UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
 
 
 
FORM 10-Q
 
 


QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019March 31, 2020 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) 
 
 
Washington 91-1857900
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
    
201 Fifth Avenue SW,OlympiaWA 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:
Title of each classTrading symbolName of each exchange on which registered
Common stock, no par valueHFWANASDAQ

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      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      No  
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.
 Large accelerated filerAccelerated 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 provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes      No  
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:
As of July 31, 2019April 27, 2020 there were 36,882,16335,888,494 shares of the registrant's common stock, no par value per share, outstanding.






HERITAGE FINANCIAL CORPORATION
FORM 10-Q
June 30, 2019March 31, 2020
TABLE OF CONTENTS

    Page
     
PART I.
ITEM 1.
  
  
  
  
  
  
  NOTE 1.
  NOTE 2.
  NOTE 3.
  NOTE 4.
  NOTE 5.
  NOTE 6.
NOTE 7.
  NOTE 8.7.
  NOTE 9.8.
NOTE 9.
  NOTE 10.
  NOTE 11.
NOTE 12.
NOTE 13.
  NOTE 14.12.
NOTE 13.
  NOTE 15.14.
  NOTE 16.15.
NOTE 16.
NOTE 15.
ITEM 2.



ITEM 3.
ITEM 4.
Part II.
ITEM 1.
ITEM 1A.
ITEM 2.
ITEM 3.
ITEM 4.
ITEM 5.
ITEM 6.
 



Glossary of Acronyms, Abbreviations, and TermsGLOSSARY OF ACRONYMS, ABBREVIATIONS, AND TERMS

The acronyms, abbreviations, and terms listed below are used in various sections of the Form 10-Q, including “Item 1. Financial Statements” and “Item 2. Management Discussion and Analysis of Financial Condition and Results of Operations".Operations." 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.
20182019 Annual Form 10-K Company's Annual Report on Form 10-K for the year ended December 31, 20182019
ACLAllowance for Credit Losses
ALL Allowance for Loan Losses
AOCI Accumulated Other Comprehensive Income (Loss)other comprehensive income (loss), net
ASC Accounting Standards Codification
ASU Accounting Standards Update
Bank Heritage Bank
Basel IIIA comprehensive capital framework and rules for U.S. banking organizations approved by the Federal Reserve Board and the FDIC in 2013
BOLI Bank owned life insurance
CARES ActCoronavirus Aid, Relief, and Economic Security Act of 2020
CDI Core Deposit Intangible
CECL Current Expected Credit Loss Model
CECL Adoption
Adoption 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 on January 1, 2020
CEOChief Executive Officer
CFOChief Financial Officer
Company Heritage Financial Corporation
GAAPCOVID-19 U.S. Generally Accepted Accounting Principles
HeritageHeritage Financial CorporationCoronavirus Disease of 2019 pandemic
FASB Financial Accounting Standards Board
FDIC Federal Deposit Insurance Corporation
Federal ReserveBoard of Governors of the Federal Reserve System
Federal Reserve BankFederal Reserve Bank of San Francisco
FHLB Federal Home Loan Bank of Des Moines
GAAPU.S. Generally Accepted Accounting Principles
GDPU.S. Gross Domestic Product
HeritageHeritage Financial Corporation
LIBOR London Interbank Offering Rate
OAEMOther Assets Especially Mentioned
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
Premier MergerPCD MergerPurchased Credit Deteriorated; loans purchased with Premier Commercial Bancorp & Premier Community Bank completed July 2, 2018evidence 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
Puget Sound MergerPPP Merger with Puget Sound Bancorp, Inc. & Puget Sound Bank completed January 16, 2018Paycheck Protection Program
Premier and Puget MergersPPPLF Premier Merger and Puget Sound Mergers, collectively
ROURight-of-UsePaycheck Protection Program Liquidity Facility
SBA Small Business Administration
SEC Securities and Exchange Commission
TDR Troubled Debt Restructured
Unfunded CommitmentsOff-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments
Washington Banking MergerMerger with Washington Banking Company & Whidbey Island Bank completed on May 1, 2014




FORWARD LOOKING STATEMENTS:
This Quarterly Report on Form 10-Q 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 but not limited to: customer
the effect of the COVID-19 pandemic, including on our credit quality and employee retention, which might be greater than expected; business operations, as well as its impact on general economic and financial market conditions including economic activity, employment levels and market liquidity;
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 lossesACL on loans and provision for loancredit losses on loans that may be effected by deterioration in the housing and commercial real estate markets, which may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our allowance for loan lossesACL on loans no longer being adequate to cover actual losses, and require us to increase our allowance for loan losses; credit losses 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 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 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 and
implementing regulations, changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules as a result of Basel III; rules;
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;
difficulties in reducing risk associated with the loans on our Condensed Consolidated Statements of Financial Condition;
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;
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



other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services, including from the COVID-19 pandemic, and the other risks detailed from time to time in our filings with the Securities and Exchange CommissionSEC including our 20182019 Annual Form 10-K.
The Company cautions readers not to place undue reliance on any forward-looking 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 the Company. The Company does not undertake and specifically disclaims 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 the Company’s operating results and stock price performance.
As used throughout this report, the terms “we”, “our”, “us”, or the “Company” refer to Heritage Financial Corporation and its consolidated subsidiaries, unless the context otherwise requires.



PART I.     FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS

HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)
(In thousands, except shares)
 June 30, 2019 December 31, 2018 March 31, 2020 December 31, 2019
ASSETS        
Cash on hand and in banks $95,878

$92,704
 $105,097

$95,039
Interest earning deposits 43,412

69,206
 57,816

133,529
Cash and cash equivalents 139,290

161,910
 162,913

228,568
Investment securities available for sale, at fair value 960,680

976,095
Investment securities available for sale, at fair value, net (amortized cost of $937,828 and $939,160 at March 31, 2020 and December 31, 2019) 961,092

952,312
Loans held for sale 3,692
 1,555
 3,808
 5,533
Loans receivable 3,852,376
 3,767,879
Allowance for credit losses on loans (47,540) (36,171)
Loans receivable, net 3,718,283
 3,654,160
 3,804,836
 3,731,708
Allowance for loan losses (36,363) (35,042)
Total loans receivable, net 3,681,920
 3,619,118
Other real estate owned 1,224

1,983
 841

841
Premises and equipment, net 84,296

81,100
 87,958

87,888
Federal Home Loan Bank stock, at cost 10,005

6,076
 6,661

6,377
Bank owned life insurance 94,417
 93,612
 106,756
 103,616
Accrued interest receivable 15,401

15,403
 14,940

14,446
Prepaid expenses and other assets 126,259

98,522
 180,846

164,129
Other intangible assets, net 18,563

20,614
 15,710

16,613
Goodwill 240,939

240,939
 240,939

240,939
Total assets $5,376,686

$5,316,927
 $5,587,300

$5,552,970
LIABILITIES AND STOCKHOLDERS' EQUITY        
Deposits $4,347,708
 $4,432,402
 $4,617,948
 $4,582,676
Federal Home Loan Bank advances 90,700
 
Junior subordinated debentures 20,448
 20,302
 20,668
 20,595
Securities sold under agreement to repurchase 23,141
 31,487
 11,792
 20,169
Accrued expenses and other liabilities 98,064
 72,013
 138,454
 120,219
Total liabilities 4,580,061
 4,556,204
 4,788,862
 4,743,659
Stockholders’ equity:        
Preferred stock, no par value, 2,500,000 shares authorized; no shares issued and outstanding at June 30, 2019 and December 31, 2018 
 
Common stock, no par value, 50,000,000 shares authorized; 36,882,771 and 36,874,055 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively 591,703
 591,806
Preferred stock, no par value, 2,500,000 shares authorized; no shares issued and outstanding at March 31, 2020 and December 31, 2019 
 
Common stock, no par value, 50,000,000 shares authorized; 35,888,494 and 36,618,729 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively 568,439
 586,459
Retained earnings 195,168
 176,372
 211,707
 212,474
Accumulated other comprehensive income (loss), net 9,754
 (7,455)
Accumulated other comprehensive income, net 18,292
 10,378
Total stockholders’ equity 796,625
 760,723
 798,438
 809,311
Total liabilities and stockholders’ equity $5,376,686
 $5,316,927
 $5,587,300
 $5,552,970

See accompanying Notes to Condensed Consolidated Financial Statements.



HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In thousands, except per share amounts)
 Three Months Ended June 30, Six Months Ended June 30, Three Months Ended March 31,
 2019 2018 2019 2018 2020 2019
INTEREST INCOME            
Interest and fees on loans $48,107
 $41,141
 $94,806
 $79,300
 $46,277
 $46,699
Taxable interest on investment securities 5,933
 4,068
 11,756
 7,597
 5,639
 5,823
Nontaxable interest on investment securities 893
 1,220
 1,843
 2,561
 756
 950
Interest on other interest earning assets 283
 240
 618
 458
 420
 335
Total interest income 55,216
 46,669
 109,023
 89,916
 53,092
 53,807
INTEREST EXPENSE            
Deposits 4,017
 2,195
 7,620
 4,155
 4,216
 3,603
Junior subordinated debentures 340
 315
 694
 598
 285
 354
Other borrowings 323
 418
 385
 585
 34
 62
Total interest expense 4,680
 2,928
 8,699
 5,338
 4,535
 4,019
Net interest income 50,536
 43,741
 100,324
 84,578
 48,557
 49,788
Provision for loan losses 1,367
 1,750
 2,287
 2,902
Net interest income after provision for loan losses 49,169
 41,991
 98,037
 81,676
Provision for credit losses 7,946
 920
Net interest income after provision for credit losses 40,611
 48,868
NONINTEREST INCOME            
Service charges and other fees 4,845
 4,695
 9,330
 9,238
 4,376
 4,485
Gain on sale of investment securities, net 33
 18
 48
 53
 1,014
 15
Gain on sale of loans, net 368
 706
 620
 1,580
 547
 252
Interest rate swap fees 161
 309
 161
 360
 296
 
Other income 2,157
 1,847
 4,834
 3,892
 3,247
 2,677
Total noninterest income 7,564
 7,575
 14,993
 15,123
 9,480
 7,429
NONINTEREST EXPENSE            
Compensation and employee benefits 21,982
 19,321
 43,896
 40,688
 22,506
 21,914
Occupancy and equipment 5,451
 4,810
 10,909
 9,437
 5,731
 5,458
Data processing 2,109
 2,507
 4,282
 5,112
 2,360
 2,173
Marketing 1,106
 823
 2,204
 1,631
 866
 1,098
Professional services 1,305
 3,529
 2,478
 6,366
 1,377
 1,173
State/municipal business and use taxes 809
 716
 1,607
 1,404
 757
 798
Federal deposit insurance premium 426
 375
 711
 730
 
 285
Other real estate owned, net 289
 
 375
 
 25
 86
Amortization of intangible assets 1,026
 796
 2,051
 1,591
 903
 1,025
Other expense 3,044
 2,829
 5,559
 5,494
 2,735
 2,515
Total noninterest expense 37,547
 35,706
 74,072
 72,453
 37,260
 36,525
Income before income taxes 19,186
 13,860
 38,958
 24,346
 12,831
 19,772
Income tax expense 3,202
 2,003
 6,422
 3,402
 640
 3,220
Net income $15,984
 $11,857
 $32,536
 $20,944
 $12,191
 $16,552
Basic earnings per common share $0.43
 $0.35
 $0.88
 $0.62
 $0.34
 $0.45
Diluted earnings per common share $0.43
 $0.35
 $0.88
 $0.62
 $0.33
 $0.45
Dividends declared per common share $0.18
 $0.15
 $0.36
 $0.30
 $0.20
 $0.18
See accompanying Notes to Condensed Consolidated Financial Statements.



HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(In thousands)

  Three Months Ended June 30, Six Months Ended June 30,
  2019 2018 2019 2018
Net income $15,984
 $11,857
 $32,536
 $20,944
Change in fair value of investment securities available for sale, net of tax of $2,463, $(630), $4,608, and $(2,638), respectively 9,219
 (2,358) 17,247
 (9,874)
Reclassification adjustment for net gain from sale of investment securities available for sale included in income, net of tax of $(7), $(4), $(10), and $(12), respectively (26) (14) (38) (41)
Other comprehensive income (loss) 9,193
 (2,372) 17,209
 (9,915)
Comprehensive income $25,177
 $9,485
 $49,745
 $11,029
  Three Months Ended March 31,
  2020 2019
Net income $12,191
 $16,552
Change in fair value of investment securities available for sale, net of tax of $2,419 and $2,145, respectively 8,707
 8,028
Reclassification adjustment for net gain from sale of investment securities available for sale included in income, net of tax of $(221) and $(3), respectively (793) (12)
Other comprehensive income 7,914
 8,016
Comprehensive income $20,105
 $24,568
See accompanying Notes to Condensed Consolidated Financial Statements.




HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
(In thousands, except per share amounts)
 Three Months Ended June 30, 2019
 Number of
common
shares
 Common
stock
 Retained
earnings
 Accumulated
other
comprehensive income, net
 Total
stockholders’
equity
Balance at March 31, 201936,899
 $591,767
 $185,863
 $561
 $778,191
Restricted stock units vested, net of forfeitures of restricted stock awards13
 
 
 
 
Exercise of stock options1
 20
 
 
 20
Stock-based compensation expense
 795
 
 
 795
Common stock repurchased(30) (879) 
 
 (879)
Net income
 
 15,984
 
 15,984
Other comprehensive income, net of tax
 
 
 9,193
 9,193
Cash dividends declared on common stock ($0.18 per share)
 
 (6,679) 
 (6,679)
Balance at June 30, 201936,883
 $591,703
 $195,168
 $9,754
 $796,625

 Three Months Ended March 31, 2020
 Number of
common
shares
 Common
stock
 Retained
earnings
 Accumulated
other
comprehensive income, net
 Total
stockholders’
equity
Balance at December 31, 201936,619
 $586,459
 $212,474
 $10,378
 $809,311
Cumulative effect from change in accounting policy (1)

 
 (5,615) 
 (5,615)
Restricted stock units vested, net of forfeitures, of restricted stock awards87
 
 
 
 
Exercise of stock options5
 71
 
 
 71
Stock-based compensation expense
 969
 
 
 969
Common stock repurchased(822) (19,060) 
 
 (19,060)
Net income
 
 12,191
 
 12,191
Other comprehensive income, net of tax
 
 
 7,914
 7,914
Cash dividends declared on common stock ($0.20 per share)

 
 (7,343) 
 (7,343)
Balance at March 31, 202035,889
 $568,439
 $211,707
 $18,292
 $798,438
 Six Months Ended June 30, 2019
 
Number of
common
shares
 
Common
stock
 
Retained
earnings
 
Accumulated
other
comprehensive (loss) income, net
 Total
stockholders’
equity
Balance at December 31, 201836,874
 $591,806
 $176,372
 $(7,455) $760,723
Restricted stock units vested, net of forfeitures of restricted stock awards62
 
 
 
 
Exercise of stock options3
 42
 
 
 42
Stock-based compensation expense
 1,536
 
 
 1,536
Common stock repurchased(56) (1,681) 
 
 (1,681)
Net income
 
 32,536
 
 32,536
Other comprehensive income, net of tax
 
 
 17,209
 17,209
Cash dividends declared on common stock ($0.36 per share)
 
 (13,341) 
 (13,341)
Effects of implementation of accounting change related to operating leases
 
 (399) 
 (399)
Balance at June 30, 201936,883
 $591,703
 $195,168
 $9,754
 $796,625



Three Months Ended June 30, 2018         
Number of
common
shares
 Common
stock
 Retained
earnings
 Accumulated
other
comprehensive loss, net
 Total
stockholders’
equity
Three Months Ended March 31, 2019
Balance at March 31, 201834,018
 $490,566
 $153,076
 $(8,934) $634,708
Number of
common
shares
 Common
stock
 Retained
earnings
 Accumulated
other
comprehensive (loss) income, net
 Total
stockholders’
equity
Balance at December 31, 201836,874
 $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 awards8
 
 
 
 
49
 
 
 
 
Exercise of stock options2
 26
 
 
 26
2
 22
 
 
 22
Stock-based compensation expense
 684
 
 
 684

 741
 
 
 741
Common stock repurchased(7) (250) 
 
 (250)(26) (802) 
 
 (802)
Net income
 
 11,857
 
 11,857

 
 16,552
 
 16,552
Other comprehensive loss, net of tax
 
 
 (2,372) (2,372)
Cash dividends declared on common stock ($0.15 per share)
 
 (5,130) 
 (5,130)
Balance at June 30, 201834,021
 $491,026
 $159,803
 $(11,306) $639,523
Other comprehensive income, net of tax
 
 
 8,016
 8,016
Cash dividends declared on common stock ($0.18 per share)
 
 (6,662) 
 (6,662)
Balance at March 31, 201936,899
 $591,767
 $185,863
 $561
 $778,191
(1) Effective January 1, 2020, Company adopted ASU 2016-13, Financial Instruments - Credit Losses. Effective January 1, 2019, the Company adopted ASU 2016-02, Leases.

 Six Months Ended June 30, 2018
 Number of
common
shares
 Common
stock
 Retained
earnings
 Accumulated
other
comprehensive loss, net
 Total
stockholders’
equity
Balance at December 31, 201729,928
 $360,590
 $149,013
 $(1,298) $508,305
Restricted stock units vested, net of forfeitures of restricted stock awards30
 
 
 
 
Exercise of stock options3
 47
 
 
 47
Stock-based compensation expense
 1,307
 
 
 1,307
Common stock repurchased(52) (1,688) 
 
 (1,688)
Net income
 
 20,944
 
 20,944
Other comprehensive loss, net of tax
 
 
 (9,915) (9,915)
Common stock issued in business combination4,112
 130,770
 
 
 130,770
Cash dividends declared on common stock ($0.30 per share)
 
 (10,247) 
 (10,247)
Effects of implementation of accounting change related to equity investments, net
 
 93
 (93) 
Balance at June 30, 201834,021
 $491,026
 $159,803
 $(11,306) $639,523
See accompanying Notes to Condensed Consolidated Financial Statements.




HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
 Six Months Ended June 30, Three Months Ended
March 31,
 2019 2018 2020 2019
Cash flows from operating activities:        
Net income $32,536
 $20,944
 $12,191
 $16,552
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 4,255
 5,140
 2,095
 2,234
Changes in net deferred loan costs, net of amortization 829
 (254) (239) 276
Provision for loan losses 2,287
 2,902
Provision for credit losses 7,946
 920
Net change in accrued interest receivable, prepaid expenses and other assets, and accrued expenses and other liabilities (3,645) 419
 (7,581) 1,345
Stock-based compensation expense 1,536
 1,307
 969
 741
Amortization of intangible assets 2,051
 1,591
 903
 1,025
Origination of loans held for sale (20,328) (40,048)
Proceeds from sale of loans 18,811
 39,962
Origination of mortgage loans held for sale (16,026) (8,607)
Proceeds from sale of mortgage loans held for sale 18,298
 7,458
Earnings on bank owned life insurance (1,014) (666) (885) (487)
Valuation adjustment on other real estate owned 51
 
Loss on sale of other real estate owned 279
 
Loss on sale of other real estate owned, net 4
 
Gain on sale of loans, net (620) (1,580) (547) (252)
Gain on sale of investment securities, net (48) (53) (1,014) (15)
Impairment of assets held for sale 
 75
Impairment of right of use asset 117
 
Gain on sale of premises and equipment, net (10) 
Gain on sale of assets held for sale (9) 
Impairment for right of use asset 
 117
(Gain) loss on sale of premises and equipment, net (9) 5
Net cash provided by operating activities 37,087
 29,739
 16,096
 21,312
Cash flows from investing activities:        
Loans originated, net of principal payments (65,972) (96,127) (86,596) (42,357)
Maturities, calls and payments of investment securities available for sale 105,400
 41,436
 74,320
 47,004
Purchase of investment securities available for sale (104,324) (147,360) (90,517) (57,606)
Proceeds from sales of investment securities available for sale 34,479
 107,579
 25,177
 10,932
Purchase of premises and equipment (6,374) (16,659) (1,423) (1,030)
Proceeds from sales of other loans 54
 4,532
Proceeds from sales of other real estate owned 429
 
 266
 79
Proceeds from sales of assets held for sale 394
 
Proceeds from redemption of Federal Home Loan Bank stock 12,684
 22,138
 760
 2,276
Purchases of Federal Home Loan Bank stock (16,613) (21,784) (1,044) (3,577)
Proceeds from sales of premises and equipment 31
 21
 9
 
Purchase of bank owned life insurance (3,579) 
Proceeds from bank owned life insurance death benefit 1,324
 
Capital contributions to low-income housing tax credit partnerships and new market tax credit partnerships, net (2,242) (8,169) (1,434) (80)
Net cash received from acquisitions 
 80,133
Net cash used in investing activities (42,448) (34,260) (82,343) (44,359)
Cash flows from financing activities:        
Net (decrease) increase in deposits (84,694) 69,990
Net increase (decrease) in deposits 35,272
 (38,687)
Federal Home Loan Bank advances 402,800
 536,450
 19,000
 76,900
Repayments of Federal Home Loan Bank advances (312,100) (553,450)
Repayment of Federal Home Loan Bank advances (19,000) (51,900)
Common stock cash dividends paid (13,280) (10,247) (7,314) (6,662)
Net decrease in securities sold under agreement to repurchase (8,346) (9,653) (8,377) (6,564)
Proceeds from exercise of stock options 42
 47
 71
 22
Repurchase of common stock (1,681) (1,688) (19,060) (802)
Net cash (used in) provided by financing activities (17,259) 31,449
Net cash provided by (used in) financing activities 592
 (27,693)




  Six Months Ended June 30,
  2019 2018
Net (decrease) increase in cash and cash equivalents (22,620) 26,928
Cash and cash equivalents at beginning of period 161,910
 103,015
Cash and cash equivalents at end of period $139,290
 $129,943
     
Supplemental disclosures of cash flow information:    
Cash paid for interest $8,535
 $5,156
Cash paid for income taxes 5,545
 2,724
     
Supplemental non-cash disclosures of cash flow information:    
Transfers of loans receivable to other real estate owned $
 $434
Transfers of properties held for sale recorded in premises and equipment, net to prepaid expenses and other assets 763
 221
Transfer of BOLI to prepaid expenses and other assets 209
 
     Business Combinations:    
Common stock issued for business combinations 
 130,770
Assets acquired (liabilities assumed) in acquisitions:    
Investment securities available for sale 
 80,353
Loans receivable 
 388,462
Premises and equipment 
 732
Federal Home Loan Bank stock 
 623
Accrued interest receivable 
 1,448
Bank owned life insurance 
 6,264
Prepaid expenses and other assets 
 1,354
Other intangible assets 
 11,270
Deposits 
 (505,885)
Accrued expenses and other liabilities 
 (2,504)
  Three Months Ended
March 31,
  2020 2019
Net decrease in cash and cash equivalents (65,655) (50,740)
Cash and cash equivalents at beginning of period 228,568
 161,910
Cash and cash equivalents at end of period $162,913
 $111,170
     
Supplemental disclosures of cash flow information:    
Cash paid for interest $4,507
 $3,801
Cash paid for income taxes, net of refunds 58
 
     
Supplemental non-cash disclosures of cash flow information:    
Transfers of loans receivable to other real estate owned $270
 $
Transfers of properties held for sale recorded in premises and equipment, net to prepaid expenses and other assets 
 763
Purchase of investment securities available for sale not settled 7,303
 
Cumulative effect from change in accounting policy (1)
 7,175
 29,754
Impact of new or modified leases 591
 335
(1) Effective January 1, 2020, Company adopted ASU 2016-13, Financial Instruments - Credit Losses. Effective January 1, 2019, the Company adopted ASU 2016-02, Leases.

See accompanying Notes to Condensed Consolidated Financial Statements.



HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(1)Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements
(a) Description of Business
Heritage Financial Corporation 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, theHeritage Bank. The Bank is a Washington-chartered commercial bank and its deposits are insured by the FDIC. The Bank is headquartered in Olympia, Washington and conducts business from its 62 branch offices as of June 30, 2019March 31, 2020 located throughout Washington State and the greater Portland, Oregon area. The Bank’s business consists primarily of commercial lending and deposit relationships with small 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.
Effective January 16, 2018, the Company completed the Puget Sound Merger and on July 2, 2018, the Company completed the Premier Merger. See Note (2) Business Combinations for additional information on the Premier and Puget Mergers.

(b) Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with GAAP for interim financial information and pursuant to the rules and regulations of the SEC. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. It is recommended that these unaudited Condensed Consolidated Financial Statements and accompanying Notes be read with the audited Consolidated Financial Statements and the accompanying Notes included in the 20182019 Annual Form 10-K. In management's opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2019March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. In preparing2020.
To prepare unaudited Condensed Consolidated Financial Statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. It is reasonably possible management's estimate of ACL on loans and the fair value of financial instruments could change from $47.5 million and the amounts disclosed in Note (13) Fair Value Measurements, respectively. The resulting change in these estimates would be material to the unaudited Condensed Consolidated Financial Statements, management is requiredStatements.
Certain prior year amounts have been reclassified to make estimates and assumptions that affectconform to the reported amounts of assets, liabilities, revenues, expenses and related disclosures. Management believes that the judgments, estimates and assumptions usedcurrent year’s presentation. Namely, loan receivable balances in the preparationdisclosures of Note (3) Loans Receivable and Note (4) Allowance for Credit Losses on Loans have been reclassified to conform to the financial statements are appropriate basedcurrent period presentation, which is net of deferred fees and costs. Reclassifications had no effect on the facts and circumstances at the time. Actual results, however, could differ significantly from those estimates.prior years' net income or stockholders’ equity.

(c) Significant Accounting Policies
The significant accounting policies used in preparation of the Company's Condensed Consolidated Financial Statements are disclosed in the 20182019 Annual Form 10-K. ThereOther than the adoption of new accounting standard discussed below, there have not been any material changes in the Company's significant accounting policies from those contained in the 20182019 Annual Form 10-K, except10-K.
Adoption of New Accounting Standard
On January 1, 2020, the Company adopted 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. The measurement of expected credit losses 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, the CECL Adoption made changes to the accounting for investment securities available for sale.
The Company adopted ASU 2016-13 using the modified retrospective method for all financial assets measured at amortized cost and unfunded commitments. The Company elected not to measure an ACL on accrued interest receivable on loans receivable or accrued interest receivable on investment securities available for sale as Company policy is to reverse interest income for uncollectible accrued interest receivable balances in a timely manner.



Results for the accounting policy relating to operating leases adoptedreporting period beginning after January 1, 2020 are presented under ASU 2016-13, while prior period amounts were not restated and continue to be reported in accordance with previously applicable GAAP. The accounting policies for prior periods are included in the 2019 Form 10-K.
The accounting policies for all financial instruments impacted by the CECL adoption are as discussed below.follows:
Operating leases
DuringInvestment Securities
A debt security is placed on nonaccrual status at the normal course of business,time any principal or payments become more than 90 days delinquent. Interest accrued, but not received for a security placed on nonaccrual, is reversed against interest income during the period that the debt security is placed on nonaccrual status.
Allowance for Credit Losses on Investment Securities
Management evaluates the need for an ACL on investment securities on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For investment securities available for sale in an unrealized loss position, the Company enters into agreements,first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before the recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through 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 it determines ifadverse conditions specifically related to the security, among other 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. If the present value of cash flows expected to be collected is less than the amortized cost basis, a particular agreementcredit loss exists and an ACL on investment securities available for sale is a lease at inception. The Company's noncancelable operating lease agreements relate to certain banking offices, back-office operational facilities, office equipment, and sublease agreements. The agreementsrecorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any decline in fair value that has not been recorded through an ACL on investment securities for sale is recognized in other comprehensive income.
Changes in the ACL on investment securities available for sale are recorded as ROU assetsprovision (reversal of provision) for credit losses expense. Losses are charged against the allowance 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.
Accrued interest receivable on investment securities available for sale is excluded from the estimate of credit losses as interest accrued, but not received, is reversed timely in accordance with the policy for investment securities above.
Loans Receivable
Loans receivable include loans originated and liabilities withinindirect loans purchased by the Bank as well as loans acquired in business combinations.    
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost. Amortized cost is the outstanding principal balance, net of purchased premiums and discounts, unearned discounts, and net deferred loan origination fees and costs. Accrued interest receivable for loans receivable is reported in prepaid expenses and other assets and accrued expenses and other liabilities, respectively, inon the Condensed Consolidated Statements of Financial Condition. Operating lease ROU
Purchased Loans:
Loans acquired in a business combination are designated as “purchased” loans. Upon adoption of ASU 2016-13, the Bank's PCI loans were transitioned to PCD loans. The Bank elected to account for the PCD loans individually, terminating the pools of loans that were previously accounted for under ASC 310-30.
Loans purchased after January 1, 2020 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 is recorded to provision for credit losses expense. For PCD loans, the initial ACL is incorporated into the calculation of the fair value of net assets acquired on the merger date and lease liabilitiesthe 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 Condensed Consolidated Statements of Income over the life



of the loan using the effective 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 provision for credit losses expense.
Troubled Debt Restructures:
The CARES Act provided guidance around the modification of loans as a result of the COVID-19 pandemic, which 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 prior to any relief, are not TDRs. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act if they are less than 30 days past due on their contractual payments at the commencement datetime a modification program is implemented.
Allowance for Credit Losses on Loans
The ACL on loans is a valuation account that is deducted from the amortized cost of loans receivable to present the net amount expected to be collected. Loans are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged off. Subsequent recoveries, if any, are credited to the allowance. The Bank record the changes in the ACL through earnings, as a provision for credit losses on the Condensed Consolidated Statements of Income.
Accrued interest receivable on loans receivable is excluded from the estimate of credit losses. Instead, interest accrued, but not received, is reversed timely in accordance with the policy for loans receivable above.
Management has adopted a historic loss, open pool CECL methodology to calculate the ACL on loans. The same methodology is applied to all loans consistent with the guidance of the accounting standard which does not require undue complexity. Under this allowance approach, the Company has identified segments of loans with similar risk characteristics that align with its identified loan classes. Nonaccrual loans are not considered similar to other loans; therefore, they are evaluated for allowance on an individual basis. The allowance for individually evaluated loans is calculated 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 net present value method, which considers the contractual principal and interest terms and estimated cash flows available from the borrower to satisfy the debt. When the net present value method is used, management adjusts the effective interest rate used to discount expected cash flows to incorporate expected prepayments.
The ACL on a TDR loan is measured using the same method as all other loans, except that the original interest rate is used to discount the expected cash flows, not the rate specified in the restructuring. Nonperforming TDR loans, including defaulted TDR loans, are evaluated for allowance on an individual basis. A performing TDR loan is evaluated for allowance on a collective basis with loans with similar risk characteristics if a) it is classified as a risk rating of "Pass", b) it has paid a minimum of six months of principal and interest in accordance with the restructured terms and c) it has not been over 30 days delinquent in the most recent six month period. If all three criteria on a performing TDR loan are not met, the loan is evaluated for allowance on an individual basis as it is not deemed to have similar characteristics of other loans in the portfolio.
For each loan segment collectively measured, the baseline loss rates are calculated using the bank's average quarterly historical loss information. 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 present valueamortized cost, as adjusted for balances guaranteed by governmental entities, such as SBA or USDA, or the unguaranteed amortized cost. The contractual term excludes expected extensions, renewals, and modifications unless either of lease paymentsthe 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 segments, which management believes is an accurate representation of future prepayment activity. Management reviews the adequacy of the prepayment period assumption on a quarterly basis.



The CECL methodology includes consideration of the forecasted direction of the economic and business environment and its likely impact to the estimated allowance as compared to the historical losses over the lease term,reasonable and represent the right to use an underlying assetsupportable time frame. Economic forecast models for the lease termcurrent period are uploaded to the model, which targets 16 forecasted macroeconomic factors, such as unemployment rate, GDP, housing price index, commercial real estate price index, disposable income growth, mortgage rates, and certain rate indices. Each of the obligationforecasted segments 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.
The 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 make lease payments arising from the lease. Aslong-term average actual losses of the Company's leases do not provide an implicit rate,dataset. The impact of those macroeconomic factors to each segment, positive or negative, using the Company usesreasonable and supportable period, are added to the calculated baseline loss rate. After the reasonable and supportable period, the estimated credit losses are reverted back to historical baseline loss levels under a reversion period on a straight-lined, input reversion basis.
The Bank also considers other qualitative risk factors to adjust the estimated ACL calculated by the above mentioned model. The Bank will have a bias for minimal factors unless internal or external factors outside those considered in its incremental borrowing ratehistorical losses or macroeconomic forecast indicate otherwise. The Bank will establish metrics to estimate the qualitative risk factor 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 allowance for loan losses evaluation 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 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 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 commencement datetime of their examinations. The Company believes the ACL on loans is appropriate given all of the above considerations.
Allowance for Credit Losses on Unfunded Commitments
The Bank estimates expected credit losses on unfunded, off-balance sheet commitments over the contractual period in determiningwhich the present value of lease payments. The operating lease ROU asset also includes any lease pre-payments made and excludes lease incentives. The Company's lease terms may include optionsBank is exposed to credit risk from a contractual obligation to extend or terminatecredit, unless the lease whenobligation is unconditionally cancellable by the Company. The Bank has determined that no allowance is necessary for its credit card portfolio as it has the ability to unconditionally cancel the available lines of credit.
The allowance methodology is reasonably certain thatsimilar to the Company will exercise that option. Lease expenseACL on loans, but additionally includes an estimate of the future utilization of the commitment as determined by historical commitment utilizations and the Bank's estimates of future utilizations given current economic forecasts. The credit risks associated with the unfunded commitments are consistent with the risks outlined for lease paymentseach loan class.
The allowance is recognized on a straight-line basis over the lease term.


The Company elected an exclusion policy for ROU assets and liabilities for operating leases with a term of twelve months or less and a capitalization threshold policy for total contractual lease payments of $25,000 or more. The Company does not account for any leases at a portfolio level.

(d) Recently Issued Accounting Pronouncements
FASB ASU 2016-02Leases (Topic 842), as amended by ASU 2017-13, 2018-01, 2018-10, ASU 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 ASU sets out the principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. The Company adopted the ASU on January 1, 2019 and elected the package of practical expedients permitted under the transition guidance within the new standard, which allowed us to carry forward the historical determination of contracts as leases, lease classification and not reassess initial direct costs for historical lease arrangements. The adoption of this ASU resulted in the recognition of operating lease ROU assets and liabilities of approximately $29.2 million and $29.8 million, respectively, in prepaid expenses and other assets and accrued expenses and other liabilities inon the Condensed Consolidated Statements of Financial Condition. This change also resultedCondition and is adjusted as a provision (reversal of provision) for credit losses on the Condensed Consolidated Statements of Income.
Provision for Credit Losses
The provision for credit losses as presented in a cumulative-effect adjustment to beginning retained earningsthe Company's Condensed Consolidated Statements of $399,000, net of tax, underIncome includes the modified retrospective approach. As a result of electing this transition method, prior periods have not been restated.provision for credit losses on loans and the provision for credit losses on unfunded commitments.
(d) Recently Issued Accounting Pronouncements
FASB ASU 2016-13Financial Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended by ASU 2018-19, ASU 2019-04, and ASU 2019-05, ASU 2019-10, ASU 2019-11, and 2020-02, was originally issued in June 2016. Commonly referred to as CECL, thisThis ASU requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected. For public business entities, this ASU is 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. The Company is anticipating adoptingadopted the Update on January 1, 2020 as discussed in the Significant Accounting Policies section above. The adoption had the following impacts:
Investment Securities
As of December 31, 2019, the Company 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 adoption 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 allowance for credit losses on investment securities available for sale was recorded upon adoption. See Note (2) Investment Securities for more information.
Loan Receivable
ASU 2016-13 was applied prospectively and replaced the allowance for loan losses with the ACL on loans on the Condensed Consolidated Statements of Financial Condition and replaced the related provision for loan losses with the provision for credit losses on loans as presented on the Condensed Consolidated Statements of Income, net of provision for credit losses on unfunded commitments.
The adoption was completed in a specific order beginning with the transition of PCI loans to PCD loans. The Bank elected to account for the PCD loans individually, terminating the pools of loans that were previously accounted for under ASC 310-30. First, an ACL was determined for each PCI loan. The ACL on PCI loans was added to the loans' carrying amount to establish a PCD loan at its amortized cost basis. The difference between the unpaid principal balance and the amortized cost basis of the PCD loan is a noncredit premium or discount, which will be 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 ASC 310-30 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 at January 1, 2020 based on its CECL methodology as part of the cumulative-effect adjustment to beginning retained earnings. The pretax increase to the ACL 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 a $1.8 million increase in the ACL on loans 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. At March 31, 2020, the ACL on loans as a percentage of loans receivable was 1.23%.
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. The total net discount for purchased loans was $9.0 million at March 31, 2020. The Company accretes the nonaccretable principal differencesnet discount or premium on PCI loans; however,purchased loans to interest and fees on loans using the Company is stilleffective interest method.
See Note (3) Loans Receivable and Note (4) Allowance for Credit Losses on Loans for more information.
Unfunded Commitments
ASU 2016-13 was applied prospectively and replaced the reserve for unfunded commitments with the ACL on unfunded commitments as included in the process of determining the magnitude of the increaseaccrued liabilities and its impactother expenses on the Condensed Consolidated Statements of Financial Statements. In addition,Condition and replaced the current accounting policy and proceduresprovision 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 develop and implement processes and procedures to ensure it is fully compliantunfunded commitments with the amendments atprovision for credit losses on unfunded commitments as presented on the Condensed Consolidated Statements of Income, net of provision for credit losses on loans. Upon adoption, date. During 2018, the CECL steering committee selectedBank recorded a vendor to assist the Companypretax increase in the beginning ACL on unfunded commitments of $3.7 million. See Note (15) Commitments and Contingencies for more information.



Overall CECL Impact
The adoption completedof ASU 2016-13, including the implementation discovery sessions,above mentioned increase to the ACL on loans of $3.4 million and selected appropriate methodologies. During 2019, the CECL steering committee compiled historical loan data and isincrease to the ACL on unfunded commitments of $3.7 million, resulted in the processa pretax cumulative-effect adjustment of finalizing qualitative factors.$7.1 million. The Company anticipates running parallel existing ALLL and CECL models using second quarter 2019 data.impact of this adjustment to beginning retained earnings on January 1, 2020 was $5.6 million, net of tax.

FASB ASU 2017-04Goodwill (Topic 350), was issued in January 2017 and eliminates Step 2 from the goodwill impairment test. The ASU is effective for annual periods or any interim goodwill impairment tests beginning after December 15, 2019 using a prospective transition method and early adoption is permitted. The Company doesadopted the guidance on January 1, 2020. The adoption did not expect the ASU will have a material impact on its Condensed Consolidated Financial Statements.Statements as of or for the three month ended March 31, 2020 as the Company's qualitative assessment indicated no goodwill impairment.
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 ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company doesadopted the guidance on January 1, 2020. The adoption did not expecthave a material impact to Note (13) Fair Value Measurements in its Condensed Consolidated Financial Statements.
FASB ASU 2020-03, Codification Improvements to Financial Instruments was issued in March 2020 and revised a wide variety of topics in the ASU willCodification with the intent to make the Codification easier to understand and apply by eliminating inconsistencies and providing clarifications. The Update was effective immediately upon its release and did not have a material impact on itsthe Company's Condensed Consolidated Financial Statements.
FASB ASU 2020-04, Reference Rate Reform (Topic 848) was issued in March 2020 and provides optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition away from LIBOR toward new interest rate benchmarks. For transactions that are modified because of reference rate reform and that meet certain scope guidance (i) modifications of loan agreements should be accounted for by prospectively adjusting the effective interest rate and the modification will be considered "minor" so that any existing unamortized origination fees/costs would carry forward and continue to be amortized and (ii) modifications of lease agreements should be accounted for as a continuation of the existing agreement with no reassessments of the lease classification and the discount rate or remeasurements of lease payments that otherwise would be required for modifications not accounted for as separate contracts. The Update also provides numerous optional expedients for derivative accounting. The Update is effective March 12, 2020 through December 31, 2022. An entity may elect to apply the Update for contract modifications as of January 1, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. Once elected for a Topic or an Industry Subtopic within the Codification, the amendments in this Update must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic. The Company anticipates this Update will simplify any modifications we execute between the selected start date (yet to be determined) and December 31, 2022 that are directly related to LIBOR transition by allowing prospective recognition of the continuation of the contract, rather than extinguishment of the old contract resulting in writing off unamortized fees/costs. The Company is evaluating the impacts of this Update and have not yet determined whether LIBOR transition and this Update will have material effects on our business operations and Condensed Consolidated Financial Statements.




(2)Business Combinations
There were no acquisitions or mergers completed during the three and six months ended June 30, 2019.
Puget Sound Merger:
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. The Puget Sound Merger resulted in $68.5 million of goodwill.


The Company incurred no acquisition-related costs for the Puget Sound Merger during the three months ended June 30, 2019 and $75,000 during the six months ended June 30, 2019. The Company incurred acquisition-related costs of approximately $551,000 and $5.0 million during the three and six months ended June 30, 2018, respectively, for the Puget Sound Merger.
Premier Merger:
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. The Premier Merger resulted in $53.4 million of goodwill.
The Company incurred no acquisition-related costs for the Premier Merger during the three months ended June 30, 2019 and $57,000 during the six months ended June 30, 2019. The Company incurred acquisition-related costs of approximately $319,000 and $636,000 during the three and six months ended June 30, 2018, respectively, for the Premier Merger.
The Company finalized the purchase price allocation for both mergers as of December 31, 2018.

(3)Investment Securities
(a) Securities by Type and Maturity
The following tables present the amortized cost gross unrealized gains, gross unrealized losses and fair valuesvalue of investment securities available for sale at the dates indicated:indicated and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss):
June 30, 2019March 31, 2020
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
(In thousands)(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies$92,103
 $774
 $
 $92,877
$85,868
 $1,314
 $(120) $87,062
Municipal securities128,900
 3,848
 (7) 132,741
174,614
 5,409
 (415) 179,608
Mortgage-backed securities and collateralized mortgage obligations(1):
       
Mortgage-backed securities and collateralized mortgage obligations:       
Residential345,927
 2,918
 (1,163) 347,682
313,710
 9,204
 (230) 322,684
Commercial333,785
 6,033
 (740) 339,078
316,683
 10,348
 (1,275) 325,756
Corporate obligations23,852
 312
 (6) 24,158
23,897
 195
 (260) 23,832
Other asset-backed securities(1)23,752
 396
 (4) 24,144
23,056
 
 (906) 22,150
Total$948,319
 $14,281
 $(1,920) $960,680
$937,828
 $26,470
 $(3,206) $961,092

(1) 
Issued and guaranteed by U.S. Government-sponsored agencies.
December 31, 2018December 31, 2019
Amortized
Cost
 Gross
Unrealized
Gains
 Gross
Unrealized
Losses
 Fair
Value
Amortized
Cost
 Gross
Unrealized
Gains
 Gross
Unrealized
Losses
 Fair
Value
(In thousands)(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies$101,595
 $155
 $(147) $101,603
$104,709
 $598
 $(84) $105,223
Municipal securities158,461
 1,209
 (806) 158,864
128,183
 4,933
 (102) 133,014
Mortgage-backed securities and collateralized mortgage obligations(1):
       
Mortgage-backed securities and collateralized mortgage obligations:       
Residential337,295
 426
 (6,119) 331,602
336,929
 3,184
 (505) 339,608
Commercial338,250
 1,035
 (5,524) 333,761
322,169
 5,575
 (649) 327,095
Corporate obligations25,662
 36
 (135) 25,563
23,893
 316
 (15) 24,194
Other asset-backed securities(1)24,278
 424
 
 24,702
23,277
 54
 (153) 23,178
Total$985,541
 $3,285
 $(12,731) $976,095
$939,160
 $14,660
 $(1,508) $952,312
(1) 
Issued and guaranteed by U.S. Government-sponsored agencies.
There were no0 securities classified as trading or held to maturity at June 30, 2019March 31, 2020 or December 31, 20182019.

For the three months ended March 31, 2020, there was 0 provision for credit loss on investment securities available for sale recorded to net income. There was no ACL on investment securities at March 31, 2020.



The amortized cost and fair value of investment securities available for sale at June 30, 2019,March 31, 2020, 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.
Amortized Cost Fair ValueAmortized Cost Fair Value
(In thousands)(In thousands)
Due in one year or less$33,196
 $33,253
$33,547
 $33,806
Due after one year through five years182,529
 184,643
162,455
 166,232
Due after five years through ten years283,379
 288,386
255,123
 263,149
Due after ten years449,215
 454,398
486,703
 497,905
Total$948,319
 $960,680
$937,828
 $961,092

There were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity at March 31, 2020 and December 31, 2019.
(b) Unrealized Losses and Other-Than-Temporary Impairments
The following tables show the gross unrealized losses and fair value of the Company's investment securities available for sale, that arefor which an ACL 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 continuous unrealized loss positions as of June 30, 2019March 31, 2020 and December 31, 20182019:
June 30, 2019March 31, 2020
Less than 12 Months 12 Months or Longer TotalLess than 12 Months 12 Months or Longer Total
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
(In thousands)(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies$5,880
 $(120) $
 $
 $5,880
 $(120)
Municipal securities$
 $
 $4,029
 $(7) $4,029
 $(7)27,434
 (415) 
 
 27,434
 (415)
Mortgage-backed securities and collateralized mortgage obligations(1):
           
Mortgage-backed securities and collateralized mortgage obligations:           
Residential22,579
 (148) 106,539
 (1,015) 129,118
 (1,163)2,045
 (6) 27,992
 (224) 30,037
 (230)
Commercial23,481
 (175) 61,766
 (565) 85,247
 (740)32,562
 (683) 25,485
 (592) 58,047
 (1,275)
Corporate obligations
 
 1,994
 (6) 1,994
 (6)7,788
 (240) 1,980
 (20) 9,768
 (260)
Other asset-backed securities
 
 1,786
 (4) 1,786
 (4)
Other asset-backed securities (1)
20,644
 (848) 1,506
 (58) 22,150
 (906)
Total$46,060
 $(323) $176,114
 $(1,597) $222,174
 $(1,920)$96,353
 $(2,312) $56,963
 $(894) $153,316
 $(3,206)
(1) 
Issued and guaranteed by U.S. Government-sponsored agencies.




December 31, 2018December 31, 2019
Less than 12 Months 12 Months or Longer TotalLess than 12 Months 12 Months or Longer Total
Fair
Value
 Unrealized
Losses
 Fair
Value
 Unrealized
Losses
 Fair
Value
 Unrealized
Losses
Fair
Value
 Unrealized
Losses
 Fair
Value
 Unrealized
Losses
 Fair
Value
 Unrealized
Losses
(In thousands)(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies$46,992
 $(58) $7,350
 $(89) $54,342
 $(147)$45,999
 $(84) $
 $
 $45,999
 $(84)
Municipal securities31,157
 (159) 38,792
 (647) 69,949
 (806)13,761
 (102) 
 
 13,761
 (102)
Mortgage-backed securities and collateralized mortgage obligations(1):
           
Mortgage-backed securities and collateralized mortgage obligations:           
Residential66,620
 (247) 193,726
 (5,872) 260,346
 (6,119)14,272
 (66) 60,232
 (439) 74,504
 (505)
Commercial43,531
 (272) 190,585
 (5,252) 234,116
 (5,524)56,263
 (177) 43,623
 (472) 99,886
 (649)
Corporate obligations13,736
 (87) 1,951
 (48) 15,687
 (135)998
 (2) 1,987
 (13) 2,985
 (15)
Other asset-backed securities (1)
14,383
 (127) 1,609
 (26) 15,992
 (153)
Total$202,036
 $(823) $432,404
 $(11,908) $634,440
 $(12,731)$145,676
 $(558) $107,451
 $(950) $253,127
 $(1,508)

(1) 
Issued and guaranteed by U.S. Government-sponsored agencies.
The Company has evaluated these investment securities available for sale as of June 30, 2019March 31, 2020 and December 31, 20182019 and has determined that no ACL is necessary. Unrealized losses on investment securities have not been recognized into income because the issuers of bonds are investment grade (rated A- or higher), the securities carry governmental guarantees, management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery and the decline in theirfair value is not other-than-temporary. The unrealized losses are primarilylargely due to increaseschanges in market interest rates since purchase ofand other market conditions. The issuers continue to make timely principal and interest payments on the securities. Thebonds and the fair value of these securities is expected to recover as the securitiesbonds approach their maturity date. None of the underlying issuers of the municipal securities and corporate obligations had credit ratings that were below investment grade levels at June 30, 2019 or December 31, 2018. The Company has the ability and intent to hold the investments until recovery of the securities' amortized cost, which may be the maturity date of the securities.
For the three and six months ended June 30, 2019 and 2018, there were no other-than-temporary charges recorded to net income.maturity.

(c) Realized Gains and Losses
The following table presents the gross realized gains and losses on the sale of securities available for sale for the three and six months ended June 30, 2019March 31, 2020 and 2018:2019:
Three Months Ended June 30, Six Months Ended June 30,Three Months Ended March 31,
2019 2018 2019 20182020 2019
(In thousands)(In thousands)
Gross realized gains$187
 $18
 $276
 $122
$1,028
 $89
Gross realized losses(154) 
 (228) (69)(14) (74)
Net realized gains$33
 $18
 $48
 $53
$1,014
 $15






(d) 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 June 30, 2019March 31, 2020 and December 31, 20182019:
June 30, 2019 December 31, 2018March 31, 2020 December 31, 2019
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
(In thousands)(In thousands)
Washington and Oregon state public deposits$195,546
 $197,856
 $199,026
 $196,786
$179,570
 $184,231
 $187,700
 $190,773
Securities sold under agreement to repurchase36,335
 36,612
 48,173
 47,407
26,420
 26,473
 22,156
 22,294
Other securities pledged15,175
 15,490
 20,778
 20,482
21,164
 22,214
 19,333
 19,850
Total$247,056
 $249,958
 $267,977
 $264,675
$227,154
 $232,918
 $229,189
 $232,917


(e) Accrued Interest Receivable
Accrued interest receivable excluded from amortized cost on investment securities available for sale totaled $3.9 million and $3.7 million at March 31, 2020 and December 31, 2019, respectively. No amounts of accrued interest receivable were reversed against interest income on investment securities during the three months ended March 31, 2020 or 2019.

(4)(3)Loans Receivable
(a) Loan Origination/Risk Management
The Company 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 inamortized cost of loans receivable generally exclude accruedas it was deemed insignificant. Accrued interest receivable on loans totaled $11.1 million and net deferred fees or costs as they were deemed insignificant.
Loans acquired in a business combination are further classified as “purchased” loans. Loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected are accounted for under FASB ASC 310-30, Receivables—Loans$10.7 million at March 31, 2020 and Debt Securities Acquired with Deteriorated Credit Quality. These loans are identified as "PCI" loans. 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, and are referred to as "non-PCI" loans. There were no PCI loans acquired in the Premier and Puget Mergers.December 31, 2019, respectively.
The Company categorizes loans in one of the four4 segments of the total loan portfolio: commercial business, one-to-four family residential, real estate construction and land development and consumer. Within these segments are classes of loans for which management monitors and assesses credit risk in the loan portfolios. A detailed description of the portfolio segments and classes is contained in the 2019 Annual Form 10-K.
LoansThe Company adopted ASU 2016-13 effective January 1, 2020, which increased the beginning ACL on loans as discussed in Note (4) Allowance for Credit Losses on Loans.
The amortized cost of loans receivable, net of ACL at June 30, 2019March 31, 2020 and December 31, 20182019 consisted of the following portfolio segments and classes:
June 30, 2019 December 31, 2018March 31, 2020 December 31, 2019
(In thousands)(In thousands)
Commercial business:      
Commercial and industrial$845,046
 $853,606
$889,685
 $852,220
Owner-occupied commercial real estate772,499
 779,814
805,636
 805,234
Non-owner occupied commercial real estate1,333,047
 1,304,463
1,312,308
 1,288,779
Total commercial business2,950,592
 2,937,883
3,007,629
 2,946,233
One-to-four family residential117,425
 101,763
136,782
 131,660
Real estate construction and land development:      
One-to-four family residential111,319
 102,730
98,730
 104,296
Five or more family residential and commercial properties143,341
 112,730
188,304
 170,350
Total real estate construction and land development254,660
 215,460
287,034
 274,646
Consumer392,926
 395,545
420,931
 415,340
Gross loans receivable3,715,603
 3,650,651
Net deferred loan costs2,680
 3,509
Loans receivable3,852,376
 3,767,879
Allowance for credit losses on loans(47,540) (36,171)
Loans receivable, net3,718,283
 3,654,160
$3,804,836
 $3,731,708
Allowance for loan losses(36,363) (35,042)
Total loans receivable, net$3,681,920
 $3,619,118






(b) Concentrations of Credit
As of June 30, 2019,March 31, 2020, and December 31, 2018,2019, there were no0 concentrations of loans related to any single industry in excess of 10% of the Company’s total loans.
(c) Credit Quality Indicators
As part of the on-going monitoring of the credit quality of the Company’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 and (v) the general economic conditions of the United States of America and specifically the states of Washington and Oregon. The Company utilizes a risk grading matrix to assign a risk grade to each loan on a numerical scale of 1 to 10. Risk grades are aggregated to create the risk categories of "Pass" for grades 1 to 6, OAEM"Special Mention" ("SM") for grade 7, "Substandard" ("SS") for grade 8, "Doubtful" for grade 9 and "Loss" for grade 10. Descriptions of the general characteristics of the risk grades, including qualitative information on how the risk grades relate to the risk of loss, are contained in the 2019 Annual Form 10-K.
Numerical loan grades for loans are established at the origination of the loan. Changes to loan grades are considered at the time new information about the performance of a loan becomes available, including the receipt of updated financial information from the borrower, and scheduled loan reviews performed by the Bank’s internal Loan Review department. 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 following table presents the amortized cost of loans receivable by risk grade as of March 31, 2020:
 
Term Loans
Amortized Cost Basis by Origination Year
      
 2020 2019 2018 2017 2016 Prior Revolving Loans 
Revolving Loans Converted to Term Loans (1)
 Loans Receivable
 (In thousands)
As of March 31, 2020                
Commercial business:                 
Commercial and industrial                 
Pass$24,236
 $159,463
 $91,045
 $68,613
 $52,123
 $132,283
 $271,477
 $710
 $799,950
SM2,291
 3,479
 3,495
 436
 1,787
 1,805
 22,187
 42
 35,522
SS106
 9,482
 4,758
 8,578
 2,427
 13,712
 14,807
 343
 54,213
Total26,633
 172,424
 99,298
 77,627
 56,337
 147,800
 308,471
 1,095
 889,685
Owner-occupied properties                

Pass21,643
 144,743
 100,332
 98,228
 85,554
 314,552
 
 1,056
 766,108
SM107
 
 
 2,073
 1,897
 13,268
 
 
 17,345
SS
 
 117
 4,731
 2,010
 15,325
 
 
 22,183
Total21,750
 144,743
 100,449
 105,032
 89,461
 343,145
 
 1,056
 805,636
Non-owner-occupied properties                

Pass33,205
 157,063
 154,514
 203,143
 282,734
 466,239
 
 
 1,296,898
SM
 
 
 
 6,216
 2,846
 
 
 9,062
SS
 
 67
 
 
 6,281
 
 
 6,348
Total33,205
 157,063
 154,581
 203,143
 288,950
 475,366
 
 
 1,312,308
Total commercial business                




 
Term Loans
Amortized Cost Basis by Origination Year
      
 2020 2019 2018 2017 2016 Prior Revolving Loans 
Revolving Loans Converted to Term Loans (1)
 Loans Receivable
 (In thousands)
Pass79,084
 461,269
 345,891
 369,984
 420,411
 913,074
 271,477
 1,766
 2,862,956
SM2,398
 3,479
 3,495
 2,509
 9,900
 17,919
 22,187
 42
 61,929
SS106
 9,482
 4,942
 13,309
 4,437
 35,318
 14,807
 343
 82,744
Total81,588
 474,230
 354,328
 385,802
 434,748
 966,311
 308,471
 2,151
 3,007,629
One-to-four family residential                 
Pass9,097
 47,795
 22,506
 17,566
 11,664
 27,371
 
 
 135,999
SS
 
 
 63
 124
 596
 
 
 783
Total9,097
 47,795
 22,506
 17,629
 11,788
 27,967
 
 
 136,782
Real estate construction and land development:
                 
One-to-four family residential                 
Pass8,102
 73,501
 10,405
 2,433
 971
 1,802
 
 
 97,214
SS
 
 
 1,516
 
 
 
 
 1,516
Total8,102
 73,501
 10,405
 3,949
 971
 1,802
 
 
 98,730
Five or more family residential and commercial properties                 
Pass13,994
 97,928
 65,440
 6,978
 880
 2,592
 
 
 187,812
SM
 
 
 
 
 39
 
 
 39
SS
 
 
 
 
 453
 
 
 453
Total13,994
 97,928
 65,440
 6,978
 880
 3,084
 
 
 188,304
Total real estate and land development                 
Pass22,096
 171,429
 75,845
 9,411
 1,851
 4,394
 
 
 285,026
SM
 
 
 
 
 39
 
 
 39
SS
 
 
 1,516
 
 453
 
 
 1,969
Total22,096
 171,429
 75,845
 10,927
 1,851
 4,886
 
 
 287,034
Consumer                 
Pass27,777
 102,909
 74,043
 45,472
 22,957
 27,370
 116,302
 87
 416,917
SM
 
 
 
 
 
 
 
 
SS
 87
 492
 489
 554
 1,624
 766
 2
 4,014
Total27,777
 102,996
 74,535
 45,961
 23,511
 28,994
 117,068
 89
 420,931
Loans receivable                 
Pass138,054
 783,402
 518,285
 442,433
 456,883
 972,209
 387,779
 1,853
 3,700,898
SM2,398
 3,479
 3,495
 2,509
 9,900
 17,958
 22,187
 42
 61,968
SS106
 9,569
 5,434
 15,377
 5,115
 37,991
 15,573
 345
 89,510
Total$140,558
 $796,450
 $527,214
 $460,319
 $471,898
 $1,028,158
 $425,539
 $2,240
 $3,852,376
(1) Represents loans receivable balance at March 31, 2020 which was converted from a revolving loan to an amortizing loan during the three months ended March 31, 2020.



The following tables presenttable presents the balanceamortized cost of loans receivable by credit quality indicator as of June 30, 2019 and December 31, 2018:2019 in accordance with pre-CECL disclosure requirements:
 June 30, 2019
 Pass OAEM Substandard Doubtful/Loss Total
 (In thousands)
Commercial business:         
Commercial and industrial$761,961
 $28,344
 $54,741
 $
 $845,046
Owner-occupied commercial real estate731,749
 25,870
 14,880
 
 772,499
Non-owner occupied commercial real estate1,309,875
 9,936
 13,236
 
 1,333,047
Total commercial business2,803,585
 64,150
 82,857
 
 2,950,592
One-to-four family residential115,707
 
 1,718
 
 117,425
Real estate construction and land development:         
One-to-four family residential110,526
 
 793
 
 111,319
Five or more family residential and commercial properties142,824
 517
 
 
 143,341
Total real estate construction and land development253,350
 517
 793
 
 254,660
Consumer388,503
 
 3,899
 524
 392,926
Gross loans receivable$3,561,145
 $64,667
 $89,267
 $524
 $3,715,603


 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 estate741,227
 27,724
 10,863
 
 779,814
Non-owner occupied commercial real estate1,283,077
 9,438
 11,948
 
 1,304,463
Total commercial business2,812,699
 53,330
 71,854
 
 2,937,883
One-to-four family residential100,401
 
 1,362
 
 101,763
Real estate construction and land development:         
One-to-four family residential101,519
 258
 953
 
 102,730
Five or more family residential and commercial properties112,678
 52
 
 
 112,730
Total real estate construction and land development214,197
 310
 953
 
 215,460
Consumer390,808
 
 4,213
 524
 395,545
Gross loans receivable$3,518,105
 $53,640
 $78,382
 $524
 $3,650,651

 December 31, 2019
 Pass Special Mention Substandard Doubtful/Loss Total
 (In thousands)
Commercial business:         
Commercial and industrial$771,559
 $16,340
 $64,321
 $
 $852,220
Owner-occupied commercial real estate765,411
 24,659
 15,164
 
 805,234
Non-owner occupied commercial real estate1,274,513
 5,662
 8,604
 
 1,288,779
Total commercial business2,811,483
 46,661
 88,089
 
 2,946,233
One-to-four family residential130,818
 
 842
 
 131,660
Real estate construction and land development:         
One-to-four family residential101,973
 1,516
 807
 
 104,296
Five or more family residential and commercial properties169,668
 682
 
 
 170,350
Total real estate construction and land development271,641
 2,198
 807
 
 274,646
Consumer411,141
 
 3,675
 524
 415,340
Gross loans receivable$3,625,083
 $48,859
 $93,413
 $524
 $3,767,879
Potential problem loans are loans classified as OAEMSpecial Mention or worse that are currently accruing interestnot classified as a TDR or nonaccrual loan and are not considered impaired,individually evaluated for credit loss, 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 June 30, 2019March 31, 2020 and December 31, 20182019 were $114.1$102.2 million and $101.3$87.8 million, respectively.
(d) Nonaccrual Loans
NonaccrualThe following table presents the amortized cost of nonaccrual loans segregated by segments and classesfor the dates indicated:
 March 31, 2020 December 31, 2019
 Nonaccrual with No ACL Nonaccrual with ACL 
Total Nonaccrual (1) 
 
Nonaccrual (2)
 (In thousands)
Commercial business:       
Commercial and industrial$24,068
 $2,019
 $26,087
 $33,544
Owner-occupied commercial real estate3,103
 888
 3,991
 4,714
Non-owner occupied commercial real estate3,830
 
 3,830
 6,062
Total commercial business31,001
 2,907
 33,908
 44,320
One-to-four family residential19
 144
 163
 19
Consumer
 92
 92
 186
Total$31,020
 $3,143
 $34,163
 $44,525
(1) At March 31, 2020, nonaccrual loans includes $2.5 million of PCD loans, of which $565,000 were classified as nonaccrual congruent with CECL adoption. Prior to the adoption of CECL, nonaccrual loans excluded pooled PCI loans as the Company recognized interest income on each pool of PCI loans as each of the pools was performing.
(2) Presentation of December 31, 2019 balances is in accordance with pre-CECL disclosure requirements.



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 June 30, 2019 and December 31, 2018:previously classified nonaccrual loans during the following period:
 June 30, 2019 December 31, 2018
 (In thousands)
Commercial business:   
Commercial and industrial$11,133
 $6,639
Owner-occupied commercial real estate4,725
 4,212
Non-owner occupied commercial real estate2,429
 1,713
Total commercial business18,287
 12,564
One-to-four family residential19
 71
Real estate construction and land development:   
One-to-four family residential793
 899
Total real estate construction and land development793
 899
Consumer194
 169
Nonaccrual loans$19,293
 $13,703

PCI loans are not included
 For the Three Months Ended March 31, 2020
 Interest Income Reversed Interest Income Recognized
 (In thousands)
Commercial business:   
Commercial and industrial$(16) $219
Owner-occupied commercial real estate
 46
Non-owner occupied commercial real estate
 45
Total commercial business(16) 310
Consumer
 10
Total$(16) $320
For the three months ended March 31, 2020 and 2019, 0 interest income was recognized subsequent to a loan’s classification as nonaccrual, except as indicated in the nonaccrual loan table 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.

above.

(e) Past due loans
The Company 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. PCI loans are not included in the past due loans table below other than as a reconciling item.
The balancesamortized cost of past due loans segregated by segments and classes of loans, as of June 30, 2019 and DecemberMarch 31, 20182020 were as follows:
 June 30, 2019
 30-89 Days 
90 Days or
Greater
 
Total Past 
Due
 Current Total
 (In thousands)
Commercial business:         
Commercial and industrial$1,991
 $1,552
 $3,543
 $838,666
 $842,209
Owner-occupied commercial real estate646
 1,073
 1,719
 763,661
 765,380
Non-owner occupied commercial real estate286
 1,843
 2,129
 1,324,516
 1,326,645
Total commercial business2,923
 4,468
 7,391
 2,926,843
 2,934,234
One-to-four family residential475
 
 475
 113,733
 114,208
Real estate construction and land development:         
One-to-four family residential
 
 
 110,993
 110,993
Five or more family residential and commercial properties258
 
 258
 142,929
 143,187
Total real estate construction and land development258
 
 258
 253,922
 254,180
Consumer1,563
 
 1,563
 389,066
 390,629
Past due gross loans receivable, excluding PCI loans5,219
 4,468
 9,687
 3,683,564
 3,693,251
PCI loans647
 18
 665
 21,687
 22,352
Gross loans receivable$5,866
 $4,486
 $10,352
 $3,705,251
 $3,715,603


 March 31, 2020
 30-89 Days 
90 Days or
Greater
 
Total Past 
Due
 Current Total
 (In thousands)
Commercial business:         
Commercial and industrial$2,632
 $6,589
 $9,221
 $880,464
 $889,685
Owner-occupied commercial real estate353
 490
 843
 804,793
 805,636
Non-owner occupied commercial real estate1,620
 
 1,620
 1,310,688
 1,312,308
Total commercial business4,605
 7,079
 11,684
 2,995,945
 3,007,629
One-to-four family residential447
 19
 466
 136,316
 136,782
Real estate construction and land development:         
One-to-four family residential
 
 
 98,730
 98,730
Five or more family residential and commercial properties
 
 
 188,304
 188,304
Total real estate construction and land development
 
 
 287,034
 287,034
Consumer1,963
 
 1,963
 418,968
 420,931
Total$7,015
 $7,098
 $14,113
 $3,838,263
 $3,852,376



The following table presents the amortized cost of past due loans as of December 31, 2019 in accordance with pre-CECL disclosure requirements:
December 31, 2018December 31, 2019
30-89 Days 
90 Days or
Greater
 
Total Past 
Due
 Current Total30-89 Days 
90 Days or
Greater
 
Total Past 
Due
 Current Total PCI Loans Loan Receivable
(In thousands)(In thousands)
Commercial business:                      
Commercial and industrial$2,711
 $2,281
 $4,992
 $845,181
 $850,173
$10,479
 $6,772
 $17,251
 $832,601
 $849,852
 $2,368
 $852,220
Owner-occupied commercial real estate513
 408
 921
 771,677
 772,598
607
 806
 1,413
 798,907
 800,320
 4,914
 805,234
Non-owner occupied commercial real estate3,412
 1,103
 4,515
 1,292,888
 1,297,403
554
 1,843
 2,397
 1,280,891
 1,283,288
 5,491
 1,288,779
Total commercial business6,636
 3,792
 10,428
 2,909,746
 2,920,174
11,640
 9,421
 21,061
 2,912,399
 2,933,460
 12,773
 2,946,233
One-to-four family residential227
 
 227
 98,221
 98,448
797
 
 797
 127,288
 128,085
 3,575
 131,660
Real estate construction and land development:                      
One-to-four family residential665
 234
 899
 101,451
 102,350
1,516
 
 1,516
 102,780
 104,296
 
 104,296
Five or more family residential and commercial properties
 
 
 112,688
 112,688

 
 
 170,350
 170,350
 
 170,350
Total real estate construction and land development665
 234
 899
 214,139
 215,038
1,516
 
 1,516
 273,130
 274,646
 
 274,646
Consumer2,559
 
 2,559
 389,525
 392,084
2,071
 
 2,071
 411,507
 413,578
 1,762
 415,340
Past due gross loans receivable, excluding PCI loans10,087
 4,026
 14,113
 3,611,631
 3,625,744
PCI loans2,271
 550
 2,821
 22,086
 24,907
Gross loans receivable$12,358
 $4,576
 $16,934
 $3,633,717
 $3,650,651
Total$16,024
 $9,421
 $25,445
 $3,724,324
 $3,749,769
 $18,110
 $3,767,879

There were no0 loans 90 days or more past due that were still accruing interest as of June 30, 2019March 31, 2020 or December 31, 2018, excluding PCI loans.2019.




(f) ImpairedCollateral-dependent Loans
The types of collateral securing loans individually evaluated for ACL on loans, and for which the repayment was expected to be provided substantially through the operation or sale of the collateral as of March 31, 2020, were as follows:
 
Loans receivable(1) at March 31, 2020
 
Commercial
Real Estate
 Farmland Single Family Residence Equipment or Accounts Receivable Other Total
 (In thousands)
Commercial business:      
   
Commercial and industrial$2,063
 $19,350
 $1,445
 $2,232
 $311
 $25,401
Owner-occupied commercial real estate3,106
 
 
 
 
 3,106
Non-owner occupied commercial real estate5,794
 
 
 
 
 5,794
Total commercial business10,963
 19,350
 1,445
 2,232
 311
 34,301
One-to-four family residential
 
 19
 
 
 19
Real estate construction and land development:          

One-to-four family residential
 
 1,516
 
 
 1,516
Total$10,963
 $19,350
 $2,980
 $2,232
 $311
 $35,836
(1) Balances represent the amortized cost of loans receivable at date indicated. If multiple collateral secured the loan, the entire loan receivable balance is presented in the primary collateral category, which generally represents the majority of the collateral balance.
Under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans, comparative disclosures of collateral-dependent loans as of December 31, 2019 and for the three months ended March 31, 2019 are similar to the disclosures for impaired loans. Impaired loans include nonaccrual loans, and performing TDR loans, and other loans with a specific valuation allowance, excluding PCI loans. The balancesamortized cost of impaired loans as of June 30, 2019 and December 31, 2018 are set forth in the following tables:
 June 30, 2019
 
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$4,815
 $22,793
 $27,608
 $28,909
 $3,211
Owner-occupied commercial real estate817
 5,484
 6,301
 6,752
 1,294
Non-owner occupied commercial real estate5,132
 4,543
 9,675
 9,753
 629
Total commercial business10,764
 32,820
 43,584
 45,414
 5,134
One-to-four family residential
 224
 224
 231
 57
Real estate construction and land development:         
One-to-four family residential560
 233
 793
 878
 28
Total real estate construction and land development560
 233
 793
 878
 28
Consumer
 617
 617
 628
 154
Total$11,324
 $33,894
 $45,218
 $47,151
 $5,373
 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 estate816
 5,000
 5,816
 6,150
 1,142
Non-owner occupied commercial real estate3,352
 2,924
 6,276
 6,414
 206
Total commercial business6,691
 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 residential899
 
 899
 1,662
 
Total real estate construction and land development899
 
 899
 1,662
 
Consumer
 527
 527
 538
 139
Total$7,590
 $28,849
 $36,439
 $39,233
 $4,170



The average recorded investment of impaired loans for the three and six months ended June 30, 2019 and 2018 are set forth in the following table:
 Three Months Ended June 30, Six Months Ended June 30,
 2019 2018 2019 2018
 (In thousands)
Commercial business:       
Commercial and industrial$25,219
 $17,299
 $24,426
 $15,534
Owner-occupied commercial real estate6,178
 12,643
 6,057
 12,622
Non-owner occupied commercial real estate8,221
 10,426
 7,506
 10,366
Total commercial business39,618
 40,368
 37,989
 38,522
One-to-four family residential249
 293
 259
 295
Real estate construction and land development:       
One-to-four family residential858
 1,116
 872
 1,159
Five or more family residential and commercial properties
 
 
 215
Total real estate construction and land development858
 1,116
 872
 1,374
Consumer607
 381
 581
 401
Total$41,332
 $42,158
 $39,701
 $40,592

For
 December 31, 2019
 
Amortized Cost With
No Specific
Valuation
Allowance
 
Amortized Cost With
Specific
Valuation
Allowance
 
Total
Amortized Cost
 
Unpaid
Contractual
Principal
Balance
 
Related
Specific
Valuation
Allowance
 (In thousands)
Commercial business:         
Commercial and industrial$30,179
 $13,629
 $43,808
 $45,585
 $1,372
Owner-occupied commercial real estate3,921
 2,415
 6,336
 6,764
 426
Non-owner occupied commercial real estate5,309
 1,015
 6,324
 6,458
 146
Total commercial business39,409
 17,059
 56,468
 58,807
 1,944
One-to-four family residential
 215
 215
 223
 56
Real estate construction and land development:         
One-to-four family residential237
 
 237
 237
 
Consumer
 561
 561
 570
 143
Total$39,646
 $17,835
 $57,481
 $59,837
 $2,143



The average amortized cost of impaired loans for the three and six months ended June 30,March 31, 2019 and 2018, no interest income was recognized subsequent to a loan’s classification as nonaccrual. Forare set forth in the three and six months ended June 30, 2019, the Bank recorded $397,000 and $698,000, respectively, of interest income related to performing TDR loans. For the three and six months ended June 30, 2018, the Bank recorded $360,000 and $686,000, respectively, of interest income related to performing TDR loans.following table:
 Three Months Ended March 31, 2019
 (In thousands)
Commercial business: 
Commercial and industrial$22,639
Owner-occupied commercial real estate5,935
Non-owner occupied commercial real estate6,619
Total commercial business35,193
One-to-four family residential277
Real estate construction and land development: 
One-to-four family residential911
Consumer562
Total$36,943

(g) Troubled Debt Restructured Loans
The recorded investment balanceamortized cost and related allowance for loan lossesACL on loans of performing and nonaccrual TDR loans as of June 30, 2019March 31, 2020 and December 31, 20182019 were as follows:
 June 30, 2019 December 31, 2018
 
Performing
TDRs
 
Nonaccrual
TDRs
 
Performing
TDRs
 Nonaccrual
TDRs
 (In thousands)
TDR loans$25,925
 $8,090
 $22,736
 $6,943
Allowance for loan losses on TDR loans2,887
 981
 2,257
 658

 March 31, 2020 December 31, 2019
 
Performing
TDR loans
 
Nonaccrual
TDR loans
 
Performing
TDR loans
 
Nonaccrual
TDR loans
 (In thousands)
TDR loans$19,309
 $19,980
 $14,469
 $26,338
ACL on TDR loans1,519
 223
 1,259
 218
The unfunded commitment to borrowers related to TDR loans was $1.7$3.0 million and $943,000$736,000 at June 30, 2019March 31, 2020 and December 31, 2018,2019, respectively.




Loans that were modified as TDR loans during the three and six months ended June 30,March 31, 2020 and 2019 and 2018 are set forth in the following table:
Three Months Ended June 30,Three Months Ended March 31,
2019 20182020 2019
Number of
Contracts
(1)
 
Recorded Investment
(1)(2)
 
Number of
Contracts
(1)
 
Recorded Investment
(1)(2)
Number of
Contracts
 
Amortized Cost (1)
 Number of
Contracts
 
Amortized Cost (1)
(Dollars in thousands)(Dollars in thousands)
Commercial business:           
Commercial and industrial14
 $8,628
 9
 $2,981
14 $4,950
 9 $10,100
Owner-occupied commercial real estate1
 710
 1
 570
4 2,183
 2 934
Non-owner occupied commercial real estate2
 3,554
 
 
3 2,210
 1 2,112
Total commercial business17
 12,892
 10
 3,551
21 9,343
 12 13,146
Real estate construction and land development:    
One-to-four family residential4 1,516
 2 665
Consumer3
 53
 3
 33
5 93
 6 122
Total loans modified as TDR loans20
 $12,945
 13
 $3,584
Total30 $10,952
 20 $13,933
(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 three months ended June 30, 2019 and 2018.
(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 three months ended June 30, 2019 and 2018.
 Six Months Ended June 30,
 2019 2018
 
Number of
Contracts
(1)
 
Recorded Investment
(1)(2)
 
Number of
Contracts
(1)
 
Recorded Investment
(1)(2)
 (Dollars in thousands)
Commercial business:       
Commercial and industrial20
 $18,066
 17
 $6,193
Owner-occupied commercial real estate3
 1,628
 1
 570
Non-owner occupied commercial real estate3
 5,643
 2
 2,380
Total commercial business26
 25,337
 20
 9,143
Real estate construction and land development:       
One-to-four family residential1
 560
 
 
Total real estate construction and land development1
 560
 
 
Consumer8
 162
 6
 107
Total TDR loans35
 $26,059
 26
 $9,250

(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 six months ended June 30, 2019 and 2018.
(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,modifications, the Bank’s recorded investmentamortized cost 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 six months ended June 30, 2019 and 2018..
The tables above includes 12 and 2011 loans respectively, for both the three and six months ended June 30,March 31, 2020 and 2019 and 10 and 23 loans, respectively, for the three and six months ended June 30, 2018 that were 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. Of the remaining first-reported TDR loans, the concessions granted largely consisted of maturity extensions, interest rate modifications or a combination of both. The potential losses related to TDR loans are 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. The related specific valuation allowanceACL at June 30, 2019March 31, 2020 for loans that were modified as TDR loans during the sixthree months ended June 30, 2019March 31, 2020 was $3.1 million.$768,000.
Loans that were modified during the previous twelve months that subsequently defaulted during the three and six months ended June 30,March 31, 2020 and 2019 and 2018 are set forth in the following tables:table:
Three Months Ended June 30,Three Months Ended March 31,
2019 20182020 2019
Number of
Contracts
 Recorded Investments Number of
Contracts
 Recorded Investments
Number of
Contracts
 Amortized Cost Number of
Contracts
 Amortized Cost
(Dollars in thousands)(Dollars in thousands)
Commercial business:              
Commercial and industrial6
 $1,278
 4
 $2,725
2
 $1,873
 1
 $829
Owner-occupied properties1
 399
 
 

 
 1
 717
Total commercial business7
 1,677
 4
 2,725
Real estate construction and land development:       
One-to-four family residential1
 560
 
 
Total real estate construction and land development1
 560
 
 
Non-owner occupied commercial real estate3
 590
 1
 601
Total8
 $2,237
 4
 $2,725
5
 $2,463
 3
 $2,147
 Six Months Ended June 30,
 2019 2018
 
Number of
Contracts
 Recorded Investments Number of
Contracts
 Recorded Investments
 (Dollars in thousands)
Commercial business:       
Commercial and industrial6
 $1,278
 5
 $3,006
Owner-occupied commercial real estate2
 1,109
 
 
Non-owner occupied commercial real estate1
 586
 1
 73
Total commercial business9
 2,973
 6
 3,079
Real estate construction and land development:       
One-to-four family residential1
 560
 2
 775
Total real estate construction and land development1
 560
 2
 775
Total10
 $3,533
 8
 $3,854

During the three and six months ended June 30,March 31, 2020 and 2019, eightall of these loans and ten loans, respectively, defaulted because each was past its modified maturity date, and the borrower has not subsequently repaid the credits. One loan defaulted during both the three and six months ended June 30, 2019. The Bank has chosen not to extend further the maturity date on these loans. The Bank had a specific valuation allowance of $304,000 at June 30, 2019 related to these TDR loans which defaulted during the six months ended June 30, 2019.
During the three and six months ended June 30, 2018, two and six loans, respectively, defaulted because each was past its modified maturity date and the borrower has not subsequently repaid the credits. The Bank hadhas chosen not to extend further the maturitiesmaturity date on these loans. In addition, during each of the three and six months ended June 30, 2018, two loans defaulted because the borrowers were more than 90 days delinquent on their scheduled loan payments. The Bank had no specific valuation allowanceACL of $334,000 at June 30, 2018March 31, 2020 related to these TDR loans which defaulted during the sixthree months ended June 30, 2018.March 31, 2020.

For the three months ended March 31, 2020 and 2019, the Bank recorded $608,000 and $301,000, respectively, of interest income related to performing TDR loans.




(h) Purchased Credit Impaired Loans
Upon adoption of CECL, the Company transitioned PCI loans to PCD loans. The following table reflects the outstanding principal balance and recorded investment of the PCI loans at June 30, 2019 and December 31, 2018:2019:
June 30, 2019 December 31, 2018December 31, 2019
Outstanding Principal Recorded Investment Outstanding Principal Recorded InvestmentOutstanding Principal Recorded Investment
(In thousands)(In thousands)
Commercial business:          
Commercial and industrial$5,232
 $2,837
 $6,319
 $3,433
$4,439
 $2,368
Owner-occupied commercial real estate7,260
 7,120
 7,830
 7,215
4,925
 4,914
Non-owner occupied commercial real estate8,019
 6,402
 8,685
 7,059
7,028
 5,491
Total commercial business20,511
 16,359
 22,834
 17,707
16,392
 12,773
One-to-four family residential3,056
 3,217
 3,169
 3,315
3,095
 3,575
Real estate construction and land development:       
One-to-four family residential
 326
 67
 380
Five or more family residential and commercial properties182
 154
 188
 43
Total real estate construction and land development182
 480
 255
 423
Consumer1,012
 2,297
 2,203
 3,462
1,463
 1,762
Gross PCI loans$24,761
 $22,353
 $28,461
 $24,907
$20,950
 $18,110
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 three and six months ended June 30, 2019 and 2018:March 31, 2019:
Three Months Ended June 30, Six Months Ended June 30,
2019 2018 2019 2018Three Months Ended March 31, 2019
(In thousands)(In thousands)
Balance at the beginning of the period$8,460
 $11,269
 $9,493
 $11,224
$9,493
Accretion(513) (587) (1,094) (1,368)(581)
Disposal and other(198) (273) (650) (1,971)(452)
Reclassification from nonaccretable difference823
 (349) 823
 2,175
Balance at the end of the period$8,572
 $10,060
 $8,572
 $10,060
$8,460



(4)Allowance for Credit Losses on Loans
Effective January 1, 2020, the Bank adopted ASU 2016-13. The adoption replaced the allowance for loan losses with the ACL on loans and replaced the related provision for loan losses with the provision for credit losses on loans.
For the ACL on loans at January 1, 2020 and March 31, 2020, the baseline loss rates were calculated using the bank's average quarterly historical loss information from December 31, 2007 through the respective balance sheet date. The Bank has chosen to anchor the 2008-2009 periods to allow for a complete economic cycle to have occurred in its historical loss period. The Bank evaluates the historical period and the need to release the anchor periods on a quarterly basis, with the assumption that economic cycles have historically lasted between 10 and 15 years. The Bank believes the historic loss rates are viable inputs to the current expected credit loss methodology 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 consistent.
Prepayments included in the methodology were based on the 48-month rolling historical averages for each segment, which management believes is an accurate representation of future prepayment activity. Management's allowance estimates at January 1, 2020 and March 31, 2020 used a four quarter reasonable and supportable period, as forecasts beyond this 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 will likely increase. The Bank used a two quarter reversion period in calculating its allowance



(5)Allowance for Loan Losses
The allowance for loanas of January 1, 2020 and March 31, 2020 as it believes the historical loss information is relevant to the expected credit losses is maintained at a level deemed appropriate by management to provide for probable incurredand recognizes the declining precision and increasing uncertainty of estimating credit losses in those periods beyond which it can make reasonable and supportable forecasts. Risk characteristics by segment considered in the CECL methodology are the same as those disclosed in the 2019 Annual Form 10-K.
The following table details the activity in the ACL on loans disaggregated by segment and class for the three months ended March 31, 2020:
 Three Months Ended March 31, 2020
 Beginning Balance Impact of CECL Adoption Beginning Balance, as Adjusted Charge-offs Recoveries Provision for Credit Losses Ending Balance
 (In thousands)
Commercial business:             
Commercial and industrial$11,739
 $(1,348) $10,391
 $(1,087) $1,057
 $3,539
 $13,900
Owner-occupied commercial real estate4,512
 452
 4,964
 (135) 12
 1,375
 6,216
Non-owner occupied commercial real estate7,682
 (2,039) 5,643
 
 
 2,107
 7,750
Total commercial business23,933
 (2,935) 20,998
 (1,222) 1,069
 7,021
 27,866
One-to-four family residential1,458
 1,471
 2,929
 
 3
 94
 3,026
Real estate construction and land development:             
One-to-four family residential1,455
 (571) 884
 
 14
 (34) 864
Five or more family residential and commercial properties1,605
 7,240
 8,845
 
 
 2,599
 11,444
Total real estate construction and land development3,060
 6,669
 9,729
 
 14
 2,565
 12,308
Consumer6,821
 (2,484) 4,337
 (375) 94
 284
 4,340
Unallocated899
 (899) 
 
 
 
 
Total$36,171
 $1,822
 $37,993
 $(1,597) $1,180
 $9,964
 $47,540
The Bank recognized net charge-offs of $417,000 during the quarter ended March 31, 2020. Net charge-offs include the charge-off of one commercial and industrial relationship of $373,000 and a large volume of small-dollar amount consumer loans, offset by the full recovery of an agricultural lending relationship charge-off of $963,000 which was recorded during the three months ended December 31, 2019.
During the three months ended March 31, 2020, the Bank recorded a provision for credit losses on loans of $10.0 million, an increase of 26.2% from the adjusted beginning balance. Of the provision for credit loses on loans, approximately $6.9 million was due to the Company's economic forecast under the CECL methodology, which included a decline in economic conditions due to the COVID-19 pandemic. The economic model utilized as of March 31, 2020 is forecasting profound, but not permanent, reductions in activity, with widespread cuts in discretionary and social spending, severe disruptions to supply chains, and a major interruption in travel activity. The model predicts a so-called "v-shaped" recession, with unemployment rate peaking at 6% and Real GDP contracting 0.2% in 2020. These projections are compared to predicted unemployment rate of 3.7% and Real GDP growth of 1.7% prior to the onset of the pandemic. While the negative impact is projected to occur immediately, the model is projecting the downturn to be short-term with a strong recovery toward the end of 2020.
The provision for credit losses on loans also includes qualitative factors related to the industries in the loan portfolio. portfolio that the Company believes may suffer the most losses as a result of the COVID-19 pandemic, such as restaurants, hotels, dentists, religious organizations, and recreational and entertainment centers.
Approximately $3.1 million of the provision for credit losses on loans was due to an increase in the amortized cost balance, including the change in the mix of loans in the portfolio, and other changes such as term modifications or credit quality changes.



The following tables detail thetable details activity in the allowance for loan losses disaggregated by segment and class for the three and six months ended June 30, 2019:March 31, 2019 under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans:
Balance at Beginning of Period Charge-offs Recoveries Provision for Loan Losses Balance at End of PeriodThree Months Ended March 31, 2019
(In thousands)Beginning Balance Charge-offs Recoveries Provision for Loan Losses Ending Balance
Three Months Ended June 30, 2019         
(In thousands)
Commercial business:                  
Commercial and industrial$11,755
 $(774) $62
 $950
 $11,993
$11,343
 $(103) $7
 $508
 $11,755
Owner-occupied commercial real estate5,256
 
 
 (190) 5,066
4,898
 
 3
 355
 5,256
Non-owner occupied commercial real estate7,825
 
 
 239
 8,064
7,470
 
 149
 206
 7,825
Total commercial business24,836
 (774) 62
 999
 25,123
23,711
 (103) 159
 1,069
 24,836
One-to-four family residential1,247
 (15) 
 113
 1,345
1,203
 (15) 
 59
 1,247
Real estate construction and land development:                  
One-to-four family residential1,422
 
 7
 42
 1,471
1,240
 
 618
 (436) 1,422
Five or more family residential and commercial properties995
 
 
 65
 1,060
954
 
 
 41
 995
Total real estate construction and land development2,417
 
 7
 107
 2,531
2,194
 
 618
 (395) 2,417
Consumer6,480
 (566) 130
 496
 6,540
6,581
 (586) 117
 368
 6,480
Unallocated1,172
 
 
 (348) 824
1,353
 
 
 (181) 1,172
Total$36,152
 $(1,355) $199
 $1,367
 $36,363
$35,042
 $(704) $894
 $920
 $36,152


 Balance at Beginning of Period Charge-offs Recoveries Provision for Loan Losses Balance at End of Period
 (In thousands)
Six Months Ended June 30, 2019         
Commercial business:         
Commercial and industrial$11,343
 $(877) $69
 $1,458
 $11,993
Owner-occupied commercial real estate4,898
 
 3
 165
 5,066
Non-owner occupied commercial real estate7,470
 
 149
 445
 8,064
Total commercial business23,711
 (877) 221
 2,068
 25,123
One-to-four family residential1,203
 (30) 
 172
 1,345
Real estate construction and land development:         
One-to-four family residential1,240
 
 625
 (394) 1,471
Five or more family residential and commercial properties954
 
 
 106
 1,060
Total real estate construction and land development2,194
 
 625
 (288) 2,531
Consumer6,581
 (1,152) 247
 864
 6,540
Unallocated1,353
 
 
 (529) 824
Total$35,042
 $(2,059) $1,093
 $2,287
 $36,363

The following table details the allowance for loan losses disaggregated on the basis of the Company's impairment method as of June 30, 2019:
 Loans Individually Evaluated for Impairment Loans Collectively Evaluated for Impairment PCI Loans Total Allowance for Loan Losses
 (In thousands)
Commercial business:       
Commercial and industrial$3,211
 $8,094
 $688
 $11,993
Owner-occupied commercial real estate1,294
 3,180
 592
 5,066
Non-owner occupied commercial real estate629
 6,900
 535
 8,064
Total commercial business5,134
 18,174
 1,815
 25,123
One-to-four family residential57
 1,188
 100
 1,345
Real estate construction and land development:       
One-to-four family residential28
 1,259
 184
 1,471
Five or more family residential and commercial properties
 982
 78
 1,060
Total real estate construction and land development28
 2,241
 262
 2,531
Consumer154
 5,988
 398
 6,540
Unallocated
 824
 
 824
Total$5,373
 $28,415
 $2,575
 $36,363





The following table details the recorded investment balance of the loan receivables disaggregated on the basis of the Company’s impairment method as of June 30, 2019:
 Loans Individually Evaluated for Impairment Loans Collectively Evaluated for Impairment PCI Loans Total Gross Loans Receivable
 (In thousands)
Commercial business:       
Commercial and industrial$27,608
 $814,601
 $2,837
 $845,046
Owner-occupied commercial real estate6,301
 759,078
 7,120
 772,499
Non-owner occupied commercial real estate9,675
 1,316,970
 6,402
 1,333,047
Total commercial business43,584
 2,890,649
 16,359
 2,950,592
One-to-four family residential224
 113,984
 3,217
 117,425
Real estate construction and land development:       
One-to-four family residential793
 110,200
 326
 111,319
Five or more family residential and commercial properties
 143,187
 154
 143,341
Total real estate construction and land development793
 253,387
 480
 254,660
Consumer617
 390,012
 2,297
 392,926
Total$45,218
 $3,648,032
 $22,353
 $3,715,603



The following tables detail activity in the allowance for loan losses disaggregated by segment and class for the three and six months ended June 30, 2018:
 Balance at Beginning of Period Charge-offs Recoveries Provision for Loan Losses Balance at End of Period
 (In thousands)
Three Months Ended June 30, 2018         
Commercial business:         
Commercial and industrial$9,943
 $(541) $65
 $721
 $10,188
Owner-occupied commercial real estate5,040
 (1) 3
 204
 5,246
Non-owner occupied commercial real estate7,589
 
 
 137
 7,726
Total commercial business22,572
 (542) 68
 1,062
 23,160
One-to-four family residential1,083
 (15) 
 53
 1,121
Real estate construction and land development:         
One-to-four family residential941
 
 2
 73
 1,016
Five or more family residential and commercial properties1,115
 
 
 (71) 1,044
Total real estate construction and land development2,056
 
 2
 2
 2,060
Consumer6,054
 (694) 142
 803
 6,305
Unallocated1,496
 
 
 (170) 1,326
Total$33,261
 $(1,251) $212
 $1,750
 $33,972


 Balance at Beginning of Period Charge-offs Recoveries Provision for Loan Losses Balance at End of Period
 (In thousands)
Six Months Ended June 30, 2018         
Commercial business:         
Commercial and industrial$9,910
 $(622) $564
 $336
 $10,188
Owner-occupied commercial real estate3,992
 (1) 5
 1,250
 5,246
Non-owner occupied commercial real estate8,097
 
 
 (371) 7,726
Total commercial business21,999
 (623) 569
 1,215
 23,160
One-to-four family residential1,056
 (15) 
 80
 1,121
Real estate construction and land development:         
One-to-four family residential862
 
 2
 152
 1,016
Five or more family residential and commercial properties1,190
 
 
 (146) 1,044
Total real estate construction and land development2,052
 
 2
 6
 2,060
Consumer6,081
 (1,179) 230
 1,173
 6,305
Unallocated898
 
 
 428
 1,326
Total$32,086
 $(1,817) $801
 $2,902
 $33,972

The following table details the allowance for loan losses disaggregated on the basis of the Company's impairment method as of December 31, 2018:2019 under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans:
Loans Individually Evaluated for Impairment Loans Collectively Evaluated for Impairment PCI Loans Total Allowance for Loan LossesLoans Individually Evaluated for Impairment Loans Collectively Evaluated for Impairment PCI Loans Total Allowance for Loan Losses
(In thousands)(In thousands)
Commercial business:              
Commercial and industrial$2,607
 $7,913
 $823
 $11,343
$1,372
 $9,772
 $595
 $11,739
Owner-occupied commercial real estate1,142
 3,063
 693
 4,898
426
 3,558
 528
 4,512
Non-owner occupied commercial real estate206
 6,630
 634
 7,470
146
 7,064
 472
 7,682
Total commercial business3,955
 17,606
 2,150
 23,711
1,944
 20,394
 1,595
 23,933
One-to-four family residential76
 1,015
 112
 1,203
56
 1,316
 86
 1,458
Real estate construction and land development:              
One-to-four family residential
 1,040
 200
 1,240

 1,296
 159
 1,455
Five or more family residential and commercial properties
 875
 79
 954

 1,527
 78
 1,605
Total real estate construction and land development
 1,915
 279
 2,194

 2,823
 237
 3,060
Consumer139
 5,965
 477
 6,581
143
 6,327
 351
 6,821
Unallocated
 1,353
 
 1,353

 899
 
 899
Total$4,170
 $27,854
 $3,018
 $35,042
$2,143
 $31,759
 $2,269
 $36,171






The following table details the recorded investment balanceamortized cost of the loan receivables disaggregated on the basis of the Company’s impairment method as of December 31, 2018:2019 under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans:
Loans Individually Evaluated for Impairment Loans Collectively Evaluated for Impairment PCI Loans Total Gross Loans ReceivableLoans Individually Evaluated for Impairment Loans Collectively Evaluated for Impairment PCI Loans Total Gross Loans Receivable
(In thousands)(In thousands)
Commercial business:              
Commercial and industrial$22,642
 $827,531
 $3,433
 $853,606
$43,808
 $806,044
 $2,368
 $852,220
Owner-occupied commercial real estate5,816
 766,783
 7,215
 779,814
6,336
 793,984
 4,914
 805,234
Non-owner occupied commercial real estate6,276
 1,291,128
 7,059
 1,304,463
6,324
 1,276,964
 5,491
 1,288,779
Total commercial business34,734
 2,885,442
 17,707
 2,937,883
56,468
 2,876,992
 12,773
 2,946,233
One-to-four family residential279
 98,169
 3,315
 101,763
215
 127,870
 3,575
 131,660
Real estate construction and land development:       
   
 
One-to-four family residential899
 101,451
 380
 102,730
237
 104,059
 
 104,296
Five or more family residential and commercial properties
 112,687
 43
 112,730

 170,350
 
 170,350
Total real estate construction and land development899
 214,138
 423
 215,460
237
 274,409
 
 274,646
Consumer527
 391,556
 3,462
 395,545
561
 413,017
 1,762
 415,340
Total$36,439

$3,589,305
 $24,907
 $3,650,651
$57,481

$3,692,288
 $18,110
 $3,767,879


(6)(5)Other Real Estate Owned
Changes in other real estate owned during the three and six months ended June 30,March 31, 2020 and 2019 and 2018 were as follows:
Three Months Ended 
 June 30,
 Six Months Ended 
 June 30,
Three Months Ended
March 31,
2019 2018 2019 20182020 2019
(In thousands)(In thousands)
Balance at the beginning of the period$1,904
 $
 $1,983
 $
$841
 $1,983
Additions
 434
 
 434
270
 
Proceeds from dispositions(350) 
 (429) 
(266) (79)
Loss on sales, net(279) 
 (279) 
(4) 
Valuation adjustment(51) 
 (51) 
Balance at the end of the period$1,224
 $434
 $1,224
 $434
$841
 $1,904


At June 30, 2019, the carrying amount of March 31, 2020, there was noother real estate owned that was the result of foreclosure and obtaining physical possession of residential real estate properties was $383,000.properties. At June 30, 2019,March 31, 2020, there were no consumer mortgage loans secured by residential real estate properties (included in the one-to-four family residential loans in Note (4)(3) Loans Receivable) for which formal foreclosure proceedings were in process.

(7)(6)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 following mergers: Premier MergerCommercial Bancorp on July 2, 2018; Puget Sound MergerBancorp on January 16, 2018; Washington Banking Company on May 1, 2014; Valley Community Bancshares on July 15, 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).


The following table presentsThere were no additions to goodwill during the change in goodwill for the periods indicated:
 Three Months Ended June 30, Six Months Ended June 30,
 2019 2018 2019 2018
 (In thousands)
Balance at the beginning of the period$240,939
 $187,549
 $240,939
 $119,029
Additions as a result of acquisitions (1)

 
 
 68,520
Balance at the end of the period$240,939
 $187,549
 $240,939
 $187,549
(1) See Note (2) Business Combinationsthree months ended March 31, 2020 and 2019.
The Company performed its annual goodwill impairment test during the fourth quarter of 20182019 and determined based on its Step 1 analysis that the fair value of the reporting unit exceeded the carrying value, such that the Company's goodwill was not0t considered impaired. Due to the current market conditions as a result of the COVID-19 pandemic,



the Company performed a qualitative assessment of goodwill as of March 31, 2020 and determined that the fair value of the reporting unit more likely than not exceeded the carrying value at March 31, 2020. 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 adverse impact on the Company’s operating results. No events or circumstances since the annual impairment test were noted that would indicate it was more likely than not a goodwill impairment exists.

(b) Other Intangible Assets
Other intangible assets represent CDI acquired in business combinations. The useful life of the CDI was estimated to be ten years for the acquisitions of Premier Commercial Bancorp, Puget Sound Bancorp, Washington Banking Company, and Valley Community Bancshares, and was estimated to be five years for the acquisition of Northwest Commercial Bank.Bancshares.
The following table presents the change in other intangible assets for the periods indicated:
 Three Months Ended March 31,
 2020 2019
 (In thousands)
Balance at the beginning of the period$16,613
 $20,614
Amortization(903) (1,025)
Balance at the end of the period$15,710
 $19,589
 Three Months Ended June 30, Six Months Ended June 30,
 2019 2018 2019 2018
 (In thousands)
Balance at the beginning of the period$19,589
 $16,563
 $20,614
 $6,088
Additions as a result of acquisitions (1)

 
 
 11,270
Amortization(1,026) (796) (2,051) (1,591)
Balance at the end of the period$18,563
 $15,767
 $18,563
 $15,767

(1) See Note (2) Business Combinations

(8)(7)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 June 30, 2019March 31, 2020 and December 31, 2018,2019, the balance of the junior subordinated debentures, net of unaccreted discount, was $20.4$20.7 million and $20.3$20.6 million, respectively.
The adjustable rate of the trust preferred securities at June 30, 2019March 31, 2020 was 3.88%3.01%. The following table presents the weighted average rate of the junior subordinated debentures for the periods indicated:
 Three Months Ended June 30, Six Months Ended June 30,
 2019 2018 2019 2018
Weighted average rate (1)
6.68% 6.28% 6.87% 6.01%
 Three Months Ended March 31,
 2020 2019
Weighted average rate (1)
5.56% 7.06%
(1) 
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.




(9)(8)Securities Sold Under Agreement to Repurchase
The Company utilizes securities sold under agreement to repurchase with one-dayone day maturities secured by pledged investment securities available for sale as a supplement to funding sources. For additional information on the total value of investment securities pledged for securities sold under agreement to repurchase see Note (3)(2) Investment Securities.
The following table presents the Company's securities sold under agreement to repurchase obligations by class of collateral pledged at the dates indicated:
 June 30, 2019 December 31, 2018
 (In thousands)
U.S. Treasury and U.S. Government-sponsored agencies$4,952
 $4,878
Mortgage-backed securities and collateralized mortgage obligations: (1)
   
Residential5,536
 9,335
Commercial12,653
 17,274
Total securities sold under agreement to repurchase$23,141
 $31,487
 March 31, 2020 December 31, 2019
 (In thousands)
Mortgage-backed securities and collateralized mortgage obligations (1):
   
Residential$2,621
 $8,452
Commercial9,171
 11,717
Securities sold under agreement to repurchase$11,792
 $20,169
(1) Issued and guaranteed by U.S. Government-sponsored agencies.




(10)(9)Other Borrowings
(a) FHLB
The FHLB functions as a member-owned cooperative providing credit for member financial institutions. At June 30, 2019,March 31, 2020, the Bank maintained a credit facility with the FHLB with available borrowing capacity of $827.7$898.5 million. At June 30,March 31, 2020 and December 31, 2019 the Bank had short-term FHLB advances outstanding of $90.7 million with maturity dates within 30 days. At December 31, 2018 the Bank had no0 FHLB advances outstanding.
The following table sets forth the details of FHLB advances during the three and six months ended June 30, 2019March 31, 2020 and 2018:2019:
Three Months Ended June 30, Six Months Ended June 30,Three Months Ended March 31,
2019 2018 2019 20182020 2019
(In thousands)(In thousands)
FHLB Advances:          
Average balance during the period$42,101
 $79,120
 $22,086
 $57,546
$989
 $1,849
Maximum month-end balance during the period$90,700
 $154,500
 $90,700
 $154,500
$
 $25,000
Weighted average rate during the period2.65% 2.04% 2.68% 1.93%0.41% 3.29%

Advances from the FHLB are collateralized by a blanket pledge on FHLB stock owned by the Bank, deposits at the FHLB, certain commercial real estate and one-to-four single family residential 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’ Bank and JP Morgan Chase to purchase federal funds of up to $90.0$140.0 million as of June 30, 2019.March 31, 2020. The lines generally mature annually or are reviewed annually. As of June 30, 2019March 31, 2020 and December 31, 2018,2019, there were no0 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 $43.6$74.0 million as of June 30, 2019.March 31, 2020. There were no0 borrowings outstanding as of June 30, 2019March 31, 2020 and December 31, 2018.2019. Any advances on the credit facility would have to be first secured by the Bank's investment securities or loans receivable.




(11)(10)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 Condensed Consolidated Statements of Income. Because the Company acts only as an intermediary for its customer, subsequent changes in the fair value of the underlying derivative contracts offset each other and do not significantly impact the Company’s results of operations.
The following table presents the notional amounts and estimated fair values of interest rate derivative contracts outstanding at June 30, 2019March 31, 2020 and December 31, 2018:2019:
June 30, 2019 December 31, 2018March 31, 2020 December 31, 2019
Notional Amounts Estimated Fair Value Notional Amounts Estimated Fair ValueNotional Amounts Estimated Fair Value Notional Amounts Estimated Fair Value
(In thousands)(In thousands)
Non-hedging interest rate derivatives              
Interest rate swap asset (1)
$177,655
 $8,033
 $171,798
 $5,095
$233,014
 $28,075
 $221,436
 $8,318
Interest rate swap liability (1)
177,655
 (8,033) 171,798
 (5,095)223,014
 (28,075) 221,436
 (8,318)

 (1)The estimated fair value of derivatives with customers was $7,647$49,000 and $(1,643)$8.1 million as of June 30, 2019March 31, 2020 and December 31, 2018,2019, respectively. The estimated fair value of derivatives with third parties was $(7,647)$(49,000) and $1,643$(8.1) million as of June 30, 2019March 31, 2020 and December 31, 2018,2019, respectively.




(12)(11)Stockholders’ Equity
(a) Earnings Per Common Share
The following table illustrates the reconciliation of weighted average shares used for earnings per common share computations for the three and six months ended June 30, 2019March 31, 2020 and 2018:2019:
Three Months Ended June 30, Six Months Ended June 30,Three Months Ended March 31,
2019 2018 2019 20182020 2019
(In thousands)(In thousands)
Net income:          
Net income$15,984
 $11,857
 $32,536
 $20,944
$12,191
 $16,552
Dividends and undistributed earnings allocated to participating securities(1)(48) (57) (100) (110)(6) (27)
Net income allocated to common shareholders$15,936
 $11,800
 $32,436
 $20,834
$12,185
 $16,525
Basic:          
Weighted average common shares outstanding36,895,625
 34,023,566
 36,888,601
 33,680,014
36,357,812
 36,881,499
Restricted stock awards(25,466) (88,905) (40,632) (107,897)(15,722) (55,967)
Total basic weighted average common shares outstanding36,870,159
 33,934,661
 36,847,969
 33,572,117
36,342,090
 36,825,532
Diluted:          
Basic weighted average common shares outstanding36,870,159
 33,934,661
 36,847,969
 33,572,117
36,342,090
 36,825,532
Effect of potentially dilutive common shares (1)(2)
144,714
 172,631
 163,767
 157,819
254,551
 185,108
Total diluted weighted average common shares outstanding37,014,873
 34,107,292
 37,011,736
 33,729,936
36,596,641
 37,010,640

(1)
Represents dividends paid and undistributed earnings allocated to nonvested restricted stock awards.
(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. Anti-dilution occurs when the exercise price of a stock option or the unrecognized compensation cost per share of a restricted stock award exceeds the market price of the Company’s stock. For the three and six months ended June 30,March 31, 2020 and 2019, there were 89,50721,475 and 61,33331,557 anti-dilutive shares outstanding, respectively. There were no anti-dilutive shares outstanding for the three and six months ended June 30, 2018.

(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 for the sixthree months ended June 30, 2019March 31, 2020 and calendar year 2018:2019:
Declared Cash Dividend per Share Record Date Paid Date 
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
 
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
 

* 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 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 Board of Governors of the Federal Reserve System and the FDIC.

(c) Stock Repurchase Program
The Company has had various stock repurchase programs since March 1999. On October 23, 2014,March 12, 2020 the Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares, or approximately 1,513,0001,799,054 shares, under the eleventhtwelfth stock repurchase plan. The number, timing and price of shares repurchased will depend on business and market conditions and other factors, including opportunities to deploy the Company's capital.
SinceDuring the inception ofquarter ended March 31, 2020, the Company repurchased the remaining 639,922 shares available under the eleventh stock repurchase plan the Company has repurchased 607,966 shares at ana weighted average price per share price of $17.33, including 28,000 shares repurchased at an average share price of $29.12 during both the three and six months ended June 30, 2019. No$23.95. NaN shares were repurchased under this plan during the three and six months ended June 30, 2018.March 31, 2019. The Company has repurchased 155,778 shares at a weighted average share price per share of $20.34 during the three months ended March 31, 2020. The Company halted its buybacks in March 2020, and will not resume repurchase activity until management is confident it can understand the economic impacts of the COVID-19 pandemic on the Company's long-term capital position.
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:
 Three Months Ended March 31,
 2020 2019
Repurchased shares to pay withholding taxes25,882
 25,854
Stock repurchase to pay withholding taxes average share price$21.79
 $31.01
 Three Months Ended June 30, Six Months Ended June 30,
 2019 2018 2019 2018
Repurchased shares to pay withholding taxes (1)
2,175
 7,394
 28,029
 52,820
Stock repurchase to pay withholding taxes average share price$29.31
 $33.84
 $30.88
 $31.96
(1)
During the six months ended June 30, 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 an average share price of $31.80 under the terms of the Puget Sound Merger. See Note (2) Business Combinations.



(13)(12)Accumulated Other Comprehensive Income (Loss)
The changes in accumulated other comprehensive income (loss) (“AOCI”),AOCI, all of which are due to changes in the fair value of available for sale securities and are net of tax, during the three and six months ended June 30,March 31, 2020 and 2019 and 2018 are as follows:
Three Months Ended June 30, Six Months Ended June 30,Three Months Ended March 31,
2019 2018 2019 20182020 2019
(In thousands)(In thousands)
Balance of AOCI at the beginning of period$561
 $(8,934) $(7,455) $(1,298)$10,378
 $(7,455)
Other comprehensive income (loss) before reclassification9,219
 (2,358) 17,247
 (9,874)
Other comprehensive income before reclassification8,707
 8,028
Amounts reclassified from AOCI for gain on sale of investment securities included in net income(26) (14) (38) (41)(793) (12)
Net current period other comprehensive income (loss)9,193
 (2,372) 17,209
 (9,915)
Effects of implementation of accounting change related to equity investments, net
 
 
 (93)
Net current period other comprehensive income7,914
 8,016
Balance of AOCI at the end of period$9,754
 $(11,306) $9,754
 $(11,306)$18,292
 $561



(14)(13)Fair Value Measurements
Fair value is the exchange price that would be received for 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 on 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). Security valuations are obtained from third party pricing services for comparable assets or liabilities.


ImpairedCollateral-dependent 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 valueCollateral-dependent loans are identified as part 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-impaired loans. If the Company utilizes the fair market valuecalculation of the collateral method, theACL on loans. The 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. Such adjustments are usually 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 client and client’s business (Level 3). ImpairedIndividually evaluated loans are evaluated on a quarterly basis and impairmenttheir ACL on loans is adjusted accordingly.
Other Real Estate Owned:
Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less costs to sell. Fair value is commonly based on recent real estate appraisals.appraisals which are generally obtained at least every 18 months or earlier. 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. 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 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. On 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.
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).




The following tables summarize the balances of assets and liabilities measured at fair value on a recurring basis as of June 30, 2019March 31, 2020 and December 31, 2018:2019:
June 30, 2019March 31, 2020
Total Level 1 Level 2 Level 3Total Level 1 Level 2 Level 3
(In thousands)(In thousands)
Assets              
Investment securities available for sale:              
U.S. Treasury and U.S. Government-sponsored agencies$92,877
 $16,059
 $76,818
 $
$87,062
 $
 $87,062
 $
Municipal securities132,741
 
 132,741
 
179,608
 850
 178,758
 
Mortgage-backed securities and collateralized mortgage obligations:              
Residential347,682
 
 347,682
 
322,684
 
 322,684
 
Commercial339,078
 
 339,078
 
325,756
 
 325,756
 
Corporate obligations24,158
 
 24,158
 
23,832
 
 23,832
 
Other asset-backed securities24,144
 
 24,144
 
22,150
 
 22,150
 
Total investment securities available for sale960,680
 16,059
 944,621
 
961,092
 850
 960,242
 
Equity Security128
 128
 
 
Equity security96
 96
 
 
Derivative assets - interest rate swaps8,033
 
 8,033
 
28,075
 
 28,075
 
Liabilities              
Derivative liabilities - interest rate swaps$8,033
 $
 $8,033
 $
$28,075
 $
 $28,075
 $
December 31, 2018December 31, 2019
Total Level 1 Level 2 Level 3Total Level 1 Level 2 Level 3
(In thousands)(In thousands)
Assets              
Investment securities available for sale:              
U.S. Treasury and U.S. Government-sponsored agencies$101,603
 $15,936
 $85,667
 $
$105,223
 $
 $105,223
 $
Municipal securities158,864
 
 158,864
 
133,014
 
 133,014
 
Mortgage-backed securities and collateralized mortgage obligations:              
Residential331,602
 
 331,602
 
339,608
 
 339,608
 
Commercial333,761
 
 333,761
 
327,095
 
 327,095
 
Corporate obligations25,563
 
 25,563
 
24,194
 
 24,194
 
Other asset-backed securities24,702
 
 24,702
 
23,178
 
 23,178
 
Total investment securities available for sale976,095
 15,936
 960,159
 
952,312
 
 952,312
 
Equity Security114
 114
 
 
148
 148
 
 
Derivative assets - interest rate swaps5,095
 
 5,095
 
8,318
 
 8,318
 
Liabilities              
Derivative liabilities - interest rate swaps$5,095
 $
 $5,095
 $
$8,318
 $
 $8,318
 $

There were no transfers between Level 1 and Level 2 during the three and six months ended June 30, 2019 and 2018.
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 June 30, 2019March 31, 2020 and December 31, 20182019 and the net losses recorded in earnings during three and six months ended June 30, 2019March 31, 2020 and 2018:2019:
Basis(1)
 Fair Value at June 30, 2019    
Basis(1)
 Fair Value at March 31, 2020  
Total Level 1 Level 2 Level 3 
Net Losses
Recorded in
Earnings 
During
the Three Months Ended June 30, 2019
 
Net Losses
Recorded in
Earnings 
During
the Six Months Ended
June 30, 2019
Total Level 1 Level 2 Level 3 Net Losses
Recorded in
Earnings
During the
Three Months Ended March 31, 2020
(In thousands)(In thousands)
Impaired loans:             
Collateral-dependent loans:           
Commercial business:                        
Commercial and industrial$179
 $173
 $
 $
 $173
 $91
 $91
$374
 $335
 $
 $
 $335
 $5
Total commercial business179
 173
 
 
 173
 91
 91
Consumer8
 7
 
 
 7
 
 
Total assets measured at fair value on a nonrecurring basis$187
 $180
 $
 $
 $180
 $91
 $91
$374
 $335
 $
 $
 $335
 $5
(1)
Basis represents the unpaid principal balance of impaired loans. Excludes loans whose fair value was determined to be $0.
 
Basis(1)
 Fair Value at December 31, 2019  
 Total Level 1 Level 2 Level 3 
Net Losses
Recorded in
Earnings 
During
the Three Months Ended March 31, 2019
 (In thousands)
Impaired loans:           
Commercial business:           
Commercial and industrial$4,111
 $3,380
 $
 $
 $3,380
 $
Total assets measured at fair value on a nonrecurring basis$4,111
 $3,380
 $
 $
 $3,380
 $
(1) 
Basis represents the unpaid principal balance of impaired loans.
 
Basis(1)
 Fair Value at December 31, 2018    
 Total Level 1 Level 2 Level 3 
Net Losses
Recorded in
Earnings 
During
the Three Months Ended June 30, 2018
 
Net Losses
Recorded in
Earnings 
During
the Six Months Ended June 30, 2018
 (In thousands)
Impaired loans:             
Commercial business:             
Commercial and industrial$117
 $107
 $
 $
 $107
 $
 $
Non-owner occupied commercial real estate1,378
 1,102
 
 
 1,102
 
 
 Total commercial business1,495
 1,209
 
 
 1,209
 
 
Consumer9
 7
 
 
 7
 
 
Total assets measured at fair value on a nonrecurring basis$1,504
 $1,216
 $
 $
 $1,216
 $
 $
(1)
Basis represents the unpaid principal balance of impaired loans.


The following tables present quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at June 30, 2019March 31, 2020 and December 31, 2018:2019:
 June 30, 2019
 
Fair
Value
 
Valuation
Technique(s)
 Unobservable Input(s) 
Range of Inputs; Weighted
Average
 (Dollars in thousands)
Impaired loans$180
 Market approach Adjustment for differences between the comparable sales 17.0% - (16.0%); (3.0%)
 March 31, 2020
 
Fair
Value
 
Valuation
Technique(s)
 Unobservable Input(s) 
Range of Inputs; Weighted
Average
 (Dollars in thousands)
Collateral-dependent loans$335
 Market approach Adjustment for differences between the comparable sales 
N/A (1)
(1)
Quantitative disclosures are not provided for collateral-dependent impaired loans because there were no adjustments made to the appraisal or stated values during the current period.
 December 31, 2019
 
Fair
Value
 
Valuation
Technique(s)
 Unobservable Input(s) 
Range of Inputs; Weighted
Average
 (Dollars in thousands)
Impaired loans$3,380
 Market approach Adjustment for differences between the comparable sales 173.5% - (18.5%); 36.8%

 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%)



(b) Fair Value of Financial Instruments
Because broadly traded markets do not exist for most of the Company’s financial instruments, 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 present the carrying value amount of the Company’s financial instruments and their corresponding estimated fair values at June 30, 2019March 31, 2020 and December 31, 2018:2019:
 March 31, 2020
 Carrying Value
Fair Value
Fair Value Measurements Using:
 
Level 1
Level 2
Level 3
 (In thousands)
Financial Assets:         
Cash and cash equivalents$162,913
 $
 $162,913
 $
 $
Investment securities available for sale961,092
 961,092
 850
 960,242
 
Loans held for sale3,808
 3,935
 
 
 3,935
Loans receivable, net3,804,836
 3,851,281
 
 
 3,851,281
Accrued interest receivable14,940
 14,940
 1
 3,851
 11,088
Derivative assets - interest rate swaps28,075
 28,075
 

28,075
 
Equity security96
 96
 96
 
 
Financial Liabilities:         
Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts$4,091,959
 $4,091,959
 $4,091,959
 $
 $
Certificate of deposit accounts525,989
 530,580
 
 530,580
 
Securities sold under agreement to repurchase11,792
 11,792
 11,792
 
 
Junior subordinated debentures20,668
 17,750
 
 
 17,750
Accrued interest payable154
 154
 69
 59
 26
Derivative liabilities - interest rate swaps28,075
 28,075
 
 28,075
 

 June 30, 2019
 Carrying Value
Fair Value
Fair Value Measurements Using:
 
Level 1
Level 2
Level 3
 (In thousands)
Financial Assets:         
Cash and cash equivalents$139,290
 $139,290
 $139,290
 $
 $
Investment securities available for sale960,680
 960,680
 16,059
 944,621
 
Federal Home Loan Bank stock10,005
 N/A
 N/A
 N/A
 N/A
Loans held for sale3,692
 3,803
 
 
 3,803
Total loans receivable, net3,681,920
 3,742,461
 
 
 3,742,461
Accrued interest receivable15,401
 15,401
 62
 3,697
 11,642
Derivative assets - interest rate swaps8,033
 8,033
 

8,033
 
Equity security128
 128
 128
 
 
Financial Liabilities:         
Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts$3,843,940
 $3,843,940
 $3,843,940
 $
 $
Certificate of deposit accounts503,768
 508,338
 
 508,338
 
Federal Home Loan Bank advances90,700
 90,700
 
 90,700
 
Securities sold under agreement to repurchase23,141
 23,141
 23,141
 
 
Junior subordinated debentures20,448
 20,000
 
 
 20,000
Accrued interest payable209
 209
 78
 91
 40
Derivative liabilities - interest rate swaps8,033
 8,033
 
 8,033
 




December 31, 2018December 31, 2019
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:                  
Cash and cash equivalents$161,910
 $161,910
 $161,910
 $
 $
$228,568
 $228,568
 $228,568
 $
 $
Investment securities available for sale976,095
 976,095
 15,936
 960,159
 
952,312
 952,312
 
 952,312
 
Federal Home Loan Bank stock6,076
 N/A
 N/A
 N/A
 N/A
Loans held for sale1,555
 1,605
 
 1,605
 
5,533
 5,704
 
 
 5,704
Loans receivable, net of allowance for loan losses3,619,118
 3,617,857
 
 
 3,617,857
Loans receivable, net

3,731,708
 3,791,557
 
 
 3,791,557
Accrued interest receivable15,403
 15,403
 68
 4,091
 11,244
14,446
 14,446
 79
 3,668
 10,699
Derivative assets - interest rate swaps5,095
 5,095
 
 5,095
 
8,318
 8,318
 
 8,318
 
Equity security114
 114
 114
 
 
148
 148
 148
 
 
Financial Liabilities:                  
Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts$3,965,510
 $3,965,510
 $3,965,510
 $
 $
$4,058,098
 $4,058,098
 $4,058,098
 $
 $
Certificate of deposit accounts466,892
 470,222
 
 470,222
 
524,578
 529,679
 
 529,679
 
Federal Home Loan Bank advances
 
 
 
 
Securities sold under agreement to repurchase31,487
 31,487
 31,487
 
 
20,169
 20,169
 20,169
 
 
Junior subordinated debentures20,302
 20,500
 
 
 20,500
20,595
 20,000
 
 
 20,000
Accrued interest payable191
 191
 63
 81
 47
199
 199
 95
 64
 40
Derivative liabilities - interest rate swaps5,095
 5,095
 
 5,095
 
8,318
 8,318
 
 8,318
 


(15)(14)Cash Requirement
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. TheEffective March 24, 2020 the Federal Reserve lowered the reserve ratios on transaction accounts maintained at a depository institution to zero percent. There was 0 required reserve balance at June 30, 2019March 31, 2020 and a required balance of $17.1 million at December 31, 2018 was $14.2 million and $9.2 million, respectively, and2019 which was met by holding cash and maintaining an average balance with the Federal Reserve Bank.

(16)(15)LeasesCommitments and Contingencies
On January 1, 2019,In the ordinary course of business, the Company adoptedmay enter into various types of transactions that include commitments to extend credit that are not included in its Condensed 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. Loan commitments can be either revolving or nonrevolving. The Company’s exposure to credit and market risk under commitments to extend credit is represented by the amount of these commitments.
Upon adoption of ASU 2016-02, Leases,2016-13, as further explaineddescribed in Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements.
AsPronouncements, the Company recorded an increase in the beginning ACL on unfunded commitments of June 30, 2019,$3.7 million, representing the Company’s lease ROU assets and related lease liabilities were $27.3 million and $28.6 million, respectively. The Company does not have leases designated as finance leases.

change in methodology from an estimate of incurred losses at the balance sheet date, with an estimated probability of funding, to an estimate of losses on future utilization over the entire contractual period.

The table below summarizes the net lease cost recognized during the periods presented:


 Three Months Ended June 30, 2019 Six Months Ended June 30, 2019
 (In thousands)
Operating Lease Cost$1,209
 $2,452
Variable Lease Cost174
 392
Sublease Income(61) (99)
Total net lease cost$1,322
 $2,745
The tables below summarizes other information related to the Company's operating leases during the periods presented:
 Three Months Ended June 30, 2019 Six Months Ended June 30, 2019
 (In thousands)
Cash paid for amounts included in the measurement of lease liabilities:   
Operating cash flows from operating leases$1,179
 $2,366
ROU assets obtained in exchange for lease liabilities, excluding adoption impact$
 $335
    
    
  As of June 30, 2019
Weighted average remaining lease term of operating leases in years 8.67
Weighted average discount rate of operating leases 3.33%

The following table outlines lease payment obligations as outlinedpresents outstanding commitments to extend credit, including letters of credit, at the dates indicated:
  March 31, 2020 December 31, 2019
  (In thousands)
Commercial business:    
Commercial and industrial $557,050
 $584,287
Owner-occupied commercial real estate 13,665
 17,193
Non-owner occupied commercial real estate 30,132
 35,573
Total commercial business 600,847
 637,053
Real estate construction and land development:    
One-to-four family residential 65,740
 75,066
Five or more family residential and commercial properties 201,003
 230,343
Total real estate construction and land development 266,743
 305,409
Consumer 256,312
 269,898
Total outstanding commitments $1,123,902
 $1,212,360
The following table details the activity in the Company’s lease agreements for each ofACL on unfunded commitments during the next five years, as of June 30, 2019, and thereafter in addition to a reconcilement to the Company’s right of use liability at the date indicated:three months ended March 31, 2020:
 Year Ending December 31,
 (In thousands)
2019$2,421
20204,581
20214,155
20223,730
20233,738
Thereafter14,220
Total lease payments32,845
Implied interest(4,271)
Right of use liability$28,574
 Three Months Ended
 March 31,
2020
 March 31,
2019
 (In thousands)
Balance, beginning of period$306
 $306
Impact of CECL adoption3,702
 
Adjusted balance, beginning of period4,008
 306
Reversal of provision for credit losses on unfunded commitments(2,018) 
Balance, end of period$1,990
 $306



For comparative purposes as of December 31, 2018, the estimated future minimum annual rental commitments under noncancelable leases having an original or remaining term of more than one year as calculated prior to applying the modified retrospective method of ASU 2016-02 implementation are as follows:
 Year Ending December 31,
 (In thousands)
2019$4,766
20204,251
20212,477
20221,704
20231,568
Thereafter1,788
 $16,554

As of June 30, 2019, the Company had not entered into any material leases that have not yet commenced.

(16)Income Taxes
The effective tax rate was 5.0% and 16.3% for the three months ended March 31, 2020 and 2019, respectively. The decrease in the effective tax rate was due to lower pre-tax income during the three months ended March 31, 2020, reflective of increasing tax-exempt investments, and a provision in the CARES Act, which permitted the Company to recognize a benefit from net operating losses related to prior acquisitions of $1.0 million during the quarter ended March 31, 2020.

(17)Subsequent Event
The Company began originating loans under the SBA's Paycheck Protection Program on April 6, 2020, including loans to independent contractors, sole proprietors and partnerships as allowed under the guidance from the U.S. Treasury and SBA that was issued April 14, 2020.
As of May 3, 2020, the Bank has funded 3,386 loans totaling $785.0 million and has received SBA approval on an additional 784 loans totaling $86.1 million. The average loan balance for funded and approved PPP loans was $216,000. The Bank earns 1% interest on these loans as well as a fee to cover processing costs.
Liquidity for the originations was initially provided from cash reserves. As fund are used and withdrawn by borrowers for operating expenses, the Bank expects to transition the entire funded balance to the Federal Reserve's Paycheck Protection Program Liquidity Facility.




ITEM 2.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 the Company as of and for the three and six months ended June 30, 2019.March 31, 2020. The information contained in this section should be read with the unaudited Condensed Consolidated Financial Statements and the accompanying Notes included herein, the Forward Looking Statements included herein, the Risk Factors included herein, and the December 31, 20182019 audited Consolidated Financial Statements and the accompanying Notes included in our 20182019 Annual Form 10-K.

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. At June 30, 2019,March 31, 2020, we had total assets of $5.38$5.59 billion, total liabilities of $4.58$4.79 billion and total stockholders’ equity of $796.6$798.4 million. 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.
Our business consists primarily of commercial lending and deposit relationships with small 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 one-to-four family residential loans on residential properties located primarily in our markets.
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 strives to match the repricing characteristics of the 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 affected significantly 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 on 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 loan losses.credit losses on loans. The provision for loancredit 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. The allowance for loanACL on loans was impacted during the three months ended March 31, 2020 based on the adoption of ASU 2016-13, which estimates losses over the life of the loans as compared to the prior model of incurred loss as of period end, and by forecasted credit deterioration due to the COVID-19 pandemic, as discussed below. Management believes that the ACL on loans reflects the amount that we believe is appropriate to provide for probable incurredcurrent expected credit losses in our loan portfolio.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 consistconsists primarily of lease payments, depreciation charges, maintenance, and costs of utilities. Data processing consists primarily of processing and network services related to the Bank’s core operating system, including account processing systems, electronic payments processing of products and services, and internet and mobile banking channels. Professional services consists primarily of third party service providers, such as consultants and software-as-a-service providers, and legal fees.
Results of operations may also be affected significantly by general and local economic and competitive conditions, governmental policies and actions of regulatory authorities. Other income and other expenses are also impacted by growth of operations and growth in the number of loan and deposit accounts through acquisitions and core banking business growth.
Because the length of the COVID-19 pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including the recent 150 basis point reductions in the targeted federal funds rate, until the pandemic subsides, the Company expects its net interest income and net interest margin will be adversely affected in the near term, if not longer.




COVID-19 Impact
In response to the COVID-19 pandemic, and in an effort to mitigate the adverse impact on our employees, customers and the communities we serve, the Bank has implemented various lending measures to address customer and community needs, including commercial lending, mortgage and consumer assistance. The Bank has also implemented various retail-impacting measures for the safety and health of customers and employees. The following provides details of the Bank's special programs and policies.
Commercial Lending Assistance
The Bank has made available the following short-term relief option to commercial borrowers affected by COVID-19:
Interest only payments on term debt for up to 90 days;
Temporary increases to line of credit commitments when supported by underlying assets, including changing the borrowing base formula or changing existing commitment restrictions to allow higher advance rates;
Full payment deferrals for up to 90 days when an interest only period does not provide sufficient relief (contingent on credit administration approval );
Loan re-amortization, especially in cases where significant prepayments of principal have occurred;
Covenant waivers and resets;
Processing new loan requests, such as a line of credit for working capital support;
Maturity extensions of up to 90 days for maturing lines of credit or term loans.
All commercial loans modified due to COVID-19 will be risk rated 6 ("Watch") except in certain cases where a borrower has performed well prior to the modification request and exhibits a strong financial position, or the loan has significant guarantor support. Further requests for relief beyond the initial modification will be reassessed for a more severe risk rating as part of the review process to grant further relief.
The Bank has implemented a special, streamlined 90-day interest only payment modification process for borrowers in certain industries as a result of the COVID-19 "stay at home" orders.
During the three months ended March 31, 2020 and as a direct result of cited COVID-19 related issues, the Bank had modified 134 commercial business loans totaling $77.5 million at March 31, 2020 and two commercial real estate construction and land development loans totaling $2.1 million at March 31, 2020. The most prevalent modification, totaling $49.4 million, was on amortizing loans, modifying the payments to interest only for a period of time, generally 90 days. The second most prevalent modification, totaling $23.8 million, was payment deferral for a period of time, generally 90 days. These modifications were not classified as TDRs at March 31, 2020 in accordance with the guidance of the CARES Act.
From April 1, 2020 through April 27, 2020, the Bank modified an additional 479 commercial and construction loans totaling $270.0 million at March 31, 2020. The most prevalent modification were interest-only periods and payment deferrals.
For TDR relationships, the Bank will work constructively with commercial borrowers to identify loan modifications that are based on the facts and circumstances of each borrower, and to protect the safety and soundness of the Bank.

Mortgage and Consumer Lending Assistance
In order to effectively manage or mitigate adverse impacts on mortgage and consumer borrowers affected by COVID-19, the Bank has implemented relief action through a streamlined approval process to include 90-day payment deferrals when the borrower meets the following criteria:
The borrower's ability to pay has been negatively impacted by COVID-19;
The loan is not over 30 days past due on the date of the request; and
The loan is risk rated "Pass" grade of 4 or better prior to the request for payment deferral.



Mortgage and consumer loans that do not meet the criteria to receive streamlined approval qualifications are considered outside of the automatic deferral process and will be evaluated on a case-by-case basis by the Bank's credit team. Certain consumer term loans with current balances over $100,000 with original terms over 96 months will also be reviewed on a case-by-case basis and will not qualify for the streamlined approval process. For consumer lines of credit, for borrowers that have sufficient available credit on their line, the borrower can draw on their line of credit to make payments in lieu of payment deferrals, and for borrowers that do not have sufficient available credit, the Bank will offer a 90-day payment deferral. However, after the deferral period these borrowers will be billed for the deferred months of accrued interest and the Bank will work with those borrowers unable to pay all months of interest at that time. For credit card customers, a skip payment option will be included in the borrowers' billing statements between April 1, 2020 and May 30, 2020.
All mortgage and consumer loans modified via the streamlined process due to COVID-19 will remain risk rated 4 ("Pass") through the initial 90-day relief period. This risk rating is subject to change should the Bank receive additional information within the 90-day relief period that borrower does not intend to repay the loan, which may result in a risk rating downgrade and the implementation of further collection efforts.
Borrowers under COVID-19 related deferral programs will not have negative data reported to the credit reporting agencies. Credit reporting will not be turned off on these accounts, but contractual due dates will be advanced in the core loan system with appropriate loan documentation to legally support the new due dates.
During three months ended March 31, 2020, the Bank modified 27 consumer loans due to COVID-19 related issues totaling $760,000 at March 31, 2020, all of which were not considered TDRs based on the guidance of the CARES Act. The Bank did not modify any mortgage loans as of March 31, 2020.
From April 1, 2020 through April 27, 2020, the Bank modified 775 consumer loans totaling $20.4 million at March 31, 2020. The majority of these modifications were payment deferrals. During the same period, the Bank modified 16 single family residence loans totaling $5.9 million at March 31, 2020, which were primarily extension of maturity dates.

SBA Paycheck Protection Program ("PPP")
Subsequent to March 31, 2020, the Bank began to offer PPP loans to its existing customers as a result of the COVID-19 pandemic. PPP loans are designed to provide a direct incentive for small businesses to keep their workers on the payroll, and the CARES Act allocated $349.0 billion to the program. Utilizing our internal technology solutions team, we were able to develop an automated platform to control and manage processing for PPP loans and began originations under this program on April 6, 2020. The Bank accepted applications for SBA loans, including loans to independent contractors, sole proprietors and partnerships as allowed under the guidance from the U.S. Treasury and SBA that was issued April 14, 2020.
As of May 3, 2020, the Bank has funded 3,386 loans totaling $785.0 million and has received SBA approval on an additional 784 loans totaling $86.1 million. The average loan balance for funded and approved PPP loans was $216,000. The Bank earns 1% interest on these loans as well as a fee to cover processing costs.
The Bank will utilize the Federal Reserve Bank's Paycheck Protection Program Liquidity Facility ("PPPLF") pursuant to which the Bank will pledge PPP loans as collateral to obtain Federal Reserve Bank non-recourse loans to support the origination of these loans, which will have a pass through effect on our liquidity position. The PPPLF will take the PPP loans as collateral at face value.

SBA Relief
Heritage is an active SBA lender in the Pacific Northwest, and had SBA loans totaling $65.1 million and $64.1 million at March 31, 2020 and December, 31, 2019, respectively. Subsequent to March 31, 2020, Heritage participated in the SBA's Debt Relief Program under the CARES Act. The Act appropriated $17.0 billion to subsidize small business loans. Under this program, the SBA will pay principal and interest to the following loans for a period of six months, commencing on payments due after March 27, 2020:
Current status 7(a) loans,
New 7(a) loans issued prior to September 27, 2020,
Lender portion of 504 loans,
SBA microloans.
Under this program, the borrowers will not have to reimburse the SBA or the Bank for these payments. If a borrower had already requested a payment deferral, and the deferral was granted, the six month period begins after



the deferment period. There is no limitation to the monthly principal and interest amount that the SBA will pay on behalf of the borrower. The first reimbursement was due on April 23, 2020, for eligible borrower payments that are due during the month of April. Due to the timing of the program implementation, Heritage has an obligation to inform borrowers that made payments between March 27, 2020 and April 23, 2020 that SBA is reimbursing for these amounts as part of the six months. The borrower can choose to receive a refund from Heritage or apply those funds to the loan as a principal payment. The borrower can also make other principal-only payments during the six month period. Heritage will be required to submit for reimbursement of the monthly payments due by the 10th of every following month.

Retail Policy Changes
The COVID-19 pandemic has caused significant disruptions to the Bank's operations and resulted in the implementation by the Bank of various social distancing measures to address customer and community needs.
Branch Lobby Closures. To ensure the safety of our customers and employees, most branches remain open with most services processed through the drive-up or by appointment.
Early Withdrawal Penalty Waivers. For customers that may need access to funds in their certificate of deposits to assist with living expenses during the COVID-19 pandemic, the Bank will assist these customers by waiving early withdrawal penalties for withdrawals up to $25,000.
Overdraft & Fee Reversals. Overdraft and fee reversals are waived on a case-by-case basis. The Bank is cautious when paying overdrafts beyond the customer's total deposit relationship, overdraft protection options or their overdraft coverage limits.
Employee Changes
Heritage has committed to keeping its employees safe during this COVID-19 pandemic. As a result, many policy changes have occurred during the three months ended March 31, 2020, including some that extended subsequent to the period. The following are a list of those significant measures:
Heritage follows the guidelines recommended by the Centers for Disease Control and/or local officials, such as social distancing and maintaining six feet of separation between employees.
Heritage has provided additional cleaning and disinfecting solutions to each location.
Significant number of back-office employees are working remotely.
Essential business travel is limited to those situations where business cannot reasonably be conducted without face-to-face interaction or visits to specific locations.
Certain front-line employees have been given additional hourly pay until further notice.
Heritage has offered up to 80 hours for full time employees of COVID-19 related absences, to use in lieu of sick or vacation time, for the employee's own illness, to care for an ill family member, due to a required self-isolation/quarantine or school/day care closures.

Heritage continues to monitor the situation and makes additional accommodations as necessary.

Earnings Summary
Comparison of quarter ended June 30, 2019March 31, 2020 to the comparable quarter in the prior year.
Net income was $16.0$12.2 million, or $0.43$0.33 per diluted common share, for the three months ended June 30, 2019March 31, 2020 compared to $11.9$16.6 million, or $0.35$0.45 per diluted common share, for the three months ended June 30, 2018.March 31, 2019. Net income increased $4.1decreased $4.4 million, or 34.8%26.3%, for the three months ended June 30, 2019March 31, 2020 compared to the three months ended June 30, 2018same period in 2019 primarily due to an increase in net interest incomethe provision for credit losses on loans of $6.8$10.0 million or 15.5%. The increase in net interest income compared to the prior period in 2018 was primarily due to an increase in both the average balance and yield on total loans receivable, net as a result of the Premier Merger completed July 2, 2018adoption of CECL and secondarilymanagement's forecast of credit deterioration due primarily to the economic impact of the COVID-19 pandemic, as compared to a provision for loan losses of $920,000 during the three months ended March 31, 2019 under the incurred loss methodology. The impact of the increase in the provision for credit losses on loans was offset partially by higher interest rates reflectinga reversal of provision for credit losses on unfunded commitments of $2.0 million as a result of a decrease in unfunded commitment balances; a decrease in income tax expense of $2.6 million, or 80.1%, due to lower pre-tax income, while increasing tax-exempt instruments, and a provision in the CARES Act permitting the recognition of benefit from net operating losses related to prior acquisitions; and an increase in noninterest income of $2.1 million, or 27.6%, related primarily to increases in the targeted federal funds rate during 2018.net gain on sale of investment securities and increases in BOLI income.
Net interest income as a percentage of average interest earning assets, (netor net interest margin) increased 11margin, decreased 28 basis points to 4.33%4.06% for the three months ended June 30, 2019March 31, 2020 compared to 4.22%4.34% for the same period in 2018.2019. The increasedecrease in net interest margin was due primarily due to decreases in yields of interest earning assets as a result of market interest rate decreases and increases in both the average balance and yield on loans and secondarily by increases in both the average balances and yields on investments, offset partially by increases in both the balance and cost of total interest bearing deposits.liabilities which often lag market interest rate decreases.



The efficiency ratio consists of noninterest expense divided by the sum of net interest income before provision for loancredit losses plus noninterest income. The Company’s efficiency ratio was 64.62%64.20% for the three months ended June 30, 2019March 31, 2020 compared to 69.58%63.84% for the three months ended June 30, 2018.March 31, 2019. The improvementchange in the efficiency ratio was primarily attributable to the increase net interest income as compared to the same quarter in 2018, as described above, in addition to lower acquisition-related expenses during the three months ended June 30, 2019.
Comparison of six months ended June 30, 2019 to the comparable period in the prior year.
Net income was $32.5 million, or $0.88 per diluted common share, fornoninterest expense and a decrease in the six months ended June 30, 2019 compared to $20.9 million, or $0.62 per diluted common share, for the six months ended June 30, 2018. Net income increased $11.6 million, or 55.3%, for the six months ended June 30, 2019 compared to the six months ended June 30, 2018 primarily due to an increase in net interest income of $15.7 million, or 18.6%. The increase in net interest income compared to the same period in 2018 was primarily due to an increase in both the average balance and yield of total loans receivable, net primarily as a result of the Premier and Puget Mergers completed during 2018 and secondarily by higher interest rates reflecting increases in targeted federal funds rate during 2018.
The net interest margin increased 17 basis points to 4.34% for the six months ended June 30, 2019 compared to 4.17% for the same period in 2018. The increase in net interest margin was primarily due to increases in both the average balance and yield on loans and secondarily by increases in both the average balances and yields on investments, offset partially by increases in both the balance and cost of interest bearing deposits.
The Company’s efficiency ratio was 64.23% for the six months ended June 30, 2019 compared to 72.67% for the six months ended June 30, 2018. The improvement in the efficiency ratio was primarily attributable to the increase net interest income as compared to the same period in 2018, as described above, in addition to lower acquisition-related expenses during the six months ended June 30, 2019.previously mentioned.

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 deposits and other liabilities and stockholders' equity; the volume of noninterest earning assets; market interest rate fluctuations; and asset quality.

Market rates impact the results of the Company's net interest income, including the significant decreases in the federal funds target rate by the Federal Reserve in response to the COVID-19 pandemic during the three months ended March 31, 2020. The following table provides the federal funds target rate history and changes from each period since December 31, 2018:
Change DateRate (%)Rate Change (%)
December 31, 20182.25 - 2.50%N/A
July 31, 20192.00 - 2.25%-0.25%
September 18, 20191.75 - 2.00%-0.25%
October 30, 20191.50 - 1.75%-0.25%
March 3, 20201.00 - 1.25%-0.50%
March 15, 20200.00 - 0.25%-1.00%

Comparison of quarter ended June 30, 2019March 31, 2020 to the comparable quarter in the prior year.
Net interest income increased $6.8decreased $1.2 million, or 15.5%2.5%, to $50.5$48.6 million for the three months ended June 30, 2019March 31, 2020 compared to $43.7$49.8 million for the same period in 2018.2019. The following table provides relevant net interest income information for the datesperiods indicated:



Three Months Ended June 30,Three Months Ended March 31,
2019 20182020 2019
Average
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate (1)
 
Average
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate
(1)
Average
Balance
 Interest
Earned/
Paid
 
Average
Yield/
Rate
(1)
 Average
Balance
 Interest
Earned/
Paid
 
Average
Yield/
Rate
(1)
(Dollars in thousands)(Dollars in thousands)
Interest Earning Assets:                      
Total loans receivable, net (2) (3)
$3,654,475
 $48,107
 5.28% $3,266,092
 $41,141
 5.05%
Loans receivable, net (2) (3)
$3,748,573
 $46,277
 4.97% $3,622,494
 $46,699
 5.23%
Taxable securities840,254
 5,933
 2.83
 638,092
 4,068
 2.56
815,686
 5,639
 2.78
 820,981
 5,823
 2.88
Nontaxable securities (3)
139,278
 893
 2.57
 201,104
 1,220
 2.43
122,153
 756
 2.49
 149,825
 950
 2.57
Other interest earning assets47,581
 283
 2.39
 51,022
 240
 1.89
Interest earning deposits125,357
 420
 1.35
 55,959
 335
 2.43
Total interest earning assets4,681,588
 55,216
 4.73% 4,156,310
 46,669
 4.50%4,811,769
 53,092
 4.44% 4,649,259
 53,807
 4.69%
Noninterest earning assets669,217
     570,409
    748,443
     668,066
    
Total assets$5,350,805
     $4,726,719
    $5,560,212
     $5,317,325
    
Interest Bearing Liabilities:                      
Certificates of deposit$514,220
 $1,694
 1.32% $418,129
 $797
 0.76%$528,009
 $2,012
 1.53% $502,153
 $1,440
 1.16%
Savings accounts500,135
 707
 0.57
 512,832
 487
 0.38
434,459
 188
 0.17
 507,670
 674
 0.54
Interest bearing demand and money market accounts2,016,901
 1,616
 0.32
 1,796,095
 911
 0.20
2,201,921
 2,016
 0.37
 2,051,046
 1,489
 0.29
Total interest bearing deposits3,031,256
 4,017
 0.53
 2,727,056
 2,195
 0.32
3,164,389
 4,216
 0.54
 3,060,869
 3,603
 0.48
Junior subordinated debentures20,620
 285
 5.56
 20,328
 354
 7.06
Securities sold under agreement to repurchase19,246
 33
 0.69
 33,055
 47
 0.58
FHLB advances and other borrowings42,101
 278
 2.65
 79,120
 402
 2.04
989
 1
 0.41
 1,849
 15
 3.29
Securities sold under agreement to repurchase29,265
 45
 0.62
 27,935
 16
 0.23
Junior subordinated debentures20,400
 340
 6.68
 20,108
 315
 6.28
Total interest bearing liabilities3,123,022
 4,680
 0.60% 2,854,219
 2,928
 0.41%3,205,244
 4,535
 0.57% 3,116,101
 4,019
 0.52%
Demand and other noninterest bearing deposits1,345,917
     1,175,331
    1,420,247
     1,332,223
    
Other noninterest bearing liabilities99,147
     60,434
    128,650
     102,550
    
Stockholders’ equity782,719
     636,735
    806,071
     766,451
    
Total liabilities and stockholders’ equity$5,350,805
     $4,726,719
    $5,560,212
     $5,317,325
    
Net interest income
 $50,536
     $43,741
  
 $48,557
     $49,788
  
Net interest spread    4.13%     4.09%    3.87%     4.17%
Net interest margin    4.33%     4.22%    4.06%     4.34%
Average interest earning assets to average interest bearing liabilities    149.91%     145.62%    150.12%     149.20%
(1)
(1) Annualized
(2) The average loan balances presented in the table are net of allowances for credit losses on loans. Nonaccrual loans have been included in the table as loans carrying a zero yield.
(3) Yields on tax-exempt securities and loans have not been stated on a tax-equivalent basis.
Annualized
(2)
The average loan balances presented in the table are net of allowances for loan losses. Nonaccrual loans have been included in the table as loans carrying a zero yield.
(3)
Yields on tax-exempt securities and loans have not been stated on a tax-equivalent basis.
Interest Income
Total interest income increased $8.5 million,decreased $715,000, or 18.3%1.3%, to $55.2$53.1 million for the three months ended June 30, 2019March 31, 2020 compared to $46.7$53.8 million for the same period in 2018.2019. The balance of average interest earning assets increased $525.3$162.5 million, or 12.6%3.5%, to $4.68$4.81 billion for the three months ended June 30, 2019March 31, 2020 from $4.16$4.65 billion for the three months ended June 30, 2018March 31, 2019 and the yield on total interest earning assets increased 23decreased 25 basis points to 4.73%4.44% for the three months ended June 30, 2019March 31, 2020 compared to 4.50%4.69% for the three months ended June 30, 2018.March 31, 2019. The increasedecrease in thetotal interest income was primarily due primarily to increaseda decrease in interest income from interest and fees on loans and interest income and to a lesser extent, an increase in interest income on investment securities.
Interest income from interest and fees on loans increased $7.0 million,decreased $422,000, or 16.9%0.9%, to $48.1$46.3 million for the three months ended June 30, 2019March 31, 2020 from $41.1$46.7 million for the same period in 20182019 due primarily due to an increasea decrease in average


total loans receivable, net of $388.4 million, or 11.9%, as a result of loan growth which was substantially due to the Premier Merger. Additionally, interest income from interest and fees on loans increased as the loan yield increased 23of 26 basis points to 5.28%4.97% for the three months ended June 30, 2019March 31, 2020 from 5.05%5.23% for the three months ended June 30, 2018.March 31, 2019. The increasedecrease in loan yield was primarily due to decreases in short-term market rates and secondarily due to a combination of higher contractual loan rates as a result of the increasing interest rate environment and an increase in loan yields from the loans acquired in the Premier Merger as compared to legacy Heritage loans, offset partially by afour basis points decrease in incremental accretion on purchased loans. The decrease in loan yield was partially offset by the increase in the average balance of loans receivable of $126.1 million, or 3.5%, to $3.75 billion during the three months ended March 31, 2020 compared to $3.62 billion during the three months ended March 31, 2019. Of



this increase, the average balance of construction real estate and land development loans increased $58.4 million, or 25.4%, to $288.1 million during the three months ended March 31, 2020 compared to $229.7 million during the same period in 2019. While the yield on construction loans decreased 0.71%, or 10.9%, to 5.77% during the three months ended March 31, 2020 compared to 6.47% for the same period in 2019, the yield represents the highest interest earning asset yield.
Incremental accretion income was $1.4$1.0 million and $2.0$1.4 million for the three months ended June 30,March 31, 2020 and 2019, and 2018, respectively. The adoption of ACS 326 on January 1, 2020 resulted in an increase of the noncredit purchase discount due to the PCI to PCD transition of $1.5 million, which positively impacted the accretion recognized during the quarter ended March 31, 2020. 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. The decrease for the three months ended June 30, 2019March 31, 2020 compared to the same period in 20182019 was substantially due primarily to less accretion on loans acquiredthe decrease in the Puget Sound Merger.purchased loan balance.
The following table presents the loan yield and effects of the incremental accretion on purchased loans for the three months ended June 30, 2019March 31, 2020 and 2018:2019:
 Three Months Ended June 30, Three Months Ended March 31,
 2019 2018 2020 2019
 (Dollars in thousands) (Dollars in thousands)
Yield non-GAAP reconciliations:(2)
Yield non-GAAP reconciliations:(2)
Loan yield (GAAP) 5.28% 5.05% 4.97% 5.23%
Exclude impact on loan yield from incremental accretion on purchased loans (1)
 0.16
 0.24
 0.11
 0.15
Loan yield, excluding incremental accretion on purchased loans (non-GAAP) (1)(2)
 5.12% 4.81% 4.86% 5.08%
        
Incremental accretion on purchased loans (1)
 $1,416
 $1,992
 $1,012
 $1,373
(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 representsRepresents the amount of interest income recorded on the purchased loans in excess of the contractual stated interest rate in the individual loan notes.notes due to incremental accretion of purchased discount or premium. Purchased discount or premium is the difference between the contractual loan balance and the fair value of acquired loans at the acquisition date, or as modified under ASU 2016-13 adoption. The purchased discount is accreted into income over the remaining life of the loan.
(2) 
For additional information, see "Non-GAAP Financial Information."
Interest income on investment securities increased $1.5 million,decreased $378,000, or 29.1%5.6%, to $6.4 millionduring the three months ended March 31, 2020 from $6.8 million during the three months ended June 30,March 31, 2019, primarily as a result of decreases in market interest rates impacting adjustable rate securities. Yields on taxable securities decreased 10 basis points to 2.78% for the three months ended March 31, 2020 from $5.32.88% for the same period in 2019. Yields on nontaxable securities decreased eight basis points to 2.49% for the three months ended March 31, 2020 from 2.57% for the same period in 2019. Additionally, the average balance of investment securities decreased by $33.0 million, or 3.4%, to $937.8 millionduring the three months ended June 30, 2018.March 31, 2020 from $970.8 millionduring the three months ended March 31, 2019. The increasedecrease in interest on investment securities was primarilyincluded a result of a $202.2$27.7 million, or 31.7% increase18.47%, decrease in the average balance of higher yielding taxable securities. A portion of this increasetax exempt securities and a $5.3 million, or 0.6%, decrease in the average balance of taxable securities wasas the Company actively managed portfolio performance in the changing interest rate environment.
Interest income on interest earning deposits increased $85,000, or 25.4%, to $420,000 during the three months ended March 31, 2020 from $335,000 during the three months ended March 31, 2019 due to the decision toa significant increase in the percentage of taxable securities compared to nontaxable securities. The average balance of total investment securities increased by $140.3interest earning deposits of $69.4 million, or 16.7%124.0%, to $979.5$125.4 million during the three months ended June 30, 2019 from $839.2March 31, 2020, representing 2.6% of total interest earning assets, compared to $56.0 million, or 1.2% of total interest earning assets, during the same period in 2019. The increase was primarily due to deposit growth which outpaced loan growth. These changes in percentage of interest earning deposits to total interest earning assets negatively impacted our net interest margin during the three months ended June 30, 2018. Additionally,March 31, 2020. The yield on interest income increased as a result of an increase in the investment yields, reflecting the effect of the rise in interest rates on our adjustable rate investment securities and secondarily dueearning deposits decreased 108 bps to higher yields on new investment purchases for1.35% during the three months ended June 30, 2019March 31, 2020 compared to 2.43% during the same period in 2018. Yields on taxable securities increased 27 basis points2019 due to 2.83% for the three months ended June 30, 2019 from 2.56% for the same perioda decrease in 2018. Yields on nontaxable securities increased 14 basis points to 2.57% for the three months ended June 30, 2019 from 2.43% for the same period in 2018. The Company actively managed its investment securities portfolio to improve performance in the changing rate environment over the past year.short-term market rates.
Interest Expense
Total interest expense increased $1.8 million,$516,000, or 59.8%12.8%, to $4.7$4.5 million for the three months ended June 30, 2019March 31, 2020 compared to $2.9$4.0 million for the same period in 2018,2019, due primarily due to an increase in the cost of interest bearing liabilities as a result of the rise in market interest rates and secondarily duelag the market's response to an increaselowering deposit pricing when the targeted federal funds rate decreased in the average balance substantially due to the Premier Merger.second half of 2019 and during 2020. The average cost of interest bearing liabilities increased 19five basis points



to 0.60%0.57% for the three months ended June 30, 2019March 31, 2020 from 0.41%0.52% for the three months ended June 30, 2018. TotalMarch 31, 2019. The average interest bearing liabilities increased $268.8$89.1 million, or 9.4%2.9%, to $3.12$3.21 billion forduring the three months ended June 30, 2019 from $2.85March 31, 2020 compared to $3.12 billion forduring the three months ended June 30, 2018.same period in 2019.
Interest expense on total interest bearing deposits increased $1.8 million,$613,000, or 83.0%17.0%, to $4.0$4.2 million for the three months ended June 30, 2019March 31, 2020 compared to $2.2$3.6 million for the same period in 2018 due to a combination of an increase in market interest rates, competitive pressures and an increase in the average balance2019 due primarily to competitive pressures in a challenging rate environment and the Premier Merger.lag in deposit repricing. The cost of total interest bearing deposits increased 21six basis points to 0.53%0.54% for the three months ended June 30, 2019March 31, 2020 from 0.32%


0.48% for the same period in 2018.2019. The average balance of total interest bearing deposits increased $103.5 million, or 3.4%, to $3.16 billion during the three months ended March 31, 2020 compared to $3.06 billion during the same period in 2019.
The increase in interest expense on total interest bearing deposits is primarily related to certificates of deposit and to a slightly lesser extent due to interest bearing demand and money market deposits. The cost of certificates of deposit increased 5637 basis points to 1.32%1.53% for the three months ended June 30, 2019March 31, 2020 from 0.76%1.16% for the same period in 2018. The2019, and the average balance of certificatecertificates of deposit accounts increased $96.1$25.9 million, or 23.0%5.1%, to $514.2$528.0 million for the three months ended June 30, 2019March 31, 2020 compared to $418.1$502.2 million for the same period in 2018.2019. The cost of interest bearing demand and money market deposits increased 12eight basis points to 0.32%0.37% for the three months ended June 30, 2019March 31, 2020 from 0.20%0.29% for the same period in 2018,2019, and the average balance of interest bearing demand and money market deposits increased $220.8$150.9 million, or 12.3%7.4%, to $2.02$2.20 billion at June 30, 2019 duringfor the three months ended June 30, 2019March 31, 2020 compared to $1.80$2.05 billion duringfor the same period in 2018.2019.
The Company was able to reduce the impact of the rising marketincreasing cost of interest ratesbearing deposits by increasing the average balance of demand and other noninterest bearing deposits at a higher growth rate than thecompared to total interest bearing deposits described above.deposits. The average balance of demand and other noninterest bearing deposits increased by $170.6$88.0 million, or 14.5%6.6%, to $1.35$1.42 billion for the three months ended June 30, 2019March 31, 2020 compared to $1.18$1.33 billion for the same period in 2018 due primarily to the Premier Merger.2019. The total cost of total deposits increased 14four basis points to 0.37% for the three months ended June 30, 2019March 31, 2020 compared to 0.23%0.33% for the same period in 2018.
Interest expense on FHLB advances and other borrowings decreased by $124,000, or 30.8%, to $278,000 for the three months ended June 30, 2019 compared to $402,000 for the same period in 2018 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 by $37.0 million, or 46.8%, to $42.1 million for the three months ended June 30, 2019 compared to $79.1 million for the same period in 2018 due to a decline in the utilization of overnight FHLB advances reflecting the increase in the average deposit balances. The average rate of the FHLB advances and other borrowings increased 61 basis points to 2.65% for the three months ended June 30, 2019 compared to 2.04% for the same period in 2018 as a result of the increase in market rates.2019.
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, increased 40decreased 150 basis points to 6.68%5.56% for the three months ended June 30, 2019March 31, 2020 compared to 6.28%7.06% for the same period in 2018.2019. The rate increasedecrease on the debentures was due to an increasea decrease in the average three-month LIBOR rate to 2.51%1.53% for the three months ended June 30, 2019March 31, 2020 from 2.34%2.69% for the same period in 2018.2019.
Net Interest Margin
Net interest margin increased 11decreased 28 basis points to 4.33%4.06% for the three months ended June 30, 2019March 31, 2020 from 4.22%4.34% for the same period in 20182019 primarily due to the above mentioned changes in asset yields and costs of funds. The net interest spread increased fourdecreased 30 basis points to 4.13%3.87% for the three months ended June 30, 2019March 31, 2020 from 4.09%4.17% for the same period in 20182019 primarily due to the increasedecrease in the yield earned on totalof interest earning assets.
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 three months ended June 30, 2019March 31, 2020 and 2018:2019:
 Three Months Ended June 30, Three Months Ended March 31,
 2019 2018 2020 2019
Net interest margin (GAAP) 4.33% 4.22% 4.06% 4.34%
Exclude impact on net interest margin from incremental accretion on purchased loans (1)
 0.12
 0.19
 0.08
 0.12
Net interest margin, excluding incremental accretion on purchased loans (non-GAAP)(1)(2)
 4.21% 4.03% 3.98% 4.22%
(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 representsRepresents the amount of interest 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."


Comparison of six months ended June 30, 2019notes due to incremental accretion of purchased discount or premium. Purchased discount or premium is the comparable period in the prior year
Net interest income increased $15.7 million, or 18.6%, to $100.3 million for the six months ended June 30, 2019 compared to $84.6 million for the same period in 2018. The following table provides relevant net interest income information for the dates indicated:

 Six Months Ended June 30,
 2019 2018
 
Average
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate (1)
 
Average
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate
 (1)
 (Dollars in thousands)
Interest Earning Assets:           
Total loans receivable, net (2) (3)
$3,638,573
 $94,806
 5.25% $3,208,799
 $79,300
 4.98%
Taxable securities830,671
 11,756
 2.85
 614,488
 7,597
 2.49
Nontaxable securities (3)
144,522
 1,843
 2.57
 212,305
 2,561
 2.43
Other interest earning assets51,747
 618
 2.41
 52,302
 458
 1.77
Total interest earning assets4,665,513
 109,023
 4.71% 4,087,894
 89,916
 4.44%
Noninterest earning assets668,644
     552,736
    
Total assets$5,334,157
     $4,640,630
    
Interest Bearing Liabilities:           
Certificates of deposit$508,220
 $3,133
 1.24% $420,834
 $1,557
 0.75%
Savings accounts503,882
 1,381
 0.55
 509,514
 902
 0.36
Interest bearing demand and money market accounts2,033,878
 3,106
 0.31
 1,771,084
 1,696
 0.19
Total interest bearing deposits3,045,980
 7,620
 0.50
 2,701,432
 4,155
 0.31
FHLB advances and other borrowings22,086
 294
 2.68
 57,546
 552
 1.93
Securities sold under agreement to repurchase31,149
 91
 0.59
 29,094
 33
 0.23
Junior subordinated debentures20,364
 694
 6.87
 20,071
 598
 6.01
Total interest bearing liabilities3,119,579
 8,699
 0.56% 2,808,143
 5,338
 0.38%
Demand and other noninterest bearing deposits1,339,108
     1,144,479
    
Other noninterest bearing liabilities100,840
     62,094
    
Stockholders’ equity774,630
     625,914
    
Total liabilities and stockholders’ equity$5,334,157
     $4,640,630
    
Net interest income  $100,324
     $84,578
  
Net interest spread    4.15%     4.06%
Net interest margin    4.34%     4.17%
Average interest earning assets to average interest bearing liabilities    149.56%     145.57%
(1)
Annualized
(2)
The average loan balances presented in the table are net of allowances for loan losses. Nonaccrual loans have been included in the table as loans carrying a zero yield.
(3)
Yields on tax-exempt securities and loans have not been stated on a tax-equivalent basis.
Interest Income
Total interest income increased $19.1 million, or 21.2%, to $109.0 million for the six months ended June 30, 2019 compared to $89.9 million for the same period in 2018. The balance of average interest earning assets increased $577.6 million, or 14.1%, to $4.67 billion for the six months ended June 30, 2019 from $4.09 billion for the six months ended June 30, 2018 and the yield on total interest earning assets increased 27 basis points to 4.71% for the six months ended June 30, 2019 compared to 4.44% for the six months ended June 30, 2018. The increase in the interest


income was due primarily to increased interest income from interest and fees on loans and to a lesser extent, an increase in interest income on investment securities.
Interest income from interest and fees on loans increased $15.5 million, or 19.6%, to $94.8 million for the six months ended June 30, 2019 from $79.3 million for the same period in 2018 due primarily to an increase in average loans receivable, net and an increase in loan yields. Average total loans receivable, net increased $429.8 million, or 13.4%, to $3.64 billion for the six months ended June 30, 2019 compared to $3.21 billion for the six months ended June 30, 2018 primarily as a result of the Premier Merger. Loan yields increased 27 basis points to 5.25% for the six months ended June 30, 2019 from 4.98% for the six months ended June 30, 2018. The increase in loan yield was due to a combination of higher contractual loan rates as a result of the increasing interest rate environment and an increase in loan yields from the loans acquired in the Premier Merger as compared to legacy Heritage loans, offset partially by a decrease in incremental accretion on purchased loans.
Incremental accretion income was $2.8 million and $3.6 million for the six months ended June 30, 2019 and 2018, respectively. 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 decrease for the six months ended June 30, 2019 compared to the same period in 2018 was substantially due to less accretion on loans acquired in the Puget Sound Merger.
The following table presents the loan yield and effects of the incremental accretion on purchased loans for the six months ended June 30, 2019 and 2018:
  Six Months Ended June 30,
  2019 2018
  (Dollars in thousands)
Loan yield (GAAP) 5.25% 4.98%
Exclude impact on loan yield from incremental accretion on purchased loans (1)
 0.15
 0.23
Loan yield, excluding incremental accretion on purchased loans (non-GAAP) (1)(2)
 5.10% 4.75%
     
Incremental accretion on purchased loans (1)
 $2,789
 $3,624
(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 representsof acquired loans at the purchased discount.acquisition date, or as modified under ASU 2016-13 adoption. 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 $3.4 million, or 33.9%, to $13.6 million during the six months ended June 30, 2019 compared to $10.2 million for the six months ended June 30, 2018. The increase in interest income on investment securities was primarily a result of a result of a $216.2 million or 35.2% increase in the average balance of higher yielding taxable securities. A portion of this increase in the average balance of taxable securities was due to the decision to increase the percentage of taxable securities compared to nontaxable securities. The average balance of total investment securities increased $148.4 million, or 17.9%, to $975.2 million during the six months ended June 30, 2019 from $826.8 million during the six months ended June 30, 2018. Additionally, interest income increased as a result of an increase in the investment yields, reflecting the effect of the rise in interest rates on the adjustable rate investment securities and secondarily due to higher yields on new investment purchases during the six months ended June 30, 2019 compared to the same period in 2018. Yields on taxable securities increased 36 basis points to 2.85% for the six months ended June 30, 2019 compared to 2.49% for the same period in 2018. Yields on nontaxable securities increased 14 basis points to 2.57% for the six months ended June 30, 2019 from 2.43% for the same period in 2018. The Company has actively managed its investment securities portfolio to improve performance.
Interest Expense
Total interest expense increased $3.4 million, or 63.0%, to $8.7 million for the six months ended June 30, 2019 compared to $5.3 million for the same period in 2018. The average cost of interest bearing liabilities increased 18 basis points to 0.56% for the six months ended June 30, 2019 from 0.38% for the six months ended June 30, 2018 as a result of the rise in market rates and an increase in the average balance. Total average interest bearing liabilities


increased $311.4 million, or 11.1%, to $3.12 billion for the six months ended June 30, 2019 from $2.81 billion for the six months ended June 30, 2018 substantially due to the Premier Merger.
Interest expense on deposits increased $3.5 million, or 83.4%, to $7.6 million for the six months ended June 30, 2019compared to $4.2 million for the same period in 2018 due to a combination of an increase in market interest rates and competitive pressures and an increase in the average balance due primarily to the Premier Merger. The cost of interest bearing deposits increased 19 basis points to 0.50% for the six months ended June 30, 2019 from 0.31% for the same period in 2018. The increase of interest expense on deposits is primarily related to the certificates of deposit and to a slightly lesser extent due to interest bearing demand and money market deposits accounts. The cost of certificates of deposit increased 49 basis points to 1.24% for the six months ended June 30, 2019 from 0.75% for the same period in 2018. The average balance of certificate of deposit accounts increased $87.4 million, or 20.8%, to $508.2 million for the six months ended June 30, 2019 compared to $420.8 million for the same period in 2018. The cost of interest bearing demand and money market deposits increased 12 basis points to 0.31% for the six months ended June 30, 2019 from 0.19% for the same period in 2018, and the average balance of interest bearing demand and money market deposits increased $262.8 million, or 14.8%, to $2.03 billion during the six months ended June 30, 2019 compared to $1.77 billion during the same period in 2018.
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 the interest bearing deposits described above. The average balance of noninterest bearing deposits increased $194.6 million, or 17.0%, to $1.34 billion for the six months ended June 30, 2019 compared to $1.14 billion for the same period in 2018. The total cost of deposits increased 13 basis points to 0.35% for the six months ended June 30, 2019 compared to 0.22% for the same period in 2018.
Interest expense on FHLB advances and other borrowings decreased $258,000, or 46.7%, to $294,000 for the six months ended June 30, 2019 from $552,000 for the six months ended June 30, 2018 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 by $35.5 million, or 61.6%, to $22.1 million for the six months ended June 30, 2019 from $57.5 million for the same period in 2018 due to a decline in the utilization of overnight FHLB advances reflecting the increase in the average deposit balances. The average rate of the FHLB advances and other borrowings increased 75 basis points to 2.68% for the six months ended June 30, 2019 compared to 1.93% for the same period in 2018 as a result of the increase in market rates.
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, increased 86 basis points to 6.87% for the six months ended June 30, 2019 compared to 6.01% for the same period in 2018. The rate increase on the debentures was due to an increase in the average three-month LIBOR rates to 2.60% for the six months ended June 30, 2019 from 2.13% for the same period in 2018.
Net Interest Margin
Net interest margin increased 17 basis points to 4.34% for the six months ended June 30, 2019 from 4.17% for the same period in 2018 primarily due to the above mentioned changes in asset yields and costs of funds. The net interest spread increased nine basis points to 4.15% for the six months ended June 30, 2019 from 4.06% for the same period in 2018 primarily due to the increase in yield earned on total interest earning assets.


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 six months ended June 30, 2019 and 2018:

  Six Months Ended June 30,
  2019 2018
Net interest margin (GAAP) 4.34% 4.17%
Exclude impact on net interest margin from incremental accretion on purchased loans (1)
 0.12
 0.18
Net interest margin, excluding incremental accretion on purchased loans (non-GAAP) (1)(2)
 4.22% 3.99%
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.loan.
(2) 
For additional information, see "Non-GAAP Financial Information."




Provision for LoanCredit Losses
Comparison of quarter ended June 30, 2019March 31, 2020 to the comparable quarter in the prior year.
Effective January 1, 2020, the Bank adopted ASU 2016-13. The adoption replaced the allowance for loan losses with the ACL on loans and replaced the related provision for loan losses with the provision for credit losses on loans. The adoption also replaced the allowance for unfunded commitments with the ACL on unfunded commitments and replaced the related provision for unfunded commitments with the provision for credit losses on unfunded commitments. The aggregate of the provision for credit losses on loans and the provision for credit losses on unfunded commitments is presented on the Company's Condensed Consolidated Statements of Income as the provision for credit losses. The ACL on unfunded commitments is included on the Company's Condensed Consolidated Statements of Financial Condition as accrued expenses and other liabilities.
The following table presents the provision for credit losses for the periods presented below:
 Three Months Ended
 March 31,
2020
 March 31,
2019
 (In thousands)
Provision for credit losses on loans$9,964
 $920
Reversal of provision for credit losses on unfunded commitments(2,018) 
Total$7,946
 $920
Provision for Credit Losses on Loans
The Bank has established a comprehensive methodology for determining its allowance for loan losses.ACL on loans. The allowance for loan lossesACL on loans is increased by provisions for loancredit losses on loans charged to expense, which is comprised of the reserve build and the net credit losses. Net credit losses is the mechanism used to increase the allowance by the net charge-offs as the ACL on loans is reduced by loans charged-off,loan charge-offs, net of loan recoveries or a recovery of previous provision.recoveries. The amount of the provision expense recognized during the three and six months ended June 30, 2019 and 2018March 31, 2020 was calculated in accordance with the Bank's CECL methodology. The amount of the provision expense recognized during the three months ended March 31, 2019 was calculated in accordance with the Bank's incurred loss methodology. For additional information, see the section entitled "Analysis of Allowance for Loan Losses"Credit Losses on Loans" below.
The provision for loancredit losses on loans 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 further decline in general economic conditions, including as a result of COVID-19, could increase future provisions for loancredit losses on loans and have a material adverse effect on the Company’s net income.
The provision for loancredit losses decreased $383,000, or 21.9%,on loans increased $9.0 million to $1.4$10.0 million for the three months ended June 30, 2019March 31, 2020 from $1.8 million$920,000 for the three months ended June 30, 2018March 31, 2019 due primarily due to lower growththe adoption of CECL and the change in methodology to a current expected credit loss over the life of the loan from an incurred loss at the balance sheet date. The provision for credit losses on loans receivable, net during the three months ended June 30,March 31, 2019 comparedincluded approximately $6.9 million of expense related to the same period in 2018 in additionforecasted credit deterioration due to continued relatively stable and strong credit quality metrics.the impact of the COVID-19 pandemic. Based on a thorough review of the loan portfolio, the Bank determined that the provision for loancredit losses on loans for the three months ended June 30, 2019March 31, 2020 was appropriate as it was calculated in accordance with the Bank's CECL methodology for determining the allowancecurrent expected credit losses on loans.
Reversal of Provision for loan losses.Credit Losses on Unfunded Commitments
Comparison of six months ended June 30, 2019The Bank has established a comprehensive methodology for determining its ACL on unfunded commitments, which is similar to the comparable period inACL on loans with additional considerations for the prior year.likelihood of funding over the contractual life of the commitment. Upon adoption of CECL, the Bank recorded a $3.7 million adjustment to the ACL on unfunded commitment, bringing the adjusted beginning balance to $4.0 million. The majority of the allowance was related to the commercial construction loan portfolio which had a utilization rate on the commitment of 42.4% at December 31, 2019.
The Bank recorded a reversal of provision for loancredit losses decreased $615,000, or 21.2%, to $2.3on unfunded commitments of $2.0 million for the sixthree months ended June 30, 2019 from $2.9 million for the six months ended June 30, 2018. TheMarch 31, 2020 due to a decrease in the provision forunfunded commercial construction loan losses forbalance, resulting from increased funding of the sixunderlying projects during the three months ended June 30, 2019 fromMarch 31, 2020. The commercial construction utilization rate on the same periodcommitment was 35.6% at March 31, 2020. The Company expects volatility in 2018 was primarilythis provision and related allowance based on the resulttiming of lower loan growth in addition to the mixoriginations, commitments, and volumefunding of the loan portfolio during the six months ended June 30, 2019. Based on a thorough review of the loan portfolio, the Bank determined that the provision for loan losses for the six months ended June 30, 2019 was appropriate as it was calculated in accordance with the Bank's methodology for determining the allowance for loan losses.its construction portfolio.




Noninterest Income
Comparison of quarter ended June 30, 2019March 31, 2020 to the comparable quarter in the prior year.
Total noninterest income remained constant at $7.6increased $2.1 million, or 27.6%, to $9.5 million for the three months ended June 30, 2019 and 2018.March 31, 2020 from $7.4 million for the same period in 2019. The following table presents the change in the key components of noninterest income for the periods noted:
Three Months Ended 
 June 30,
    Three Months Ended
March 31,
    
2019 2018 Change Percentage Change2020 2019 Change Percentage Change
(Dollars in thousands)(Dollars in thousands)
Service charges and other fees$4,845
 $4,695
 $150
 3.2 %$4,376
 $4,485
 $(109) (2.4)%
Gain on sale of investment securities, net33
 18
 15
 83.3
1,014
 15
 999
 6,660.0
Gain on sale of loans, net368
 706
 (338) (47.9)547
 252
 295
 117.1
Interest rate swap fees161
 309
 (148) (47.9)296
 
 296
 100.0
Other income2,157
 1,847
 310
 16.8
3,247
 2,677
 570
 21.3
Total noninterest income$7,564
 $7,575
 $(11) (0.1)%$9,480
 $7,429
 $2,051
 27.6 %
Gain on sale of investment securities, net, increased $999,000 to $1.0 million for the three months ended March 31, 2020 compared to $15,000 for the same period in 2019 as a result of the Bank's active management of the investment portfolio in the current rate environment.
Other income increased $570,000, or 21.3%, to $3.2 million for the three months ended March 31, 2020 compared to $2.7 million for the same period in 2019 due primarily to the gain on a BOLI death benefit of $332,000 recognized during the three months ended March 31, 2020.
Interest rate swap fees increased to $296,000 for the three months ended March 31, 2020 compared to no interest rate swap fee in the same period in 2019 as a result of an increased volume of executed interest rate swap contracts.
Gain on sale of loans, net, decreased $338,000,increased $295,000, or 47.9%117.1%, to $368,000$547,000 for the three months ended June 30, 2019March 31, 2020 compared to $706,000$252,000 for the same period in 2018 primarily2019 due to lowerincreased mortgage origination volume. Mortgage loan originations decreasedincreased by $7.9$7.4 million, or 40.4%86.2%, to $11.7$16.0 million for the three months ended June 30, 2019March 31, 2020 from $19.7 millionfor the three months ended June 30, 2018. Proceeds from mortgage loan sales decreased by $8.0 million, or 41.2%, to $11.4 million for the three months ended June 30, 2019 from $19.3 millionfor the three months ended June 30, 2018. The Company also recognized a decrease in the gain on sale of the guaranteed portion of SBA loans during the three months ended June 30, 2019 compared to the same period in 2018 as it was more advantageous for the Company to portfolio these loans based on a lower gain environment. The detail of gain on sale of loans, net is included in the following schedule:
 Three Months Ended 
 June 30,
    
 2019 2018 Change Percentage Change
 (Dollars in thousands)
Gain on sale of mortgage loans, net$368
 $572
 $(204) (35.7)%
Gain on sale of guaranteed portion of SBA loans, net
 134
 (134) (100.0)
     Gain on sale of loans, net$368
 $706
 $(338) (47.9)%
The decreases in gain on sale of loans, net was offset partially by an increase in other income of $310,000, or 16.8%, to $2.2 million for the three months ended June 30, 2019 compared to $1.8$8.6 million for the same period in 20182019 primarily due primarily to increases in recoveries of zero-balance purchased loan notes which were charged-off prior to the consummation of the related acquisition during the three months ended June 30, 2019. These recoveries were primarily from the merger with Washington Banking Company which was effective May 1, 2014.


Comparison of six months ended June 30, 2019 to the comparable period in the prior year
Total noninterest income decreased $130,000, or 0.9%, to $15.0 million for the six months ended June 30, 2019 compared to $15.1 million for the same period in 2018. The following table presents the change in the key components of noninterest income for the periods noted:increased refinance activity reflecting lower market interest rates.
 Six Months Ended 
 June 30,
    
 2019 2018 Change Percentage Change
 (Dollars in thousands)
Service charges and other fees$9,330
 $9,238
 $92
 1.0 %
Gain on sale of investment securities, net48
 53
 (5) (9.4)
Gain on sale of loans, net620
 1,580
 (960) (60.8)
Interest rate swap fees161
 360
 (199) (55.3)
Other income4,834
 3,892
 942
 24.2
Total noninterest income$14,993
 $15,123
 $(130) (0.9)%
Gain on sale of loans, net decreased $960,000, or 60.8%, to $620,000 for the six months ended June 30, 2019 compared to $1.6 million for the same period in 2018 primarily due to lower mortgage origination volume. Mortgage loan originations decreased by $19.7 million, or 49.2%, to $20.3 million for the six months ended June 30, 2019 from $40.0 millionfor the six months ended June 30, 2018. Proceeds from mortgage loan sales decreased by $21.2 million, or 52.9%, to $18.8 million for the six months ended June 30, 2019 from $40.0 millionfor the six months ended June 30, 2018. Additionally, the gain on sale of the guaranteed portion of SBA loans decreased during the six months ended June 30, 2019 compared to the same period in 2018 as it was more advantageous for the Company to keep these loans in the portfolio during 2019 based on market rates. The following table presents gain on sale of loans, net for the periods noted:
 Six Months Ended 
 June 30,
  
 2019 2018 Change Percentage Change
 (Dollars in thousands)
Gain on sale of mortgage loans, net$620
 $1,224
 $(604) (49.3)%
Gain on sale of guaranteed portion of SBA loans, net
 356
 (356) (100.0)
     Gain on sale of loans, net$620
 $1,580
 $(960) (60.8)%
The decreases in noninterest income from the gain on sale of loans, net was offset partially by an increase in other income of $942,000, or 24.2%, to $4.8 million for the six months ended June 30, 2019 compared to $3.9 million for the same period in 2018 due primarily to increases in recoveries of zero-balance purchased loan notes which were charged-off prior to the consummation of the related acquisition during the six months ended June 30, 2019. These recoveries were also primarily from our merger with Washington Banking Company.




Noninterest Expense
Comparison of quarter ended June 30, 2019March 31, 2020 to the comparable quarter in the prior year.
Noninterest expense increased $1.8 million,$735,000, or 5.2%2.0%, to $37.5$37.3 million during the three months ended June 30, 2019March 31, 2020 from $35.7$36.5 million during the three months ended June 30, 2018. There were no acquisition-related expenses incurred during the three months ended June 30,March 31, 2019. Acquisition-related expenses incurred as a result of the Premier and Puget Mergers were $880,000 during the three months ended June 30, 2018of which $425,000 and $337,000 were due to data processing expense and professional services expense, respectively. The following table presents changes in the key components of noninterest expense for the periods noted:
 Three Months Ended June 30,    
 2019 2018 Change Percentage Change
 (Dollars in thousands)
Compensation and employee benefits$21,982
 $19,321
 $2,661
 13.8 %
Occupancy and equipment5,451
 4,810
 641
 13.3
Data processing2,109
 2,507
 (398) (15.9)
Marketing1,106
 823
 283
 34.4
Professional services1,305
 3,529
 (2,224) (63.0)
State and local taxes809
 716
 93
 13.0
Federal deposit insurance premium426
 375
 51
 13.6
Other real estate owned, net289
 
 289
 100.0
Amortization of intangible assets1,026
 796
 230
 28.9
Other expense3,044
 2,829
 215
 7.6
Total noninterest expense$37,547
 $35,706
 $1,841
 5.2 %
Acquisition-related expenses incurred as a result of the Premier and Puget Mergers during the three months ended June 30, 2019 and 2018 are included in the following components of noninterest expense:
 Three Months Ended June 30,
 2019 2018
 (Dollars in thousands)
Compensation and employee benefits$
 $67
Occupancy and equipment
 28
Data processing
 425
Marketing
 5
Professional services
 337
Other expense
 18
Total acquisition costs$
 $880
Compensation and employee benefits increased $2.7 million, or 13.8%, to $22.0 million during the three months ended June 30, 2019 from $19.3 million during the three months ended June 30, 2018 primarily as a result of additional employees acquired in the Premier Merger and the expansion of the commercial banking team in greater Portland, Oregon. The average full time equivalent employees increased to 880 for the three months ended June 30, 2019 compared to 819 for the same period in 2018.
Occupancy and equipment increased $641,000, or 13.3%, to $5.5 million during the three months ended June 30, 2019 from $4.8 million during the three months ended June 30, 2018 primarily due to five leases acquired in the Premier Merger.
Professional services decreased $2.2 million, or 63.0%, to $1.3 million during the three months ended June 30, 2019 from $3.5 million during the three months ended June 30, 2018 primarily due to the buy-out of a third-party contract in the amount of $1.7 million during the three months ended June 30, 2018 and due to no acquisition-related expenses during the three months ended June 30, 2019. The third-party contract related to the Company’s deposit product realignment and after assessment, the Company determined that it was advantageous to buy-out the contract


prior to the system conversions relating to the Premier Merger. 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.
The ratio of noninterest expense to average total assets (annualized) was 2.81% for the three months ended June 30, 2019 compared to 3.03% for the three months ended June 30, 2018. The decrease was primarily due to the buy-out of a third party contract during the three months ended June 30, 2018 and the absence of acquisition-related expenses during the three months ended June 30, 2019.
Comparison of six months ended June 30, 2019 to the comparable period in the prior year
Noninterest expense increased $1.6 million, or 2.2%, to $74.1 million during the six months ended June 30, 2019 compared to $72.5 million for the six months ended June 30, 2018. The following table presents changes in the key components of noninterest expense for the periods noted:
 Six Months Ended June 30,    
 2019 2018 Change Percentage Change
 (Dollars in thousands)
Compensation and employee benefits$43,896
 $40,688
 $3,208
 7.9 %
Occupancy and equipment10,909
 9,437
 1,472
 15.6
Data processing4,282
 5,112
 (830) (16.2)
Marketing2,204
 1,631
 573
 35.1
Professional services2,478
 6,366
 (3,888) (61.1)
State and local taxes1,607
 1,404
 203
 14.5
Federal deposit insurance premium711
 730
 (19) (2.6)
Other real estate owned, net375
 
 375
 100.0
Amortization of intangible assets2,051
 1,591
 460
 28.9
Other expense5,559
 5,494
 65
 1.2
Total noninterest expense$74,072
 $72,453
 $1,619
 2.2 %

Acquisition-related expenses incurred as a result of the Premier and Puget Mergers during the six months ended June 30, 2019 and 2018 are included in the following components of noninterest expense:
Six Months ended June 30,Three Months Ended March 31,    
2019 20182020 2019 Change Percentage Change
(Dollars in thousands)(Dollars in thousands)
Compensation and employee benefits$76
 $2,891
$22,506
 $21,914
 $592
 2.7 %
Occupancy and equipment
 37
5,731
 5,458
 273
 5.0
Data processing55
 777
2,360
 2,173
 187
 8.6
Marketing
 5
866
 1,098
 (232) (21.1)
Professional services1
 1,935
1,377
 1,173
 204
 17.4
State/municipal business and use tax757
 798
 (41) (5.1)
Federal deposit insurance premium
 285
 (285) (100.0)
Other real estate owned, net25
 86
 (61) (70.9)
Amortization of intangible assets903
 1,025
 (122) (11.9)
Other expense
 43
2,735
 2,515
 220
 8.7
Total acquisition costs$132
 $5,688
Total noninterest expense$37,260
 $36,525
 $735
 2.0 %
Compensation and employee benefits increased $3.2 million,$592,000, or 7.9%2.7%, to $43.9$22.5 million duringfor the sixthree months ended June 30, 2019March 31, 2020 from $40.7$21.9 million during the six months ended June 30, 2018 primarily as a result of additional employees acquired in the Premier Merger, the expansion of the commercial banking team in greater Portland, Oregon and standard salary increases The average full time equivalent employees increased to 879 for the six months ended June 30, 2019 compared to 808 for the same period in 2018.2019 as a result of an increase in salaries and related payroll taxes, an increase in benefits and costs related to a new medical plan, and an increase in stock compensation expense.
Occupancy and equipment increased $1.5 million,$273,000, or 15.6%5.0%, to $10.9$5.7 million during the six months ended June 30, 2019 from $9.4 million during the six months ended June 30, 2018 due substantially to branch expansion, including additional leased space in Seattle and Bellevue, Washington and in 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.


Marketing increased $573,000, or 35.1%, to $2.2 million during the six months ended June 30, 2019 from $1.6 million during the six months ended June 30, 2018 primarily due to timing of various marketing campaigns.
Professional services decreased $3.9 million, or 61.1%, to $2.5 million during the six months ended June 30, 2019 from $6.4 million during the six months ended June 30, 2018 primarily due to the buy-out of a third-party contract in the amount of $1.7 million discussed above for the three months ended June 30,March 31, 2020 from $5.5 million for the same period in 2019 due mostly to depreciation and dueoperating costs associated with a new operations center in Tacoma, Washington which was placed into service in December 2019.
There was no federal deposit insurance premium expense for the three months ended March 31, 2020 compared to lower acquisition related expenses$285,000 for the same period in 2019 as a result of a small bank credit awarded by the FDIC recognized during the six monthsquarter ended June 30, 2019.March 31, 2020. The Bank has $139,000 in small bank credits on future assessments remaining as of March 31, 2020, which may be recognized in future periods when allowed for by the FDIC upon insurance fund levels being met.
The ratio of noninterest expense to average total assets (annualized) was 2.80% 2.70%for the sixthree months ended June 30, 2019,March 31, 2020 compared to 3.15%2.79% for the sixthree months ended June 30, 2018.March 31, 2019. The decrease was primarily due to an increase in the noninterest expense and a result ofdecrease in the buy-out of a third-party contractnet interest margin during the sixthree months ended June 30, 2018 and lower acquisition related expenses during the six months ended June 30, 2019.March 31, 2020, as mentioned above.

Income Tax Expense
Comparison of quarter ended June 30, 2019March 31, 2020 to the comparable quarter in the prior year.
Income tax expense increased $1.2decreased $2.6 million, or 59.9%80.1%, to $640,000 for the three months ended March 31, 2020 from $3.2 million for the three months ended June 30, 2019 from $2.0 millionMarch 31, 2019. The effective tax rate was 5.0% for the three months ended June 30, 2018. The effective tax rate was 16.7% for the three months ended June 30, 2019March 31, 2020 compared to 14.5%16.3% for the same period in 2018.2019. The increasedecrease in the income tax expense and effective tax rate was due to lower pre-tax income, also reflecting increasing tax-exempt instruments, and a provision in the CARES Act of 2020, which permitted the Company to recognize a $1.0 million benefit from net operating losses related to prior acquisitions during the three months ended June 30, 2019 was primarily due to a decrease in tax-exempt securities, the impact of stock-based compensation activity, an increased Oregon presence, and higher pre-tax income.
Comparison of six months ended June 30, 2019 to the comparable period in the prior year.
Income tax expense increased $3.0 million, or 88.8%, to $6.4 million for the six months ended June 30, 2019 from $3.4 million for the six months ended June 30, 2018. The effective tax rate was 16.5% for the six months ended June 30, 2019 compared to 14.0% for the same period in 2018. The increase in the income tax expense and effective tax rate during the six months ended June 30, 2019 was primarily due to those described above for the three months ended June 30, 2019.March 31, 2020.

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 of 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 expected 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.


Reconciliations of the GAAP and non-GAAP financial measures on net interest income, interest and fees on loans, loan yield and net interest margin are presented below for the three and six months ended June 30, 2019March 31, 2020 and 2018:2019:
Three Months Ended June 30, Six Months Ended June 30,Three Months Ended March 31,
2019 2018 2019 20182020 2019
(Dollars in thousands)(Dollars in thousands)
Net interest income and interest and fees on loans:Net interest income and interest and fees on loans:    Net interest income and interest and fees on loans:
Net interest income (GAAP)$50,536
 $43,741
 $100,324
 $84,578
$48,557
 $49,788
Exclude incremental accretion on purchased loans1,416
 1,992
 2,789
 3,624
(1,012) (1,373)
Adjusted net interest income (non-GAAP)$49,120
 $41,749
 $97,535
 $80,954
$47,545
 $48,415
          
Average total interest earning assets, net$4,681,588
 $4,156,310
 $4,665,513
 $4,087,894
$4,811,769
 $4,649,259
Net interest margin, annualized (GAAP)4.33% 4.22% 4.34% 4.17%4.06% 4.34%
Net interest margin, excluding incremental accretion on purchased loans, annualized (non-GAAP)4.21% 4.03% 4.22% 3.99%3.98% 4.22%
          
Interest and fees on loans (GAAP)$48,107
 $41,141
 $94,806
 $79,300
$46,277
 $46,699
Exclude incremental accretion on purchased loans1,416
 1,992
 2,789
 3,624
(1,012) (1,373)
Adjusted interest and fees on loans (non-GAAP)$46,691
 $39,149
 $92,017
 $75,676
$45,265
 $45,326
          
Average total loans receivable, net$3,654,475
 $3,266,092
 $3,638,573
 $3,208,799
Average loans receivable, net$3,748,573
 $3,622,494
Loan yield, annualized (GAAP)5.28% 5.05% 5.25% 4.98%4.97% 5.23%
Loan yield, excluding incremental accretion on purchased loans, annualized (non-GAAP)5.12% 4.81% 5.10% 4.75%4.86% 5.08%



Financial Condition Overview
The table below provides a comparison of the changes in the Company's financial condition from December 31, 20182019 to June 30, 2019:March 31, 2020:
 June 30, 2019 December 31, 2018 Change % Change March 31, 2020 December 31, 2019 Change % Change
 (Dollars in thousands) (Dollars in thousands)
Assets                
Cash and cash equivalents $139,290
 $161,910
 $(22,620) (14.0)% $162,913
 $228,568
 $(65,655) (28.7)%
Investment securities available for sale, at fair value 960,680
 976,095
 (15,415) (1.6)
Investment securities available for sale, at fair value, net 961,092
 952,312
 8,780
 0.9
Loans held for sale 3,692
 1,555
 2,137
 137.4
 3,808
 5,533
 (1,725) (31.2)
Total loans receivable, net 3,681,920
 3,619,118
 62,802
 1.7
Loans receivable, net 3,804,836
 3,731,708
 73,128
 2.0
Other real estate owned 1,224
 1,983
 (759) (38.3) 841
 841
 
 
Premises and equipment, net 84,296
 81,100
 3,196
 3.9
 87,958
 87,888
 70
 0.1
Federal Home Loan Bank stock, at cost 10,005
 6,076
 3,929
 64.7
 6,661
 6,377
 284
 4.5
Bank owned life insurance 94,417
 93,612
 805
 0.9
 106,756
 103,616
 3,140
 3.0
Accrued interest receivable 15,401
 15,403
 (2) 
 14,940
 14,446
 494
 3.4
Prepaid expenses and other assets 126,259
 98,522
 27,737
 28.2
 180,846
 164,129
 16,717
 10.2
Other intangible assets, net 18,563
 20,614
 (2,051) (9.9) 15,710
 16,613
 (903) (5.4)
Goodwill 240,939
 240,939
 
 
 240,939
 240,939
 
 
Total assets $5,376,686
 $5,316,927
 $59,759
 1.1 % $5,587,300
 $5,552,970
 $34,330
 0.6 %
                
Liabilities                
Deposits $4,347,708
 $4,432,402
 $(84,694) (1.9)% $4,617,948
 $4,582,676
 $35,272
 0.8 %
Federal Home Loan Bank advances 90,700
 
 90,700
 100.0
Junior subordinated debentures 20,448
 20,302
 146
 0.7
 20,668
 20,595
 73
 0.4
Securities sold under agreement to repurchase 23,141
 31,487
 (8,346) (26.5) 11,792
 20,169
 (8,377) (41.5)
Accrued expenses and other liabilities 98,064
 72,013
 26,051
 36.2
 138,454
 120,219
 18,235
 15.2
Total liabilities 4,580,061
 4,556,204
 23,857
 0.5
 4,788,862
 4,743,659
 45,203
 1.0
Stockholders' equity                
Common stock 591,703
 591,806
 (103) 
 568,439
 586,459
 (18,020) (3.1)
Retained earnings 195,168
 176,372
 18,796
 10.7
 211,707
 212,474
 (767) (0.4)
Accumulated other comprehensive gain (loss), net 9,754
 (7,455) 17,209
 (230.8) 18,292
 10,378
 7,914
 76.3
Total stockholders' equity 796,625
 760,723
 35,902
 4.7
 798,438
 809,311
 (10,873) (1.3)
Total liabilities and stockholders' equity $5,376,686
 $5,316,927
 $59,759
 1.1 % $5,587,300
 $5,552,970
 $34,330
 0.6 %
Total assets increased $59.8$34.3 million, or 1.1%0.6%, to $5.38$5.59 billion as of June 30, 2019March 31, 2020 compared to $5.32$5.55 billion as of December 31, 2018.2019.
Total loansLoans receivable, net, increased $62.8$73.1 million, or 1.7%2.0%, to $3.68$3.80 billion at June 30, 2019March 31, 2020 compared to $3.62$3.73 billion as of December 31, 20182019 due primarily to an increaseincreases in totalcommercial and industrial loans of $37.5 million, non-owner occupied commercial real estate loans of $23.5 million and real estate construction and land development loans of $39.2$12.4 million. The increase in commercial and industrial loans was driven primarily by an increase in funding on existing commercial lines of credit of $29.7 million one-to-four family residential loans of $15.7 million,during the three months ended March 31, 2020. The commercial and total commercial business loans of $12.7 million.industrial loan utilization rate was 40.2% and 35.8% at March 31, 2020 and December 31, 2019, respectively.
Prepaid expenses and other assets increased $27.7$16.7 million, or 28.2%10.2%, to $126.3$180.8 million at June 30,March 31, 2020 from $164.1 million at December 31, 2019 primarily as a result of an increase in the fair value of back-to-back interest rate swap contracts of $19.8 million, with a corresponding increase in accrued expenses and other liabilities. Accrued expenses and other liabilities increased $18.2 million, or 15.2%, to $138.5 million at March 31, 2020 compared to $98.5$120.2 million as of December 31, 20182019.
Total deposits increased $35.3 million, or 0.8%, to $4.62 billion at March 31, 2020 from $4.58 billion at December 31, 2019 due primarily to increases in money market accounts of $124.4 million, or 16.5%, to $878.1 million



and interest bearing demand deposits of $24.3 million, or 1.8%, to $1.37 billion, partially offset by decreases in savings accounts of $83.5 million, or 16.4%, to $425.6 million and in noninterest bearing demand deposits of $31.3 million, or 2.2%, to $1.42 billion. The increase in money market account and the ROU lease asset of $27.3 million thatdecrease in savings accounts was recorded during the six months ended June 30, 2019primarily due to the implementation of ASU 2016-02.
Investment securities available for sale decreased $15.4 million, or 1.6%, to $960.7 million at June 30, 2019 from $976.1 million at December 31, 2018 primarily as a result of maturities, calls, principal payments and sales of investment securities, offset partially by a new purchases and a decrease in net unrealized losses due to a decrease in interest rates during the six months ended June 30, 2019 that positively impacted the fair value of our bond portfolio.


Total deposits decreased $84.7 million or 1.9% during the six months ended June 30, 2019. The decrease was due primarily to non-maturity deposits declining $121.6 million, or 3.1%, to $3.84 billion, offset partially by an increase in certificate oftransfer between deposit accounts of 36.9$95.3 million or 7.9%.from a large public depositor. Non-maturity deposits as a percentage of total deposits decreased to 88.4%remained constant at 88.6% as of June 30, 2019 from 89.5% atboth March 31, 2020 and December 31, 2018.
FHLB advances totaled $90.7 million at June 30, 2019 to fund growth and to offset the decrease in total deposits, discussed above. There were no FHLB advances outstanding at December 31, 2018.
Accrued expenses and other liabilities increased $26.1 million, or 36.2%, to $98.1 million at June 30, 2019 compared to $72.0 million as of December 31, 2018 due primarily to the lease ROU obligation of $28.6 million that was recorded during the six months ended June 30, 2019 based on the implementation of ASU 2016-02.

2019.

Lending Activities
The Bank is a full service commercial bank, which originates a wide variety of loans with a focus on commercial business loans. Total loansLoans receivable, net of allowance for loan losses,ACL, increased $62.8$73.1 million, or 1.7%2.0%, to $3.68$3.80 billion at June 30, 2019March 31, 2020 from $3.62$3.73 billion at December 31, 2018.2019.
The following table provides information about our loan portfolio by type of loan at the dates indicated and the change between these dates. These balances are net of unearned fees and costs, and are prior to deduction for the allowance for loan losses.ACL on loans.
June 30, 2019 December 31, 2018  March 31, 2020 December 31, 2019  
Balance (1)
 
% of Total (2)
 
Balance (1)
 
% of Total (2)
 Change %of Balance Change
Balance (1)
 
% of Total (2)
 
Balance (1)
 
% of Total (2)
 Change %of Balance Change
(Dollars in thousands)(Dollars in thousands)
Commercial business:                      
Commercial and industrial$845,046
 22.7% $853,606
 23.4% $(8,560) (1.0)%$889,685
 23.1% $852,220
 22.6% $37,465
 4.4 %
Owner-occupied commercial real estate772,499
 20.8
 779,814
 21.3
 (7,315) (0.9)805,636
 20.9
 805,234
 21.4
 402
 
Non-owner occupied commercial real estate1,333,047
 35.8
 1,304,463
 35.7
 28,584
 2.2
1,312,308
 34.1
 1,288,779
 34.2
 23,529
 1.8
Total commercial business2,950,592
 79.3
 2,937,883
 80.4
 12,709
 0.4
3,007,629
 78.1
 2,946,233
 78.2
 61,396
 2.1
One-to-four family residential (3)
117,425
 3.2
 101,763
 2.8
 15,662
 15.4
136,782
 3.5
 131,660
 3.5
 5,122
 3.9
Real estate construction and land development:      
          
    
One-to-four family residential111,319
 3.0
 102,730
 2.8
 8,589
 8.4
98,730
 2.6
 104,296
 2.8
 (5,566) (5.3)
Five or more family residential and commercial properties143,341
 3.8
 112,730
 3.1
 30,611
 27.2
188,304
 4.9
 170,350
 4.5
 17,954
 10.5
Total real estate construction and land development (3)
254,660
 6.8
 215,460
 5.9
 39,200
 18.2
287,034
 7.5
 274,646
 7.3
 12,388
 4.5
Consumer392,926
 10.6
 395,545
 10.8
 (2,619) (0.7)420,931
 10.9
 415,340
 11.0
 5,591
 1.3
Gross loans receivable3,715,603
 99.9
 3,650,651
 99.9
 64,952
 1.8
Net deferred loan costs2,680
 0.1
 3,509
 0.1
 (829) (23.6)
Loans receivable, net$3,718,283
 100.0% $3,654,160
 100.0% $64,123
 1.8 %
Loans receivable3,852,376
 100.0
 3,767,879
 100.0
 84,497
 2.2
(1) Balances do not include undisbursed loan commitments.
(2) Percent of loans receivable, net.receivable.
(3) Excludes loans held for sale of $3.7$3.8 million and $1.6$5.5 million as of June 30, 2019March 31, 2020 and December 31, 2018,2019, respectively.

Included in the amortized cost of loans are net discounts on loans purchased in mergers and acquisitions. Upon adoption of ASU 2016-13, the Bank increased the net discount for PCD loans by $1.6 million related to the PCI to PCD transition. The remaining total net discount for purchased loans, including PCD loans and non-PCD loans, was $9.0 million at March 31, 2020 compared to $8.4 million at December 31, 2019.




Nonperforming Assets and Credit Quality Metrics
The following table provides information about our nonaccrual loans, other real estate owned and performing TDR loans for the indicated dates:
June 30, 2019 December 31, 2018March 31, 2020 December 31, 2019
(Dollars in thousands)(Dollars in thousands)
Nonaccrual loans:      
Commercial business$18,287
 $12,564
$33,908
 $44,320
One-to-four family residential19
 71
163
 19
Real estate construction and land development793
 899
Consumer194
 169
92
 186
Total nonaccrual loans (1)
19,293
 13,703
34,163
 44,525
Other real estate owned1,224
 1,983
841
 841
Total nonperforming assets$20,517
 $15,686
$35,004
 $45,366
      
Allowance for loan losses$36,363
 $35,042
Nonperforming loans to loans receivable, net0.52% 0.37%
Allowance for loan losses to loans receivable, net0.98% 0.96%
Allowance for loan losses to nonperforming loans188.48% 255.73%
ACL on loans$47,540
 $36,171
Nonperforming loans to loans receivable0.89% 1.18%
ACL on loans to loans receivable1.23% 0.96%
ACL on loans to nonperforming loans139.16% 81.24%
Nonperforming assets to total assets0.38% 0.30%0.63% 0.82%
      
Performing TDR loans:      
Commercial business$25,298
 $22,170
$17,222
 $13,661
One-to-four family residential204
 208
194
 196
Real estate construction and land development1,516
 237
Consumer423
 358
377
 375
Total performing TDR loans$25,925
 $22,736
$19,309
 $14,469
Accruing loans past due 90 days or more$
 $
$
 $
Potential problem loans114,095
 101,349
102,167
 87,788
(1) 
At June 30, 2019March 31, 2020 and December 31, 2018, $8.12019, $20.0 million and $6.9$26.3 million of nonaccrual loans were considered nonperforming TDR loans, respectively.
Nonaccrual Loans.    Nonaccrual loans increased $5.6decreased $10.3 million to $19.3$34.2 million, or 0.52%0.89% of loans receivable net, at June 30, 2019March 31, 2020 from $13.7$44.5 million, or 0.37%1.18% of loans receivable net, at December 31, 2018.2019. The increasedecrease was due primarily to the net principal payment of $7.8 million related to the additiona significant agricultural lending relationship and a full payoff of fivea commercial lending relationships totaling $8.7 million which showed increased signsbusiness relationship of cash flow deterioration, including two agricultural business relationships of $3.9$2.3 million. Management has allocated a specific reserve of $937,000 at June 30, 2019 for these five lending relationships.


The following table reflects the changes in nonaccrual loans during the sixthree months ended June 30, 2019March 31, 2020 and 2018:2019:
Six Months Ended June 30,Three Months Ended
March 31,
2019 20182020 2019
(In thousands)(In thousands)
Nonaccrual loans      
Balance, beginning of period$13,703
 $10,703
$44,525
 $13,696
Addition of previously classified pass graded loans3,583
 4,196
255
 
Addition of previously classified potential problem loans(1)6,353
 3,691
2,579
 6,189
Net principal payments(3,946) (438)
Net principal payments, transfer to OREO and transfer to accruing status(12,570) (2,393)
Charge-offs(400) (1,629)(626) (39)
Balance, end of period$19,293
 $16,523
$34,163
 $17,453
(1) Includes $1.3 million of previously pooled PCI loans which were converted to individual PCD loans as part of the adoption of ASU 2016-13.



At June 30,March 31, 2020, nonaccrual loans of $3.1 million had a related ACL on loans of $861,000 and nonaccrual loans of $31.1 million had no related ACL on loans. At December 31, 2019, nonaccrual loans of $11.3$4.4 million had related allowance for loan losses of $2.5 million$763,000 and nonaccrual loans of $8.0 million had no related allowance for loan losses. 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$40.1 million had no allowance for loan losses.
At June 30, 2019,March 31, 2020, nonperforming TDR loans, included in the nonaccrual loan table above, were $8.1$20.0 million and had a related ACL on loans of $223,000, including $19.3 million of nonperforming TDR loans with no related ACL on loans. At December 31, 2019, nonperforming TDR loans were $26.3 million and had a related allowance for loan losses of $981,000. At December 31, 2018,$218,000, including $24.2 million of nonperforming TDR loans were $6.9 million and had awith no related allowance for loan losses of $658,000.ACL on loans.
Nonperforming Assets.    Nonperforming assets consist of nonaccrual loans and other real estate owned. Nonperforming assets increased $4.8decreased $10.4 million to $20.5$35.0 million, or 0.38%0.63% of total assets, at June 30, 2019March 31, 2020 from $15.7$45.4 million, or 0.30%0.82% of total assets, at December 31, 20182019 due entirely to the increasedecrease in nonaccrual loans discussed above, offset partially by aabove. The decrease in nonperforming assets was unaffected by other real estate owned of 759,000, or 38.3% to $1.2 millionas the balance was $841,000 at June 30, 2019 from $2.0 million atboth March 31, 2020 and December 31, 2018 as a result of a disposition of properties during the six months ended June 30, 2019.
Troubled Debt Restructured Loans. TDR loans are considered impaired and are separately measured for impairment whether on accrual or nonaccrual status. The performing TDR loans are not considered nonperforming assets as they continue to accrue interest despite being considered impaired due to the restructured status. Performing TDR loans increased $3.2$4.8 million, or 14.0%33.5%, to $25.9$19.3 million at June 30, 2019March 31, 2020 from $22.7$14.5 million at December 31, 2018.2019. The increase was due primarily to extending maturities on threeadditions of previously classified potential problem loans, including one residential construction relationship of $1.5 million and additions of previously classified pass graded loans, including two commercial lending relationships totaling $5.5 million which showed signs of cash flow deterioration, offset partially by net principal payments.$2.1 million.
The following table reflects the changes in performing TDR loans during the sixthree months ended June 30, 2019March 31, 2020 and 2018:2019:
Six Months Ended June 30,Three Months Ended
March 31,
2019 20182020 2019
(In thousands)(In thousands)
Performing TDR loans      
Balance, beginning of period$22,736
 $26,757
$14,469
 $22,744
Addition of previously classified pass graded loans2,633
 1,236
2,269
 243
Addition of previously classified potential problem loans4,667
 551
2,660
 91
Charge-offs(10) 
Loans added formerly nonaccrual177
 
Net principal payments(4,101) (2,587)(266) (3,087)
Balance, end of period$25,925
 $25,957
$19,309
 $19,991
The related allowanceACL on loans for loan losses on performing TDR loans was $2.9$1.5 million as of June 30, 2019March 31, 2020 and $2.3$1.3 million as of December 31, 2018.2019.
Potential Problem Loans. Potential problem loans increased $12.7$14.4 million, or 12.6%16.4%, to $114.1$102.2 million at June 30, 2019March 31, 2020 compared to $101.3$87.8 million at December 31, 2018.2019. The increase was primarily attributed to eightthe addition of four commercial lendingbusiness relationships totaling $30.3$18.1 million that experienced cash flow deteriorationwhich were downgraded as a result of customer-specific events. Of the adverse economic impact from the COVID-19 pandemic, including two hotels, and eight downgraded relationships, six totaling $23.2 million at June 30, 2019 were downgraded


to OAEM while twocommercial business relationships totaling $7.2$7.8 million which were downgraded to Substandard. The risk rating downgradeincrease oversight of these relationships will enhancecredits due to other concerns. The activity for the Company's monitoring of these credits. The increase to potential problem loans was offset partially by net principal payments, including loans paidthree months ended March 31, 2020 also includes payment in full of $9.8 million,three commercial and the significant pay down of two commercial lines of creditindustrial relationships totaling $3.2$4.7 million.



The following table reflects the changes in potential problem loans during the sixthree months ended June 30, 2019March 31, 2020 and 2018:2019:
Six Months Ended June 30,Three Months Ended
March 31,
2019 20182020 2019
  
Potential problem loans  
Balance, beginning of period$101,349
 $83,543
$87,788
 $101,320
Addition of previously classified pass graded loans40,677
 44,955
29,919
 9,779
Upgrades to pass graded loan status(2,858) (9,043)(476) 
Net principal payments(13,626) (4,242)(9,825) (13,521)
Transfers of loans to nonaccrual and TDR status(11,020) (257)(5,239) (3,303)
Charge-offs(427) (13,465)
 (187)
Balance, end of period$114,095
 $101,491
$102,167
 $94,088

Analysis of Allowance for LoanCredit Losses on Loans
Allowance for credit losses on loans
Effective January 1, 2020, the Bank adopted ASU 2016-13. The allowance for loan losses is established through a provision for loan losses charged against earnings. The balance ofadoption replaced the allowance for loan losses is maintained atwith the amount management believes will be appropriate to absorb probable incurredACL on loans on the Condensed Consolidated Statements of Financial Condition and replaced the related provision for loan losses with the provision for credit losses inon loans on the Condensed Consolidated Statements of Income.
Management has adopted a historic loss, open pool CECL methodology to calculate the ACL on loans. The same methodology is applied to all loans consistent with the guidance of the accounting standard which does not require undue complexity. Under this allowance approach, the Company has identified segments of loans with similar risk characteristics that align with its identified loan portfolio at the balance sheet date.classes. Nonaccrual loans and certain TDR loans are not considered similar other loans; therefore, they are evaluated for allowance on an individual basis. The allowance for individually evaluated loans is calculated 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 net present value method, which considers the contractual principal and interest terms and estimated cash flows available from the borrower to satisfy the debt.
For each loan segment collectively measured, the baseline loss rates are calculated using the bank's average quarterly historical loss information. 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, including prepayment estimates. The CECL methodology includes consideration of the forecasted direction of the economic and business environment and its likely impact to the estimated allowance as compared to the historical losses is determined by applying estimated lossover the reasonable and supportable time frame. The impact of those macroeconomic factors to each segment, positive or negative, using the credit exposure from outstanding loans.
We assessreasonable and supportable period, are added to the calculated baseline loss rate. After the reasonable and supportable period, the estimated credit losses inherent in our loan portfolio by consideringare reverted back to historical baseline loss levels under a number of elements including:
reversion period on a straight-lined, input reversion basis. Management can also consider other qualitative factors to add to the ACL if internal or external conditions suggest adjustments to the historical loss experience ininformation or 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
other factors
We calculate an appropriate allowance for loan losses 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 specific provisions for impaired loans, including loans on nonaccrual status and 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.
The allowance for loan losses on loans designated as non-PCI loans is similar to the methodology described above except that for non-PCI loans, the remaining unaccreted discounts resulting from the fair value adjustments recorded at the time the loans were purchased are additionally factored into the allowance methodology.
For the PCI loans, the acquisition date fair value incorporated our estimate of future expected cash flows until the ultimate resolution of these credits. To the extent actual or projected cash flows are less than previously estimated, additional provisions for loan losses on the PCI loan portfolio 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 previously recognized provision for that loan or pool of loans, if any, and then prospectively recognized in interest income as a yield adjustment.


macroeconomic forecast.
While we believe we use the best information available to determine the allowance for loan losses,ACL on loans, our results of operations could be significantly affected if circumstances differ substantially from the assumptions used in determining the allowance. A further decline in national and local economic conditions, including as a result of COVID-19 pandemic or other factors, could result in a material increase in the allowance for loan lossesACL on loans 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 lossesACL on loans 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 lossesACL on loans based upon their judgment of information available to them at the time of their examination.



The following table provides information regarding changes in our ACL on loans and the allowance for loan losses at and for the three and six months ended June 30,March 31, 2020 and 2019, and 2018:respectively:
Three Months Ended June 30, Six Months Ended June 30,Three Months Ended March 31,
2019 2018 2019 20182020 2019
(Dollars in thousands)(Dollars in thousands)
Allowance for loan losses on loans at the beginning of the period$36,152
 $33,261
 $35,042
 $32,086
Provision for loan losses1,367
 1,750
 2,287
 2,902
ACL on loans at the beginning of the period$36,171
 $35,042
Impact of CECL adoption1,822
 
Adjusted ACL on loans, beginning of the period37,993
 35,042
   
Charge-offs:          
Commercial business(774) (542) (877) (623)(1,222) (103)
One-to-four family residential(15) (15) (30) (15)
 (15)
Consumer(566) (694) (1,152) (1,179)(375) (586)
Total charge-offs(1,355) (1,251) (2,059) (1,817)(1,597) (704)
Recoveries:          
Commercial business62
 68
 221
 569
1,069
 159
One-to-four family residential3
 
Real estate construction and land development7
 2
 625
 2
14
 618
Consumer130
 142
 247
 230
94
 117
Total recoveries199
 212
 1,093
 801
1,180
 894
Net charge-offs(1,156) (1,039) (966) (1,016)(417) 190
Allowance for loan losses at the end of the period$36,363
 $33,972
 $36,363
 $33,972
          
Allowance for loan losses to loans receivable, net0.98% 1.02% 0.98% 1.02%
Net recoveries on loans to average loans, annualized0.13% 0.13% 0.05% 0.06%
Net Credit Loss417
 
Reserve Build9,547
 920
Provision for credit losses on loans9,964
 920
          
Loans receivable, net at the end of the period (1)
$3,718,283
 $3,328,288
 $3,718,283
 $3,328,288
Average loans receivable during the period (1)
3,654,475
 3,266,092
 3,638,573
 3,208,799
ACL on loans at the end of the period$47,540
 $36,152
   
ACL on loans to loans receivable1.23% 0.98 %
Net charge-offs (recoveries) on loans to average loans, net (1)
0.04% (0.02)%
   
Loans receivable at the end of the period (2)
$3,852,376
 $3,696,431
Average loans receivable, net during the period (2)
3,748,573
 3,622,494
(1) Annualized
(2) Excludes loans held for sale.
The allowance for loan lossesACL on loans increased $1.3$11.4 million, or 3.8%31.4%, to $36.4$47.5 million at June 30, 2019March 31, 2020 from $35.0$36.2 million at December 31, 2018.2019. Of this increase, $1.8 million related to the adoption of ASU 2016-13 as discussed above. The allowance at March 31, 2020 increased 26.2% from the adjusted beginning balance. The increase was primarily the result of the provision for loancredit losses on loans of $2.3$10.0 million recognized during the sixthree months ended June 30, 2019, offset partially by net charge-offsMarch 31, 2020 due to credit deteriorations forecasted on economic conditions as a result of $966,000 recorded during the same period.COVID-19 pandemic. The allowance for loan lossesACL on loans to loans receivable net increased to 0.98%1.23% at June 30, 2019March 31, 2020 from 0.96% at December 31, 2018. Included2019.
Prior to the adoption of ASU 2016-13, included in the carrying value of nonPCI purchased loans arewere net fair value discounts on loans purchased in mergers and acquisitions which may reducereduced the need for an allowance for loan losses on these loans because they arewere carried at an amount below the outstanding principal balance. As these fair value discounts are accreted, increasing the loan balance, the Company may record an allowance for loan loss, which has the net impact of increasing the allowance for loan losses to loans receivable, net. The remaining net fair valuepurchased discount on purchasednonPCI loans was $10.0 million at June 30, 2019 compared to $11.8$8.4 million at December 31, 2018.2019.
The Company recorded charge-offs of $2.1$1.6 million during the sixthree months ended June 30, 2019March 31, 2020 due primarily to commercial and industrial loan charge-offs of three commercial$1.1 million, including $373,000 related to one lending relationships totaling $632,000, including one agricultural business relationship charge-off of $278,000, and small dollar charge-offs on a large volume of consumer loans.relationship. The Company recorded recoveries of $1.1$1.2 million during the sixthree months ended June 30, 2019March 31, 2020 primarily due to the



full recovery of a one-to-four family residential construction loanan agricultural lending relationship of $602,000 as a result of a bankruptcy resolution and small recoveries on a large volume of small dollar consumer loans.


As of June 30, 2019,$963,000 which was charged-off during the Bank identified $19.3 million of nonaccrual loans and $25.9 million of performing TDR loans for a total of $45.2 million of impaired loans. Of these impaired loans, $11.3 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. The remaining $33.9 million of impaired loans had related allowances for loan losses totaling $5.4 million. As ofquarter ended December 31, 2018, the Bank identified $13.7 million of nonaccrual loans 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. The remaining $28.8 million of impaired loans had related allowances for loan losses totaling $4.2 million.
The following table outlines the allowance for loan losses and related loan balances on loans at June 30, 2019 and December 31, 2018:
 June 30, 2019 December 31, 2018
 (Dollars in thousands)
General Valuation Allowance:   
Allowance for loan losses$28,415
 $27,854
Gross loans, excluding PCI and impaired loans$3,648,032
 $3,589,305
Percentage0.78% 0.78%
    
PCI Allowance:   
Allowance for loan losses$2,575
 $3,018
Gross PCI loans$22,353
 $24,907
Percentage11.52% 12.12%
    
Specific Valuation Allowance:   
Allowance for loan losses$5,373
 $4,170
Gross impaired loans$45,218
 $36,439
Percentage11.88% 11.44%
    
Total Allowance for Loan Losses:   
Allowance for loan losses$36,363
 $35,042
Gross loans receivable$3,715,603
 $3,650,651
Percentage0.98% 0.96%
2019.
Based on the Bank's established comprehensive CECL methodology, management deemed the allowance for loan lossesACL on loans of $36.4$47.5 million (0.98%(1.23% of loans receivable net and 188.48%139.16% of nonperforming loans) at June 30, 2019March 31, 2020 appropriate to provide for probable incurredcurrent expected credit losses based on an evaluation of known and inherent risks in the loan portfolio at that date.Company's comprehensive methodology. This compares to an allowance for loan losses of $35.0$36.2 million (0.96% of loans receivable net and 255.73%81.24% of nonperforming loans) at December 31, 2018.2019 under the incurred loss methodology.
While we believe we use the best information available to determine the allowance for loan losses,ACL on loans, our results of operations could be significantly affected if circumstances differ substantially from the assumptions used in determining the allowance. A further decline in national and local economic conditions, as a result of the COVID-19 pandemic or other factors, could result in a material increase in the allowance for loan lossesACL on loans 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 lossesACL on loans 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 lossesACL on loans based upon their judgment of information available to them at the time 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 lossesACL on loans 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 lossesACL on loans would adversely affect the Company’s financial condition and results of operations.

Deposits and Other Borrowings
Total deposits decreased $84.7increased $35.3 million, or 1.9%0.8%, to $4.35$4.62 billion at June 30, 2019March 31, 2020 from $4.43$4.58 billion at December 31, 2018.2019. Non-maturity deposits as a percentage of total deposits decreased to 88.4%were 88.6% at June 30, 2019


from 89.5% atboth March 31, 2020 and December 31, 20182019 and the percentage of certificates of deposit to total deposits increased to 11.6%were 11.4% at June 30, 2019 from 10.5% atboth March 31, 2020 and December 31, 2018.2019.
The following table summarizes the Company's deposits as of June 30, 2019March 31, 2020 and December 31, 2018:2019:
June 30, 2019 December 31, 2018    March 31, 2020 December 31, 2019    
Balance % of Total Balance % of Total Change % of Balance ChangeBalance % of Total Balance % of Total Change % of Balance Change
(Dollars in thousands)(Dollars in thousands)
Noninterest demand deposits$1,320,743
 30.3% $1,362,268
 30.7% $(41,525) (3.0)%$1,415,177
 30.6% $1,446,502
 31.6% $(31,325) (2.2)%
Interest bearing demand deposits1,263,843
 29.1
 1,317,513
 29.7
 (53,670) (4.1)1,373,091
 29.7
 1,348,817
 29.4
 24,274
 1.8
Money market accounts757,156
 17.4
 765,316
 17.3
 (8,160) (1.1)878,075
 19.0
 753,684
 16.4
 124,391
 16.5
Savings accounts502,198
 11.6
 520,413
 11.8
 (18,215) (3.5)425,616
 9.3
 509,095
 11.2
 (83,479) (16.4)
Total non-maturity deposits3,843,940
 88.4
 3,965,510
 89.5
 (121,570) (3.1)4,091,959
 88.6
 4,058,098
 88.6
 33,861
 0.8
Certificate of deposit503,768
 11.6
 466,892
 10.5
 36,876
 7.9
Certificates of deposit525,989
 11.4
 524,578
 11.4
 1,411
 0.3
Total deposits$4,347,708
 100.0% $4,432,402
 100.0% $(84,694) (1.9)$4,617,948
 100.0% $4,582,676
 100.0% $35,272
 0.8
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 assets. The Bank also utilizes securities sold under agreement to repurchase as a supplement to its funding sources. During 2019, the Bank made an effort to transition customers from securities sold under agreement to repurchase to other deposit products. As of March 31, 2020 and December 31, 2020, only three customers utilized this product. Our securities sold under agreement to repurchase are secured by available for sale investment securities. At June 30, 2019,March 31, 2020, the Bank had securities sold under agreement to repurchase of $23.1$11.8 million, a decrease of $8.3$8.4 million, or 26.5%41.5%, from $31.5$20.2 million at December 31, 2018.2019. The decrease was the result of customerone customer's 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 $20.4$20.7 million at June 30, 2019,March 31, 2020, 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 June 30, 2019,March 31, 2020, the Bank maintained credit facilities with the FHLB of Des Moines for $827.7$898.5 million and credit facilities with the Federal Reserve Bank for $43.6$74.0 million. The Company had $90.7 million ofno FHLB or Federal Reserve Bank advances outstanding at June 30, 2019. There were no FHLB advances outstanding atboth March 31, 2020 and December 31, 2018.2019. The average cost of the FHLB advances during the sixthree months ended June 30,March 31, 2020 and 2019 and 2018 was 2.68%0.41% and 1.93%3.29%, respectively. The Bank also maintains lines of credit with fourfive correspondent banks to purchase federal funds totaling $90.0$140.0 million as of June 30, 2019.March 31, 2020. There were no federal funds purchased as of June 30, 2019March 31, 2020 or December 31, 2018.2019.

Liquidity and Cash Flows
Our primary sources of funds are customer and local government deposits, loan principal and interest payments, and interest earned on and proceeds from sales and maturities 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. 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.
Heritage Bank: The principal objective of the Bank’s liquidity management program is to maintain the ability to meet day-to-day cash flow requirements of its customers who either wish to withdraw funds or to draw upon credit facilities to meet their cash needs. The Bank monitors the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. In addition to liquidity from core deposits and the repayment and maturities of loans, the Bank can utilize established credit facilities and lines with correspondent banks or sale of investment securities. As a result of the Federal Reserve Bank response to the COVID-19 pandemic, the Bank’s liquidity will be supplemented by loans obtained through the PPPLF as mentioned above.
Heritage Financial Corporation: The Company is a separate legal entity from the Bank and must provide for its own liquidity. Substantially all of the Company’s revenues are obtained from dividends declared and paid by the Bank. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to the Company. However, management believes that such restrictions will not have an adverse impact on the ability of the Company to meets its ongoing cash obligations. At June 30, 2019,March 31, 2020, the Company (on an unconsolidated basis) had cash and cash equivalents of $13.6$1.2 million.


We are required to maintain an adequate level of liquidity to ensure the availability of sufficient funds to fund loan originations and deposit withdrawals, satisfy other financial commitments and fund operations. We generally maintain sufficient cash and short-term investments to meet short-term liquidity needs. At June 30, 2019,March 31, 2020, cash and cash equivalents totaled $139.3$162.9 million, or 2.6%2.9% of total assets. The fair value of investment securities available for sale totaled $960.7$961.1 million at June 30, 2019,March 31, 2020, of which $250.0$232.9 million were pledged to secure public deposits or borrowing arrangements. The fair value of investment securities available for sale that were not pledged totaled $710.7$728.2 million, or 13.2%13.0% of total assets, at June 30, 2019.March 31, 2020. The fair value of investment securities available for sale with contractual maturities of one year or less were $33.3$33.8 million, or 0.6% of total assets, at June 30, 2019.March 31, 2020.
Consolidated Cash Flows: As disclosed in the Condensed Consolidated Statements of Cash Flows, net cash provided by operating activities was $37.1$16.1 million for the sixthree months ended June 30, 2019,March 31, 2020, and primarily consisted of net income of $32.5$12.2 million. During the sixthree months ended June 30, 2019,March 31, 2020, net cash used by investing activities was $42.4$82.3 million, which consisted primarily of net loan originations of $66.0 million and purchases of premises and equipment of $6.4 million, offset partially by cash provided from sales of securities available-for-sale of $34.5$86.6 million. Net cash usedprovided by financing activities was $17.3 million$592,000 for the sixthree months ended June 30, 2019,March 31, 2020 and primarily consisted of a net decreaseincrease in deposits of $84.7$35.3 million, andpartially offset by dividends paid of $13.3$7.3 million and repurchases of common stock of $19.1 million during the period, partially offset by net FHLB advances of $90.7 million.period.

Capital



Stockholders' Equity and Regulatory Capital Requirements
Stockholders’ equity was $796.6$798.4 million at June 30, 2019March 31, 2020 compared to $760.7$809.3 million at December 31, 2018.2019. The Company’s stockholders' equity to assets ratio was 14.8%14.3% as of June 30, 2019March 31, 2020 and 14.3%14.6% as of December 31, 2018.2019. The following table reflects the changes to stockholders' equity during the three and six months ended June 30, 2019March 31, 2020 and 2018:2019:
Three Months Ended June 30, Six Months Ended June 30,Three Months Ended March 31,
2019 2018 2019 20182020 2019
(In Thousands)(In Thousands)
Balance, beginning of period$778,191
 $634,708
 $760,723
 $508,305
$809,311
 $760,723
Common stock issued in the Premier and Puget Mergers
 
 
 130,770
Cumulative effect from change in accounting policy (1)
(5,615) (399)
Net income15,984
 11,857
 32,536
 20,944
12,191
 16,552
Dividends declared(6,679) (5,130) (13,341) (10,247)(7,343) (6,662)
Other comprehensive income (loss)9,193
 (2,372) 17,209
 (9,915)
Effects of implementation of accounting change related to operating leases
 
 (399) 
Other comprehensive income, net of tax7,914
 8,016
Repurchase of common stock(19,060) (802)
Other(64) 460
 (103) (334)1,040
 763
Balance, end of period$796,625
 $639,523
 $796,625
 $639,523
$798,438
 $778,191
(1) Effective January 1, 2020, Company adopted ASU 2016-13, Financial Instruments - Credit Losses. Effective January 1, 2019, the Company adopted ASU 2016-02, Leases.
During the quarter ended March 31, 2020, the Company repurchased the remaining 639,922 shares of its common stock available under the previous stock repurchase plan of at a weighted average price per share of $23.95, or $15.3 million. The Company commenced a new stock repurchase plan on March 12, 2019, and repurchased 155,778 shares of its common stock under that plan at a weighted average price per share of $20.34, or $3.2 million during the quarter ended March 31, 2020. As of March 31, 2020, there were 1.6 million shares available for repurchase under the new stock repurchase plan. The Company halted its buybacks in March 2020, and will not resume repurchase activity until management is confident it can understand the economic impacts of the COVID-19 pandemic on the Company's long-term capital position.
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 July 24, 2019,April 29, 2020, the Company’s Board of Directors declared a regular dividend of $0.19$0.20 per common share which is payable on August 22, 2019May 27, 2020 to shareholders of record on August 8, 2019.May 13, 2020.
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. 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 June 30, 2019,March 31, 2020, the Company and the Bank meet all capital adequacy requirements to which they are subject.



As of June 30, 2019March 31, 2020 and December 31, 2018,2019, 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. The following table represents the minimum required ratios of the Company and the Bank and the actual capital ratios at the periods indicated:
 Minimum Requirements Well-Capitalized Requirements Actual Minimum Requirements Well-Capitalized Requirements Actual
 (Dollars in thousands) (Dollars in thousands)
As of June 30, 2019:            
As of March 31, 2020:            
The Company consolidated                        
Common equity Tier 1 capital to risk-weighted assets $203,156
 4.5% N/A
 N/A
 $531,362
 11.8% $214,253
 4.5% N/A
 N/A
 $532,695
 11.2%
Tier 1 leverage capital to average assets 203,834
 4.0
 N/A
 N/A
 551,810
 10.8
 213,152
 4.0
 N/A
 N/A
 553,363
 10.4
Tier 1 capital to risk-weighted assets 270,875
 6.0
 N/A
 N/A
 551,810
 12.2
 285,671
 6.0
 N/A
 N/A
 553,363
 11.6
Total capital to risk-weighted assets 361,166
 8.0
 N/A
 N/A
 588,479
 13.0
 380,895
 8.0
 N/A
 N/A
 595,157
 12.5
Heritage Bank                        
Common equity Tier 1 capital to risk-weighted assets 202,919
 4.5
 $293,105
 6.5% 535,423
 11.9
 214,106
 4.5
 $309,264
 6.5% 549,933
 11.6
Tier 1 leverage capital to average assets 203,643
 4.0
 254,554
 5.0
 535,423
 10.5
 211,777
 4.0
 264,721
 5.0
 549,933
 10.4
Tier 1 capital to risk-weighted assets 270,558
 6.0
 360,744
 8.0
 535,423
 11.9
 285,474
 6.0
 380,633
 8.0
 549,933
 11.6
Total capital to risk-weighted assets 360,744
 8.0
 450,930
 10.0
 572,092
 12.7
 380,633
 8.0
 475,791
 10.0
 591,727
 12.4
                        
As of December 31, 2018:            
As of December 31, 2019:            
The Company consolidated                        
Common equity Tier 1 capital to risk-weighted assets $197,189
 4.5% N/A
 N/A
 $510,618
 11.7% $211,110
 4.5% N/A
 N/A
 $541,154
 11.5%
Tier 1 leverage capital to average assets 201,920
 4.0
 N/A
 N/A
 530,920
 10.5
 212,578
 4.0
 N/A
 N/A
 561,749
 10.6
Tier 1 capital to risk-weighted assets 262,918
 6.0
 N/A
 N/A
 530,920
 12.1
 281,479
 6.0
 N/A
 N/A
 561,749
 12.0
Total capital to risk-weighted assets 350,558
 8.0
 N/A
 N/A
 566,268
 12.9
 375,306
 8.0
 N/A
 N/A
 598,226
 12.8
Heritage Bank                        
Common equity Tier 1 capital to risk-weighted assets 197,004
 4.5
 $284,561
 6.5% 513,993
 11.7
 211,017
 4.5
 $304,803
 6.5% 538,560
 11.5
Tier 1 leverage capital to average assets 203,339
 4.0
 254,174
 5.0
 513,993
 10.1
 211,187
 4.0
 263,984
 5.0
 538,560
 10.2
Tier 1 capital to risk-weighted assets 262,671
 6.0
 350,229
 8.0
 513,993
 11.7
 281,356
 6.0
 375,142
 8.0
 538,560
 11.5
Total capital to risk-weighted assets 350,229
 8.0
 437,786
 10.0
 549,341
 12.5
 375,142
 8.0
 468,927
 10.0
 575,037
 12.3
As of March 31, 2020, the capital measures reflect the revised CECL capital transition provisions adopted by the Federal Reserve and the FDIC, that allows 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.
Under applicable capital requirements both the Company and the Bank are required to have a common equity Tier 1 capital ratio of 4.5%, 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 maintain a capital conservation buffer of common equity Tier 1 capital above 2.5% to avoid restrictions on certain activities including payment of dividends, stock repurchases and discretionary bonuses to executive officers. At June 30, 2019,March 31, 2020, the capital conservation buffer was 5.0%4.50% and 4.7%4.44% for the Company and the Bank, respectively.




ITEM 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to interest rate risk through our lending and deposit gathering activities. Our results of operations are highly dependent upon our ability to manage interest rate risk. We consider interest rate risk to be a significant market risk that could have a material effect on our financial condition and results of operations. Interest rate risk is measured and assessed on a quarterly basis. In our opinion, there has not been
As a material change inresult of the COVID-19 pandemic, our interest rate risk exposure has changed since the information disclosed in our 20182019 Annual Form 10-K. The following table presents the change in our net interest income as a result of parallel rate shock scenarios presented in the periods after the dates shown:


 March 31, 2020 December 31, 2019
 (In thousands)
Up 100   
Year 1$7,129
 $8,149
Year 215,017
 15,933
Up 200   
Year 114,033
 15,572
Year 229,306
 29,806
Down 100   
Year 1(2,028) (7,415)
Year 2(5,274) (15,178)
These scenarios are based on interest rates as of the last day of a reporting period published by independent sources and incorporate relevant spread of instruments that are actively traded in the open market. Given that the short-term rates have declined during the three months ended March 31, 2020, we do not believe that the result of the "Down 200" analysis provide meaningful results, and 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 simulations used to manage market risk are based on numerous assumptions regarding the effect of changes in interest rates on the timing and extent of reprice characteristics, future cash flows and customer behavior. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower net interest income. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes as well as changes in market condition, customer behavior and management strategies, among other factors.
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 4.     CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
An evaluation of the Company’s disclosure controls and procedure (as defined in Section 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934 (the “Act”)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and the Company’s Disclosure Committee as of the end of the period covered by this quarterly report. In designing and evaluating the Company’s disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Based on their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of June 30, 2019March 31, 2020 are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief



Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
(b) Changes in Internal Control Over Financial Reporting
Effective January 1, 2020, Heritage adopted FASB ASU 2016-13, Financial Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended. The Company designed new controls and modified existing controls as part of its adoption. These additional controls over financial reporting included controls over model creation and design, model governance, assumptions and expanded controls over loan level data.
There have been no other changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the quarter ended June 30, 2019,March 31, 2020, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company does not expect that its internal control over financial reporting will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

PART II.    OTHER INFORMATION

ITEM 1.     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.

ITEM 1A.     RISK FACTORS
There have been no material changes to the risk factors set forth in Part I. Item 1A of the Company’s 20182019 Annual Form 10-K.10-K related to the COVID-19 pandemic. The following provides a discussion of certain risks that management believes are specific to our business as a result of the COVD-19 pandemic.
The outbreak of the novel coronavirus ("COVID-19") has adversely impacted 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, and 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 started to cause major economic disruption and volatility as a result of governmental mandates (e.g., “shelter in place” mandates, school closures) and voluntary changes in consumer behavior (e.g., “social distancing”) in March 2020. In response to the shelter in place orders, currently many of our employees are working remotely to enable us to continue to provide banking services to our customers. Heightened cybersecurity, information security and operational risks may result from these work-from-home arrangements. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of the COVID-19 pandemic. Further, we also rely upon our third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.
There is pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years following the start of the pandemic. As a result, management is confronted with a significant and unfamiliar degree of uncertainty in estimating the impact of the pandemic on its credit quality, revenues and asset values. To date, the COVID-19 pandemic has resulted in declines in loan demand and loan originations, deposit availability, market interest rates and negatively impacted many of our business and consumer borrower’s ability to make their loan payments. Because the length of the pandemic and the efficacy of the extraordinary measures being put in place



to address its economic consequences are unknown, including recent reductions in the targeted federal funds rate, until the pandemic subsides, we expect our net interest income and net interest margin will be adversely affected in the near term, if not longer. Many of our borrowers have become unemployed or may face unemployment, and certain businesses are at risk of insolvency as revenues declined precipitously, especially in businesses related to travel, hospitality, leisure, and physical personal services. Businesses may ultimately not reopen as there is a significant level of uncertainty regarding the level of economic activity that will return to the Pacific Northwest region over time, the impact of governmental assistance, the speed of economic recovery, the resurgence of COVID-19 in subsequent seasons and changes to demographic and social norms that will take place.
The impact of the pandemic is expected to continue to adversely affect us during 2020 as the ability of many of our customers to make loan payments has been significantly affected. Although the Company has made estimates of credit losses related to the pandemic as part of its evaluation of the ACL on loans, such estimates involve significant judgment and are made in the context of significant uncertainty as to the impact that the pandemic will have on the credit quality of our loan portfolio. The extent of the economic impact of the pandemic is also impossible to determine with certainty at this time as it is partly dependent on a still evolving virus. Accordingly, estimates of the pandemic's effect on credit losses could change over time as additional information becomes available. If our estimates are incorrect, our ACL on loans may not be sufficient to cover losses in our loan portfolio, resulting in the need for increases in our ACL on loans through the provision for credit losses which is recorded and charged against income. Any increases in the ACL on loans will result in a decrease in net income and, most likely, capital, and may have a material negative effect on our financial condition and results of operations.
In addition, the Company is providing assistance to commercial business loan borrowers in response to the economic disruption caused by COVID-19 by offering short-term modifications such as interest only payments, payment deferrals, loan re-amortization, and increases of lines of credit. Also, the Company is assisting mortgage and consumer loan borrowers by offering short-term modifications via a streamlined approval process for 90-day payment deferrals when the borrower meets certain criteria, or on a case-by-case analysis.Notwithstanding these modifications, these borrowers may not be able to resume making full payments on their loans once the COVID-19 pandemic is resolved. If the economic disruption from the COVID-19 pandemic continues for several months or worsens, it may result in increased loan delinquencies, adversely classified loans and loan charge-offs. As a result, our ACL on loans may prove to be insufficient to absorb losses in our loan portfolio, which would cause our results of operations, liquidity and financial condition to be adversely affected.
Further, given the widespread level of disruption to commercial and consumer activity due to COVID-19, the Company decided to adopt certain measures to assist its deposit customers in affected areas. These measures include the waiver of certain fees and charges, such as early withdrawal penalties for certificates of deposit and overdrafts, and while important to assist our customers, these concessions will negatively impact our results of operations.
In accordance with GAAP, we record assets acquired and liabilities assumed at their fair value with the excess of the purchase consideration over the net assets acquired resulting in the recognition of goodwill. If adverse economic conditions or the recent decrease in our stock price and market capitalization as a result of the pandemic were to be deemed sustained rather than temporary, it may significantly affect the fair value of our goodwill and may trigger impairment charges. Any impairment charge could have a material adverse effect on our results of operations and financial condition.
We are an entity separate and distinct from our principal subsidiary, Heritage Bank, and derive substantially all of our revenue at the holding company level in the form of dividends from that subsidiary. If the COVID-19 pandemic were to materially adversely affect Heritage Bank’s regulatory capital levels or liquidity, it may result in Heritage Bank being unable to pay dividends to us, which may result in our not being able to pay dividends on our common stock at the same rate or at all.
Even after the COVID-19 pandemic subsides, the U.S. economy may experience a recession, and we anticipate our business would be materially and adversely affected by a prolonged recession. To the extent the COVID-19 pandemic adversely affects our business, financial condition, liquidity or results of operations, it may also have the effect of heightening many of the other risks described in the section entitled "Risk Factors" in our 2019 Annual Report on Form 10-K and any subsequent Quarterly Reports on Form 10-Q.

ITEM 2.     UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Not applicable.
(b) Not applicable.


(c) Repurchase Plans



The Company has had various stock repurchase programs since March 1999. On October 23, 2014,March 12, 2020 the Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares, or approximately 1,513,0001,799,054 shares, under the eleventh stock repurchase plan. At December 31, 2018, there were approximately 933,000 shares remaining to be purchased under the eleventhtwelfth stock repurchase plan. The number, timing and price of shares repurchased will depend on business and market conditions and other factors, including opportunities to deploy the Company's capital.
SinceDuring the inception ofthree months ended March 31, 2020, the Company repurchased the remaining 639,922 shares available under the eleventh stock repurchase plan the Company has repurchased 607,966 shares at ana weighted average price per share price of $17.33 including 28,000 shares repurchased under this plan during the three and six months ended June 30, 2019.$23.95. No shares were repurchased under this plan during the three and six months ended June 30, 2018.March 31, 2019. The Company has repurchased 155,778 shares under the twelfth plan at a weighted average share price per share of $20.34 during the three months ended March 31, 2020. The Company halted its buybacks in March 2020, and will not resume repurchase activity until management is confident it can understand the economic impacts of the COVID-19 pandemic on the Company's long-term capital position.
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:
 Three Months Ended June 30, Six Months Ended June 30,
 2019 2018 2019 2018
Repurchased shares to pay withholding taxes (1)
2,175
 7,394
 28,029
 52,820
Stock repurchase to pay withholding taxes average share price$29.31
 $33.84
 $30.88
 $31.96
(1) During the three months ended June 30, 2018, the Company repurchased 26,741 of 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 an average share price of $31.80 under the terms of the merger agreement.
 Three Months Ended March 31,
 2020 2019
Repurchased shares to pay withholding taxes25,882
 25,854
Stock repurchase to pay withholding taxes average share price$21.79
 $31.01
The following table sets forth information about the Company’s purchases of its outstanding common stock during the quarter ended June 30, 2019:March 31, 2020:
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
April 1, 2019— April 30, 2019 
 $
 7,893,389
 932,634
May 1, 2019— May 31, 2019 28,000
 29.12
 7,921,389
 904,634
June 1, 2019— June 30, 2019 2,175
 29.31
 7,921,389
 904,634
Total 30,175
 $29.13
 

 

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
January 1, 2020— January 31, 2020 56,919
 $26.09
 8,242,101
 583,922
February 1, 2020— February 29, 2020 282,620
 25.76
 8,524,022
 302,001
March 1, 2020— March 31, 2020 482,043
 21.36
 8,981,801
 1,643,276
Total 821,582
 $23.20
    
(1) Of the common shares repurchased by the Company between April 1, 2019 and June 30, 2019, 2,175 represented the cancellation of stock to pay withholding taxes on vested restricted stock awards or units.
(1)
Of the common shares repurchased by the Company between January 1, 2020 and March 31, 2020, shares totaling 25,882 represented the cancellation of stock to pay withholding taxes on vested restricted stock awards or units.

ITEM 3.     DEFAULTS UPON SENIOR SECURITIES
None

ITEM 4.     MINE SAFETY DISCLOSURES
Not applicable

ITEM 5.        OTHER INFORMATION
None



ITEM 6.     EXHIBITS
Incorporated by Reference
Exhibit No.Description of ExhibitFormExhibitFiling Date/Period End Date



    Incorporated by Reference
Exhibit No. Description of Exhibit Form Exhibit Filing Date/Period End Date
         
2.5
  8-K 2.1 7/27/2017
         
2.6
  8-K 2.1 3/9/2018
         
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)
      
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)
(1) Filed herewith.

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
  HERITAGE FINANCIAL CORPORATION
   
Date:  
August 7, 2019May 4, 2020 /S/ JEFFREY J. DEUEL
  Jeffrey J. Deuel
  President and Chief Executive Officer
   
Date:  
August 7, 2019May 4, 2020 /S/ DONALD J. HINSON
  Donald J. Hinson
  Executive Vice President and Chief Financial Officer



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