | — |
| | $ | 754 |
| | $ | 2,019 |
| Balance at the beginning of the year | $ | — | | | $ | 841 | | | $ | 1,983 | |
| Additions | 434 |
| | 32 |
| | 1,431 |
| Additions | — | | | 270 | | | — | |
| Additions from acquisitions | 1,796 |
| | — |
| | — |
| |
| | Proceeds from dispositions | (198 | ) | | (930 | ) | | (2,486 | ) | Proceeds from dispositions | — | | | (1,290) | | | (864) | |
| Gain on sale, net | — |
| | 144 |
| | 173 |
| |
| Gain (loss) on sale, net | | Gain (loss) on sale, net | — | | | 179 | | | (227) | |
| Valuation adjustment | (49 | ) | | — |
| | (383 | ) | Valuation adjustment | — | | | — | | | (51) | |
| Balance at the end of the year | $ | 1,983 |
| | $ | — |
| | $ | 754 |
| Balance at the end of the year | $ | — | | | $ | — | | | $ | 841 | |
At December 31, 2018, the carrying amount of other real estate owned that was the result of foreclosure and obtaining physical possession of residential real estate properties was $434,000. At December 31, 2018,2021, there were no consumer mortgage loans secured by residential real estate properties (which would be included(included in Loans receivable on the one-to-four family residential loans in Note (4) Loans Receivable)Consolidated Statements of Financial Position) for which formal foreclosure proceedings were in process.
(7) (6)Premises and Equipment
A summary of premises and equipment is as follows:
| | | | | December 31, 2018 | | December 31, 2017 | | December 31, 2021 | | December 31, 2020 |
| | | (In thousands) | | (In thousands) |
| Land | | $ | 22,954 |
| | $ | 21,483 |
| Land | $ | 19,973 | | | $ | 21,599 | |
| Buildings and building improvements | | 69,315 |
| | 50,984 |
| Buildings and building improvements | 65,550 | | | 71,653 | |
| Furniture, fixtures and equipment | | 25,354 |
| | 20,894 |
| Furniture, fixtures and equipment | 23,815 | | | 26,341 | |
| Total premises and equipment | | 117,623 |
| | 93,361 |
| Total premises and equipment | 109,338 | | | 119,593 | |
| Less: Accumulated depreciation | | 36,523 |
| | 33,036 |
| Less: Accumulated depreciation | 29,968 | | | 34,141 | |
| Premises and equipment, net | | $ | 81,100 |
| | $ | 60,325 |
| Premises and equipment, net | $ | 79,370 | | | $ | 85,452 | |
Total depreciation expense on premises and equipment was $4.4$5.3 million, $3.9$5.5 million and $3.9$4.7 million for the years ended December 31, 2018, 20172021, 2020 and 2016,2019, respectively.
| |
(8) | Goodwill and Other Intangible Assets |
(7)Goodwill and Other Intangible Assets
(a) Goodwill
The Company’s goodwill represents the excess of the purchase price over the fair value of net assets acquired in the recentfollowing mergers: Premier Merger on July 2, 2018Commercial Bancorp and Puget Sound Merger on January 16, 2018 and the historical acquisitions ofBancorp in 2018; Washington Banking Company on May 1,in 2014; Valley Community Bancshares on July 15,in 2013; Western Washington Bancorp in 2006 and North Pacific Bank in 1998. The Company’s goodwill is assigned to the Bank and is evaluated for impairment at the Bank level (reporting unit). There were no additions to goodwill during the years ended December 31, 2021, 2020, and 2019.
The following table presents the change in goodwill for the periods indicated:
|
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | (In thousands) |
| Balance at the beginning of the period | $ | 119,029 |
| | $ | 119,029 |
| | $ | 119,029 |
|
Additions as a result of acquisitions (1) | 121,910 |
| | — |
| | — |
|
| Balance at the end of the period | $ | 240,939 |
| | $ | 119,029 |
| | $ | 119,029 |
|
| |
(1)
| See Note (2) Business Combinations |
At December 31, 2018,2021, the Company’s step-one analysis concluded that the reporting unit’s fair value of the reporting unit exceeded the carrying value such thatso the Company's goodwill was not considered impaired. Similarly, no goodwill impairment charges were required, or recorded for the years ended December 31, 20172020 and 2016.2019. Even though there was no goodwill impairment at December 31, 2018,2021, changes in
the economic environment, operations of the reporting unit or other adverse events could result in future impairment charges which could have a material impact on the Company’s operating results.
(b) Other Intangible Assets
The otherOther intangible assets represent the core deposit intangible ("CDI") acquired in business combinations. Thecombinations with estimated useful lifelives of ten years. There were no additions to goodwill during the CDI was estimated to be ten years related toended December 31, 2021, 2020, and 2019 and the acquisitions of Premier Commercial Bancorp, Puget Sound Bancorp, Washington Banking Company, and Valley Community Bancshares and estimated to be five years related to the acquisition of Northwest Commercial Bank.
The following table presents the change in other intangible assets for the periods indicated: |
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | (In thousands) |
| Balance at the beginning of the year | $ | 6,088 |
| | $ | 7,374 |
| | $ | 8,789 |
|
Additions as a result of acquisitions (1) | 18,345 |
| | — |
| | — |
|
| Amortization | (3,819 | ) | | (1,286 | ) | | (1,415 | ) |
| Balance at the end of the year | $ | 20,614 |
|
| $ | 6,088 |
|
| $ | 7,374 |
|
| |
(1)
| See Note (2) Business Combinations |
The estimated aggregate amortization expense related to theseother intangible assets for future years as of December 31, 2021 is as follows:follows, in thousands:
| | | | | |
| |
| |
| 2022 | $ | 2,750 | |
| 2023 | 2,435 | |
| 2024 | 1,640 | |
| 2025 | 1,173 | |
| 2026 | 1,006 | |
| Thereafter | 973 | |
| Total | $ | 9,977 | |
(8)Derivative Financial Instruments
|
| | | | |
| | | Year Ending December 31, |
| | | (In thousands) |
| 2019 | | $ | 4,001 |
|
| 2020 | | 3,525 |
|
| 2021 | | 3,111 |
|
| 2022 | | 2,750 |
|
| 2023 | | 2,435 |
|
| Thereafter | | 4,792 |
|
| | | $ | 20,614 |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 | | December 31, 2020 |
| Notional Amounts | | Estimated Fair Value | | Notional Amounts | | Estimated Fair Value |
| (In thousands) |
| Non-hedging interest rate derivatives: | | | | | | | |
Interest rate swap asset (1) | 322,726 | | | $ | 15,219 | | | $ | 308,126 | | | $ | 25,740 | |
Interest rate swap liability (1) | 322,726 | | | (15,286) | | | 308,126 | | | (26,162) | |
(1) The estimated fair value of derivatives with customers was $9.8 million and $25.4 million as of December 31, 2021 and December 31, 2020, respectively. The estimated fair value of derivatives with third-parties was $(9.8) million and $(25.9) million as of December 31, 2021 and December 31, 2020, respectively.
Generally, the gains and losses of the interest rate derivatives offset due to the back-to-back nature of the contracts. However, the settlement values of the Bank's net derivative assets with customers were increased by $355,000 and reduced by $422,000 as of December 31, 2021 and December 31, 2020, respectively, due to the recognition of a credit valuation adjustment. A credit valuation adjustment was not recorded on the Bank's net derivative assets as of December 31, 2019.
(9)Deposits
Deposits consisted of the following:
| | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2021 | | December 31, 2020 |
| | Amount | | Percent | | Amount | | Percent |
| | (Dollars in thousands) |
| Noninterest demand deposits | $ | 2,330,956 | | | 36.5 | % | | $ | 1,980,531 | | | 35.4 | % |
| Interest bearing demand deposits | 1,946,605 | | | 30.5 | | | 1,716,123 | | | 30.7 | |
| Money market accounts | 1,120,174 | | | 17.6 | | | 962,983 | | | 17.2 | |
| Savings accounts | 640,763 | | | 10.0 | | | 538,819 | | | 9.6 | |
| Total non-maturity deposits | 6,038,498 | | | 94.6 | | | 5,198,456 | | | 92.9 | |
| Certificates of deposit | 342,839 | | | 5.4 | | | 399,534 | | | 7.1 | |
| Total deposits | $ | 6,381,337 | | | 100.0 | % | | $ | 5,597,990 | | | 100.0 | % |
|
| | | | | | | | | | | | | | |
| | | December 31, 2018 | | December 31, 2017 |
| | | Amount | | Percent | | Amount | | Percent |
| | | (Dollars in thousands) |
| Noninterest demand deposits | | $ | 1,362,268 |
| | 30.7 | % | | $ | 944,791 |
| | 27.8 | % |
| Interest bearing demand deposits | | 1,317,513 |
| | 29.7 |
| | 1,051,752 |
| | 31.1 |
|
| Money market accounts | | 765,316 |
| | 17.3 |
| | 499,618 |
| | 14.7 |
|
| Savings accounts | | 520,413 |
| | 11.8 |
| | 498,501 |
| | 14.7 |
|
| Total non-maturity deposits | | 3,965,510 |
| | 89.5 |
| | 2,994,662 |
| | 88.3 |
|
| Certificate of deposit accounts | | 466,892 |
| | 10.5 |
| | 398,398 |
| | 11.7 |
|
| Total deposits | | $ | 4,432,402 |
| | 100.0 | % | | $ | 3,393,060 |
| | 100.0 | % |
Deposit accounts overdrawn and reclassified to loans receivable were $216,000 and $187,000 as of December 31, 2021 and December 31, 2020. Accrued interest payable on deposits was $144,000$53,000 and $124,000$73,000 as of December 31, 20182021 and 2017,December 31, 2020, respectively and is included in accrued expenses and other liabilities in the Consolidated Statements of Financial Condition.
Interest expense, by category, was as follows:
| | | | | Year Ended December 31, | | Year Ended December 31, |
| | | 2018 | | 2017 | | 2016 | | 2021 | | 2020 | | 2019 |
| | | (In thousands) | | (In thousands) |
| Interest bearing demand deposits | | $ | 2,728 |
| | $ | 1,812 |
| | $ | 1,569 |
| Interest bearing demand deposits | $ | 2,497 | | | $ | 3,234 | | | $ | 3,940 | |
| Money market accounts | | 1,654 |
| | 682 |
| | 749 |
| Money market accounts | 1,485 | | | 2,830 | | | 2,754 | |
| Savings accounts | | 2,056 |
| | 1,311 |
| | 756 |
| Savings accounts | 367 | | | 527 | | | 2,634 | |
| Certificate of deposit accounts | | 3,959 |
| | 2,244 |
| | 1,936 |
| |
| | | $ | 10,397 |
| | $ | 6,049 |
| | $ | 5,010 |
| |
| Certificates of deposit | | Certificates of deposit | 1,811 | | | 5,674 | | | 7,021 | |
| Total interest expense | | Total interest expense | $ | 6,160 | | | $ | 12,265 | | | $ | 16,349 | |
Scheduled maturities of certificates of deposit for future years as of December 31, 2021 are as follows:follows, in thousands:
|
| | | | |
| | | Year Ending December 31, |
| | | (In thousands) |
| 2019 | | $ | 313,830 |
|
| 2020 | | 93,675 |
|
| 2021 | | 14,608 |
|
| 2022 | | 24,914 |
|
| 2023 | | 19,847 |
|
| Thereafter | | 18 |
|
| | | $ | 466,892 |
|
| | | | | |
| |
| |
| 2022 | $ | 290,497 | |
| 2023 | 32,608 | |
| 2024 | 9,072 | |
| 2025 | 4,531 | |
| 2026 | 6,131 | |
| |
| Total | $ | 342,839 | |
Certificates of deposit issued in denominations equal to or in excess of $250,000 totaled $146.2$100.0 million and $113.7$123.1 million as of December 31, 20182021 and 2017,December 31, 2020, respectively.
Deposits received from related parties as of December 31, 2021 and December 31, 2020 totaled $8.8 million and $6.3 million, respectively.
| |
(10) | Junior Subordinated Debentures |
(10)Junior Subordinated Debentures
As part of the acquisition of Washington Banking Company on May 1, 2014, the Company assumed trust preferred securities and junior subordinated debentures with a total fair value of $18.9 million at the merger date. At December 31, 2021 and December 31, 2020, the balance of the junior subordinated debentures, net of unaccreted discount, was $21.2 million and $20.9 million, respectively.
Washington Banking Master Trust, a Delaware statutory business trust, was a wholly-ownedwholly owned subsidiary of the Washington Banking Company created for the exclusive purposes of issuing and selling capital securities and utilizing sale proceeds to acquire junior subordinated debentures issued by the Washington Banking Company. During 2007, the Trust issued $25.0 million of trust preferred securities with a 30-year maturity, callable after the fifth year. The trust preferred securities have a quarterly adjustable rate based upon the three-month London Interbank Offered Rate (“LIBOR”)LIBOR plus 1.56%. On the merger date, the Company acquired the Trust, which retained the Washington Banking
Master Trust name, and assumed the performance and observance of the covenants under the indenture related to the trust preferred securities.
The adjustable rate of the trust preferred securities at December 31, 20182021 and December 31, 2020 was 4.37%.1.77% and 1.80%, respectively. The weighted average rate of the junior subordinated debentures was as follows for the indicated periods:
|
| | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
Weighted average rate (1) | 6.27 | % | | 5.11 | % | | 4.50 | % |
(1) years ended December 31, 2021, 2020 and 2019 was 3.53%, 4.29% and 6.55%, respectively. The weighted average rate includes the accretion of the discount established at the merger date which is amortized over the life of the trust preferred securities.
The junior subordinated debentures are the sole assets of the Trust and payments under the junior subordinated debentures are the sole revenues of the Trust. At December 31, 2018 and December 31, 2017, the balance of the junior subordinated debentures, net of unaccreted discount, was $20.3 million and $20.0 million, respectively. All of the common securities of the Trust are owned by the Company. HeritageThe Company has fully and unconditionally guaranteed the capital securities along with all obligations of the Trust under the trust agreements. For financial reporting purposes, the Company's investment in the Master Trust is accounted for under the equity method and is included in prepaid expenses and other assets on the Company's Consolidated Statements of Financial Condition. The junior subordinated debentures issued and guaranteed by the Company and held by the Master Trust are reflected as liabilities on the Company's Consolidated Statements of Financial Condition.
| |
(11) | Repurchase Agreements |
(11)Securities Sold Under Agreement to Repurchase
The Company utilizes securities sold under agreement to repurchase agreements with one-dayone day maturities as a supplement to funding sources. Repurchase agreementsSecurities sold under agreement to repurchase are secured by pledged investment securities available for sale.securities. Under the securities sold under agreement to repurchase agreements,, the Company is required to maintain an aggregate market value of securities pledged greater than the balance of the securities sold under agreement to repurchase agreements.. The Company is required to pledge additional securities to cover any declines below the balance of the securities sold under agreement to repurchase agreements.. For additional information on the total value of investment securities pledged for securities sold under agreement to repurchase agreements see Note (3)(2) Investment Securities.
The following table presents the balance of the Company's securities sold under agreement to repurchase agreement obligations by class of collateral pledged:pledged at the dates indicated:
| | | | | | | | | | | |
| December 31, 2021 | | December 31, 2020 |
| (In thousands) |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 4,914 | | | $ | — | |
| Residential CMO and MBS | 4,134 | | | 7,388 | |
| Commercial CMO and MBS | 41,791 | | | 28,295 | |
| Total | $ | 50,839 | | | $ | 35,683 | |
(12)Other Borrowings
|
| | | | | | | |
| | December 31, 2018 | | December 31, 2017 |
| | (In thousands) |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 4,878 |
| | $ | — |
|
Mortgage-backed securities and collateralized mortgage obligations (1): | | | |
| Residential | 9,335 |
| | 11,239 |
|
| Commercial | 17,274 |
| | 20,582 |
|
| Total repurchase agreements | $ | 31,487 |
| | $ | 31,821 |
|
(1) Issued and guaranteed by U.S. Government-sponsored agencies.
(a) FHLB
The Federal Home Loan Bank ("FHLB") of Des MoinesFHLB functions as a member-owned cooperative providing credit for member financial institutions. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Limitations on the amount of advances are based on a percentage of the Bank's assets or on the FHLB’s assessment of the institution’s creditworthiness. At December 31, 2018,2021, the Bank maintained a credit facility with the FHLB of Des Moines with available borrowing capacity of $921.7 million. The$1.06 billion. At December 31, 2021 and December 31, 2020 the Bank had no FHLB advances outstanding at December 31, 2018. At December 31, 2017 there were short-term FHLB advances outstanding of $92.5 million with maturity dates within 30 days.
The following table sets forth the details of FHLB advances during and as of the years ended December 31, 2018 and 2017:
|
| | | | | | | |
| | December 31, 2018 | | December 31, 2017 |
| | (In thousands) |
| FHLB Advances: | | | |
| Average balance during the year | $ | 33,913 |
| | $ | 105,646 |
|
| Maximum month-end balance during the year | $ | 154,500 |
| | $ | 137,450 |
|
| Weighted average rate during the year | 1.98 | % | | 1.16 | % |
| Weighted average rate at the end of year | n/a |
| | 1.56 | % |
Advances from the FHLB aremay be collateralized by a blanket pledge on FHLB stock owned by the Bank, deposits at the FHLB, certain one-to-four single familycommercial and residential real estate loans, or other assets, investment securities which are obligations of or guaranteed by the United States or other assets. In accordance with the pledge agreement, the Company must maintain unencumbered collateral in an amount equal to varying percentages ranging from 100% to 160% of outstanding advances depending on the type of collateral.
(b) Federal Funds Purchased
The Bank maintains advance lines with Wells Fargo Bank, US Bank, The Independent Bankers Bank and Pacific Coast Bankers’ Bankfive correspondent banks to purchase federal funds of up to $90.0totaling $215.0 million as of December 31, 2018.2021. The lines generally mature annually or are reviewed annually. As of December 31, 20182021 and 2017,December 31, 2020, there were no federal funds purchased.
(c) Credit Facilities
The Bank maintains a credit facility with the Federal Reserve Bank of San Francisco with available borrowing capacity of $37.4$57.0 million as of December 31, 2018.2021. There were no borrowings outstanding as of December 31, 2018 or 2017.2021 and December 31, 2020. Any advances on the credit facility would have to be first secured by the Bank'seither investment securities or certain types of the Bank's loans receivable.
(d) Related Party Borrowings
The Company did not have any borrowings from related parties as of December 31, 2021 or December 31, 2020.
(13)Leases
The Company's noncancelable operating lease agreements relate to certain banking offices, back-office operational facilities, office equipment and sublease agreements. The majority of the leases contain renewal options and provisions for increases in rental rates based on an agreed upon index or predetermined escalation schedule. As of December 31, 2021 and December 31, 2020, the Company’s operating lease ROU asset was $27.6 million and $18.0 million, respectively, and the related operating lease ROU liability was $28.8 million and $19.3 million, respectively. The Company does not have any leases designated as finance leases.
On December 30, 2021, the Company sold its Olympia, Washington headquarters campus for total proceeds of $5.4 million resulting in a net gain of $2.7 million. Contemporaneously with the closing of the sale, the Company entered into 2 leases pursuant to which the Company leased back the first and second floors of the main building for an initial annual rent of $227,000, subject to annual escalations of 3% over the lease terms. The leases are being accounted for as operating leases and have initial lease terms of ten and five years for the first and second floor, respectively, and both leases additionally provide the Company with 2 five-year options to extend. The new operating leases were incorporated into the required disclosures below.
The table below summarizes the information about our leases during the periods or at period end presented:
| | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 |
| (In thousands) |
| Operating lease cost | $ | 4,758 | | | $ | 4,717 | |
| Short-term lease cost | 49 | | | 49 | |
| Variable lease cost | 947 | | | 967 | |
| |
(13) | Employee Benefit Plans |
| | | | | | | | | | | |
| Sublease income | (24) | | | (55) | |
| Total net lease cost during the period | $ | 5,730 | | | $ | 5,678 | |
| | | |
| Operating cash used for amounts included in the measurement of lease liabilities during the period | $ | 5,004 | | | $ | 4,881 | |
| ROU assets obtained in exchange for lease liabilities during the period | 13,966 | | | 1,265 | |
| | | |
| Weighted average remaining lease term of operating leases, in years, at period end | 7.1 | | 7.2 |
| Weighted average discount rate of operating leases, at period end | 2.32 | % | | 3.12 | % |
The following table presents the lease payment obligations as of December 31, 2021 as outlined in the Company’s lease agreements for each of the next five years and thereafter, in thousands:
| | | | | |
| |
| |
| 2022 | $ | 4,750 | |
| 2023 | 4,844 | |
| 2024 | 4,614 | |
| 2025 | 4,480 | |
| 2026 | 3,930 | |
| Thereafter | 8,703 | |
| Total lease payments | 31,321 | |
| Implied interest | (2,480) | |
| ROU liability | $ | 28,841 | |
(14)Employee Benefit Plans
(a) 401(k) Plan
The Company provides its eligible employees with a 401(k) plan called "Heritage Financial Corporation 401(k) Profit Sharing Plan, and Trust" (the “Plan”). The Company fundsincluding funding certain Plan costs as incurred.
The Plan includes the Company’s salary savings 401(k) plan for its employees. All employees hired may participate in the Plan commencing with the first of the month following thirty daysthe start of service.employment or concurrent to their hire date if starting the first of the month. Participants may contribute a portion of their salary, which is matched by the Company at 50%, not to be greater than 3% of eligible compensation, up to certain Internal Revenue Service limits. A Roth feature was added to the plan in 2016. All participants are 100% vested in all accounts at all times. Employer matching contributions for the years ended December 31, 2018, 20172021, 2020 and 20162019 were $1.4$1.7 million, $1.1$1.7 million and $1.0$1.6 million, respectively.
The profit sharing portion of the Plan is a defined contribution retirement plan. Allmay make profit sharing and discretionary contributions which are completely discretionary. Participants are eligible for profitfor-profit sharing contributions upon credit of 1,000 hours of service during the plan year, the attainment of 18 years of age and employment on the last day of the year. Employees are 100% vested in profit sharing contributions in the same manner as employer matching contributions discussed above.at all times. For the years ended December 31, 2018, 20172021, 2020 and 2016,2019, the Company made no employer profit sharing contributions.
(b) Employment Agreements
The Company has entered into contracts with certain senior officers that provide benefits under certain conditions following termination without cause and/or following a change in control of the Company.
(c) Deferred Compensation Plan
During 2012, theThe Company adoptedhas a Deferred Compensation Plan which provides its directors and select executive officers with the opportunity to defer current compensation. UnderThe following table presents a summary of the Plan, participants are permitted to elect to defer compensation and the Company has the discretion to make additional contributions to the Plan on behalf of any participant based on a number of factors. Compensation expense underchanges in the Deferred Compensation Plan totaled $810,000, $652,000 and $540,000 forduring the years ended December 31, 2018, 2017 and 2016, respectively. Theperiods indicated:
Company’s contributions totaled $583,000, $453,000 and $521,000 for the years ended December 31, 2018, 2017 and 2016, respectively. As of December 31, 2018 and 2017, the carrying value of the obligation related to the deferred compensation plans was $3.7 million and $2.8 million, respectively. | | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 | | 2019 |
| (In thousands) |
| Balance outstanding at the beginning of the year | $ | 4,101 | | | $ | 4,244 | | | $ | 3,654 | |
| Employer contributions | 634 | | | 207 | | | 443 | |
| Interest credited | 78 | | | 128 | | | 147 | |
| Benefits Paid | (959) | | | (478) | | | — | |
| Balance outstanding at the end of the year | $ | 3,854 | | | $ | 4,101 | | | $ | 4,244 | |
(d) Split-Dollar Life Insurance Benefit Plan
In conjunction with the Washington Banking Merger, the Company assumed the split-dollar life insurance benefit plan previously maintained by Washington Banking. Life insurance policies are maintained for current or former officers of the Bank or former Washington Banking officers that are subject to split-dollar life insurance agreements, which continue after the participant's employment and retirement. All participants are fully vested in their split-dollar life insurance benefits. The accrued benefit liability for the split-dollar life insurance agreements represents the present value of the future death benefits payable to the participants' beneficiaries.
The split-dollar life insurance projected benefit obligation is included in accrued expenses and other liabilities on the Company's Consolidated Statements of Financial Condition. As of December 31, 2018 and 2017, the carrying value of the obligation was $268,000 and $250,000, respectively.
(e) Salary Continuation Plan
In conjunction with the Company's merger with Premier Merger,Commercial Bancorp in 2018, the Company assumed an unfunded deferred compensation plan for select former Premier Commercial executive officers, some of which are current Heritage officers. Under the Salary Continuation Plan, the Company will pay each participant, or their beneficiary, specified benefits over specified periods beginning with the individual's termination of service due to retirement subject to early termination provisions. A liability is accrued for the obligation under this plan. As of December 31, 2018, the carrying value of the obligation was $4.6 million. The expense incurred for the Salary Continuation Plan was $184,000 during the year ended December 31, 2018. There was no expense incurred for the Salary Continuation Plan during the years ended December 31, 2017 and 2016.
| |
(14) | Commitments and Contingencies |
(a) Lease Commitments
The Bank leases certain premises and equipment under operating leases. Rental expense of leased premises and equipment was $6.1 million, $3.8 million and $4.4 million for the years ended December 31, 2018, 2017 and 2016, respectively, which is included in occupancy and equipment expense on the Company's Consolidated Statements of Income.
The estimated future minimum annual rental commitments under noncancelable leases having an original or remaining term of more than one year are as follows:
|
| | | | |
| | | Year Ending December 31, |
| | | (In thousands) |
| 2019 | | $ | 4,766 |
|
| 2020 | | 4,251 |
|
| 2021 | | 2,477 |
|
| 2022 | | 1,704 |
|
| 2023 | | 1,568 |
|
| Thereafter | | 1,788 |
|
| | | $ | 16,554 |
|
The leases contain various provisions for increases in rental rates, based either on changes in the published Consumer Price Index or a predetermined escalation schedule. Substantially all of the leases provide the Company with the option to extend the lease term one or more times following expiration of the initial term.
(b) Commitments to Extend Credit
In the ordinary course of business, the Company may enter into various types of transactions that include commitments to extend credit that are not included in the Consolidated Financial Statements. The Company applies the same credit standards to these commitments as it uses in all its lending activities and has included these commitments in its lending risk evaluations. The majority of the commitments presented below are variable rate. The Company’s exposure to credit and market risk under commitments to extend credit is represented by the amount of these commitments.
Company officers. The following table presents outstanding commitments to extend credit, including lettersa summary of credit, at the dates indicated:
|
| | | | | | | | |
| | | December 31, 2018 | | December 31, 2017 |
| | | (In thousands) |
| Commercial business: | | | | |
| Commercial and industrial | | $ | 568,215 |
| | $ | 363,272 |
|
| Owner-occupied commercial real estate | | 13,065 |
| | 6,815 |
|
| Non-owner occupied commercial real estate | | 13,621 |
| | 13,543 |
|
| Total commercial business | | 594,901 |
| | 383,630 |
|
| One-to-four family residential | | — |
| | — |
|
| Real estate construction and land development: | | | | |
| One-to-four family residential | | 59,772 |
| | 38,160 |
|
| Five or more family residential and commercial properties | | 95,535 |
| | 86,787 |
|
| Total real estate construction and land development | | 155,307 |
| | 124,947 |
|
| Consumer | | 239,822 |
| | 204,625 |
|
| Total outstanding commitments | | $ | 990,030 |
| | $ | 713,202 |
|
(c) Variable Interests
The Company has two equity investments in Low-Income Housing Tax Credit partnerships ("LIHTCs") which are indirect federal subsidies that finance low-income housing projects. The Company reported the investments in the unconsolidated LIHTCs as prepaid expenses and other assets on the Company’s Statements of Financial Condition with carrying values of $50.9 million and $54.0 million as of December 31, 2018 and 2017, respectively. As a limited liability investor in these partnerships, the Company receives tax benefits in the form of tax deductions from partnership operating losses and federal income tax credits. The federal income tax credits are earned over a 10-year period as a result of the investment properties meeting certain criteria and are subject to recapture for noncompliance with such criteria over a 15-year period. The Company accounts for the LIHTCs under the proportional amortization method and amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance on the Company's Consolidated Statements of Income as a component of income tax expense. During the years ended December 31, 2018, 2017, and 2016 the Company recognized tax benefits of $2.4 million, $2.9 million and $640,000, respectively. See Note (21) Income Taxes for further information on tax benefits.
The maximum exposure to loss in the LIHTCs is the amount of equity invested and credit extended by the Company. Loans to these entities are underwritten in substantially the same manner as are other loans and are generally secured. The Company has evaluated the variable interests held by the Company in each LIHTC investment and determined that the Company does not have controlling financial interests in such investments, and is not the primary beneficiary.
Total unfunded contingent commitments related to the Company’s LIHTC investments totaled $31.5 million and $39.8 million at December 31, 2018 and 2017, respectively, and is reported as accrued expenses and other liabilities on the Company's Statements of Financial Condition. The Company expects to fund LIHTC commitments of $26.4 million during the year ended December 31, 2019 and $523,000 during the year ended December 31, 2020, with the remaining commitments of $4.5 million paid by December 31, 2034. There were no impairment losses on the Company’s LIHTC investments during the years ended December 31, 2018, 2017 or 2016.
The Company also made a total of $25.0 million of Qualified Equity Investments ("QEIs") into three Certified Development Entities (“CDEs”) in May 2014 and is eligible to receive New Markets Tax Credits (“NMTC”) on the QEIs. The NMTC program provides federal tax incentives to investors to make investments in distressed communities and promotes economic improvements through the development of successful businesses in these communities. The NMTC is available to investors over a seven-year period and is subject to recapture if certain events occur during such period. Gross tax credits related to the Company's CDEs totaling $9.8 million are available through 2020. The Company is required to fund 85 percent of a tranche to claim the entire tax credit, and it had until May 15, 2015 to complete the funding. The tranche was funded in 2015 before the deadline.
The Company accounts for its NMTC on the equity method and reported the investment balance as prepaid expenses and other assets on the Company’s Statements of Financial Condition with carrying value of $25.7 million and $25.8 million at December 31, 2018 and December 31, 2017, respectively. The Company recorded investment income of $708,000, $735,000 and $740,000 during the years ended December 31, 2018, 2017 and 2016, respectively, in other income on the Company's Statements of Income.
| |
(15) | Derivative Financial Instruments |
The Company has entered into certain interest rate swap contracts that are not designated as hedging instruments. The purpose of these derivative contracts is primarily to provide commercial business loan customers the ability to convert their loans from variable to fixed interest rates. Upon the origination of a derivative contract with a customer, the Company simultaneously enters into an offsetting derivative contract with a third party in order to offset its exposure on the variable and fixed rate components of the customer agreement. The Company recognizes immediate income based upon the difference in the bid/ask spread of the underlying transactions with its customers and the third party, which is recorded in interest rate swap fees on the Consolidated Statements of Income. Because the Company acts only as an intermediary for its customer, subsequent changes in the fair value ofsalary continuation plan during the underlying derivative contracts offset each other and do not significantly impact the Company’s results of operations.periods indicated:
The notional amounts and estimated fair values of interest rate derivative contracts outstanding at December 31, 2018 and December 31, 2017 are presented in the following table: | | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 | | 2019 |
| (In thousands) |
| Obligation, at the beginning of the year | $ | 4,162 | | | $ | 4,334 | | | $ | 4,600 | |
| | | | | |
| Benefits paid | (536) | | | (460) | | | (554) | |
| Expenses incurred | 209 | | | 288 | | | 288 | |
| Obligation, at the end of the year | $ | 3,835 | | | $ | 4,162 | | | $ | 4,334 | |
(15)Stockholders’ Equity
|
| | | | | | | | | | | | | | | |
| | December 31, 2018 | | December 31, 2017 |
| | Notional Amounts | | Estimated Fair Value | | Notional Amounts | | Estimated Fair Value |
| | (In thousands) |
| Non-hedging interest rate derivatives | | | | | | | |
Interest rate swaps with customer (1) | $ | 171,798 |
| | $ | (1,643 | ) | | $ | 146,537 |
| | $ | (882 | ) |
Interest rate swap with third party (1) | 171,798 |
| | 1,643 |
| | 146,537 |
| | 882 |
|
(1) The estimated fair value of the derivative included in prepaid and other assets on the Consolidated Statements of Financial Condition was $5.1 million and $3.4 million as of December 31, 2018 and 2017, respectively. The estimated fair value of the derivative included in accrued expenses and other liabilities on the Consolidated Statements of Financial Condition was $5.1 million and $3.4 million as of December 31, 2018 and 2017, respectively.
(a) Earnings Per Common Share
The following table illustrates the reconciliationcalculation of weighted average shares used for earnings per common share computations for the years ended December 31, 2018, 2017periods indicated:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 | | 2019 |
| (In thousands, except shares) |
| Net income: | | | | | |
| Net income | $ | 98,035 | | | $ | 46,570 | | | $ | 67,557 | |
Dividends and undistributed earnings allocated to participating securities (1) | — | | | (7) | | | (57) | |
| Net income allocated to common shareholders | $ | 98,035 | | | $ | 46,563 | | | $ | 67,500 | |
| Basic: | | | | | |
| Weighted average common shares outstanding | 35,677,851 | | | 36,018,627 | | | 36,789,244 | |
| Restricted stock awards | — | | | (4,182) | | | (31,014) | |
| Total basic weighted average common shares outstanding | 35,677,851 | | | 36,014,445 | | | 36,758,230 | |
| Diluted: | | | | | |
| Basic weighted average common shares outstanding | 35,677,851 | | | 36,014,445 | | | 36,758,230 | |
Effect of potentially dilutive common shares (2) | 295,535 | | | 155,621 | | | 227,536 | |
| Total diluted weighted average common shares outstanding | 35,973,386 | | | 36,170,066 | | | 36,985,766 | |
Potentially dilutive shares that were excluded from the computation of diluted earnings per share because to do so would be anti-dilutive (3) | 7,043 | | | 137,093 | | | 1,501 | |
(1) Represents dividends paid and 2016:undistributed earnings allocated to unvested restricted stock awards.
|
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | (In thousands) |
| Net income: | | | | | |
| Net income | $ | 53,057 |
| | $ | 41,791 |
| | $ | 38,918 |
|
| Dividends and undistributed earnings allocated to participating securities | (321 | ) | | (293 | ) | | (358 | ) |
| Net income allocated to common shareholders | $ | 52,736 |
| | $ | 41,498 |
| | $ | 38,560 |
|
| Basic: | | | | | |
| Weighted average common shares outstanding | 35,281,408 |
| | 29,937,400 |
| | 29,963,365 |
|
| Restricted stock awards | (87,405 | ) | | (179,581 | ) | | (285,063 | ) |
| Total basic weighted average common shares outstanding | 35,194,003 |
| | 29,757,819 |
| | 29,678,302 |
|
| Diluted: | | | | | |
| Basic weighted average common shares outstanding | 35,194,003 |
| | 29,757,819 |
| | 29,678,302 |
|
Effect of potentially dilutive common shares(1) | 177,587 |
| | 91,512 |
| | 13,851 |
|
| Total diluted weighted average common shares outstanding | 35,371,590 |
| | 29,849,331 |
| | 29,692,153 |
|
(1)(2) Represents the effect of the assumed exercise of stock options and vesting of restricted stock awards and units.
Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. For the years ended December 31, 2018 and December 31, 2017, there were no anti-dilutive shares outstanding related to options to acquire common stock. For the year ended December 31, 2016, anti-dilutive shares outstanding related to options to acquire common stock totaled 436.(3) Anti-dilution occurs when the exercise price of a stock option or the unrecognized compensation cost per share of a restricted stock award or unit exceeds the market price of the Company’s stock.
(b) Dividends
The timing and amount of cash dividends paid on the Company's common stock depends on the Company’s earnings, capital requirements, financial condition and other relevant factors. Dividends on common stock from the Company depend substantially upon receipt of dividends from the Bank, which is the Company’s predominant source of income.
The following table summarizes the dividend activity forduring the years ended December 31, 2018, 2017 and 2016:
most recent three year period: | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Declared | | Cash Dividend per Share | | Record Date | | Paid Date | | |
| | | | | | | | |
Declared | | Cash Dividend per Share | | Record Date | | Paid Date | | |
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| | | | | | | | |
| January 23, 2019 | | $0.18 | | February 7, 2019 | | February 21, 2019 | | |
| April 24, 2019 | | $0.18 | | May 8, 2019 | | May 22, 2019 | | |
| July 24, 2019 | | $0.19 | | August 8, 2019 | | August 22, 2019 | | |
| October 23, 2019 | | $0.19 | | November 7, 2019 | | November 21, 2019 | | |
| October 23, 2019 | | $0.10 | | November 7, 2019 | | November 21, 2019 | | * |
| January 22, 2020 | | $0.20 | | February 6, 2020 | | February 20, 2020 | | |
| April 29, 2020 | | $0.20 | | May 13, 2020 | | May 27, 2020 | | |
| July 22, 2020 | | $0.20 | | August 5, 2020 | | August 19, 2020 | | |
| October 21, 2020 | | $0.20 | | November 4, 2020 | | November 18, 2020 | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
January 27, 20162021 | | $0.110.20 | | February 10, 20162021 | | February 24, 20162021 | | |
April 20, 201621, 2021 | | $0.120.20 | | May 5, 20162021 | | May 19, 20162021 | | |
July 20, 201621, 2021 | | $0.120.20 | | August 4, 20162021 | | August 18, 20162021 | | |
October 26, 201620, 2021 | | $0.120.21 | | November 8, 20163, 2021 | | November 22, 201617, 2021 | | |
October 26, 2016 | | $0.25 | | November 8, 2016 | | November 22, 2016 | | * |
January 25, 2017 | | $0.12 | | February 9, 2017 | | February 23, 2017 | | |
April 25, 2017 | | $0.13 | | May 10, 2017 | | May 24, 2017 | | |
July 25, 2017 | | $0.13 | | August 10, 2017 | | August 24, 2017 | | |
October 25, 2017 | | $0.13 | | November 8, 2017 | | November 22, 2017 | | |
October 25, 2017 | | $0.10 | | November 8, 2017 | | November 22, 2017 | | * |
January 24, 2018 | | $0.15 | | February 7, 2018 | | February 21, 2018 | | |
April 25, 2018 | | $0.15 | | May 10, 2018 | | May 24, 2018 | | |
July 24, 2018 | | $0.15 | | August 9, 2018 | | August 23, 2018 | | |
October 24, 2018 | | $0.17 | | November 7, 2018 | | November 21, 2018 | | |
October 24, 2018 | | $0.10 | | November 7, 2018 | | November 21, 2018 | | * |
* Denotes a special dividend.
The FDIC and the Washington State Department of Financial Institutions, Division of Banks have the authority under their supervisory powers to prohibit the payment of dividends by the Bank to the Company. Additionally, current guidance from the Board of Governors of the Federal Reserve System ("Federal Reserve") provides, among other things, that dividends per share on the Company’s common stock generally should not exceed earnings per share, measured over the previous four fiscal quarters. Current regulations allow the Company and the Bank to pay dividends on their common stock if the Company’s or the Bank’s regulatory capital would not be reduced below the statutory capital requirements set by the Federal Reserve and the FDIC.
(c) Stock Repurchase Program
The Company has had various stock repurchase programs since March 1999. On October 23, 2014, the Company's Boardboard of Directorsdirectors authorized the repurchase of up to 5% of the Company's outstanding common shares, or approximately 1,513,0001,512,600 shares, under the eleventh stock repurchase plan. On March 12, 2020, the Company's board of directors authorized the repurchase of up to 5% of the Company's outstanding common shares, or 1,799,054 shares, under the twelfth stock repurchase plan after all shares under the eleventh stock repurchase plan had been repurchased. The number, timing and price of shares repurchased under the twelfth stock repurchase plan will depend on business and market conditions and other factors, including opportunities to deploy the Company's capital.
Since the inception of the eleventh plan, the Company hasThe following table provides total repurchased 579,996 shares at anand average share prices of $16.67. Nounder the applicable plans for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | |
| 2021 | | 2020 | | 2019 | | Plan Total(1) |
| Eleventh Stock Repurchase Plan | | | | | | | |
| Repurchased shares | — | | | 639,922 | | | 292,712 | | | 1,512,600 | |
| Stock repurchase average share price | $ | — | | | $ | 23.95 | | | $ | 26.50 | | | $ | 21.69 | |
| | | | | | | |
| Twelfth Stock Repurchase Plan | | | | | | | |
| Repurchased shares | 904,972 | | | 155,778 | | | — | | | 1,060,750 | |
| Stock repurchase average share price | $ | 24.43 | | | $ | 20.34 | | | $ | — | | | $ | 23.83 | |
(1)Represents shares were repurchased under this planand average price per share paid during the years ended December 31, 2018 and 2017. During the year ended December 31, 2016, 138,000 shares were repurchased with an average share priceduration of $17.16.each plan.
In addition to the stock repurchases under a stock repurchase plan, the Company repurchases shares to pay withholding taxes on the vesting of restricted stock awards and units. The following table provides total shares repurchased shares forto pay withholding taxes during the periods indicated:
|
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2018 | | 2017 | | 2016 |
Repurchased shares to pay withholding taxes (1) | 53,256 |
| | 29,429 |
| | 29,512 |
|
| Stock repurchase to pay withholding taxes average share price | $ | 31.99 |
| | $ | 25.01 |
| | $ | 17.82 |
|
(1) During the year ended December 31, 2018, the Company repurchased 26,741 shares related to the withholding taxes due on the accelerated vesting of the restricted stock units of Puget Sound which were converted to Heritage common stock shares with a share price of $31.80 under the terms of the Puget Sound Merger. See Note (2) Business Combinations. There were no shares repurchased as a result of the accelerated vesting of the restricted stock awards related to the Premier Merger. | | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 | | 2019 |
| Repurchased shares to pay withholding taxes | 26,869 | | | 28,887 | | | 28,479 | |
| Stock repurchase to pay withholding taxes average share price | $ | 29.10 | | | $ | 21.57 | | | $ | 30.83 | |
(d) Issuance of Common Stock
In conjunction with the Premier Merger effective on July 2, 2018 and the Puget Sound Merger effective on January 16, 2018, Heritage issued 2,848,579 and 4,112,258 shares, respectively, of the Company's common stock at the merger date share price of $34.85 and $31.80, respectively, for a fair value of $99.3 million and $130.8 million, respectively.
In addition, commonCommon stock was issued during the years ended December 31, 2018, 20172020 and 20162019 related to the exercise of stock options and issuance of restricted stock awards as further described in Note (19)(17) Stock-Based Compensation.
| |
(17) | Accumulated Other Comprehensive Loss |
The changes in accumulated other comprehensive (loss) income (“AOCI”), all of which are due to changes in the fair value of available for sale securities and are net of tax, during the years ended December 31, 2018, 2017 and 2016 are as follows:
(16)Fair Value Measurements
|
| | | | | | | | | | | |
| | December 31, 2018 | | December 31, 2017 | | December 31, 2016 |
| | (In thousands) |
| Balance of AOCI at the beginning of the year | $ | (1,298 | ) | | $ | (2,606 | ) | | $ | 2,559 |
|
| Other comprehensive (loss) income before reclassification | (5,956 | ) | | 1,530 |
| | (4,311 | ) |
| Amounts reclassified from AOCI for gain on sale of investment securities included in net income | (108 | ) | | (4 | ) | | (854 | ) |
| Net current period other comprehensive (loss) income | (6,064 | ) | | 1,526 |
| | (5,165 | ) |
| ASU 2016-01 and 2018-02 Implementations | (93 | ) | | (218 | ) | | — |
|
| Balance of AOCI at the end of the year | $ | (7,455 | ) | | $ | (1,298 | ) | | $ | (2,606 | ) |
| |
(18) | Fair Value Measurements |
Fair value is the exchange price that would be received forto sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants onat the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1: Valuations for assets and liabilities traded in active exchange markets, or interest in open-end mutual funds that allow the Company to sell its ownership interest back to the fund at net asset value on a daily basis. Valuations are obtained from readily available pricing sources for market transactions involving identical assets, liabilities, or funds.
Level 2: Valuations for assets and liabilities traded in less active dealer or broker markets, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or valuations using methodologies with observable inputs.
Level 3: Valuations for assets and liabilities that are derived from other valuation methodologies, such as option pricing models,
discounted cash flow models and similar techniques using unobservable inputs, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.
(a) Recurring and Nonrecurring Basis
The Company used the following methods and significant assumptions to measure the fair value of certain assets on a recurring and nonrecurring basis:
Investment Securities Available for Sale:
The fair values of all investment securities are based upon the assumptions that market participants would use in pricing the security. If available, fair values of investment securities are determined by quoted market prices (Level 1). For investment securities where quoted market prices are not available, fair values are calculated based on market prices on similar securities (Level 2). For investment securities where quoted prices or market prices of similar securities are not available, fair values are calculated by using observable and unobservable inputs such as discounted cash flows or other market indicators (Level 3). SecurityInvestment security valuations are obtained from third partythird-party pricing servicesservices.
Collateral-Dependent Loans:
Collateral-dependent loans are identified for comparable assets or liabilities.
Impaired Loans:
At the time a loan is considered impaired, its impairment is measured based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the observable market price, or the fair market valuecalculation of the collateral (less costs to sell) if the loan is collateral-dependent. Impaired loans for which impairment is measured using the discounted cash flow approach are not considered to be measured at fair value because the loan’s effective interest rate is generally not a fair value input, and for the purposes of fair value disclosures, the fair value of these loans are measured commensurate with non-impairedACL on loans. If the Company utilizes the fair market value of the collateral method, theThe fair value used to measure impairmentcredit loss for this type of loan is commonly based on recent real estate appraisals.appraisals which are generally obtained at least every 18 months or earlier if there are changes to risk characteristics of the underlying loan. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available. The Bank also incorporates an estimate of cost to sell the collateral when the sale is probable. Such adjustments are usuallymay be significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value based on the borrower’s financial statements or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation and management’s expertise and knowledge of the clientcustomer and client’scustomer’s business (Level 3). ImpairedIndividually evaluated loans are evaluatedanalyzed for credit loss on a quarterly basis and impairmentthe ACL on loans is adjusted accordingly.as required based on the results.
Other Real Estate Owned:Appraisals on collateral-dependent loans are performed by certified general appraisers for commercial properties or certified residential appraisers for residential properties whose qualifications and licenses have been reviewed and verified by the Bank. Once received, the Bank's internal appraisal department reviews and approves the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.
Assets acquired throughDerivative Financial Instruments:
The Bank obtains broker or insteaddealer quotes to value its interest rate derivative contracts, which use valuation models using observable market data as of loan foreclosurethe measurement date (Level 2), and incorporates credit valuation adjustments to reflect nonperformance risk in the measurement of fair value (Level 3). Although the Bank has determined that the majority of the inputs used to value its interest rate swap derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as borrower risk ratings, to evaluate the likelihood of default by itself and its counterparties. As of December 31, 2021 and December 31, 2020, the Bank assessed the significance of the impact of the credit valuation adjustment on the overall valuation of its interest rate swap derivatives and determined the credit valuation adjustment was not significant to the overall valuation of its interest rate swap derivatives. As a result, the Bank has classified its interest rate swap derivative valuations in Level 2 of the fair value hierarchy.
Branches held for sale:
Branches held for sale are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. Thesetransferred from premises and equipment, net to prepaid expenses and other assets are subsequently accounted for at loweron the Consolidated Statements of cost orFinancial Condition with any valuation adjustment recorded within other noninterest expense on the Consolidated Statements of Income. The fair value less costs to sell. Fair valueof branches held for sale is commonlydetermined based on recenta real estate appraisals. These appraisals may utilize a single valuation approachappraisal or a combination of approaches including comparable sales and the income approach.broker price opinion. Adjustments are routinely made in the appraisal and broker price opinion process by independent appraisers and commercial real estate brokers, respectively, to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in Level 3 classification of the inputs for determining fair value.
Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers for commercial properties or certified residential appraisers for residential properties whose qualifications and licenses have been reviewed and verified by Additionally, the Company. Once received, the Company reviews
the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. Onof branches held for sale can be adjusted based on executed agreements of sale to be completed at a quarterly basis, the Company compares the actual selling price of collateral that has been liquidated to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value.future date.
Derivative Financial Instruments:
The Company obtains broker or dealer quotes to value its interest rate derivative contracts, which use valuation models using observable market data as of the measurement date (Level 2).
Recurring Basis
The following tables summarize the balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2018 and December 31, 2017:at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Total | | Level 1 | | Level 2 | | Level 3 |
| (In thousands) |
| Assets | | | | | | | |
| Investment securities available for sale: | | | | | | | |
| U.S. government and agency securities | $ | 21,373 | | | $ | — | | | $ | 21,373 | | | $ | — | |
|
| | | | | | | | | | | | | | | |
| | December 31, 2018 |
| | Total | | Level 1 | | Level 2 | | Level 3 |
| | (In thousands) |
| Assets | | | | | | | |
| Investment securities available for sale: | | | | | | | |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 101,603 |
| | $ | 15,936 |
| | $ | 85,667 |
| | $ | — |
|
| Municipal securities | 158,864 |
| | — |
| | 158,864 |
| | — |
|
| Mortgage backed securities and collateralized mortgage obligations: |
| | | | | | |
| Residential | 331,602 |
| | — |
| | 331,602 |
| | — |
|
| Commercial | 333,761 |
| | — |
| | 333,761 |
| | — |
|
| Corporate obligations | 25,563 |
| | — |
| | 25,563 |
| | — |
|
| Other asset-backed securities | 24,702 |
| |
|
| | 24,702 |
| | — |
|
| Total investment securities available for sale | 976,095 |
|
| 15,936 |
|
| 960,159 |
|
| — |
|
| Derivative assets - interest rate swaps | 5,095 |
| | — |
| | 5,095 |
| | — |
|
| Liabilities | | | | | | | |
| Derivative liabilities - interest rate swaps | $ | 5,095 |
| | $ | — |
| | $ | 5,095 |
| | $ | — |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Total | | Level 1 | | Level 2 | | Level 3 |
| (In thousands) |
| Municipal securities | 221,212 | | | — | | | 221,212 | | | — | |
| Residential CMO and MBS | 306,884 | | | — | | | 306,884 | | | — | |
| Commercial CMO and MBS | 315,861 | | | — | | | 315,861 | | | — | |
| | | | | | | |
| Corporate obligations | 2,014 | | | — | | | 2,014 | | | — | |
| Other asset-backed securities | 26,991 | | | 0 | | 26,991 | | | — | |
| Total investment securities available for sale | 894,335 | | | — | | | 894,335 | | | — | |
| Equity security | 240 | | | 240 | | | — | | | — | |
| Derivative assets - interest rate swaps | 15,219 | | | — | | | 15,219 | | | — | |
| Liabilities | | | | | | | |
| Derivative liabilities - interest rate swaps | $ | 15,286 | | | $ | — | | | $ | 15,286 | | | $ | — | |
|
| | | | | | | | | | | | | | | |
| | December 31, 2017 |
| | Total | | Level 1 | | Level 2 | | Level 3 |
| | (In thousands) |
| Assets | | | | | | | |
| Investment securities available for sale: | | | | | | | |
| U.S. Treasury and U.S. Government-sponsored agencies | $ | 13,442 |
| | $ | — |
| | $ | 13,442 |
| | $ | — |
|
| Municipal securities | 250,015 |
| | — |
| | 250,015 |
| | — |
|
| Mortgage backed securities and collateralized mortgage obligations: |
| | | | | | |
| Residential | 280,211 |
| | — |
| | 280,211 |
| | — |
|
| Commercial | 217,079 |
| | — |
| | 217,079 |
| | — |
|
| Collateralized loan obligations | 4,580 |
| | — |
| | 4,580 |
| | — |
|
| Corporate obligations | 16,770 |
| | — |
| | 16,770 |
| | — |
|
| Other securities | 28,433 |
| | 146 |
| | 28,287 |
| | — |
|
| Total investment securities available for sale | 810,530 |
|
| 146 |
|
| 810,384 |
|
| — |
|
| Derivative assets - interest rate swaps | 3,418 |
| | — |
| | 3,418 |
| | — |
|
| Liabilities | | | | | | | |
| Derivative liabilities - interest rate swaps | $ | 3,418 |
| | $ | — |
| | $ | 3,418 |
| | $ | — |
|
There were no transfers between Level 1 and Level 2 during the years ended December 31, 2018 and 2017.
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2020 |
| Total | | Level 1 | | Level 2 | | Level 3 |
| (In thousands) |
| Assets | | | | | | | |
| Investment securities available for sale: | | | | | | | |
| U.S. government and agency securities | $ | 45,660 | | | $ | — | | | $ | 45,660 | | | $ | — | |
| Municipal securities | 209,968 | | | — | | | 209,968 | | | — | |
| Residential CMO and MBS | 201,872 | | | — | | | 201,872 | | | — | |
| Commercial CMO and MBS | 303,746 | | | — | | | 303,746 | | | — | |
| | | | | | | |
| Corporate obligations | 11,096 | | | — | | | 11,096 | | | — | |
| Other asset-backed securities | 29,821 | | | — | | | 29,821 | | | — | |
| Total investment securities available for sale | 802,163 | | | — | | | 802,163 | | | — | |
| Equity security | 131 | | | 131 | | | — | | | — | |
| Derivative assets - interest rate swaps | 25,740 | | | — | | | 25,740 | | | — | |
| Liabilities | | | | | | | |
| Derivative liabilities - interest rate swaps | $ | 26,162 | | | $ | — | | | $ | 26,162 | | | $ | — | |
Nonrecurring Basis
The Company may be required to measure certain financial assets and liabilities at fair value on a nonrecurring basis. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets.
The following tables below represent assets measured at fair value on a nonrecurring basis at December 31, 2018 and December 31, 2017the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Basis(1) | | Fair Value at December 31, 2021 | | |
| Total | | Level 1 | | Level 2 | | Level 3 | | |
| (In thousands) |
| Collateral-dependent loans: | | | | | | | | | | | |
| Commercial business: | | | | | | | | | | | |
| Commercial and industrial | $ | 1,911 | | | $ | 1,049 | | | $ | — | | | $ | — | | | $ | 1,049 | | | |
| Owner-occupied CRE | 613 | | | 189 | | | — | | | — | | | 189 | | | |
| | | | | | | | | | | |
| Total commercial business | 2,524 | | | 1,238 | | | — | | | — | | | 1,238 | | | |
| | | | | | | | | | | |
| Real estate construction and land development: | | |
| | | | | | | | | | | |
| Commercial and multifamily | 991 | | | 534 | | | — | | | — | | | 534 | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Total | 3,515 | | | 1,772 | | | — | | | — | | | 1,772 | | | |
| Prepaid expenses and other assets: | | | | | | | | | | | |
Branch held for sale (2) | 698 | | | 698 | | | — | | | — | | | 698 | | | |
| Total assets measured at fair value on a nonrecurring basis | $ | 4,213 | | | $ | 2,470 | | | $ | — | | | $ | — | | | $ | 2,470 | | | |
(1)Basis represents the outstanding principal balance of collateral-dependent loans and the carrying value of the branch held for sale.
(2) In December 2021, one branch was written down to its net lossesrealizable value concurrent with the signing of an agreement for sale at a future date.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Basis(1) | | Fair Value at December 31, 2020 | | |
| Total | | Level 1 | | Level 2 | | Level 3 | | |
| (In thousands) |
| Collateral-dependent loans: | | | | | | | | | | | |
| Commercial business: | | | | | | | | | | | |
| Commercial and industrial | $ | 1,305 | | | $ | 1,289 | | | $ | — | | | $ | — | | | $ | 1,289 | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Prepaid expenses and other assets: | | | | | | | | | | | |
Branch held for sale (2) | 1,330 | | | 1,330 | | | — | | | — | | | 1,330 | | | |
| Total assets measured at fair value on a nonrecurring basis | $ | 2,635 | | | $ | 2,619 | | | $ | — | | | $ | — | | | $ | 2,619 | | | |
(1) Basis represents the outstanding principal balance of collateral-dependent loans and the carrying value of the branch held for sale.
(2) In October 2020, one branch was reclassified as held for sale in accordance with ASC 360-10. As part of the transfer, the branch was written down to its net realizable value at that time.
The following table represents the net (loss) gain recorded in earnings as a result of nonrecurring fair value adjustments recorded during years ended December 31, 2018 and 2017:the periods indicated:
| | | | | | | | | | | | | | | | | |
| Year ended December 31, |
| 2021 | | 2020 | | 2019 |
| (In thousands) |
| Collateral-dependent loans: | | | | | |
| Commercial business: | | | | | |
| Commercial and industrial | $ | (691) | | | $ | (8) | | | $ | (78) | |
| Owner-occupied CRE | (359) | | | — | | | — | |
| | | | | |
| Total commercial business | (1,050) | | | (8) | | | (78) | |
| | | | | |
| Real estate construction and land development: | | | | | |
| | | | | |
| Commercial and multifamily | (38) | | | — | | | — | |
| Prepaid expenses and other assets: | | | | | |
| Branch held for sale | (145) | | | $ | (630) | | | $ | — | |
| Net loss from nonrecurring fair value adjustments | $ | (1,233) | | | $ | (638) | | | $ | (78) | |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| | Basis(1) | | Fair Value at December 31, 2018 | | |
| | Total | | Level 1 | | Level 2 | | Level 3 | | Net Losses Recorded in Earnings During the Year Ended December 31, 2018 |
| | (In thousands) |
| Impaired loans: | | | | | | | | | | | |
| Commercial business: | | | | | | | | | | | |
| Commercial and industrial | $ | 117 |
| | $ | 107 |
| | $ | — |
| | $ | — |
| | $ | 107 |
| | $ | 10 |
|
| Non-owner occupied commercial real estate | 1,378 |
| | 1,102 |
| | — |
| | — |
| | 1,102 |
| | 150 |
|
| Total commercial business | 1,495 |
|
| 1,209 |
|
| — |
|
| — |
|
| 1,209 |
|
| 160 |
|
| Consumer | 9 |
| | 7 |
| | — |
| | — |
| | 7 |
| | 8 |
|
| Total assets measured at fair value on a nonrecurring basis | $ | 1,504 |
|
| $ | 1,216 |
|
| $ | — |
|
| $ | — |
|
| $ | 1,216 |
|
| $ | 168 |
|
| |
(1)
| Basis represents the unpaid principal balance of impaired loans. |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| | Basis(1) | | Fair Value at December 31, 2017 | | |
| | Total | | Level 1 | | Level 2 | | Level 3 | | Net Losses (Gains) Recorded in Earnings During the Year Ended December 31, 2017 |
| | (In thousands) |
| Impaired loans: | | | | | | | | | | | |
| Real estate construction and land development: | | | | | | | | | | | |
| One-to-four family residential | $ | 976 |
| | $ | 307 |
| | $ | — |
| | $ | — |
| | $ | 307 |
| | $ | (558 | ) |
| Total assets measured at fair value on a nonrecurring basis | $ | 976 |
|
| $ | 307 |
|
| $ | — |
|
| $ | — |
|
| $ | 307 |
|
| $ | (558 | ) |
| |
(1)
| Basis represents the unpaid principal balance of impaired loans. |
The following table presentstables present quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2018 and December 31, 2017:the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Fair
Value | | Valuation
Technique(s) | | Unobservable Input(s) | | Range of Inputs; Weighted
Average |
| (Dollars in thousands) |
| Collateral-dependent loans | $ | 1,772 | | | Market approach | | Adjustment for differences between the comparable sales | | 35.0% - (11.0%); 13.8% |
| Branch held for sale | $ | 698 | | | Market approach | | Sale agreement | | Not applicable |
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2020 |
| Fair
Value | | Valuation
Technique(s) | | Unobservable Input(s) | | Range of Inputs; Weighted
Average |
| (Dollars in thousands) |
| Collateral-dependent loans | $ | 1,289 | | | Market approach | | Adjustment for differences between the comparable sales | | 0.6% - (40.1%); (24.1%) |
| Branch held for sale | $ | 1,330 | | | Market approach | | Adjustment for differences between the comparable sales | | 140.7% - (40.3%); 33.2% |
|
| | | | | | | | | |
| | December 31, 2018 |
| | Fair Value | | Valuation Technique(s) | | Unobservable Input(s) | | Range of Inputs; Weighted Average |
| | (Dollars in thousands) |
| Impaired loans | $ | 1,216 |
| | Market approach | | Adjustment for differences between the comparable sales | | 10.4% - (37.3%); (10.9%) |
|
| | | | | | | | | |
| | December 31, 2017 |
| | Fair Value | | Valuation Technique(s) | | Unobservable Input(s) | | Range of Inputs; Weighted Average |
| | (Dollars in thousands) |
| Impaired loans | $ | 307 |
| | Market approach | | Adjustment for differences between the comparable sales | | (91.5%) - (14.4%); (44.0%) |
(b) Fair Value of Financial Instruments
Because broadlyBroadly traded markets do not exist for most of the Company’s financial instruments,instruments; therefore, the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications; therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.
The following tables below present the carrying value amount of the Company’s financial instruments and their corresponding estimated fair values at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Carrying
Value | | Fair Value | | Fair Value Measurements Using: |
| Level 1 | | Level 2 | | Level 3 |
| (In thousands) |
| Financial Assets: | | | | | | | | | |
| Cash and cash equivalents | $ | 1,723,292 | | | $ | 1,723,292 | | | $ | 1,723,292 | | | $ | — | | | $ | — | |
| Investment securities available for sale | 894,335 | | | 894,335 | | | — | | | 894,335 | | | — | |
| Investment securities held to maturity | 383,393 | | | 376,331 | | | — | | | 376,331 | | | — | |
| Loans held for sale | 1,476 | | | 1,527 | | | — | | | 1,527 | | | — | |
| Loans receivable, net | 3,773,301 | | | 3,849,602 | | | — | | | — | | | 3,849,602 | |
| Accrued interest receivable | 14,657 | | | 14,657 | | | 14 | | | 4,582 | | | 10,061 | |
| | | | | | | | | |
| Derivative assets - interest rate swaps | 15,219 | | | 15,219 | | | — | | | 15,219 | | | — | |
| Equity security | 240 | | | 240 | | | 240 | | | — | | | — | |
| Financial Liabilities: | | | | | | | | | |
| Non-maturity deposits | $ | 6,038,498 | | | $ | 6,038,498 | | | $ | 6,038,498 | | | $ | — | | | $ | — | |
| Certificates of deposit | 342,839 | | | 344,025 | | | — | | | 344,025 | | | — | |
| | | | | | | | | |
| Securities sold under agreement to repurchase | 50,839 | | | 50,839 | | | 50,839 | | | — | | | — | |
| Junior subordinated debentures | 21,180 | | | 18,750 | | | — | | | — | | | 18,750 | |
| Accrued interest payable | 73 | | | 73 | | | 33 | | | 19 | | | 21 | |
| Derivative liabilities - interest rate swaps | 15,286 | | | 15,286 | | | — | | | 15,286 | | | — | |
| | | | December 31, 2018 | | December 31, 2020 |
| | Carrying Value | | Fair Value | | Fair Value Measurements Using: | | Carrying
Value | | Fair Value | | Fair Value Measurements Using: |
| | Level 1 | | Level 2 | | Level 3 | | Level 1 | | Level 2 | | Level 3 |
| | (In thousands) | | (In thousands) |
| Financial Assets: | | | | | | | | | | Financial Assets: | |
| Cash and cash equivalents | $ | 161,910 |
| | $ | 161,910 |
| | $ | 161,910 |
| | $ | — |
| | $ | — |
| Cash and cash equivalents | $ | 743,322 | | | $ | 743,322 | | | $ | 743,322 | | | $ | — | | | $ | — | |
| Investment securities available for sale | 976,095 |
| | 976,095 |
| | 15,936 |
| | 960,159 |
| | — |
| Investment securities available for sale | 802,163 | | | 802,163 | | | — | | | 802,163 | | | — | |
| Federal Home Loan Bank stock | 6,076 |
| | N/A |
| | N/A |
| | N/A |
| | N/A |
| |
| | Loans held for sale | 1,555 |
| | 1,605 |
| | — |
| | 1,605 |
| | — |
| Loans held for sale | 4,932 | | | 5,156 | | | — | | | — | | | 5,156 | |
| Total loans receivable, net | 3,619,118 |
| | 3,614,348 |
| | — |
| | — |
| | 3,614,348 |
| |
| Loans receivable, net | | Loans receivable, net | 4,398,462 | | | 4,556,862 | | | — | | | — | | | 4,556,862 | |
| Accrued interest receivable | 15,403 |
| | 15,403 |
| | 68 |
| | 4,091 |
| | 11,244 |
| Accrued interest receivable | 19,418 | | | 19,418 | | | 2 | | | 3,648 | | | 15,768 | |
| | Derivative assets - interest rate swaps | 5,095 |
| | 5,095 |
| | — |
|
| 5,095 |
| | — |
| Derivative assets - interest rate swaps | 25,740 | | | 25,740 | | | — | | | 25,740 | | | — | |
| Equity security | 114 |
| | 114 |
| | 114 |
| | — |
| | — |
| Equity security | 131 | | | 131 | | | 131 | | | — | | | — | |
| Financial Liabilities: | | | | | | | | | | Financial Liabilities: | |
| Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts | $ | 3,965,510 |
| | $ | 3,965,510 |
| | $ | 3,965,510 |
| | $ | — |
| | $ | — |
| |
| Certificate of deposit accounts | 466,892 |
| | 470,222 |
| | — |
| | 470,222 |
| | — |
| |
| Non-maturity deposits | | Non-maturity deposits | $ | 5,198,456 | | | $ | 5,198,456 | | | $ | 5,198,456 | | | $ | — | | | $ | — | |
| Certificates of deposit | | Certificates of deposit | 399,534 | | | 402,701 | | | — | | | 402,701 | | | — | |
| | Securities sold under agreement to repurchase | 31,487 |
| | 31,487 |
| | 31,487 |
| | — |
| | — |
| Securities sold under agreement to repurchase | 35,683 | | | 35,683 | | | 35,683 | | | — | | | — | |
| Junior subordinated debentures | 20,302 |
| | 20,500 |
| | — |
| | — |
| | 20,500 |
| Junior subordinated debentures | 20,887 | | | 18,500 | | | — | | | — | | | 18,500 | |
| Accrued interest payable | 191 |
| | 191 |
| | 63 |
| | 81 |
| | 47 |
| |
| Derivative liabilities - interest rate swaps | 5,095 |
| | 5,095 |
| | — |
| | 5,095 |
| | — |
| |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2020 |
| Carrying
Value | | Fair Value | | Fair Value Measurements Using: |
| | Level 1 | | Level 2 | | Level 3 |
| (In thousands) |
| Accrued interest payable | 94 | | | 94 | | | 42 | | | 33 | | | 19 | |
| Derivative liabilities - interest rate swaps | 26,162 | | | 26,162 | | | — | | | 26,162 | | | — | |
(17)Stock-Based Compensation
|
| | | | | | | | | | | | | | | | | | | |
| | December 31, 2017 |
| | Carrying Value | | Fair Value | | Fair Value Measurements Using: |
| | | Level 1 | | Level 2 | | Level 3 |
| | (In thousands) |
| Financial Assets: | | | | | | | | | |
| Cash and cash equivalents | $ | 103,015 |
| | $ | 103,015 |
| | $ | 103,015 |
| | $ | — |
| | $ | — |
|
| Investment securities available for sale | 810,530 |
| | 810,530 |
| | 146 |
| | 810,384 |
| | — |
|
| Federal Home Loan Bank stock | 8,347 |
| | N/A |
| | N/A |
| | N/A |
| | N/A |
|
| Loans held for sale | 2,288 |
| | 2,364 |
| | — |
| | 2,364 |
| | — |
|
| Total loans receivable, net | 2,816,985 |
| | 2,810,401 |
| | — |
| | — |
| | 2,810,401 |
|
| Accrued interest receivable | 12,244 |
| | 12,244 |
| | 23 |
| | 3,772 |
| | 8,449 |
|
| Derivative assets - interest rate swaps | 3,418 |
| | 3,418 |
| | — |
| | 3,418 |
| | — |
|
| Financial Liabilities: | | | | | | | | | |
| Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts | $ | 2,994,662 |
| | $ | 2,994,662 |
| | $ | 2,994,662 |
| | $ | — |
| | $ | — |
|
| Certificate of deposit accounts | 398,398 |
| | 397,039 |
| | — |
| | 397,039 |
| | — |
|
| Federal Home Loan Bank advances | 92,500 |
| | 92,500 |
| | — |
| | 92,500 |
| | — |
|
| Securities sold under agreement to repurchase | 31,821 |
| | 31,821 |
| | 31,821 |
| | — |
| | — |
|
| Junior subordinated debentures | 20,009 |
| | 18,500 |
| | — |
| | — |
| | 18,500 |
|
| Accrued interest payable | 162 |
| | 162 |
| | 45 |
| | 79 |
| | 38 |
|
| Derivative liabilities - interest rate swaps | 3,418 |
| | 3,418 |
| | — |
| | 3,418 |
| | — |
|
| |
(19) | Stock-Based Compensation |
On July 24, 2014, the Company's shareholders approved the Heritage Financial Corporation 2014 Omnibus Equity Plan ("Equity Plan") that provides for the issuance of 1,500,000 shares of the Company's common stock in the form of stock options, stock appreciation rights, stock awards (which includes restricted stock units, restricted stock awards, performance units, performance shares or bonus shares) and cash incentive awards. The Company issues new sharesvarious types of common stock to satisfy share option exercises and restricted stock awards.stock-based compensation. As of December 31, 2018,2021, shares remainremaining available for future issuance under the Equity Plan totaled 955,282.522,228.
(a) Stock Option Awards
Stock options generally vestvested ratably over three years and expireexpired five years after they become exercisable or vestvested ratably over four years and expireexpired ten years from date of grant. For the years ended December 31, 2018, 2017 and 2016, the Company did not recognize any compensation expense or related tax benefit related to stock options as all of the compensation expense related to theAll outstanding stock options had been previously recognized.were exercised during the year ended December 31, 2020. The intrinsic value from options exercised during the years ended December 31, 2018, 20172020 and 20162019 was $202,000, $161,000$61,000 and $177,000,$60,000, respectively. The cash proceeds from options exercised during the years ended December 31, 2018, 20172020 and 20162019 were $132,000, $164,000$122,000 and $540,000,$58,000, respectively.
The following table summarizes the stock option activity forduring the years ended December 31, 2018, 2017 and 2016:periods indicated:
| | | | Shares | | Weighted-Average Exercise Price |
| Outstanding at December 31, 2018 | | Outstanding at December 31, 2018 | 12,558 | | | $ | 14.77 | |
| Exercised | | Exercised | (3,901) | | | 14.77 | |
| | Outstanding at December 31, 2019 | | Outstanding at December 31, 2019 | 8,657 | | | 14.77 | |
| Exercised | | Exercised | (8,248) | | | 14.77 | |
| Forfeited or expired | | Forfeited or expired | (409) | | | 14.77 | |
| Outstanding at December 31, 2020 | | Outstanding at December 31, 2020 | — | | | $ | — | |
| | | | Shares | | Weighted-Average Exercise Price | | Weighted-Average Remaining Contractual Term (In years) | | Aggregate Intrinsic Value (In thousands) | |
| Outstanding at December 31, 2015 | 79,408 |
| | $ | 14.19 |
| | | |
| Exercised | (37,713 | ) | | 14.31 |
| | | |
| Forfeited or expired | (4,200 | ) | | 16.80 |
| | | |
| Outstanding at December 31, 2016 | 37,495 |
| | 13.77 |
| | | |
| Exercised | (12,662 | ) | | 12.97 |
| | | |
| Forfeited or expired | (1,602 | ) | | 13.76 |
| | | |
| Outstanding at December 31, 2017 | 23,231 |
| | 14.21 |
| | | |
| Exercised | (9,842 | ) | | 13.45 |
| | | |
| Forfeited or expired | (831 | ) | | 14.77 |
| | | |
| Outstanding, vested and expected to vest and exercisable at December 31, 2018 | 12,558 |
| | $ | 14.77 |
| | 1.39 | | $ | 188 |
| |
(b) Restricted Stock Awards
Restricted stock awards granted generally havehad a four-year cliff vesting or four-year ratable vesting schedule. The remaining restricted stock awards vested during the year ended December 31, 2020. For the years ended December 31, 2018, 20172020 and 20162019, the Company recognized compensation expense related to restricted stock awards of $907,000, $1.4 million$76,000 and $1.8 million,$440,000, respectively, and a related tax benefit of $191,000, $488,000$17,000 and $644,000,$93,000, respectively. As of December 31, 2018, the total unrecognized compensation expense related to non-vested restricted stock awards was $556,000 and the related weighted average period over which the compensation expense is expected to be recognized is approximately 0.88 years. The vesting date fair value of the restricted stock awards that vested during the years ended December 31, 2018, 20172020 and 20162019 was $2.2 million, $2.9 million$442,000 and $2.0$1.3 million, respectively.
The following table summarizes the restricted stock award activity for the years ended December 31, 2018, 2017 and 2016:periods indicated
| | | | Shares | | Weighted-Average Grant Date Fair Value |
| Nonvested at December 31, 2018 | | Nonvested at December 31, 2018 | 66,033 | | | $ | 17.28 | |
| | Vested | | Vested | (43,148) | | | 17.07 | |
| Forfeited | | Forfeited | (2,178) | | | 18.32 | |
| Nonvested at December 31, 2019 | | Nonvested at December 31, 2019 | 20,707 | | | 17.59 | |
| | Vested | | Vested | (20,707) | | | 17.59 | |
| | Nonvested at December 31, 2020 | | Nonvested at December 31, 2020 | — | | | $ | — | |
| | | | Shares | | Weighted-Average Grant Date Fair Value | |
| Nonvested at December 31, 2015 | 264,521 |
| | $ | 15.92 |
| |
| Granted | 121,039 |
| | 17.60 |
| |
| Vested | (112,516 | ) | | 15.62 |
| |
| Forfeited | (11,748 | ) | | 16.62 |
| |
| Nonvested at December 31, 2016 | 261,296 |
| | 16.80 |
| |
| Vested | (113,479 | ) | | 16.55 |
| |
| Forfeited | (10,418 | ) | | 16.80 |
| |
| Nonvested at December 31, 2017 | 137,399 |
| | 17.00 |
| |
| Vested | (67,877 | ) | | 16.74 |
| |
| Forfeited | (3,489 | ) | | 16.92 |
| |
| Nonvested at December 31, 2018 | 66,033 |
| | $ | 17.28 |
| |
|
(c) Restricted Stock Units
During 2017, the Company began issuing stock-settled restrictedRestricted stock unit awards ("RSU") and performance-based stock-settled restricted stock unit awards ("PRSU"), collectively called "units". RSUs grantedunits generally vest ratably over three years. PRSUs granted generallyyears and are subject to service conditions in accordance with each award agreement.
Performance-based restricted stock units have a three-year cliff vesting schedule. Additionally, PRSU grants may beschedule, participate in dividends and are additionally subject to performance-based vesting as well as other approved vesting conditions. The number of shares of actually delivered pursuant to the PRSUs depends on the performance of the Company's Total Shareholder Return and Return on Average Assets over the performance period in relation to the performance of the common stock of a predetermined peer group.vesting. The conditions of the grants allow for an actual payout ranging between no payout and 150% of target.
The payout level is calculated based on actual performance achieved duringthe percentile level of the market condition, which is the ratio of the Company's total shareholder return and the ratio of the Company's return on average assets over the performance period comparedin relation to the performance of these metrics of a definedpredetermined peer group. The fair value of such PRSUseach performance-based
restricted stock unit, inclusive of the market condition, was determined using a Monte Carlo simulation and will be recognized over the subsequent three years.vesting period. The Monte-Carlo simulation model uses the same input assumptions as the Black-Scholes model; however, it also further incorporates into the fair value determination the possibility that the market condition may not be satisfied. Compensation costs related to these awards are recognized regardless of whether the market condition is satisfied, provided that the requisite service has been provided.
The Company used the following assumptions to estimate the fair value of performance-based restricted share units granted for the periods indicated:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 | | 2019 |
| Shares issued | 14,347 | | | 15,200 | | | 14,396 | |
| Expected Term in Years | 2.9 | | 2.8 | | 2.8 |
| Weighted-Average Risk Free Interest Rate | 0.3 | % | | 1.1 | % | | 2.5 | % |
| Weighted Average Fair Value | 24.49 | | | 23.50 | | | 30.06 | |
| Correlation coefficient | ABA NASDAQ Community Bank Index | | ABA NASDAQ Community Bank Index | | ABA NASDAQ Community Bank Index |
| Range of peer company volatilities | 31.4%-136.4% | | 18.1%-107.6% | | 19.9%-75.4% |
| Range of peer company correlation coefficients | 34.1%-94.8% | | 16.1%-90.2% | | 34.5%-90.7% |
| Company volatility | 40.2 | % | | 23.2 | % | | 23.9 | % |
| Company correlation coefficient | 90.1 | % | | 80.5 | % | | 79.9 | % |
Expected volatilities in the model were estimated using a historical period consistent with the performance period of approximately three years. The risk-free interest rate was based on the United States Treasury rate for a term commensurate with the expected life of the grant. The Company used the following assumptions to estimate the fair value of PRSUs granted during February 2018 and 2017:
|
| | | | | |
| | 2018 | | 2017 |
| Shares issued | 5,550 |
| | 6,089 |
|
| Expected Term in Years | 2.84 |
| | 2.85 |
|
| Weighted-Average Risk Free Interest Rate | 2.39 | % | | 1.40 | % |
| Expected Dividend Yield | — | % | | — | % |
| Weighted-Average Fair Value | 27.69 |
| | 24.39 |
|
| Correlation coefficient | ABA NASDAQ Community Bank Index | | ABA NASDAQ Community Bank Index |
| Range of peer company volatilities | 18.99% - 51.42% |
| | 17.8% - 63.1% |
|
| Range of peer company correlation coefficients | 28.16% - 94.29% |
| | 8.24% - 89.79% |
|
| Heritage volatility | 22.30 | % | | 21.80 | % |
| Heritage correlation coefficient | 76.44 | % | | 75.93 | % |
For the yearyears ended December 31, 20182021, 2020 and 2017,2019, the Company recognized compensation expense related to therestricted stock units of $1.8$3.7 million, $3.5 million, and $712,000,$2.8 million respectively, and a related tax benefit of $387,000$802,000, $757,000, and $249,000,$589,000, respectively. As of December 31, 2018,2021, the total unrecognized compensation expense related to non-vested restricted stock units was $3.5$5.0 million and the related weighted-average period over which the compensation expense is expected to be recognized is approximately 2.172.0 years. The vesting date fair value of the restricted stock units that vested during the year ended December 31, 20182021, 2020 and 2019 was $1.0 million. There were no PRSUs that vested during the years end December 31, 2018$3.6 million, $2.4 million and 2017.$2.0 million, respectively.
The following table summarizes the unit activity for the year endedperiods indicated:
| | | | | | | | | | | |
| Units | | Weighted-Average Grant Date Fair Value |
| Nonvested at December 31, 2018 | 179,185 | | | $ | 28.94 | |
| Granted | 126,598 | | | 31.89 | |
| Vested | (64,173) | | | 29.25 | |
| Forfeited | (8,070) | | | 30.25 | |
| Nonvested at December 31, 2019 | 233,540 | | | 30.41 | |
| Granted | 200,972 | | | 23.61 | |
| Vested | (109,853) | | | 29.21 | |
| Forfeited | (8,543) | | | 28.07 | |
| Nonvested at December 31, 2020 | 316,116 | | | 26.57 | |
| Granted | 147,944 | | | 25.70 | |
| Vested | (125,377) | | | 26.84 | |
| Forfeited | (23,669) | | | 27.20 | |
| Nonvested at December 31, 2021 | 315,014 | | | $ | 26.01 | |
(18)Cash Restriction
The Bank had restricted cash included in interest earning deposits of $9.8 million and $25.9 million as of December 31, 2018 and 2017:
|
| | | | | | |
| | Units | | Weighted-Average Grant Date Fair Value |
| Nonvested at December 31, 2016 | — |
| | $ | — |
|
| Granted | 92,356 |
| | 25.31 |
|
| Forfeited | (1,812 | ) | | 25.35 |
|
| Nonvested at December 31, 2017 | 90,544 |
| | 25.31 |
|
| Granted | 125,633 |
| | 30.62 |
|
| Vested | (32,375 | ) | | 25.44 |
|
| Forfeited | (4,617 | ) | | 27.82 |
|
| Nonvested at December 31, 2018 | 179,185 |
| | $ | 28.94 |
|
The Company is required to maintain an average reserve balance with the Federal Reserve Bank or maintain such reserve balance in the form of cash. The required reserve balance at December 31, 20182021 and December 31, 2017 was $9.2 million and $60,000,2020, respectively, and was met by holding cash and maintaining an average balancerelating to collateral required on interest rate swaps from third-parties as discussed in Note (8) Derivative Financial Instruments. The Bank does not have a collateral requirement with the Federal Reserve Bank.customers.
(19)Income Taxes
Income tax expense is substantially due to Federal income taxes as the provision for the state of Oregon income taxes is insignificant.insignificant and the state of Washington does not charge an income tax in lieu of a business and occupation tax. Income tax expense consisted of the following for the periods indicated:
| | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
| | (In thousands) |
| Current tax expense | $ | 20,896 | | | $ | 15,186 | | | $ | 12,504 | |
| Deferred tax expense (benefit) | 1,576 | | | (8,576) | | | 984 | |
| | | | | |
| Income tax expense | $ | 22,472 | | | $ | 6,610 | | | $ | 13,488 | |
The CARES Act, among other things, permitted net operating loss carryovers and carrybacks to offset 100% of taxable income for taxable years beginning before 2021. In addition, the CARES Act allowed net operating loss carrybacks incurred in 2018, 2019 and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. During the year ended December 31, 2020, the Company recorded a tax benefit from net operating loss carryback related to prior acquisitions of $967,000.
The effective tax rate was 18.6% for the year ended December 31, 2021 compared to an effective tax rate of 12.4% and 16.6% for the years ended December 31, 2018, 20172020 and 2016 consisted2019, respectively. The increase in the effective tax rate during the year ended December 31, 2021 was due primarily to the change in income before income taxes earned between the periods, including an increase in annual pre-tax income for the year ended December 31, 2021 which decreased the impact of favorable permanent tax items such as tax-exempt investments, investments in bank owned life insurance and low-income housing tax credits. The following table presents the following:
|
| | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | 2018 | | 2017 | | 2016 |
| | | (In thousands) |
| Current tax expense | | $ | 9,658 |
| | $ | 12,171 |
| | $ | 6,885 |
|
| Deferred tax expense | | 1,372 |
| | 6,185 |
| | 6,918 |
|
| Income tax expense | | $ | 11,030 |
| | $ | 18,356 |
| | $ | 13,803 |
|
A reconciliation of the Company's effective income tax rate withtaxes computed at the Federal statutory income tax rate of 35%21% to the actual effective rate for the years 2017 and 2016 and 21% for the year 2018 is as follows:periods indicated:
| | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
| | (In thousands) |
| Income tax expense at Federal statutory rate | $ | 25,307 | | | $ | 11,168 | | | $ | 17,020 | |
| State tax, net of Federal tax benefit | 960 | | | 359 | | | 357 | |
| Tax-exempt instruments | (1,929) | | | (1,785) | | | (1,745) | |
| | | | | |
Federal tax credits and other benefits (1) | (1,630) | | | (1,928) | | | (1,961) | |
| Effects of BOLI | (474) | | | (827) | | | (368) | |
| | | | | |
| | | | | |
| | | | | |
| Tax benefit of CARES Act carryback | — | | | (967) | | | — | |
| Other, net | 238 | | | 590 | | | 185 | |
| Income tax expense | $ | 22,472 | | | $ | 6,610 | | | $ | 13,488 | |
|
| | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | 2018 | | 2017 | | 2016 |
| | | (In thousands) |
| Income tax expense at Federal statutory rate | | $ | 13,502 |
| | $ | 21,051 |
| | $ | 18,452 |
|
| Tax-exempt instruments | | (1,879 | ) | | (3,212 | ) | | (3,198 | ) |
| Non-deductible acquisition costs | | 336 |
| | 210 |
| | — |
|
Federal tax credits and other benefits (1) | | (515 | ) | | (1,510 | ) | | (931 | ) |
| Effects of BOLI | | (330 | ) | | (531 | ) | | (511 | ) |
| Revaluation of net deferred tax assets | |
|
| | 2,568 |
| | — |
|
| Other, net | | (84 | ) | | (220 | ) | | (9 | ) |
| Income tax expense | | $ | 11,030 |
| | $ | 18,356 |
| | $ | 13,803 |
|
(1) Federal tax credits are provided for under the NMTC program and LIHTC programs as described in Note (14) Commitments(1) Description of Business, Basis of Presentation, Significant Accounting Policies and Contingencies. Tax benefitsRecently Issued Accounting Pronouncements. Gross tax credits related to these credits were recognized for financial reporting purposes in the same period that the credits were recognized in the Company's income tax returns. Other benefits includeNMTC totaling $9.8 million were utilized during the proportional amortization of the LIHTC of $3.1 million, $2.2 million and $523,000, for the yearsseven year period ended December 31, 2018, 2017 and 2016, respectively.
On December 22, 2017, the U.S. Government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act amended the Internal Revenue Code to reduce tax rates and modify policies, credits, and deductions for individuals and businesses. For businesses, the Tax Act reduced the corporate federal tax rate from a maximum of 35% to a flat 21% rate. The corporate tax rate reduction was effective January 1, 2018. The Tax Act required a revaluation the Company’s deferred tax assets and liabilities to account for the future impact of lower corporate tax rates and other provisions of the legislation. As a result of the Company's revaluation, the net deferred tax asset was reduced through an increase to the provision for income tax during the year ended December 31, 2017.
2020.
The following table presents major components of the deferred income tax asset (liability) resulting from differences between financial reporting and tax basis:
| | | | | | | | | | | |
| | December 31, 2021 | | December 31, 2020 |
| | (In thousands) |
| Deferred tax assets: | | | |
| Allowance for credit losses | $ | 9,756 | | | $ | 15,883 | |
| Accrued compensation | 3,480 | | | 2,988 | |
| Stock compensation | 689 | | | 642 | |
| | | |
| | | |
| | | |
| | | |
| Market discount on purchased loans | 944 | | | 1,062 | |
| Foregone interest on nonaccrual loans | 967 | | | 1,456 | |
| Net operating loss carryforward acquired | 186 | | | 207 | |
| | | |
| | | |
| ROU lease liability | 6,257 | | | 4,161 | |
| Other deferred tax assets | 1,156 | | | 160 | |
| Total deferred tax assets | 23,435 | | | 26,559 | |
|
| | | | | | | | |
| | | December 31, 2018 | | December 31, 2017 |
| | | (In thousands) |
| Deferred tax assets: | | | | |
| Allowance for loan losses | | $ | 6,941 |
| | $ | 6,699 |
|
| Accrued compensation | | 3,379 |
| | 1,779 |
|
| Stock compensation | | 769 |
| | 660 |
|
| Net unrealized losses charged to other comprehensive income on securities | | 2,070 |
| | 347 |
|
| Market discount on purchased loans | | 1,054 |
| | 539 |
|
| Foregone interest on nonaccrual loans | | 811 |
| | 471 |
|
| Net operating loss carryforward acquired from NCB | | 336 |
| | 270 |
|
| Other Real Estate Owned | | 754 |
| | — |
|
| Other deferred tax assets | | 364 |
| | 763 |
|
| Total deferred tax assets | | 16,478 |
|
| 11,528 |
|
| Deferred tax liabilities: | | | | |
| Deferred loan fees, net | | (3,333 | ) | | (2,518 | ) |
| Premises and equipment | | (1,819 | ) | | (1,091 | ) |
| FHLB stock | | (569 | ) | | (557 | ) |
| Goodwill and other intangible assets | | (3,526 | ) | | (304 | ) |
| Federal tax credits | | (1,457 | ) | | (1,107 | ) |
| Junior subordinated debentures | | (1,176 | ) | | (1,215 | ) |
| Other deferred tax liabilities | | (540 | ) | | (847 | ) |
| Total deferred tax liabilities | | (12,420 | ) |
| (7,639 | ) |
| Deferred tax asset, net | | $ | 4,058 |
|
| $ | 3,889 |
|
| | | | | | | | | | | |
| | December 31, 2021 | | December 31, 2020 |
| | (In thousands) |
| Deferred tax liabilities: | | | |
| Deferred loan fees, net | (1,838) | | | (2,643) | |
| Premises and equipment | (2,436) | | | (2,680) | |
| FHLB stock | (572) | | | (569) | |
| | | |
| | | |
| Goodwill and other intangible assets | (1,659) | | | (2,186) | |
| New market tax credit | — | | | (2,048) | |
| Junior subordinated debentures | (991) | | | (1,050) | |
| ROU lease asset | (5,995) | | | (3,879) | |
| Net unrealized gains on investment securities | (2,537) | | | (6,805) | |
| Other deferred tax liabilities | (181) | | | (264) | |
| Total deferred tax liabilities | (16,209) | | | (22,124) | |
| Deferred tax asset, net | $ | 7,226 | | | $ | 4,435 | |
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. A valuation allowance is required to be recognized for the portion of the deferred tax asset that will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. As of December 31, 2018,2021, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management expects to realize the benefits of these deductible differences.
TheAt December 31, 2021 and December 31, 2020, the Company had a net operating loss carryforward of $1.6 million$888,000 and $1.3 million at December 31, 2018$986,000, respectively, and 2017, respectively, that will begin to expire in 2024.do not expire. The Company is limited to the amount of the net operating loss carryforward that it can deduct each year. A tax planning strategy has been developed that management believes will enable the Company to deduct allyear under Section 382 of the net operating loss carryforwards priorInternal Revenue Code. Due to the expiration date. Based on these estimates,sufficient earnings history and other positive evidence, management has not recorded a valuation allowance on the net operating loss carryforward as of December 31, 20182021 and 2017.December 31, 2020.
As of December 31, 20182021 and 2017,December 31, 2020, the Company had an insignificant amount of unrecognized tax benefits, none of which would materially affect its effective tax rate if recognized. The Company does not anticipate that the amount of unrecognized tax benefits will significantly increase or decrease in the next 12 months. The amount of interest and penalties accrued as of December 31, 20182021 and 2017December 31, 2020 and forrecognized during the years ended December 31, 2018, 20172021, 2020 and 20162019 were immaterial.
The Company has qualified under provisions of the Internal Revenue Code to compute income taxes after deductions of additions to the bad debt reserves when it was registered as a Savings Bank. At December 31, 2018,2021, the Company had a taxable temporary difference of approximately $2.8 million that arose before 1988 (base-year amount). In accordance with FASB ASC 740, aan estimated deferred tax liability of an estimated $980,000$588,000 has not been recognized for the temporary difference. Management does not expect this temporary difference to reverse in the foreseeable future.
The Company and its Bank subsidiary file a United States consolidated federal income tax return and an Oregon State income tax return, and the tax years subject to examination by the Internal Revenue Service are the years ended December 31, 2018, 2017, 20162021, 2020, 2019 and 2015.2018.
(20)Commitments and Contingencies
(a) Commitments to Extend Credit
In the ordinary course of business, the Bank may enter into various types of transactions that include commitments to extend credit that are not included in its Consolidated Financial Statements. The Bank applies the same credit standards to these commitments as it uses in all its lending activities and has included these commitments in its lending risk evaluations. The majority of the commitments presented below are variable rate. Loan commitments can be either revolving or non-revolving. The Bank’s exposure to credit and market risk under commitments to extend credit is represented by the amount of these commitments.
The following table presents outstanding commitments to extend credit, including letters of credit, at the dates indicated:
| | | | | | | | | | | |
| | December 31, 2021 | | December 31, 2020 |
| | (In thousands) |
| Commercial business: | | | |
| Commercial and industrial | $ | 570,156 | | | $ | 640,018 | |
| Owner-occupied CRE | 2,252 | | | 3,488 | |
| |
(22) | Regulatory Capital Requirements |
| | | | | | | | | | | |
| | December 31, 2021 | | December 31, 2020 |
| | (In thousands) |
| Non-owner occupied CRE | 7,487 | | | 18,396 | |
| Total commercial business | 579,895 | | | 661,902 | |
| | | |
| Real estate construction and land development: | | | |
| Residential | 51,838 | | | 52,453 | |
| Commercial and multifamily | 209,217 | | | 127,821 | |
| Total real estate construction and land development | 261,055 | | | 180,274 | |
| Consumer | 285,010 | | | 263,249 | |
| Total outstanding commitments | $ | 1,125,960 | | | $ | 1,105,425 | |
The following table details the activity in the ACL on unfunded commitments during the periods indicated:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 | | 2020 | | 2019 |
| (In thousands) |
| Balance, beginning of period | $ | 4,681 | | | $ | 306 | | | $ | 306 | |
| Impact of CECL Adoption | — | | | 3,702 | | | — | |
| Adjusted balance, beginning of period | 4,681 | | | 4,008 | | | 306 | |
| (Reversal of) provision for credit losses on unfunded commitments | (2,074) | | | 673 | | | — | |
| Balance, end of period | $ | 2,607 | | | $ | 4,681 | | | $ | 306 | |
(b) Variable Interests - Low Income Housing Tax Credit Investments
The carrying values of investments in unconsolidated LIHTCs were $116.3 million and $96.4 million as of December 31, 2021 and December 31, 2020, respectively. During the years ended December 31, 2021, 2020 and 2019 the Company recognized tax benefits of $11.4 million, $7.5 million and $5.7 million, respectively, and proportional amortization of $9.7 million, $6.5 million and $5.0 million, respectively.
Total unfunded contingent commitments related to the Company’s LIHTC investments totaled $41.5 million and $53.8 million at December 31, 2021 and December 31, 2020, respectively. The Company expects to fund LIHTC commitments of $10.6 million during the year ended December 31, 2022 and $23.6 million during the year ended December 31, 2023, with the remaining commitments of $7.3 million funded by December 31, 2035. There were no impairment losses on the Company’s LIHTC investments during the years ended December 31, 2021, 2020 or 2019.
(c) Variable Interests - New Market Tax Credit Investments
The Company dissolved the NMTC investment during the year ended December 31, 2021 after gross tax credits related to the Company's certified development entities totaling $9.8 million were utilized during the seven year period ending December 31, 2020. The equity method balance of the NMTC investment was $25.2 million at December 31, 2020. The Company recognized related investment income of $247,000, $694,000 and $701,000 during the years ended December 31, 2021, 2020 and 2019, respectively.
(21)Regulatory Capital Requirements
The Company is a bank holding company under the supervision of the Federal Reserve Bank. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. HeritageThe Bank is a federally insured institution and thereby is subject to the capital requirements established by the FDIC. The Federal Reserve capital requirements generally parallel the FDIC requirements. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statementsConsolidated Financial Statements and operations. Management believes as of December 31, 2018,2021, the Company and the Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 20182021 and December 31, 2017,2020, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's categories.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Minimum
Requirements | | Well-
Capitalized
Requirements | | Actual |
| | $ | | % | | $ | | % | | $ | | % |
| | (Dollars in thousands) |
| As of December 31, 2021: | | | | | | | | | | | |
| The Company consolidated | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | $ | 200,525 | | | 4.5 | % | | N/A | | N/A | | $ | 600,390 | | | 13.5 | % |
| Tier 1 leverage capital to average assets | 285,791 | | | 4.0 | | | N/A | | N/A | | 621,570 | | | 8.7 | |
| Tier 1 capital to risk-weighted assets | 267,367 | | | 6.0 | | | N/A | | N/A | | 621,570 | | | 13.9 | |
| Total capital to risk-weighted assets | 356,489 | | | 8.0 | | | N/A | | N/A | | 660,209 | | | 14.8 | |
| Heritage Bank | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | 200,408 | | | 4.5 | | | $ | 289,478 | | | 6.5 | % | | 615,820 | | | 13.8 | |
| Tier 1 leverage capital to average assets | 285,657 | | | 4.0 | | | 357,071 | | | 5.0 | | | 615,820 | | | 8.6 | |
| Tier 1 capital to risk-weighted assets | 267,210 | | | 6.0 | | | 356,280 | | | 8.0 | | | 615,820 | | | 13.8 | |
| Total capital to risk-weighted assets | 356,280 | | | 8.0 | | | 445,350 | | | 10.0 | | | 654,459 | | | 14.7 | |
| As of December 31, 2020: | | | | | | | | | | | |
| The Company consolidated | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | $ | 203,314 | | | 4.5 | % | | N/A | | N/A | | $ | 555,644 | | | 12.3 | % |
| Tier 1 leverage capital to average assets | 256,216 | | | 4.0 | | | N/A | | N/A | | 576,531 | | | 9.0 | |
| Tier 1 capital to risk-weighted assets | 271,086 | | | 6.0 | | | N/A | | N/A | | 576,531 | | | 12.8 | |
| Total capital to risk-weighted assets | 361,448 | | | 8.0 | | | N/A | | N/A | | 633,061 | | | 14.0 | |
| Heritage Bank | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | 203,112 | | | 4.5 | | | $ | 293,383 | | | 6.5 | % | | 563,630 | | | 12.5 | |
| Tier 1 leverage capital to average assets | 256,051 | | | 4.0 | | | 320,064 | | | 5.0 | | | 563,630 | | | 8.8 | |
| Tier 1 capital to risk-weighted assets | 270,815 | | | 6.0 | | | 361,087 | | | 8.0 | | | 563,630 | | | 12.5 | |
| Total capital to risk-weighted assets | 361,087 | | | 8.0 | | | 451,359 | | | 10.0 | | | 620,124 | | | 13.7 | |
As of December 31, 2021 and December 31, 2020, the capital measures reflect the revised CECL capital transition provisions adopted by the Federal Reserve and the FDIC that allowed us the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period starting January 1, 2022 until December 31, 2024.
|
| | | | | | | | | | | | | | | | | | | |
| | | Minimum
Requirements | | Well-
Capitalized
Requirements | | Actual |
| | | $ | | % | | $ | | % | | $ | | % |
| | | (Dollars in thousands) |
| As of December 31, 2018: | | | | | | | | | | | | |
| The Company consolidated | | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | | $ | 197,189 |
| | 4.5 | % | | N/A |
| | N/A | | $ | 510,618 |
| | 11.7 | % |
| Tier 1 leverage capital to average assets | | 201,920 |
| | 4.0 |
| | N/A |
| | N/A | | 530,920 |
| | 10.5 |
|
| Tier 1 capital to risk-weighted assets | | 262,918 |
| | 6.0 |
| | N/A |
| | N/A | | 530,920 |
| | 12.1 |
|
| Total capital to risk-weighted assets | | 350,558 |
| | 8.0 |
| | N/A |
| | N/A | | 566,268 |
| | 12.9 |
|
| Heritage Bank | | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | | 197,004 |
| | 4.5 |
| | 284,561 |
| | 6.5 | | 513,993 |
| | 11.7 |
|
| Tier 1 leverage capital to average assets | | 203,339 |
| | 4.0 |
| | 254,174 |
| | 5.0 | | 513,993 |
| | 10.1 |
|
| Tier 1 capital to risk-weighted assets | | 262,671 |
| | 6.0 |
| | 350,229 |
| | 8.0 | | 513,993 |
| | 11.7 |
|
| Total capital to risk-weighted assets | | 350,229 |
| | 8.0 |
| | 437,786 |
| | 10.0 | | 549,341 |
| | 12.5 |
|
| As of December 31, 2017: | | | | | | | | | | | | |
| The Company consolidated | | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | | $ | 154,522 |
| | 4.5 | % | | N/A |
| | N/A | | $ | 386,689 |
| | 11.3 | % |
| Tier 1 leverage capital to average assets | | 159,494 |
| | 4.0 |
| | N/A |
| | N/A | | 406,687 |
| | 10.2 |
|
| Tier 1 capital to risk-weighted assets | | 206,029 |
| | 6.0 |
| | N/A |
| | N/A | | 406,687 |
| | 11.8 |
|
| Total capital to risk-weighted assets | | 274,706 |
| | 8.0 |
| | N/A |
| | N/A | | 439,044 |
| | 12.8 |
|
| Heritage Bank | | | | | | | | | | | | |
| Common equity Tier 1 capital to risk-weighted assets | | 154,400 |
| | 4.5 |
| | 223,023 |
| | 6.5 | | 391,092 |
| | 11.4 |
|
| Tier 1 leverage capital to average assets | | 159,300 |
| | 4.0 |
| | 199,125 |
| | 5.0 | | 391,092 |
| | 9.8 |
|
| Tier 1 capital to risk-weighted assets | | 205,867 |
| | 6.0 |
| | 274,490 |
| | 8.0 | | 391,092 |
| | 11.4 |
|
| Total capital to risk-weighted assets | | 274,490 |
| | 8.0 |
| | 343,112 |
| | 10.0 | | 423,348 |
| | 12.3 |
|
The Company is subject to capital adequacy requirements of the Basel Committee on Banking Supervision, commonly called Basel III. Under theapplicable capital requirements both the Company and the Bank are required to have a common equity Tier 1 capital ratio of 4.5%. In addition, both the Company and the Bank are required to have, a Tier 1 leverage ratio of 4.0%, a Tier 1 risk-based ratio of 6.0% and a total risk-based ratio of 8.0%. Both the Company and the Bank are also required to establishmaintain a “conservation buffer”,capital conservation buffer consisting of common equity Tier 1 capital above 2.5% of more than 2.5% above the minimum risk-basedrisk based capital ratios. The capital conservation buffer is designedratios to ensure that banks build up capital buffers outside periods of stress which can be drawn down as losses are incurred. An institution that does not meet the conservation buffer will be subject toavoid restrictions on certain activities including payment of dividends, stock repurchases and discretionary bonuses to executive officers. The capital conservation buffer requirement began to be phased-in on January 1, 2016 when more than 0.625% of risk-weighted assets was required, and increases by 0.625% on each subsequent January 1, until it is fully phased-in on January 1, 2019. Certain calculations under the
rules will also have phase-in periods. At December 31, 2018,2021, the capital conservation buffer was 4.92%6.8% and 4.55%6.7% for the Company and the Bank, respectively.
| |
(23) | Heritage Financial Corporation (Parent Company Only) |
(22)Heritage Financial Corporation (Parent Company Only)
Following isare the condensed financial statements of the Parent Company.
HERITAGE FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
Condensed Statements of Financial Condition
| | | | | | | | | | | |
| | December 31, 2021 | | December 31, 2020 |
| | (In thousands) |
| ASSETS | | | |
| Cash and cash equivalents | $ | 3,513 | | | $ | 9,736 | |
| Investment in subsidiary bank | 869,862 | | | 828,426 | |
| Other assets | 2,608 | | | 4,469 | |
| Total assets | $ | 875,983 | | | $ | 842,631 | |
| | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | |
| Junior subordinated debentures | $ | 21,180 | | | $ | 20,887 | |
| Other liabilities | 371 | | | 1,305 | |
| Total stockholders’ equity | 854,432 | | | 820,439 | |
| Total liabilities and stockholders’ equity | $ | 875,983 | | | $ | 842,631 | |
|
| | | | | | | | |
| | | December 31, 2018 | | December 31, 2017 |
| | | (In thousands) |
| ASSETS | | | | |
| Cash and interest earning deposits | | $ | 14,602 |
| | $ | 11,904 |
|
| Investment in subsidiary bank | | 764,097 |
| | 512,655 |
|
| Other assets | | 2,520 |
| | 4,696 |
|
| Total assets | | $ | 781,219 |
| | $ | 529,255 |
|
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | |
| Junior subordinated debentures | | $ | 20,302 |
| | $ | 20,009 |
|
| Other liabilities | | 194 |
| | 941 |
|
| Total stockholders’ equity | | 760,723 |
| | 508,305 |
|
| Total liabilities and stockholders’ equity | | $ | 781,219 |
| | $ | 529,255 |
|
HERITAGE FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
Condensed Statements of Income
| | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
| | (In thousands) |
| INTEREST INCOME: | | | | | |
| Interest on interest earning deposits | $ | 30 | | | $ | 16 | | | $ | 57 | |
| | | | | |
| INTEREST EXPENSE: | | | | | |
| Junior subordinated debentures | 742 | | | 890 | | | 1,339 | |
| | | | | |
| Net interest expense | (712) | | | (874) | | | (1,282) | |
| NONINTEREST INCOME: | | | | | |
| Dividends from subsidiary bank | 46,000 | | | 39,000 | | | 47,000 | |
| Equity in undistributed income of subsidiary bank | 57,058 | | | 12,685 | | | 25,186 | |
| Other income | 117 | | | 5 | | | 39 | |
| Total noninterest income | 103,175 | | | 51,690 | | | 72,225 | |
| NONINTEREST EXPENSE: | | | | | |
| Professional services | 394 | | | 495 | | | 517 | |
| Other expense | 5,430 | | | 5,172 | | | 4,395 | |
| Total noninterest expense | 5,824 | | | 5,667 | | | 4,912 | |
| Income before income taxes | 96,639 | | | 45,149 | | | 66,031 | |
| Income tax benefit | (1,396) | | | (1,421) | | | (1,526) | |
| Net income | $ | 98,035 | | | $ | 46,570 | | | $ | 67,557 | |
|
| | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | 2018 | | 2017 | | 2016 |
| | | (In thousands) |
| INTEREST INCOME: | | | | | | |
| Interest and dividends on interest earning deposits and other assets | | $ | 7 |
| | $ | 44 |
| | $ | 34 |
|
| Total interest income | | 7 |
| | 44 |
| | 34 |
|
| INTEREST EXPENSE: | | | | | | |
| Junior subordinated debentures | | 1,263 |
| | 1,014 |
| | 880 |
|
| Total interest expense | | 1,263 |
| | 1,014 |
| | 880 |
|
| Net interest expense | | (1,256 | ) | | (970 | ) | | (846 | ) |
| NONINTEREST INCOME: | | | | | | |
| Dividends from subsidiary bank | | 30,000 |
| | 23,000 |
| | 30,000 |
|
| Equity in undistributed income of subsidiary bank | | 29,258 |
| | 21,755 |
| | 11,848 |
|
| Other income | | 22 |
| | — |
| | — |
|
| Total noninterest income | | 59,280 |
| | 44,755 |
| | 41,848 |
|
| NONONTEREST EXPENSE: | | | | | | |
| Professional services | | 3,063 |
| | 768 |
| | 385 |
|
| Other expense | | 3,833 |
| | 3,726 |
| | 3,437 |
|
| Total noninterest expense | | 6,896 |
| | 4,494 |
| | 3,822 |
|
| Income before income taxes | | 51,128 |
| | 39,291 |
| | 37,180 |
|
| Income tax benefit | | (1,929 | ) | | (2,500 | ) | | (1,738 | ) |
| Net income | | $ | 53,057 |
| | $ | 41,791 |
| | $ | 38,918 |
|
HERITAGE FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
Condensed Statements of Cash Flows
| | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
| | (In thousands) |
| Cash flows from operating activities: | | | | | |
| Net income | $ | 98,035 | | | $ | 46,570 | | | $ | 67,557 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
| Equity in undistributed income of subsidiary bank | (57,058) | | | (12,685) | | | (25,186) | |
| | | | | |
| Stock-based compensation expense | 3,666 | | | 3,559 | | | 3,231 | |
| | | | | |
| Net change in other assets and other liabilities | 960 | | | (1,333) | | | 763 | |
| Net cash provided by operating activities | 45,603 | | | 36,111 | | | 46,365 | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| Cash flows from financing activities: | | | | | |
| Common stock cash dividends paid | (28,937) | | | (28,859) | | | (30,908) | |
| Proceeds from exercise of stock options | — | | | 122 | | | 58 | |
| | | | | |
| Repurchase of common stock | (22,889) | | | (19,119) | | | (8,636) | |
| Net cash used in financing activities | (51,826) | | | (47,856) | | | (39,486) | |
| Net (decrease) increase in cash and cash equivalents | (6,223) | | | (11,745) | | | 6,879 | |
| Cash and cash equivalents at the beginning of year | 9,736 | | | 21,481 | | | 14,602 | |
| Cash and cash equivalents at the end of year | $ | 3,513 | | | $ | 9,736 | | | $ | 21,481 | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
|
| | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | 2018 | | 2017 | | 2016 |
| | | (In thousands) |
| Cash flows from operating activities: | | | | | | |
| Net income | | $ | 53,057 |
| | $ | 41,791 |
| | $ | 38,918 |
|
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | |
| Equity in undistributed income of subsidiary bank | | (29,258 | ) | | (21,755 | ) | | (11,848 | ) |
| Net excess tax benefit from exercise of stock options and vesting of restricted stock | | — |
| | — |
| | (123 | ) |
| Stock-based compensation expense | | 2,744 |
| | 2,103 |
| | 1,840 |
|
| Net change in other assets and liabilities | | 1,735 |
| | (1,925 | ) | | (1,141 | ) |
| Net cash provided by operating activities | | 28,278 |
| | 20,214 |
| | 27,646 |
|
| Cash flows from investing activities: | | | | | | |
| Net cash received from acquisitions | | 1,782 |
| | — |
| | — |
|
| Net cash provided by investing activities | | 1,782 |
| | — |
| | — |
|
| Cash flows from financing activities: | | | | | | |
| Common stock cash dividends paid | | (25,791 | ) | | (18,305 | ) | | (21,569 | ) |
| Proceeds from exercise of stock options | | 133 |
| | 164 |
| | 540 |
|
| Net excess tax benefit from exercise of stock options and vesting of restricted stock | | — |
| | — |
| | 123 |
|
| Repurchase of common stock | | (1,704 | ) | | (737 | ) | | (2,894 | ) |
| Net cash used in financing activities | | (27,362 | ) | | (18,878 | ) | | (23,800 | ) |
| Net increase in cash and cash equivalents | | 2,698 |
| | 1,336 |
| | 3,846 |
|
| Cash and cash equivalents at the beginning of year | | 11,904 |
| | 10,568 |
| | 6,722 |
|
| Cash and cash equivalents at the end of year | | $ | 14,602 |
| | $ | 11,904 |
| | $ | 10,568 |
|
| | | | | | | |
| Supplemental non-cash disclosures of cash flow information: | | | | | | |
| Common stock issued for business combinations | | $ | 230,043 |
| | $ | — |
| | $ | — |
|
| Capital contribution of net assets acquired in business combinations to Bank | | 228,261 |
| | — |
| | — |
|
| |
(24) | Selected Quarterly Financial Data (Unaudited) |
Results of operations on a quarterly basis were as follows:
|
| | | | | | | | | | | | | | | | |
| | | Year Ended December 31, 2018 |
| | | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter |
| | | (Dollars in thousands, except per share amounts) |
| Interest income | | $ | 43,247 |
| | $ | 46,671 |
| | $ | 54,576 |
| | $ | 54,865 |
|
| Interest expense | | 2,410 |
| | 2,928 |
| | 3,480 |
| | 3,595 |
|
| Net interest income | | 40,837 |
| | 43,743 |
| | 51,096 |
| | 51,270 |
|
| Provision for loan losses | | 1,152 |
| | 1,750 |
| | 1,065 |
| | 1,162 |
|
| Net interest income after provision for loan losses | | 39,685 |
| | 41,993 |
| | 50,031 |
|
| 50,108 |
|
| Noninterest income | | 7,548 |
| | 7,573 |
| | 8,080 |
| | 8,464 |
|
| Noninterest expense | | 36,747 |
| | 35,706 |
| | 39,597 |
| | 37,345 |
|
| Income before provision for income taxes | | 10,486 |
| | 13,860 |
| | 18,514 |
|
| 21,227 |
|
| Income tax expense | | 1,399 |
| | 2,003 |
| | 3,010 |
| | 4,618 |
|
| Net income | | $ | 9,087 |
| | $ | 11,857 |
| | $ | 15,504 |
|
| $ | 16,609 |
|
| Basic earnings per common share | | $ | 0.27 |
| | $ | 0.35 |
| | $ | 0.42 |
| | $ | 0.45 |
|
| Diluted earnings per common share | | 0.27 |
| | 0.35 |
| | 0.42 |
| | 0.45 |
|
| Cash dividends declared on common stock | | 0.15 |
| | 0.15 |
| | 0.15 |
| | 0.27 |
|
| |
| | | Year Ended December 31, 2017 |
| | | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter |
| | | (Dollars in thousands, except per share amounts) |
| Interest income | | $ | 34,849 |
| | $ | 36,041 |
| | $ | 37,275 |
| | $ | 39,544 |
|
| Interest expense | | 1,717 |
| | 1,907 |
| | 2,333 |
| | 2,389 |
|
| Net interest income | | 33,132 |
| | 34,134 |
| | 34,942 |
| | 37,155 |
|
| Provision for loan losses | | 867 |
| | 1,131 |
| | 884 |
| | 1,338 |
|
| Net interest income after provision for loan losses | | 32,265 |
| | 33,003 |
| | 34,058 |
| | 35,817 |
|
| Noninterest income | | 7,363 |
| | 10,709 |
| | 8,443 |
| | 9,064 |
|
| Noninterest expense | | 27,223 |
| | 27,809 |
| | 27,955 |
| | 27,588 |
|
| Income before provision for income taxes | | 12,405 |
| | 15,903 |
| | 14,546 |
| | 17,293 |
|
| Income tax expense | | 3,089 |
| | 4,075 |
| | 3,922 |
| | 7,270 |
|
| Net income | | $ | 9,316 |
| | $ | 11,828 |
| | $ | 10,624 |
| | $ | 10,023 |
|
| Basic earnings per common share | | $ | 0.31 |
| | $ | 0.40 |
| | $ | 0.35 |
| | $ | 0.33 |
|
| Diluted earnings per common share | | 0.31 |
| | 0.40 |
| | 0.35 |
| | 0.33 |
|
| Cash dividends declared on common stock | | 0.12 |
| | 0.13 |
| | 0.13 |
| | 0.23 |
|
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our disclosure controls and procedures are designed to ensure that information the Company must disclose in its reports filed or submitted under the Securities Exchange Act, of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized, and reported on a timely basis. Our management has evaluated, with the participation and under the supervision of our chief executive officer (“CEO”)Chief Executive Officer and chief financial officer (“CFO”),Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. Based on this evaluation, our CEOChief Executive Officer and CFOChief Financial Officer have concluded that, as of such date, the Company’s disclosure controls and procedures are effective in ensuring that information relating to the Company, including its consolidated subsidiaries, required to be disclosed in reports that it files under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to our management, including our CEOChief Executive Officer and CFO,Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting
(a) Management’s report on internal control over financial reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control system is designed to provide reasonable assurance to our management and the board of directors regarding the preparation and fair presentation of published financial statements. Nonetheless, all internal control systems, no matter how well designed, have inherent limitations. Even systems determined to be effective as of a particular date can provide only reasonable assurance with respect to financial statement preparation and presentation and may not eliminate the need for restatements.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018.2021. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in the 2013 Internal Control—Integrated Framework. Based on our assessment, we believe that, as of December 31, 2018,2021, the Company’s internal control over financial reporting is effective based on these criteria.
As permitted, the Company excluded from its assessment the internal control over financial reporting the operations of Puget Sound Bancorp, Inc. and Premier Commercial Bancorp, which were acquired on January 16, 2018 and July 2, 2018, respectively.
Crowe LLP, an independent registered public accounting firm, has audited the effectiveness of our internal control over financial reporting as of December 31, 2018,2021, and their report is included in Item 8. Financial Statements And Supplementary Data.
(b) Attestation report of the registered public accounting firm.
See Item 8. Financial Statements And Supplementary Data.
(c) Changes in internal control over financial reporting.
There were no significant changes in the Company’s internal control over financial reporting duringthe fourth quarter of the period covered by this Annual Report on Form 10-K that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None
ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS
Not applicable
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning directors of the registrant is incorporated by reference to the section entitled “Proposal 1 - Election of Directors” of our definitive proxy statement for the annual meeting of shareholders to be held on May 1, 2019 (“Proxy Statement”).Statement.
For information regarding the executive officers of the Company, see Item 1. Business—Executive Officers.”
The required information with respect to compliance with Section 16(a) of the Exchange Act is incorporated by reference to the sectionssection entitled “Security Ownership of Certain Beneficial Owners and Management” and "Section 16(a) Beneficial Ownership Reporting Compliance" of the Proxy Statement.
The Company has adopted a written Code of Ethics that applies to our directors, officers and employees. The Code of Ethics can be accessed electronically by visiting the Company’s website at www.hf-wa.com.www.hf-wa.com in the section titled Overview: Governance Documents.
The Audit and Finance Committee of our Boardboard of Directorsdirectors retains our independent auditors, reviews and approves the scope and results of the audits with the auditors and management, monitors the adequacy of our system of internal controls and reviews the annual report, auditors’ fees and non-audit services to be provided by the independent auditors. The members of our Audit Committee are Deborah J. Gavin, chair of the committee, Brian S. Charneski, John A. Clees andTrevor D. Dryer, Jeffery S. Lyon, Gragg E. Miller, and Anthony B. Pickering, all of whom are considered “independent” as defined by the SEC. Our Boardboard of Directorsdirectors has determined that Mrs. Gavin meets the definition of an audit committeea financial expert as determined by the requirements of the SEC.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive and director compensation and certain matters regarding participation in the Company’s Compensation Committee required by this item is incorporated by reference to the headings “Executive Compensation,” “Director Compensation,” “Report of the Compensation Committee,” and "CEO Pay Ratio" of the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information concerning security ownership of certain beneficial owners and management is incorporated by reference to the section entitled “Security Ownership of Certain Beneficial Owners and Management” of the Proxy Statement.
The following table summarizes the consolidated activity within the Company’s stock-based compensation plans as of December 31, 2018,2021, all of which were approved by shareholders.
| | | | | | | | | | | | | | | | | | | | | | | |
| Plan Category | Number of
securities
to be issued
upon vesting of restricted stock awards | | Number of
securities
to be issued
upon vesting of restricted stock units | | Number of
securities
to be issued
upon exercise of outstanding
options | | Number of
securities
remaining
available for
future issuance
under equity
compensation
plans |
| Equity compensation plans, all of which are approved by security holders | — | | 315,014 | | — | | 522,228 |
|
| | | | | | | | | | | | | | | | |
| Plan Category | | Number of securities to be issued upon vesting of restricted stock awards | | Number of securities to be issued upon vesting of restricted stock units | | Number of securities to be issued upon exercise of outstanding options | | Weighted- average exercise price of outstanding options | | Number of securities remaining available for future issuance under equity compensation plans |
| Equity compensation plans, all of which are approved by security holders | | 66,033 | | 179,185 | | 12,558 | | $14.77 | | 955,282 |
ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information concerning certain relationships and related transactions is incorporated by reference to the sections entitled “Meetings and Committees of the Board of Directors" and "Corporate Governance” of the Proxy Statement.
Our common stock is listed on the NASDAQ Global Select Market. In accordance with NASDAQ requirements, at least a majority of our directors must be independent directors. The Boardboard of Directorsdirectors has determined that 912 of our 1013 directors are independent. Only Brian L. Vance, who serves as Chief Executive Officer of Heritage Financial Corporation, is not independent.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information concerning principal accounting fees and services is incorporated by reference to the section entitled “Proposal 3 - Ratification of the Appointment of Independent Registered Public Accounting Firm” in the Proxy Statement.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as a part of this report:
(1) Financial Statements: The Consolidated Financial Statements are included in Part II. Item 8. Financial Statements And Supplementary Data.
(2) Financial Statements Schedules: All schedules are omitted because they are not required or applicable, or the required information is shown in the Consolidated Financial Statements or Notes.
(3) Exhibits: Included in schedule below.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Incorporated by Reference |
| Exhibit No. | | Description of Exhibit | | Form | | Exhibit | | Filing Date/Period End Date |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| 3.1 | | | | 8-K | | 3.1(B) | | 05/18/2010 |
| | | | | | | | |
| 3.2 | | | | S-14A | | - | | 03/18/2011 |
| | | | | | | | |
| 3.3 | | | | 8-K | | 3.3 | | 06/30/2020 |
| | | | | | | | |
| 4.1 | | Form of Certificate of Company's Common Stock (3) | | S-1/A | | - | | 10/29/1997 |
| | | | | | | | |
| 4.2 | | | | | | | | |
| | | | | | | | |
| 10.1* | | | | 10-K | | 10.5 | | 03/09/2017 |
| | | | | | | | |
| 10.2* | | | | 8-K | | 99.2 | | 02/01/2017 |
| | | | | | | | |
| 10.3* | | | | DEF 14A | | - | | 06/11/2014 |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| 10.4* | | | | 8-K | | 99.4 | | 02/01/2017 |
| | | | | | | | |
| 10.5* | | | | 8-K | | 99.3 | | 02/01/2017 |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| 10.6* | | | | 8-K | | 10.1 | | 07/01/2019 |
| | | | | | | | |
| 10.7* | | | | 8-K | | 10.6 | | 09/07/2012 |
| | | | | | | | |
| 10.8* | | | | 8-K | | 10.2 | | 12/22/2016 |
| | | | | | | | |
| 10.9* | | | | 10-Q | | 10.15 | | 11/06/2019 |
| | | | | | | | |
| 10.10* | | | | 10-Q | | 10.22 | | 11/06/2019 |
| | | | | | | | |
| 10.11* | | | | 8-K | | 10.7 | | 09/07/2012 |
| | | | | | | | |
| 10.12* | | | | 8-K | | 10.3 | | 12/22/2016 |
| | | | | | | | |
| 10.13* | | | | 10-Q | | 10.16 | | 11/06/2019 |
| | | | | | | | |
| 10.14* | | | | 10-Q | | 10.33 | | 11/06/2019 |
| | | | | | | | |
| 10.15* | | | | 10-K | | 10.16 | | 03/11/2015 |
| | | | | | | | |
|
| | | | | | | | | |
| | | | | Incorporated by Reference |
| Exhibit No. | | Description of Exhibit | | Form | | Exhibit | | Filing Date/Period End Date |
| 2.1 |
| | | | 8-K | | 2.1 | | 7/27/17 |
| | | | | | | | | |
| 2.2 |
| | | | 8-K | | 2.1 | | 3/9/2018 |
| | | | | | | | | |
| 3.1 |
| | | | 8-K | | 3.1(B) | | 5/18/10 |
| | | | | | | | | |
| 3.2 |
| | | | 8-K | | 3.2 | | 10/3/16 |
| | | | | | | | | |
| 4.1 |
| | Form of Certificate of Heritage's Common Stock (3) | | S-1/A | | - | | 10/29/97 |
| | | | | | | | | |
| 10.1 |
| | | | 10-K | | 10.5 | | 3/9/17 |
| | | | | | | | | |
| 10.2 |
| | | | S-8 | | - | | 5/27/10 |
| | | | | | | | | |
| 10.3 |
| | | | 8-K | | 99.2 | | 2/1/17 |
| | | | | | | | | |
| 10.4 |
| | | | DEF 14A | | - | | 6/11/14 |
| | | | | | | | | |
| 10.5 |
| | | | 8-K | | 99.6 | | 2/1/17 |
| | | | | | | | | |
| 10.6 |
| | | | 10-Q | | 10.8 | | 8/8/14 |
| | | | | | | | | |
| 10.7 |
| | | | 8-K | | 99.7 | | 2/1/17 |
| | | | | | | | | |
| 10.8 |
| | | | 10-Q | | 10.9 | | 8/8/14 |
| | | | | | | | | |
| 10.9 |
| | | | 8-K | | 99.4 | | 2/1/17 |
| | | | | | | | | |
| 10.10 |
| | | | 10-Q | | 10.10 | | 8/8/14 |
| | | | | | | | | |
| 10.11 |
| | | | 8-K | | 99.3 | | 2/1/17 |
| | | | | | | | | |
| 10.12 |
| | | | 8-K | | 99.8 | | 2/1/17 |
| | | | | | | | | |
| 10.13 |
| | | | 8-K | | 99.5 | | 2/1/17 |
| | | | | | | | | |
|
| | | | | | | | | |
| 10.14 |
| | | | 8-K | | 10.1 | | 12/22/16 |
| | | | | | | | | |
| 10.15 |
| | | | 8-K | | 10.2 | | 12/22/16 |
| | | | | | | | | |
| 10.16 |
| | | | 8-K | | 10.3 | | 12/22/16 |
| | | | | | | | | |
| 10.17 |
| | | | 8-K | | 10.5 | | 9/7/12 |
| | | | | | | | | |
| 10.18 |
| | | | 8-K | | 10.6 | | 9/7/12 |
| | | | | | | | | |
| 10.19 |
| | | | 8-K | | 10.7 | | 9/7/12 |
| | | | | | | | | |
| 10.20 |
| | | | 8-K | | 10.1 | | 9/7/12 |
| | | | | | | | | |
| 10.21 |
| | | | 8-K | | 10.2 | | 9/7/12 |
| | | | | | | | | |
| 10.22 |
| | | | 8-K | | 10.3 | | 9/7/12 |
| | | | | | | | | |
| 10.23 |
| | | | 8-K | | 10.5 | | 12/22/16 |
| | | | | | | | | |
| 10.24 |
| | | | 8-K | | 10.1 | | 1/6/14 |
| | | | | | | | | |
| 10.25 |
| | | | 8-K | | 10.2 | | 1/6/14 |
| | | | | | | | | |
| 10.26 |
| | | | S-4 | | | | 1/24/14 |
| | | | | | | | | |
| 10.27 |
| | | | 8-K | | 10.4 | | 12/22/16 |
| | | | | | | | | |
| 10.28 |
| | | | 10-K | | 10.16 | | 3/11/15 |
| | | | | | | | | |
| 10.29 |
| | | | 10-Q | | 10.17 | | 8/6/15 |
| | | | | | | | | |
| 10.30 |
| | | | 8-K | | 10.1 | | 12/22/15 |
| | | | | | | | | |
| 10.31 |
| | | | 8-K | | 10.1 | | 7/10/18 |
| | | | | | | | | |
| 10.32 |
| | | | 8-K | | 10.2 | | 7/10/18 |
| | | | | | | | | |
| 10.33 |
| | | | 8-K | | 10.3 | | 7/10/18 |
| | | | | | | | | |
| 14.0 |
| | Code of Ethics and Conduct Policy (2) | | | | | | |
| | | | | | | | | |
| 21.0 |
| | | | | | | | |
| | | | | | | | | |
| 23.0 |
| | | | | | | | |
| | | | | | | | | |
| 24.0 |
| | | | | | | | |
| | | | | | | | | |
| 31.1 |
| | | | | | | | |
| | | | | | | | | |
|
| | | | | | | | | | | | | | | | | | | | | | | | | |
31.210.16* |
| | | | 8-K | | 10.4 | | 12/22/2016 |
| | | | | | | | |
| 10.17* | | | | 10-Q | | 10.27 | | 11/06/2019 |
| | | | | | | | |
| 10.18* | | | | 8-K | | 10.1 | | 07/06/2021 |
| | | | | | | | |
| 10.19* | | | | 10-Q | | 10.35 | | 11/06/2019 |
| | | | | | | | |
| 10.20* | | | | 10-Q | | 10.36 | | 11/06/2019 |
| | | | | | | | |
| 10.21* | | | | 10-Q | | 10.37 | | 11/06/2019 |
| | | | | | | | |
| 10.22* | | | | 10-Q | | 10.17 | | 08/06/2015 |
| | | | | | | | |
| 10.23* | | | | 10-Q | | 10.34 | | 05/09/2019 |
| | | | | | | | |
| 10.24* | | | | 8-K | | 10.1 | | 06/30/2020 |
| | | | | | | | |
| 10.25* | | | | 8-K | | 10.3 | | 06/30/2020 |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| 10.26* | | | | 10-Q | | 10.34 | | 05/05/2021 |
| | | | | | | | |
| 14.0 | | Code of Ethics and Conduct Policy (2) | | | | | | |
| | | | | | | | |
| 21.0 | | | | | | | | |
| | | | | | | | |
| 23.0 | | | | | | | | |
| | | | | | | | |
| 24.0 | | | | | | | | |
| | | | | | | | |
| 31.1 | | | | | | | | |
| | | | | | | | |
| 31.2 | | | | | | | | |
| | | | | | | | |
| 32.1 |
| | | | | | | | |
| | | | | | | | |
| 101.INS |
| | XBRL Instance Document (1) | | | | | | |
| | | | | | | | |
| 101.SCH |
| | XBRL Taxonomy Extension Schema Document (1) | | | | | | |
| | | | | | | | |
| 101.CAL |
| | XBRL Taxonomy Extension Calculation Linkbase Document (1) | | | | | | |
| | | | | | | | |
| 101.DEF |
| | XBRL Taxonomy Extension Definition Linkbase Document (1) | | | | | | |
| | | | | | | | |
| 101.LAB |
| | XBRL Taxonomy Extension Label Linkbase Document (1) | | | | | | |
| | | | | | | | |
| 101.PRE |
| | XBRL Taxonomy Extension Presentation Linkbase Document (1) | | | | | | |
*Indicates management contract or compensatory plan or arrangement.
(1) Filed herewith.
(2) Registrant elects to satisfy Regulation S-K §229.406(c) by posting its Code of Ethics on its website at www.HF-WA.com in the section titled Overview: Governance Documents.
(3) Exhibit not previously filed in electronic format.
ITEM 16. FORM 10-K SUMMARY
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on March 1, 2019.
| | | | | | | | |
| | HERITAGE FINANCIAL CORPORATION |
| | (Registrant) |
| | |
| | HERITAGE FINANCIAL CORPORATION/S/ JEFFREY J. DEUEL |
| | (Registrant)Jeffrey J. Deuel |
| | |
| | /S/ BRIAN L. VANCE |
| | Brian L. Vance |
| | President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 1, 2019.
|
| | | | | | | |
| | | |
| | | |
| | | Principal Executive Officer: |
| | | /S/ BRIAN L. VANCE JEFFREY J. DEUEL |
| | | Brian L. VanceJeffrey J. Deuel |
| | | President and Chief Executive Officer |
| | | |
| | | |
| | | Principal Financial Officer: |
| | | /S/ DONALD J. HINSON |
| | | Donald J. Hinson |
| | | Executive Vice President and Chief Financial Officer |
| | | |
| | | |
| Brian L. Vance,Jeffrey J. Deuel, pursuant to a power of attorney that is being filed with the Annual Report on Form 10-K, has signed this report as attorney in fact for the following directors who constitute a majority of the Board.board of directors. |
|
| | | |
| Brian S. Charneski | | |
| John A. Clees | | |
| Trevor D. Dryer | | |
| Kimberly T. Ellwanger | | |
| Deborah J. Gavin | | |
| Gail B. Giacobbe | | |
| Jeffrey S. Lyon | | |
| Gragg E. Miller | | |
| Anthony B. Pickering | | |
| Frederick B. Rivera | Ann Watson | | |
| Stephen A. Dennis | | |
| | | By |
| | | /S/ BRIAN L. VANCE |
| | | Brian L. Vance | | |
| Ann Watson | | | Attorney-in-Fact |
| | /S/ JEFFREY J. DEUEL |
| March 1, 2019 | Jeffrey J. Deuel |
| | Attorney-in-Fact |
| | February 24, 2022 |