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 ~~September 30, 2020~~March 31, 2021 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,

Olympia

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 class	Trading symbol	Name of each exchange on which registered
Common stock, no par value	HFWA	NASDAQ

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 filer

☒

Accelerated filer

☐

Non-accelerated filer

☐

Smaller reporting company

☐

Emerging growth company

☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards 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 ~~October 30, 2020,~~April 26, 2021, there were ~~35,910,300~~35,981,317 shares of the registrant's common stock, no par value per share, outstanding.

Table of Contents

HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

FORM 10-Q

~~September 30, 2020~~March 31, 2021

TABLE OF CONTENTS


				Page
GLOSSARY OF ACRONYMS, ABBREVIATIONS AND TERMS				3
FORWARD LOOKING STATEMENTS				4

PART I.	FINANCIAL INFORMATION			65
ITEM 1.	FINANCIAL STATEMENTS			65
		CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED) AS OF ~~SEPTEMBER 30, 2020~~MARCH 31, 2021 AND DECEMBER 31, ~~2019~~2020		65
		CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) FOR THE THREE ~~AND NINE~~ MONTHS ENDED ~~SEPTEMBER 30,~~MARCH 31, 2021 AND 2020 ~~AND 2019~~		76
		CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) FOR THE THREE ~~AND NINE~~ MONTHS ENDED ~~SEPTEMBER 30,~~MARCH 31, 2021 AND 2020 ~~AND 2019~~		87
		CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED) FOR THE THREE ~~AND NINE~~ MONTHS ENDED ~~SEPTEMBER 30,~~MARCH 31, 2021 AND 2020 ~~AND 2019~~		98
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE ~~NINE~~THREE MONTHS ENDED ~~SEPTEMBER 30,~~MARCH 31, 2021 AND 2020 ~~AND 2019~~		119
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS		1311
		NOTE 1.	DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, SIGNIFICANT ACCOUNTING POLICIES AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS	1311
		NOTE 2.	INVESTMENT SECURITIES	1912
		NOTE 3.	LOANS RECEIVABLE	2115
		NOTE 4.	ALLOWANCE FOR CREDIT LOSSES ON LOANS	3123
		NOTE 5.	OTHER REAL ESTATE OWNED	3525
		NOTE 6.	GOODWILL AND OTHER INTANGIBLE ASSETS	3625
		NOTE 7.	JUNIOR SUBORDINATED DEBENTURES	3626
		NOTE 8.	SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE	3726
		NOTE 9.	OTHER BORROWINGS	3726
		NOTE 10.	DERIVATIVE FINANCIAL INSTRUMENTS	3827
		NOTE 11.	STOCKHOLDERS’ EQUITY	3827
		NOTE 12.	FAIR VALUE MEASUREMENTS	4028
		NOTE 13.	CASH ~~REQUIREMENT~~RESTRICTION	4533
		NOTE 14.	COMMITMENTS AND CONTINGENCIES	4533
		~~NOTE 15.~~	~~INCOME TAXES~~	45

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			4634
	OVERVIEW			46
	~~COVID-19 IMPACT~~			4734
	EARNINGS SUMMARY			5135
	NET INTEREST INCOME OVERVIEW			5235
	PROVISION FOR CREDIT LOSSES ~~ON LOANS~~OVERVIEW			5837
	NONINTEREST INCOME OVERVIEW			5938
	NONINTEREST EXPENSE OVERVIEW			6138
	INCOME TAX EXPENSE OVERVIEW			6339
	CONSOLIDATED FINANCIAL CONDITION OVERVIEW			6339
	LENDING ACTIVITIES OVERVIEW			6440
	NONPERFORMING ASSETS AND CREDIT QUALITY METRICS			41
	ANALYSIS OF ALLOWANCE FOR CREDIT LOSSES ON LOANS			43
	DEPOSITS AND OTHER BORROWINGS OVERVIEW			7045
	LIQUIDITY AND CASH ~~FLOW~~FLOWS			7145
	STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL REQUIREMENTS OVERVIEW			7246
	RECONCILIATIONS OF NON-GAAP ~~FINANCIAL~~ MEASURES			7348
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			49

Table of Contents

ITEM 3.

~~QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK~~

~~ITEM~~ 4.

CONTROLS AND PROCEDURES

7549

Part II.

OTHER INFORMATION

ITEM 1.

ITEM 1A.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

7850

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

7850

ITEM 4.

MINE SAFETY DISCLOSURES

ITEM 5.

ITEM 6.

GLOSSARY OF ACRONYMS, ABBREVIATIONS, AND TERMS

The acronyms, abbreviations, and terms listed below are used in various sections of ~~the~~this Form ~~10-Q, including “Item 1. Financial Statements” and “Item 2. Management Discussion and Analysis of Financial Condition and Results of Operations."~~10-Q. 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.


~~2019~~2020 Annual Form 10-K			Company's Annual Report on Form 10-K for the year ended December 31, ~~2019~~2020
ACL			Allowance for ~~Credit Losses~~credit losses
~~ALL~~			~~Allowance for Loan Losses~~
~~AOCI~~			~~Accumulated other comprehensive income, net~~
ASC			Accounting Standards Codification
ASU			Accounting Standards Update
Bank			Heritage Bank

CA Act			Consolidated Appropriations Act of 2021
CARES Act			Coronavirus Aid, Relief, and Economic Security Act of 2020
CECL			Current ~~Expected Credit Loss~~expected credit loss
CECL Adoption			Company's adoption on January 1, 2020 of FASB ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the CECL methodology
CMO			Collateralized Mortgage Obligation
Company			Heritage Financial Corporation
COVID Modifications			Loans with modifications made in compliance with the CARES Act, as amended, and related regulatory guidance
COVID-19 Pandemic			Coronavirus Disease of 2019 pandemic
CRE			Commercial real estate
FASB			Financial Accounting Standards Board
FDIC			Federal Deposit Insurance Corporation
Federal Reserve			Board of Governors of the Federal Reserve System
Federal Reserve Bank			Federal Reserve Bank of San Francisco
FHLB			Federal Home Loan Bank of Des Moines
GAAP			U.S. Generally Accepted Accounting Principles
~~GDP~~			~~U.S. Gross Domestic Product~~
Heritage			Heritage Financial Corporation
LIBOR			London Interbank Offering Rate
MBS			Mortgage-backed security
~~PCD~~			Purchased Credit Deteriorated; loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected; accounted for under FASB ASC 326
~~PCI~~			Purchased Credit Impaired; loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected; accounted for under FASB ASC 310-30

~~Table of Contents~~


PPP			Paycheck Protection Program
PPP1			First tranche of the SBA's PPP commencing in April 2020 through August 8, 2020
PPP2			Second tranche of the SBA'S PPP commencing in January 2021 and expiring May 31, 2021
PPPLF			Paycheck Protection Program Liquidity Facility
SBA			Small Business Administration
SEC			Securities and Exchange Commission

SM			Special Mention

Table of Contents


SS			Substandard
TDR			Troubled ~~Debt Restructured~~debt restructured
~~Unfunded Commitments~~			~~Off-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments~~

CAUTIONARY NOTE REGARDING 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.” 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.

The COVID-19 pandemic is adversely affecting us, our customers, counterparties, employees, and third-party service providers, and the ultimate extent of the impacts on our business, financial position, results of operations, liquidity, and prospects is uncertain. ~~Continued deterioration~~Deterioration in general business and economic conditions, including ~~further~~ increases in unemployment rates, or turbulence in domestic or global financial markets could adversely affect our revenues and the values of our assets and liabilities, reduce the availability of funding, lead to a tightening of credit, and ~~further~~ increase stock price volatility. In addition, changes to statutes, regulations, or regulatory policies or practices as a result of, or in response to the COVID-19 pandemic, could affect us in substantial and unpredictable ways. Other factors that could cause or contribute to such differences include, but are not limited to:

•the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our ACL on loans and provision for credit losses on loans that may be effected by deterioration in the housing and ~~commercial real estate~~CRE markets, which may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our ACL on loans no longer being adequate to cover actual losses, and require us to increase our ~~allowance for credit losses~~ACL on loans;

•changes in general economic conditions, either nationally or in our market areas;

•changes in the levels of general interest rates, and the relative differences between ~~short~~short-term and ~~long term~~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,~~ACL on loans, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements on us, any of which could affect our ability to continue our growth through mergers, acquisitions or similar transactions and adversely affect our liquidity and earnings;

•legislative or regulatory changes that adversely affect our business

•implementing regulations, changes in regulatory policies and principles, or the interpretation of regulatory capital or other 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

~~Table of Contents~~

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;~~methods and as a result of the CARES Act and the CA Act; and

•other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services, including ~~from~~as a result of the CARES Act, CA Act and recent COVID-19 pandemic vaccination efforts, and the other risks detailed from time to time in our filings with the SEC including our ~~2019~~2020 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.

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)

(In thousands, except shares)


		September 30, 2020		December 31, 2019			March 31, 2021		December 31, 2020
ASSETS	ASSETS					ASSETS
Cash on hand and in banks	Cash on hand and in banks	$	89,039	$	95,039	Cash on hand and in banks	$	93,306	$	91,918
Interest earning deposits	Interest earning deposits	487,203		133,529		Interest earning deposits	841,010		651,404
Cash and cash equivalents	Cash and cash equivalents	576,242		228,568		Cash and cash equivalents	934,316		743,322
Investment securities available for sale, at fair value, net (amortized cost of $802,391 and $939,160, respectively)		834,492		952,312
Investment securities available for sale, at fair value, net (amortized cost of $876,357 and $770,195, respectively)						Investment securities available for sale, at fair value, net (amortized cost of $876,357 and $770,195, respectively)	893,558		802,163
Loans held for sale	Loans held for sale	8,250		5,533		Loans held for sale	6,801		4,932
Loans receivable	Loans receivable	4,666,730		3,767,879		Loans receivable	4,595,869		4,468,647
Allowance for credit losses on loans	Allowance for credit losses on loans	(73,340)		(36,171)		Allowance for credit losses on loans	(64,225)		(70,185)
Loans receivable, net	Loans receivable, net	4,593,390		3,731,708		Loans receivable, net	4,531,644		4,398,462
Other real estate owned	Other real estate owned	0		841		Other real estate owned	0		0
Premises and equipment, net	Premises and equipment, net	89,831		87,888		Premises and equipment, net	84,533		85,452
Federal Home Loan Bank stock, at cost	Federal Home Loan Bank stock, at cost	6,661		6,377		Federal Home Loan Bank stock, at cost	7,933		6,661
Bank owned life insurance	Bank owned life insurance	108,311		103,616		Bank owned life insurance	108,341		107,580
Accrued interest receivable	Accrued interest receivable	18,888		14,446		Accrued interest receivable	19,447		19,418
Prepaid expenses and other assets	Prepaid expenses and other assets	194,938		164,129		Prepaid expenses and other assets	188,589		193,301
Other intangible assets, net	Other intangible assets, net	13,947		16,613		Other intangible assets, net	12,291		13,088
Goodwill	Goodwill	240,939		240,939		Goodwill	240,939		240,939
Total assets	Total assets	$	6,685,889	$	5,552,970	Total assets	$	7,028,392	$	6,615,318
LIABILITIES AND STOCKHOLDERS' EQUITY	LIABILITIES AND STOCKHOLDERS' EQUITY					LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits	Deposits	$	5,689,048	$	4,582,676	Deposits	$	6,019,698	$	5,597,990

Junior subordinated debentures	Junior subordinated debentures	20,814		20,595		Junior subordinated debentures	20,960		20,887
Securities sold under agreement to repurchase	Securities sold under agreement to repurchase	29,043		20,169		Securities sold under agreement to repurchase	36,503		35,683
Accrued expenses and other liabilities	Accrued expenses and other liabilities	143,855		120,219		Accrued expenses and other liabilities	124,080		140,319
Total liabilities	Total liabilities	5,882,760		4,743,659		Total liabilities	6,201,241		5,794,879
Stockholders’ equity:	Stockholders’ equity:					Stockholders’ equity:
Preferred stock, 0 par value, 2,500,000 shares authorized; 0 shares issued and outstanding, respectively	Preferred stock, 0 par value, 2,500,000 shares authorized; 0 shares issued and outstanding, respectively	0		0		Preferred stock, 0 par value, 2,500,000 shares authorized; 0 shares issued and outstanding, respectively	0		0
Common stock, 0 par value, 50,000,000 shares authorized; 35,910,300 and 36,618,729 shares issued and outstanding, respectively		570,170		586,459
Common stock, 0 par value, 50,000,000 shares authorized; 35,981,317 and 35,912,243 shares issued and outstanding, respectively						Common stock, 0 par value, 50,000,000 shares authorized; 35,981,317 and 35,912,243 shares issued and outstanding, respectively	571,204		571,021
Retained earnings	Retained earnings	207,751		212,474		Retained earnings	242,486		224,400
Accumulated other comprehensive income, net	Accumulated other comprehensive income, net	25,208		10,378		Accumulated other comprehensive income, net	13,461		25,018
Total stockholders’ equity	Total stockholders’ equity	803,129		809,311		Total stockholders’ equity	827,151		820,439
Total liabilities and stockholders’ equity	Total liabilities and stockholders’ equity	$	6,685,889	$	5,552,970	Total liabilities and stockholders’ equity	$	7,028,392	$	6,615,318

See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(In thousands, except per share amounts and shares outstanding)


	Three Months Ended March 31,
	2021		2020
INTEREST INCOME:
Interest and fees on loans	$	49,524	$	46,277
Taxable interest on investment securities	3,534		5,633
Nontaxable interest on investment securities	958		756
Interest on interest earning deposits	175		420
Total interest income	54,191		53,086
INTEREST EXPENSE:
Deposits	1,728		4,216
Junior subordinated debentures	187		285
Other borrowings	38		34
Total interest expense	1,953		4,535
Net interest income	52,238		48,551
(Reversal of) provision for credit losses	(7,199)		7,946
Net interest income after (reversal of) provision for credit losses	59,437		40,605
NONINTEREST INCOME:
Service charges and other fees	4,000		4,376
Gain on sale of investment securities, net	29		1,014
Gain on sale of loans, net	1,370		547
Interest rate swap fees	152		296
Bank owned life insurance income	656		885
Other income	2,044		2,368
Total noninterest income	8,251		9,486
NONINTEREST EXPENSE:
Compensation and employee benefits	22,461		22,506
Occupancy and equipment	4,454		4,564
Data processing	3,812		3,527
Marketing	669		866
Professional services	1,331		1,377
State/municipal business and use taxes	972		757
Federal deposit insurance premium	589		0
Other real estate owned, net	0		25
Amortization of intangible assets	797		903
Other expense	2,157		2,735
Total noninterest expense	37,242		37,260
Income before income taxes	30,446		12,831
Income tax expense	5,102		640
Net income	$	25,344	$	12,191
Basic earnings per share	$	0.70	$	0.34
Diluted earnings per share	$	0.70	$	0.34
Dividends declared per share	$	0.20	$	0.20
Average number of basic shares outstanding	35,926,950		36,342,090
Average number of diluted shares outstanding	36,232,204		36,596,641

See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(In ~~thousands, except per share amounts and shares outstanding)~~thousands)

Three Months Ended
September 30, Nine Months Ended
September 30,
2020 2019 2020 2019
INTEREST INCOME
Interest and fees on loans $ 47,647 $ 47,845 $ 142,328 $ 142,651
Taxable interest on investment securities 3,865 5,704 14,068 17,460
Nontaxable interest on investment securities 953 798 2,686 2,641
Interest on interest earning deposits 98 537 561 1,155
Total interest income 52,563 54,884 159,643 163,907
INTEREST EXPENSE
Deposits 2,639 4,250 10,272 11,870
Junior subordinated debentures 196 332 699 1,026
Other borrowings 50 59 130 444
Total interest expense 2,885 4,641 11,101 13,340
Net interest income 49,678 50,243 148,542 150,567
Provision for credit losses 2,730 466 39,239 2,753
Net interest income after provision for credit losses 46,948 49,777 109,303 147,814
NONINTEREST INCOME
Service charges and other fees 4,039 4,779 12,015 14,109
Gain on sale of investment securities, net 40 281 1,463 329
Gain on sale of loans, net 1,443 993 3,125 1,613
Interest rate swap fees 396 152 1,461 313
Other income 2,292 2,253 7,880 7,087
Total noninterest income 8,210 8,458 25,944 23,451
NONINTEREST EXPENSE
Compensation and employee benefits 21,416 21,733 65,849 65,629
Occupancy and equipment 5,676 5,268 16,936 16,177
Data processing 2,363 2,333 7,046 6,615
Marketing 755 816 2,317 3,020
Professional services 1,086 1,434 4,632 3,912
State/municipal business and use taxes 964 1,370 2,626 2,977
Federal deposit insurance premium 848 9 1,086 720
Other real estate owned, net 0 (35) (145) 340
Amortization of intangible assets 860 975 2,666 3,026
Other expense 2,077 2,816 7,365 8,375
Total noninterest expense 36,045 36,719 110,378 110,791
Income before income taxes 19,113 21,516 24,869 60,474
Income tax expense 2,477 3,621 2,181 10,043
Net income $ 16,636 $ 17,895 $ 22,688 $ 50,431
Basic earnings per share $ 0.46 $ 0.49 $ 0.63 $ 1.37
Diluted earnings per share $ 0.46 $ 0.48 $ 0.63 $ 1.36
Dividends declared per share $ 0.20 $ 0.19 $ 0.60 $ 0.55
Average number of basic shares outstanding 35,908,845 36,742,862 36,049,369 36,812,548
Average number of diluted shares outstanding 35,988,734 36,876,548 36,193,615 36,973,024


	Three Months Ended March 31,
	2021		2020
Net income	$	25,344	$	12,191
Change in fair value of investment securities available for sale, net of tax of $(3,204) and $2,419, respectively	(11,534)		8,707
Reclassification adjustment for net gain from sale of investment securities available for sale included in income, net of tax of $(6), and $(221), respectively	(23)		(793)
Other comprehensive (loss) income	(11,557)		7,914
Comprehensive income	$	13,787	$	20,105

See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF ~~COMPREHENSIVE INCOME~~STOCKHOLDERS' EQUITY (Unaudited)

(In ~~thousands)~~thousands, except per share amounts)

Three Months Ended
September 30, Nine Months Ended
September 30,
2020 2019 2020 2019
Net income $ 16,636 $ 17,895 $ 22,688 $ 50,431
Change in fair value of investment securities available for sale, net of tax of $(206), $799, $4,437 and $5,407, respectively (741) 2,993 15,975 20,240
Reclassification adjustment for net gain from sale of investment securities available for sale included in income, net of tax of $(8), $(59), $(318) and $(69), respectively (32) (222) (1,145) (260)
Other comprehensive (loss) income (773) 2,771 14,830 19,980
Comprehensive income $ 15,863 $ 20,666 $ 37,518 $ 70,411


	Three Months Ended March 31, 2021
	Number of common shares	Common stock		Retained earnings		Accumulated other comprehensive income (loss), net		Total stockholders’ equity
Balance at December 31, 2020	35,912	$	571,021	$	224,400	$	25,018	$	820,439

Restricted stock units vested	92	—		—		—		—

Stock-based compensation expense	—	870		—		—		870
Common stock repurchased	(23)	(687)		—		—		(687)
Net income	—	—		25,344				25,344
Other comprehensive loss, net of tax	—	—		—		(11,557)		(11,557)

Cash dividend declared on common stock ($0.20 per share)	—	—		(7,258)		—		(7,258)
Balance at March 31, 2021	35,981	$	571,204	$	242,486	$	13,461	$	827,151


	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, 2019	36,619	$	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 awards	87	—		—		—		—
Exercise of stock options	5	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 dividend declared on common stock ($0.20 per share)	—	—		(7,343)		—		(7,343)
Balance at March 31, 2020	35,889	$	568,439	$	211,707	$	18,292	$	798,438

(1) Effective January 1, 2020, Company adopted ASU 2016-13, Financial Instruments - Credit Losses.

See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF ~~STOCKHOLDERS' EQUITY~~CASH FLOWS (Unaudited)

(In ~~thousands, except per share amounts)~~thousands)

Three Months Ended September 30, 2020
Number of
common
shares Common
stock Retained
earnings Accumulated other comprehensive income, net Total
stockholders’
equity
Balance at June 30, 2020 35,909 $ 569,329 $ 198,342 $ 25,981 $ 793,652
Restricted stock units vested, net of forfeitures of restricted stock awards 2 — — — —
Stock-based compensation expense — 848 — — 848
Common stock repurchased (1) (7) — — (7)
Net income — — 16,636 16,636
Other comprehensive loss, net of tax — — — (773) (773)
Cash dividend declared on common stock ($0.20 per share) — — (7,227) — (7,227)
Balance at September 30, 2020 35,910 $ 570,170 $ 207,751 $ 25,208 $ 803,129

Nine Months Ended September 30, 2020
Number of
common
shares Common
stock Retained
earnings Accumulated other comprehensive income, net Total
stockholders’
equity
Balance at December 31, 2019 36,619 $ 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 awards 108 — — — —
Exercise of stock options 8 122 — — 122
Stock-based compensation expense — 2,694 — — 2,694
Common stock repurchased (825) (19,105) — — (19,105)
Net income — — 22,688 — 22,688
Other comprehensive income, net of tax — — — 14,830 14,830
Cash dividend declared on common stock ($0.60 per share) — — (21,796) — (21,796)
Balance at September 30, 2020 35,910 $ 570,170 $ 207,751 $ 25,208 $ 803,129

~~(1)~~ ~~Effective January 1, 2020, Company adopted ASU 2016-13,~~ ~~Financial Instruments - Credit Losses~~.


	Three Months Ended March 31,
	2021		2020
Cash flows from operating activities:
Net income	$	25,344	$	12,191
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion	(6,796)		67
(Reversal of) provision for credit losses	(7,199)		7,946
Net change in accrued interest receivable, prepaid expenses and other assets, and accrued expenses and other liabilities	(1,205)		(7,581)
Stock-based compensation expense	870		969
Amortization of intangible assets	797		903
Origination of mortgage loans held for sale	(32,254)		(16,026)
Proceeds from sale of mortgage loans held for sale	31,755		18,298
Bank owned life insurance income	(656)		(885)

Valuation adjustment on interest rate swaps	(244)		0
Loss on sale of other real estate owned, net	0		4
Gain on sale of mortgage loans held for sale, net	(1,370)		(547)
Gain on sale of investment securities available for sale, net	(29)		(1,014)
Gain on sale of assets held for sale	(22)		(9)


Loss (gain) on sale or write-off of premises and equipment, net	90		(9)
Net cash provided by operating activities	9,081		14,307
Cash flows from investing activities:
Loans originated, net of principal payments	(117,892)		(84,807)
Maturities, calls and payments of investment securities available for sale	62,675		74,320
Purchase of investment securities available for sale	(166,038)		(90,517)
Proceeds from sales of investment securities available for sale	1,248		25,177
Purchase of premises and equipment	(475)		(1,423)

Proceeds from sales of other real estate owned	0		266
Proceeds from sales of assets held for sale	1,731		394
Proceeds from redemption of Federal Home Loan Bank stock	0		760
Purchases of Federal Home Loan Bank stock	(1,272)		(1,044)
Proceeds from sales of premises and equipment	0		9
Purchases of bank owned life insurance	(105)		(3,579)
Proceeds from bank owned life insurance death benefit	0		1,324
Capital contributions to low-income housing tax credit partnerships	(12,617)		(1,434)

Net cash used by investing activities	(232,745)		(80,554)
Cash flows from financing activities:
Net increase in deposits	421,708		35,272
Federal Home Loan Bank advances	10		19,000
Repayment of Federal Home Loan Bank advances	(10)		(19,000)
Common stock cash dividends paid	(7,183)		(7,314)
Net increase (decrease) in securities sold under agreement to repurchase	820		(8,377)
Proceeds from exercise of stock options	0		71
Repurchase of common stock	(687)		(19,060)
Net cash provided by financing activities	414,658		592

Table of Contents

Three Months Ended September 30, 2019
Number of
common
shares Common
stock Retained
earnings Accumulated other comprehensive income, net Total
stockholders’
equity
Balance at June 30, 2019 36,883 $ 591,703 $ 195,168 $ 9,754 $ 796,625
Restricted stock units vested, net of forfeitures of restricted stock awards 1 — — — 0
Exercise of stock options 1 2 — — 2
Stock-based compensation expense — 830 — — 830
Common stock repurchased (267) (6,954) — — (6,954)
Net income — — 17,895 — 17,895
Other comprehensive income, net of tax — — — 2,771 2,771
Cash dividends declared on common stock ($0.19 per share) — — (7,042) — (7,042)
Balance at September 30, 2019 36,618 $ 585,581 $ 206,021 $ 12,525 $ 804,127

Nine Months Ended September 30, 2019
Number of
common
shares Common
stock Retained
earnings Accumulated other comprehensive (loss) income, net Total
stockholders’
equity
Balance at December 31, 2018 36,874 $ 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 awards 63 — — — 0
Exercise of stock options 4 44 — — 44
Stock-based compensation expense — 2,366 — — 2,366
Common stock repurchased (323) (8,635) — — (8,635)
Net income — — 50,431 — 50,431
Other comprehensive income, net of tax — — — 19,980 19,980
Cash dividends declared on common stock ($0.55 per share) — — (20,383) — (20,383)
Balance at September 30, 2019 36,618 $ 585,581 $ 206,021 $ 12,525 $ 804,127

~~(1)~~ ~~Effective January 1, 2019, the Company adopted ASU 2016-02,~~ ~~Leases~~.

~~See accompanying Notes to Condensed Consolidated Financial Statements.~~

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~~HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES~~

~~CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)~~

~~(In thousands)~~

Nine Months Ended
September 30,
2020 2019
Cash flows from operating activities:
Net income $ 22,688 $ 50,431
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion 28,337 3,463
Provision for credit losses 39,239 2,753
Net change in accrued interest receivable, prepaid expenses and other assets, and accrued expenses and other liabilities (12,298) 303
Stock-based compensation expense 2,694 2,366
Amortization of intangible assets 2,666 3,026
Origination of mortgage loans held for sale (93,422) (45,852)
Proceeds from sale of mortgage loans held for sale 93,830 43,544
Earnings on bank owned life insurance (2,440) (1,578)
Valuation adjustment on other real estate owned 0 51
(Gain) loss on sale of other real estate owned, net (179) 227
Gain on sale of mortgage loans held for sale, net (3,125) (1,613)
Gain on sale of investment securities, net (1,463) (329)
Gain on sale of assets held for sale (9) 0
Impairment of right of use asset 102 117
Gain on sale of premises and equipment, net (25) (14)
Net cash provided by operating activities 76,595 56,895
Cash flows from investing activities:
Loans originated, net of principal payments (924,930) (79,000)
Maturities, calls and payments of investment securities available for sale 207,955 145,778
Purchase of investment securities available for sale (117,456) (156,501)
Proceeds from sales of investment securities available for sale 44,970 43,872
Purchase of premises and equipment (6,136) (10,526)
Proceeds from sales of other loans 0 3,562
Proceeds from sales of other real estate owned 1,290 864
Proceeds from sales of assets held for sale 394 0
Proceeds from redemption of Federal Home Loan Bank stock 2,560 18,032
Purchases of Federal Home Loan Bank stock (2,844) (18,333)
Proceeds from sales of premises and equipment 53 35
Purchase of bank owned life insurance (3,579) (8,000)
Proceeds from bank owned life insurance death benefit 1,324 0
Capital contributions to low-income housing tax credit partnerships and new market tax credit partnerships, net (7,109) (16,992)
Net cash used by investing activities (803,508) (77,209)

~~Table of Contents~~

Nine Months Ended
September 30,
2020 2019
Cash flows from financing activities:
Net increase in deposits 1,106,372 129,855
Federal Home Loan Bank advances 19,000 445,800
Repayment of Federal Home Loan Bank advances (19,000) (445,800)
Common stock cash dividends paid (21,676) (20,288)
Net increase (decrease) in securities sold under agreement to repurchase 8,874 (5,604)
Proceeds from exercise of stock options 122 44
Repurchase of common stock (19,105) (8,635)
Net cash provided by financing activities 1,074,587 95,372
Net increase in cash and cash equivalents 347,674 75,058
Cash and cash equivalents at beginning of period 228,568 161,910
Cash and cash equivalents at end of period $ 576,242 $ 236,968
Supplemental disclosures of cash flow information:
Cash paid for interest $ 10,972 $ 13,099
Cash paid for income taxes, net of refunds 8,279 7,098
Supplemental non-cash disclosures of cash flow information:
Transfers of loans receivable to other real estate owned $ 270 $ 0
Transfers of properties held for sale recorded in premises and equipment, net to prepaid expenses and other assets 0 1,533
Investment in low income housing tax credit partnership and related funding commitment 10,237 15,254
Cumulative effect from change in accounting policy (1)
7,175 29,754
Transfer of bank owned life insurance to prepaid expenses and other assets 0 209
Right of use assets obtained in exchange for new operating lease liabilities 273 698


	Three Months Ended March 31,
	2021		2020
Net increase (decrease) in cash and cash equivalents	190,994		(65,655)
Cash and cash equivalents at beginning of period	743,322		228,568
Cash and cash equivalents at end of period	$	934,316	$	162,913

Supplemental disclosures of cash flow information:
Cash paid for interest	$	1,889	$	4,507
Cash paid for income taxes, net of refunds	64		58

Supplemental non-cash disclosures of cash flow information:
Transfers of loans receivable to other real estate owned	$	0	$	270


Purchase of investment securities available for sale not settled	5,000		7,303
Cumulative effect from change in accounting policy (1)	0		7,175

Right of use assets obtained in exchange for new operating lease liabilities	7,381		591

(1) Effective January 1, 2020, the 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.

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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

The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, Heritage Bank. The Bank is headquartered in Olympia, Washington and conducts business from its 6253 branch offices as of ~~September 30, 2020~~March 31, 2021 located throughout Washington State and the greater Portland, Oregon area. The Bank’s business consists primarily of commercial lending and deposit relationships with small and medium-sized businesses and their owners in its market areas and attracting deposits from the general public. The Bank also makes real estate construction and land development loans, consumer loans and originates first mortgage loans on residential properties primarily located in its market areas. The Bank's deposits are insured by the FDIC.

The Company announced a plan in October 2020 to consolidate 9 branches to create a more efficient branch footprint, including 1 branch during October 2020 and 8 branches during January 2021. This will reduce the branch count from 62 to 53. The Company plans to integrate these locations into other branches within its network.

(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 ~~2019~~2020 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 nine~~ months ended ~~September 30, 2020~~March 31, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, ~~2020.~~2021.

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,~~provided. Management believes that the judgments, estimates, and ~~actual~~assumptions used in the preparation of the Condensed Consolidated Financial Statements are appropriate based on the facts and circumstances at the time. Actual results, however, could ~~differ.~~differ significantly from those estimates. Material estimates that are particularly susceptible to significant change relate to management's estimate of ACL on loans, management's estimate of ACL on unfunded commitments, management's evaluation of goodwill impairment and the fair value of financial instruments. It is reasonably possible that management's estimate of the ACL on loans of ~~$73.3~~$64.2 million at ~~September 30, 2020~~March 31, 2021 as disclosed in Note (4) Allowance for Credit Losses on Loans, management's estimate of the ACL on unfunded commitments of $3.6 million as disclosed in Note (14) Commitments and Contingencies, management's conclusion that the fair value of the reporting unit more likely than not exceeds its carrying value at ~~September 30, 2020~~March 31, 2021 as disclosed in Note (6) Goodwill and Other Intangible Assets and the estimates of fair value of financial instruments as disclosed in Note (12) Fair Value Measurements could materially change. In particular, these estimates have been and will continue to be affected by the ongoing COVID-19 pandemic. The severity, magnitude and duration, as well as the economic consequences of the COVID-19 pandemic, are uncertain, rapidly changing and difficult to predict. As a result, our accounting estimates and assumptions may change over time in response to the COVID-19 pandemic.

The accompanying Condensed Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. All significant intercompany balances and transactions among the Company and the Bank have been eliminated in consolidation.

Certain prior year amounts in the Condensed Consolidated Statements of Income and the Condensed Consolidated Statements of Cash Flows have been reclassified to conform to the current year’s presentation. Namely, loan receivable balances in the disclosures of Note (3) Loans Receivable and Note (4) Allowance for Credit Losses on Loans have been reclassified to conform to the current period presentation, which is net of deferred fees and costs. Reclassifications had no effect on the prior years' net income or stockholders’ equity.

The significant accounting policies used in preparation of the ~~Company's~~ Condensed Consolidated Financial Statements are disclosed in greater detail in the ~~2019~~2020 Annual Form 10-K. ~~Other than the adoption of the new accounting standard discussed below, there~~There have not been any material changes in the Company's significant accounting policies from those contained in the ~~2019~~2020 Annual Form ~~10-K.~~10-K during the three months ended March 31, 2021.

(d) ~~Adoption of~~ Recently Issued or Adopted Accounting Pronouncements

FASB ASU 2016-13

~~On January 1, 2020, the Company adopted FASB ASU 2016-13~~, Financial ~~Instruments -~~Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended ~~replacing~~by ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, and ASU 2020-02, was originally issued in June 2016. This ASU replaced the incurred loss methodology with an expected loss methodology, which is commonly referred to as the "CECL" methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at

~~Table of Contents~~

amortized cost, including loans receivable. It also applies to off-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments. In addition, CECL Adoption made changes to the accounting for credit losses on investment securities available for sale.

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. Due to the significant number of loan payment deferral modifications which have been made in accordance with the CARES Act, the Company assessed the need for an allowance on credit losses of its accrued interest receivable on loans and determined no allowance was required to be recorded as the ACL on accrued interest receivable on loans was not significant at September 30, 2020.

Results for the reporting 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 CECL Adoption are as follows:~~

~~Investment Securities~~

A debt security is placed on nonaccrual status at the 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 Available for Sale~~

Management evaluates the need for an ACL on investment securities available for sale 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 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 adverse 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 credit loss exists and an ACL on investment securities available for sale is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any decline in fair value that has not been recorded through an ACL on investment securities available for sale is recognized in other comprehensive income.

Changes in the ACL on investment securities available for sale are recorded as provision for credit losses expense. Losses are charged against the ACL when management believes the uncollectability of an investment security available for sale is confirmed or when either of the criteria regarding intent or requirement to sell is met.

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 stated above.

~~Loans Receivable~~

~~Loans receivable include loans originated and indirect 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 within Accrued interest receivable on the Condensed Consolidated Statements of Financial Condition.

~~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~~

~~Table of Contents~~

~~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 through earnings as a provision for credit losses. For PCD loans, the initial ACL is incorporated into the calculation of the fair value of net assets acquired on the merger date and the net of the PCD loan purchase price and the initial ACL becomes the initial amortized cost basis. The difference between the initial amortized cost basis and the par value of PCD loans is the noncredit discount or premium for PCD loans. The noncredit discount or premium for PCD loans and both the noncredit and credit discount or premium for non-PCD loans are accreted through the interest and fees on loans line item on the 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 earnings as a provision for credit losses.

~~Troubled Debt Restructures~~:

The CARES Act and regulatory agencies provided guidance around the modification of loans as a result of the COVID-19 pandemic, and outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined by the CARES Act and related regulatory guidance prior to any relief, are not TDRs. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current if they are less than 30 days past due on the contractual payments as of December 31, 2019 under the CARES Act and at the time a modification program is implemented under related regulatory guidance.

~~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 ACL 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 ACL. The Bank records 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.

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 methodology, the Company has identified segments of loans with similar risk characteristics that align with their identified loan classes. Nonaccrual loans are not considered similar to other loans; therefore, they are evaluated for credit losses 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.

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 credit losses on an individual basis as it is not deemed to have similar characteristics of other loans in the portfolio. Nonaccrual TDR loans, including defaulted TDR loans, and performing TDR loans that do not meet the similar characteristics criteria, are evaluated for allowance on an individual basis as described above except that the original interest rate is used to discount the expected cash flows, not the rate specified in the restructuring.

For each loan segment collectively measured for allowance, the baseline loss rates are calculated using the Bank's average quarterly historical loss information for an economic cycle. The Bank evaluates the historical period on a quarterly basis, with the assumption that economic cycles have historically lasted

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between 10 and 15 years. The baseline loss rates are applied to each loan's estimated cash flows over the life of the loan under the remaining life method to determine the baseline loss estimate for each loan. Estimated cash flows consider the principal and interest in accordance with the contractual term of the loan and estimated prepayments. Contractual cash flows are based on the amortized cost, and are adjusted for balances guaranteed by governmental entities, such as SBA or USDA, or the unguaranteed amortized cost. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: 1) management has a reasonable expectation at the reporting date that a TDR will be executed with an individual borrower or 2) the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company. Prepayments are established for each segment based on rolling historical averages for the 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 reasonable and supportable time frame. Economic forecast models for the current period are uploaded to the model, which targets 16 forecasted macroeconomic factors, such as unemployment rate, GDP, housing price index, commercial real estate price index, disposable income growth, mortgage rates, and certain rate indices. Each of the forecasted 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 the long-term average actual losses of the dataset. The impact of those macroeconomic factors to each segment, both positive or negative, using the reasonable and supportable period, are added to the calculated baseline loss rate. After the reasonable and supportable period, forecasted loss rates revert to historical baseline loss levels over the predetermined reversion period on a straight-lined basis.

The Bank 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 historical 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 evaluation of ACL on loans is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. While management utilizes its best judgment and information available to recognize 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 time 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 which the Bank is exposed to credit risk from a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Bank. 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 for unfunded commitments is similar to the ACL 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 each loan class under the ACL for loans.

The ACL for unfunded commitments is recognized in Accrued expenses and other liabilities on the Condensed Consolidated Statements of Financial Condition and changes are recorded through earnings as a provision for credit losses on the Condensed Consolidated Statements of Income.

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~~Provision for Credit Losses~~

The provision for credit losses as presented in the Company's Condensed Consolidated Statements of Income includes the provision for credit losses on loans and the provision for credit losses on unfunded commitments.

~~(e) Recently Issued Accounting Pronouncements~~

~~FASB ASU 2016-13~~, ~~Financial Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended by ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, and 2020-02, was originally issued in June 2016.~~ This ASU requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected. For public

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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.~~2018 and can be delayed under a provision of the CARES Act until the end of the official health emergency declaration. The ~~Company~~Bank adopted ASU 2016-13 using the modified retrospective method for all financial assets measured at amortized cost and unfunded commitments. At adoption, the Bank elected not to measure an ACL 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~~accrued interest receivable on loans receivable 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 marketaccrued 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 ACLreceivable on investment securities available for sale ~~was recorded upon adoption. See Note (2) Investment Securities~~as Bank policy is to reverse interest income 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 as presented on the Condensed Consolidated Statements of Income, net of provision for credit losses on unfunded commitments.uncollectible accrued interest receivable balances in a timely manner.

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,~~ASU 2016-13 included an ACL was determined for each PCI loan. The ACL on PCI loans was added to the loan's carrying amount to establish a PCD loan at its amortized cost basis. The difference between the outstanding 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~~ an increase in the ACL on loans of $1.8 million at January 1, 2020. Upon adoption, the adjusted beginning balance of the ACL on loans as a percentage of loans receivable was 1.01% as compared to 0.96% at December 31, 2019 under the prior incurred loss methodology.

The PCI to PCD transition also resulted in a net discount of $4.3 million for PCD loans, or an increase in the net discount for PCD loans of $1.6 million. Following the transition, the total net discount for purchased loans increased to $10.0 million at January 1, 2020 compared to $8.4 million as of December 31, 2019.

~~See Note (3) Loans Receivable and Note (4) Allowance for Credit Losses on Loans for more information.~~

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~~Unfunded Commitments~~

ASU 2016-13 was applied prospectively and replaced the reserve for unfunded commitments with the ACL on unfunded commitments as included in Accrued liabilities and other expenses on the Condensed Consolidated Statements of Financial Condition and replaced the provision for unfunded commitments with the provision for credit losses as presented on the Condensed Consolidated Statements of Income, net of provision for credit losses on loans. Upon adoption, the Bank recorded a pretax increase in the beginning ACL on unfunded commitments of $3.7 million. See Note (14) Commitments and Contingencies for more information.

~~Overall CECL Impact~~

~~The adoption of ASU 2016-13, including the above mentioned increase to the ACL on loans of $3.4 million and the~~ increase to the ACL on unfunded commitments of $3.7 million, ~~resulted~~resulting in a pretax cumulative-effect adjustment of $7.1 million. The impact of this adjustment to beginning retained earnings on January 1, 2020 was $5.6 million, net of tax.

FASB ASU ~~2017-04~~, ~~Goodwill (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 has goodwill from prior business combinations, performs an annual impairment test during the quarter ended December 31 or more frequently if changes or circumstances occur that would more-likely-than-not reduce the fair value of the reporting unit below its carrying value and adopted the guidance on January 1, 2020. Although the Company cannot anticipate future goodwill impairment assessments, based on the most recent assessment prior to adoption, it is unlikely that an impairment amount would need to be calculated and, therefore, at adoption there was no impact from these amendments to the Company’s financial position and results of operations. In addition, the current accounting policies and processes were not changed, except for the elimination of the Step 2 analysis. For additional information regarding goodwill impairment testing, see Note (6) Goodwill and Other Intangible Assets.

~~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 adopted the guidance on January 1, 2020. The adoption did not have a material impact to Note (12) 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 Codification with the intent to make the Codification easier to understand and apply by eliminating inconsistencies and providing clarifications. The ASU was effective immediately upon its release and did not have a material impact on the Company's Condensed Consolidated Financial Statements as of or for the nine months ended September 30, 2020.

~~FASB ASU~~ 2020-04, Reference Rate Reform (Topic 848), as amended by ASU 2021-01, 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. ASU 2020-04 also provides numerous optional expedients for derivative accounting and is effective March 12, 2020 through December 31, 2022. An entity may elect to apply the ASU 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 ASU must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic. The Bank’s swap related transactions are the majority of the Company's LIBOR exposure. Effective January 25, 2021, the Company has agreed to adhere to the Interbank Offered Rate Fallbacks Protocol as published by the International Swaps and Derivatives Association, Inc. and recommended by the Alternative Reference Rates Committee. The Company further anticipates this ASU will simplify any modifications ~~we execute~~executed 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.~~net deferred fees. The Company ~~is evaluating the impacts of~~does not expect this ASU ~~and has not yet determined whether LIBOR transition and this ASU will~~to have a material ~~effects~~impact on its business operations and ~~Condensed Consolidated Financial Statements.~~

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~~FASB ASU 2020-08~~, ~~Codification Improvements to Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs, was issued in October 2020 and modifies~~ the premium amortization on purchased callable debt securities on a prospective basis. The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early application is not permitted. The Company does not expect the ASU will have a material impact on its Condensed Consolidated Financial Statements.

(2)Investment Securities

The Company’s investment policy is designed primarily to provide and maintain liquidity, generate a favorable return on assets without incurring undue interest rate and credit risk, and complement the Bank’s lending activities.

There were 0 securities classified as trading or held to maturity at March 31, 2021 or December 31, 2020.

(a) Securities by Type and Maturity

The following tables present the amortized cost and fair value of investment securities available for sale at the dates indicated and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive ~~income (loss):~~income:


		September 30, 2020									March 31, 2021
		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. government and agency securities	U.S. government and agency securities	$	50,752	$	1,165	$	(24)	$	51,893	U.S. government and agency securities	$	96,415	$	630	$	(2,188)	$	94,857
Municipal securities	Municipal securities	193,300		12,247		(237)		205,310		Municipal securities	219,373		10,001		(1,711)		227,663

Residential CMO and MBS	Residential CMO and MBS	216,719		6,129		(267)		222,581		Residential CMO and MBS	179,680		4,233		(917)		182,996
Commercial CMO and MBS	Commercial CMO and MBS	292,163		12,785		(266)		304,682		Commercial CMO and MBS	341,620		9,168		(2,619)		348,169
Corporate obligations	Corporate obligations	19,947		231		(7)		20,171		Corporate obligations	10,989		66		0		11,055
Other asset-backed securities	Other asset-backed securities	29,510		460		(115)		29,855		Other asset-backed securities	28,280		548		(10)		28,818
Total	Total	$	802,391	$	33,017	$	(916)	$	834,492	Total	$	876,357	$	24,646	$	(7,445)	$	893,558

December 31, 2019
Amortized
Cost Gross
Unrealized
Gains Gross
Unrealized
Losses Fair
Value
(In thousands)
U.S. government and agency securities $ 104,709 $ 598 $ (84) $ 105,223
Municipal securities 128,183 4,933 (102) 133,014
Residential CMO and MBS 336,929 3,184 (505) 339,608
Commercial CMO and MBS 322,169 5,575 (649) 327,095
Corporate obligations 23,893 316 (15) 24,194
Other asset-backed securities 23,277 54 (153) 23,178
Total $ 939,160 $ 14,660 $ (1,508) $ 952,312

~~There were 0 securities classified as trading or held to maturity at September 30, 2020 or December 31, 2019.~~

For the three and nine months ended September 30, 2020, there was 0 provision for credit loss on investment securities available for sale recorded in the Condensed Consolidated Statements of Income. There was 0 ACL on investment securities available for sale at September 30, 2020.

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	December 31, 2020
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(In thousands)
U.S. government and agency securities	$	44,713	$	947	$	0	$	45,660
Municipal securities	197,634		12,561		(227)		209,968

Residential CMO and MBS	196,956		5,125		(209)		201,872
Commercial CMO and MBS	290,638		13,198		(90)		303,746
Corporate obligations	10,971		125		0		11,096
Other asset-backed securities	29,283		565		(27)		29,821
Total	$	770,195	$	32,521	$	(553)	$	802,163

The amortized cost and fair value of investment securities available for sale at ~~September 30, 2020,~~March 31, 2021, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.


		Amortized Cost		Fair Value			Amortized Cost		Fair Value
		(In thousands)					(In thousands)
Due in one year or less	Due in one year or less	$	63,147	$	63,749	Due in one year or less	$	48,897	$	49,279
Due after one year through five years	Due after one year through five years	138,244		144,457		Due after one year through five years	134,310		140,053
Due after five years through ten years	Due after five years through ten years	203,897		214,141		Due after five years through ten years	285,906		290,676
Due after ten years	Due after ten years	397,103		412,145		Due after ten years	407,244		413,550
Total	Total	$	802,391	$	834,492	Total	$	876,357	$	893,558

There were no holdings of investment securities of any one issuer, other than the U.S. ~~Government~~government and its agencies, in an amount greater than 10% of stockholders’ equity at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019.~~2020.

(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 ~~for which an ACL has not been recorded,~~ aggregated by investment category and length of time that the individual securities have been in continuous unrealized loss positions as of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019:~~2020:

September 30, 2020
Less than 12 Months 12 Months or Longer Total
Fair
Value Unrealized
Losses Fair
Value Unrealized
Losses Fair
Value Unrealized
Losses
(In thousands)
U.S. government and agency securities $ 3,976 $ (24) $ 0 $ 0 $ 3,976 $ (24)
Municipal securities 11,918 (237) 0 0 11,918 (237)
Residential CMO and MBS 543 (2) 26,344 (265) 26,887 (267)
Commercial CMO and MBS 11,124 (9) 18,125 (257) 29,249 (266)
Corporate obligations 1,993 (7) 0 0 1,993 (7)
Other asset-backed securities 6,914 (47) 4,666 (68) 11,580 (115)
Total $ 36,468 $ (326) $ 49,135 $ (590) $ 85,603 $ (916)


		December 31, 2019													March 31, 2021
		Less than 12 Months				12 Months or Longer				Total					Less 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. government and agency securities	U.S. government and agency securities	$	45,999	$	(84)	$	0	$	0	$	45,999	$	(84)	U.S. government and agency securities	$	54,549	$	(2,188)	$	0	$	0	$	54,549	$	(2,188)
Municipal securities	Municipal securities	13,761		(102)		0		0		13,761		(102)		Municipal securities	48,130		(1,558)		2,312		(153)		50,442		(1,711)

Residential CMO and MBS	Residential CMO and MBS	14,272		(66)		60,232		(439)		74,504		(505)		Residential CMO and MBS	16,359		(768)		24,221		(149)		40,580		(917)
Commercial CMO and MBS	Commercial CMO and MBS	56,263		(177)		43,623		(472)		99,886		(649)		Commercial CMO and MBS	79,240		(2,612)		2,606		(7)		81,846		(2,619)

Corporate obligations		998		(2)		1,987		(13)		2,985		(15)

Other asset-backed securities	Other asset-backed securities	14,383		(127)		1,609		(26)		15,992		(153)		Other asset-backed securities	0		0		1,330		(10)		1,330		(10)
Total	Total	$	145,676	$	(558)	$	107,451	$	(950)	$	253,127	$	(1,508)	Total	$	198,278	$	(7,126)	$	30,469	$	(319)	$	228,747	$	(7,445)

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	December 31, 2020
	Less than 12 Months				12 Months or Longer				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In thousands)

Municipal securities	10,264		(227)		0		0		10,264		(227)

Residential CMO and MBS	0		0		25,293		(209)		25,293		(209)
Commercial CMO and MBS	11,404		(29)		7,499		(61)		18,903		(90)


Other asset-backed securities	0		0		4,570		(27)		4,570		(27)
Total	$	21,668	$	(256)	$	37,362	$	(297)	$	59,030	$	(553)

The Company ~~has~~ evaluated ~~these~~ investment securities available for sale as of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019~~2020 and determined that any declines in fair value were attributable to changes in interest rates relative to where these investments fall within the yield curve and individual characteristics. Management monitors published credit ratings for adverse changes for all rated investment securities and none of these securities had a below investment grade credit rating as of both March 31, 2021 and December 31, 2020. In addition, the Company does not intend to sell these securities nor does the Company consider it more likely than not that it will be required to sell these securities before the recovery of the amortized cost basis, which may be upon maturity. Therefore, 0 ACL ~~is necessary. Unrealized losses~~ on investment securities available for sale ~~have not been recognized into earnings because the issuers~~was recorded as of ~~bonds are investment grade, the securities carry governmental guarantees, management does not intend to sell~~March 31, 2021 and it is likely that management will not be required to sell the securities prior to their anticipated recovery and the decline in fair value is largely due to changes in interest rates and other market conditions. The issuers continue to make timely principal and interest payments on the bonds and the fair value is expected to recover as the bonds approach maturity.December 31, 2020.

The following table presents the gross realized gains and losses on the sale of investment securities available for sale for the three ~~and nine~~ months ended ~~September 30, 2020~~March 31, 2021 and ~~2019:~~2020:


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019		2020		2019			2021		2020
		(In thousands)									(In thousands)
Gross realized gains	Gross realized gains	$	40	$	281	$	1,482	$	557	Gross realized gains	$	29	$	1,028
Gross realized losses	Gross realized losses	0		0		(19)		(228)		Gross realized losses	0		(14)
Net realized gains	Net realized gains	$	40	$	281	$	1,463	$	329	Net realized gains	$	29	$	1,014

(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 ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019:~~2020:


		September 30, 2020				December 31, 2019					March 31, 2021				December 31, 2020
		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	Washington and Oregon state public deposits	$	178,332	$	186,198	$	187,700	$	190,773	Washington and Oregon state public deposits	$	118,333	$	122,419	$	119,652	$	124,228

Securities sold under agreement to repurchase	Securities sold under agreement to repurchase	43,557		44,822		22,156		22,294		Securities sold under agreement to repurchase	47,467		48,178		38,630		39,945
Other securities pledged	Other securities pledged	31,688		32,724		19,333		19,850		Other securities pledged	27,928		28,679		29,665		30,717
Total	Total	$	253,577	$	263,744	$	229,189	$	232,917	Total	$	193,728	$	199,276	$	187,947	$	194,890

(e) Accrued Interest Receivable

Accrued interest receivable excluded from amortized cost on investment securities available for sale totaled ~~$3.3~~$3.4 million and ~~$3.7~~$3.6 million at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, respectively. No amounts of accrued interest receivable on investment securities available for sale were reversed against interest income on investment securities available for sale during the three ~~and nine~~ months ended ~~September 30, 2020~~March 31, 2021 and ~~2019.~~March 31, 2020.

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(3)Loans Receivable

(a) Loan Origination/Risk Management

The ~~Company~~Bank originates loans in the ordinary course of business and has also acquired loans through mergers and acquisitions. Accrued interest receivable was excluded from disclosures presenting the ~~Company's~~Bank's amortized cost of loans receivable as it was deemed insignificant. Accrued interest receivable on loans totaled $15.6 million and $10.7 million at September 30, 2020 and December 31, 2019, respectively. No ACL on accrued interest receivable was recorded at September 30, 2020.

The ~~Company~~Bank categorizes the individual loans in ~~one of the 4 segments of~~ the total loan ~~portfolio:~~portfolio into 4 segments: commercial business; ~~one-to-four family residential;~~residential real estate; 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~~2020 Annual Form 10-K, except for SBA PPP loans. The Bank began originating SBA PPP loans during the three months ended June 30, 2020 following the passage of the CARES Act. SBA PPP loans are fully guaranteed by the SBA, intended for businesses impacted by COVID-19 and designed to provide near term relief to help small businesses sustain operations. These

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loans have either a two-year or five-year maturity date and earn interest at 1%. The Bank also earned a fee based on the size of the loan, which is recognized over the life of the loan. The balance of unamortized net deferred fees on SBA PPP loans was $22.0 million at September 30, 2020. The Bank expects that the great majority of SBA PPP borrowers will seek full or partial forgiveness of their loan obligations in accordance with the CARES Act.

The CARES Act also provides temporary relief from the accounting and disclosure requirements for TDRs for certain loan modifications that are the result of a hardship that is related, either directly or indirectly, to the COVID-19 pandemic. In addition, interagency guidance issued by federal banking regulators and endorsed by the FASB staff has indicated that borrowers who receive relief are not TDRs if they meet qualifying criteria. The Company elected to apply the temporary relief under the CARES Act and related regulatory guidance to certain eligible short-term modifications, and therefore will not treat qualifying loan modifications as TDRs for accounting or disclosure purposes.

The regulatory agencies have also provided guidance regarding credit risk ratings, delinquency reporting and nonaccrual status for loans adversely impacted by COVID-19. The Bank will exercise judgment in determining the risk rating for impacted borrowers and will not automatically adversely classify credits that are affected by COVID-19. The Bank also will not designate loans with payment deferrals granted due to COVID-19 as past due because of the deferral. Due to the short-term nature of the forbearance and other relief programs we are offering as a result of the COVID-19 pandemic, we expect that borrowers granted relief under these programs will generally not be reported as nonaccrual during the deferral period.

~~The 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.~~10-K.

The amortized cost of loans receivable, net of ACL on loans at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019~~2020 consisted of the following portfolio segments and classes:


		September 30, 2020		December 31, 2019			March 31, 2021		December 31, 2020
		(In thousands)					(In thousands)
Commercial business:	Commercial business:					Commercial business:
Commercial and industrial	Commercial and industrial	$	750,557	$	852,220	Commercial and industrial	$	693,539	$	733,098
SBA PPP	SBA PPP	867,782		0		SBA PPP	886,761		715,121
Owner-occupied CRE	Owner-occupied CRE	859,338		805,234		Owner-occupied CRE	881,168		856,684
Non-owner occupied CRE	Non-owner occupied CRE	1,384,973		1,288,779		Non-owner occupied CRE	1,427,953		1,410,303
Total commercial business	Total commercial business	3,862,650		2,946,233		Total commercial business	3,889,421		3,715,206
One-to-four family residential		131,921		131,660
Residential real estate						Residential real estate	114,856		122,756
Real estate construction and land development:	Real estate construction and land development:					Real estate construction and land development:
One-to-four family residential		99,650		104,296
Five or more family residential and commercial properties		215,472		170,350
Residential						Residential	79,878		78,259
Commercial and multifamily						Commercial and multifamily	217,815		227,454
Total real estate construction and land development	Total real estate construction and land development	315,122		274,646		Total real estate construction and land development	297,693		305,713
Consumer	Consumer	357,037		415,340		Consumer	293,899		324,972
Loans receivable	Loans receivable	4,666,730		3,767,879		Loans receivable	4,595,869		4,468,647
Allowance for credit losses on loans	Allowance for credit losses on loans	(73,340)		(36,171)		Allowance for credit losses on loans	(64,225)		(70,185)
Loans receivable, net	Loans receivable, net	$	4,593,390	$	3,731,708	Loans receivable, net	$	4,531,644	$	4,398,462

Balances included in the amortized cost of Loans receivable:						Balances included in the amortized cost of Loans receivable:
Unamortized net discount on acquired loans						Unamortized net discount on acquired loans	$	(5,501)	$	(6,575)
Unamortized net deferred fee						Unamortized net deferred fee	$	(24,017)	$	(15,458)

(b) Concentrations of Credit

~~As of September 30, 2020, and December 31, 2019, there were 0 concentrations of loans related to any single industry in excess of 10%~~Most of the ~~Company’s total~~Bank’s lending activity occurs within its primary market areas which are concentrated along the I-5 corridor from Whatcom County to Clark County in Washington State and Multnomah County and Washington County in Oregon, as well as other contiguous markets and represents a geographic concentration. Additionally, our loan portfolio is concentrated in commercial-type loans, including commercial business loans and commercial and multifamily real estate construction and land development loans.

As part of the on-going monitoring of the credit quality of the ~~Company’s~~Bank’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) nonperforming loans, (v) past due status and ~~(v)~~(vi) the general economic conditions of the United States of America, and specifically the states of Washington and Oregon. The ~~Company~~Bank utilizes a risk grading matrix to assign a risk grade to each ~~loan~~of its loans. Loans are graded on a ~~numerical~~ scale of 1 to 10. Risk grades are aggregated to create the risk categories

~~Table~~ of ~~Contents~~

~~of "Pass"~~Pass for grades 1 to 6, ~~"Special Mention" ("SM")~~Special Mention or "SM" for grade 7, ~~"Substandard" ("SS")~~Substandard or "SS" for grade 8, ~~"Doubtful"~~Doubtful for grade 9 and ~~"Loss"~~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~~2020 Annual Form 10-K. ~~There were no loans with a risk grade of doubtful or loss at September 30, 2020.~~

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~~results of annual term loan reviews performed by the Bank's Credit department and scheduled

Table of Contents

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.

Loan grades relate to the likelihood of losses in that the higher the grade, the greater the loss potential. Loans with a pass grade may have some estimated inherent losses, but to a lesser extent than the other loan grades. The SM loan grade is transitory in that the Bank is waiting on additional information to determine the likelihood and extent of the potential loss. The likelihood of loss for SM graded loans, however, is greater than Watch graded loans because there has been measurable credit deterioration. Loans with a SS grade are generally loans with higher risk of loss if the deficiencies are not corrected. For Doubtful and Loss graded loans, the Bank is almost certain of the losses and the outstanding principal balances are generally charged off to the realizable value.

Regulatory agencies provided guidance regarding credit risk ratings, delinquency reporting and nonaccrual status for loans adversely impacted by COVID-19. The Bank has and will continue to exercise judgment in determining the risk rating for impacted borrowers and will not automatically adversely classify credits that are affected by COVID-19. The Bank also will not designate loans with payment deferrals granted due to COVID-19 as past due because of the deferral. Due to the short-term nature of the forbearance and other relief programs we are offering as a result of the COVID-19 pandemic, we expect that borrowers granted relief under these programs will generally not be reported as nonaccrual during the deferral period.

The following table presents the amortized cost of loans receivable by risk grade as of ~~September 30,~~March 31, 2021 and December 31, 2020:


																									March 31, 2021
		Term Loans Amortized Cost Basis by Origination Year												Revolving Loans			Revolving Loans Converted to Term Loans (1)			Loans Receivable					Term Loans Amortized Cost Basis by Origination Year												Revolving Loans		Revolving Loans Converted to Term Loans (1)			Loans Receivable
		2020		2019		2018		2017		2016		Prior									2021				2020		2019		2018		2017		Prior
		(In thousands)																			(In thousands)
Commercial business:	Commercial business:																							Commercial business:
Commercial and industrial	Commercial and industrial																							Commercial and industrial
Pass	Pass	$	64,817	$	142,409	$	79,659	$	53,491	$	45,436	$	116,934		$	144,505		$	802			$	648,053			Pass	$	24,439	$	120,602	$	122,697	$	64,991	$	39,950	$	124,627		$	98,202		$	1,473	$	596,981
SM	SM	13,117		6,355		5,622		2,244		1,683		2,104		18,188			98			49,411				SM	1,287		2,714		7,917		9,504		3,704		9,272		7,334		35			41,767
SS	SS	2,580		11,418		5,160		8,884		2,361		10,440		8,324			3,926			53,093				SS	463		2,255		12,178		3,982		8,941		6,816		16,478		3,678			54,791

Total	Total	80,514		160,182		90,441		64,619		49,480		129,478		171,017			4,826			750,557				Total	26,189		125,571		142,792		78,477		52,595		140,715		122,014		5,186			693,539
SBA PPP	SBA PPP																							SBA PPP
Pass	Pass	867,782		0		0		0		0		0		0			0			867,782				Pass	339,326		547,435		0		0		0		0		0		0			886,761

Total	Total	867,782		0		0		0		0		0		0			0			867,782				Total	339,326		547,435		0		0		0		0		0		0			886,761
Owner-occupied CRE	Owner-occupied CRE																							Owner-occupied CRE
Pass	Pass	78,911		167,369		99,922		88,349		78,693		275,986		0			0			789,230				Pass	41,278		88,959		170,718		93,917		76,142		312,775		0		0			783,789
SM	SM	0		0		3,344		7,789		5,499		23,170		0			0			39,802				SM	0		5,336		5,269		12,453		10,406		18,755		0		0			52,219
SS	SS	0		0		117		7,379		3,348		19,462		0			0			30,306				SS	0		695		0		3,942		7,234		33,289		0		0			45,160

Total	Total	78,911		167,369		103,383		103,517		87,540		318,618		0			0			859,338				Total	41,278		94,990		175,987		110,312		93,782		364,819		0		0			881,168
Non-owner-occupied CRE
Non-owner occupied CRE																								Non-owner occupied CRE
Pass	Pass	151,158		167,691		154,288		186,969		258,168		418,767		0			0			1,337,041				Pass	34,753		194,272		186,003		140,023		171,127		631,974		0		0			1,358,152
SM	SM	0		0		0		0		11,842		3,364		0			0			15,206				SM	0		0		1,979		357		2,371		10,282		0		0			14,989
SS	SS	0		0		3,623		0		12,811		16,292		0			0			32,726				SS	0		0		0		3,623		0		51,189		0		0			54,812

Total	Total	151,158		167,691		157,911		186,969		282,821		438,423		0			0			1,384,973				Total	34,753		194,272		187,982		144,003		173,498		693,445		0		0			1,427,953
Total commercial business	Total commercial business																							Total commercial business
Pass	Pass	1,162,668		477,469		333,869		328,809		382,297		811,687		144,505			802			3,642,106				Pass	439,796		951,268		479,418		298,931		287,219		1,069,376		98,202		1,473			3,625,683
SM	SM	13,117		6,355		8,966		10,033		19,024		28,638		18,188			98			104,419				SM	1,287		8,050		15,165		22,314		16,481		38,309		7,334		35			108,975
SS	SS	2,580		11,418		8,900		16,263		18,520		46,194		8,324			3,926			116,125				SS	463		2,950		12,178		11,547		16,175		91,294		16,478		3,678			154,763

Total	Total	1,178,365		495,242		351,735		355,105		419,841		886,519		171,017			4,826			3,862,650				Total	441,546		962,268		506,761		332,792		319,875		1,198,979		122,014		5,186			3,889,421
One-to-four family residential
Residential real estate																								Residential real estate
Pass	Pass	24,100		46,513		17,913		12,436		8,649		21,751		0			0			131,362				Pass	5,373		28,990		35,889		12,518		9,606		21,699		0		0			114,075

SS	SS	0		0		0		60		0		499		0			0			559				SS	0		0		0		0		58		723		0		0			781

Total	Total	24,100		46,513		17,913		12,496		8,649		22,250		0			0			131,921				Total	5,373		28,990		35,889		12,518		9,664		22,422		0		0			114,856
Real estate construction and land development:
One-to-four family residential
Pass		25,519		62,220		6,203		1,364		971		1,561		0			0			97,838

SS		0		0		0		1,812		0		0		0			0			1,812

Total		25,519		62,220		6,203		3,176		971		1,561		0			0			99,650

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		Term Loans Amortized Cost Basis by Origination Year												Revolving Loans			Revolving Loans Converted to Term Loans (1)			Loans Receivable					March 31, 2021
		2020		2019		2018		2017		2016		Prior										Term Loans Amortized Cost Basis by Origination Year														Revolving Loans			Revolving Loans Converted to Term Loans (1)			Loans Receivable
		(In thousands)																				2021			2020			2019		2018		2017		Prior				Revolving Loans
Five or more family residential and commercial properties
Real estate construction and land development:																								Real estate construction and land development:
Residential																								Residential
Pass	Pass	22,710		131,850		49,678		7,070		784		1,464				0			0				213,556				Pass	11,483		39,217		24,441		2,515		408					1,814			0		0	79,878
SM		0		0		0		0		0		33		0			0			33

Commercial and multifamily																								Commercial and multifamily
Pass																								Pass	1,023			34,068		148,787		28,018		1,961		2,432			0			0		216,289

SS	SS	989		450		0		0		0		444		0			0			1,883				SS	0			637		450		0		0		439			0			0		1,526

Total	Total	23,699		132,300		49,678		7,070		784		1,941		0			0			215,472				Total	1,023			34,705		149,237		28,018		1,961		2,871			0			0		217,815
Total real estate construction and land development
Pass	Pass	48,229		194,070		55,881		8,434		1,755		3,025		0			0			311,394				Pass	12,506			73,285		173,228		30,533		2,369		4,246			0			0		296,167
SM		0		0		0		0		0		33		0			0			33

SS	SS	989		450		0		1,812		0		444		0			0			3,695				SS	0			637		450		0		0		439			0			0		1,526

Total	Total	49,218		194,520		55,881		10,246		1,755		3,502		0			0			315,122				Total	12,506			73,922		173,678		30,533		2,369		4,685			0			0		297,693
Consumer	Consumer																							Consumer
Pass	Pass	40,061		86,402		59,782		35,068		16,361		20,521		94,849			473			353,517				Pass	3,984			41,029		68,276		46,869		25,950		23,893			80,090			417		290,508
SM		0		0		0		0		0		0		329			0			329

SS	SS	20		330		532		480		422		1,156		86			165			3,191				SS	0			95		594		611		681		1,271			78			61		3,391

Total	Total	40,081		86,732		60,314		35,548		16,783		21,677		95,264			638			357,037				Total	3,984			41,124		68,870		47,480		26,631		25,164			80,168			478		293,899
Loans receivable	Loans receivable																							Loans receivable
Pass	Pass	1,275,058		804,454		467,445		384,747		409,062		856,984		239,354			1,275			4,438,379				Pass	461,659			1,094,572		756,811		388,851		325,144		1,119,214			178,292			1,890		4,326,433
SM	SM	13,117		6,355		8,966		10,033		19,024		28,671		18,517			98			104,781				SM	1,287			8,050		15,165		22,314		16,481		38,309			7,334			35		108,975
SS	SS	3,589		12,198		9,432		18,615		18,942		48,293		8,410			4,091			123,570				SS	463			3,682		13,222		12,158		16,914		93,727			16,556			3,739		160,461

Total	Total	$	1,291,764	$	823,007	$	485,843	$	413,395	$	447,028	$	933,948	$	266,281		$	5,464		$	4,666,730			Total	$	463,409		$	1,106,304	$	785,198	$	423,323	$	358,539	$	1,251,250		$	202,182		$	5,664	$	4,595,869

(1) Represents loans receivable balance at ~~September 30,~~March 31, 2021 which was converted from a revolving loan to an amortizing loan during the three months ended March 31, 2021.


	December 31, 2020
	Term Loans Amortized Cost Basis by Origination Year						Revolving Loans	Revolving Loans Converted to Term Loans (1)	Loans Receivable
	2020	2019	2018	2017	2016	Prior
	(In thousands)
Commercial business:
Commercial and industrial
Pass	118,971	127,919	70,766	44,231	37,658	95,958	121,440	819	617,762
SM	14,430	9,162	10,878	4,171	5,700	3,579	11,790	814	60,524
SS	2,199	11,835	3,416	9,348	1,052	7,651	15,484	3,827	54,812

Total	135,600	148,916	85,060	57,750	44,410	107,188	148,714	5,460	733,098
SBA PPP
Pass	715,121	0	0	0	0	0	0	0	715,121




Owner-occupied CRE
Pass	89,224	167,095	94,830	80,138	74,902	254,864	0	0	761,053
SM	6,146	4,540	16,386	11,231	5,464	12,105	0	0	55,872
SS	0	0	114	7,320	3,313	29,012	0	0	39,759

Total	95,370	171,635	111,330	98,689	83,679	295,981	0	0	856,684
Non-owner-occupied CRE
Pass	197,548	173,153	148,830	172,438	240,614	406,817	0	0	1,339,400
SM	0	1,979	357	2,448	6,210	3,539	0	0	14,533
SS	0	0	3,623	0	35,455	17,292	0	0	56,370

Total	197,548	175,132	152,810	174,886	282,279	427,648	0	0	1,410,303

Table of Contents


Total commercial business
Pass	1,120,864		468,167		314,426		296,807		353,174		757,639		121,440		819		3,433,336
SM	20,576		15,681		27,621		17,850		17,374		19,223		11,790		814		130,929
SS	2,199		11,835		7,153		16,668		39,820		53,955		15,484		3,827		150,941

Total	1,143,639		495,683		349,200		331,325		410,368		830,817		148,714		5,460		3,715,206
Residential real estate
Pass	30,141		41,829		15,730		10,362		7,322		16,825		0		0		122,209

SS	0		0		0		59		0		488		0		0		547

Total	30,141		41,829		15,730		10,421		7,322		17,313		0		0		122,756
Real estate construction and land development:
Residential
Pass	33,801		36,697		2,725		1,097		971		1,042		0		0		76,333

SS	0		0		0		1,926		0		0		0		0		1,926

Total	33,801		36,697		2,725		3,023		971		1,042		0		0		78,259
Commercial and multifamily
Pass	27,423		151,020		38,682		5,660		689		1,407		0		0		224,881
SM	67		1,011		0		0		0		29		0		0		1,107
SS	572		450		0		0		0		444		0		0		1,466

Total	28,062		152,481		38,682		5,660		689		1,880		0		0		227,454
Total real estate construction and land development
Pass	61,224		187,717		41,407		6,757		1,660		2,449		0		0		301,214
SM	67		1,011		0		0		0		29		0		0		1,107
SS	572		450		0		1,926		0		444		0		0		3,392

Total	61,863		189,178		41,407		8,683		1,660		2,922		0		0		305,713
Consumer
Pass	43,742		77,083		53,195		30,559		13,443		15,453		87,547		315		321,337

SS	34		404		684		648		420		1,319		78		48		3,635

Total	43,776		77,487		53,879		31,207		13,863		16,772		87,625		363		324,972
Loans receivable
Pass	1,255,971		774,796		424,758		344,485		375,599		792,366		208,987		1,134		4,178,096
SM	20,643		16,692		27,621		17,850		17,374		19,252		11,790		814		132,036
SS	2,805		12,689		7,837		19,301		40,240		56,206		15,562		3,875		158,515

Total	$	1,279,419	$	804,177	$	460,216	$	381,636	$	433,213	$	867,824	$	236,339	$	5,823	$	4,468,647

(1) Represents loans receivable balance at December 31, 2020 which was converted from a revolving loan to an amortizing loan during the ~~nine months~~year ended ~~September 30, 2020.~~

~~The following table presents the amortized cost of loans receivable by credit quality indicator as of~~ December 31, ~~2019 in accordance with disclosure requirements prior to CECL Adoption:~~

December 31, 2019
Pass Special Mention Substandard Doubtful/Loss Total
(In thousands)
Commercial business:
Commercial and industrial $ 771,559 $ 16,340 $ 64,321 $ 0 $ 852,220
Owner-occupied CRE 765,411 24,659 15,164 0 805,234
Non-owner occupied CRE 1,274,513 5,662 8,604 0 1,288,779
Total commercial business 2,811,483 46,661 88,089 0 2,946,233
One-to-four family residential 130,818 0 842 0 131,660
Real estate construction and land development:
One-to-four family residential 101,973 1,516 807 0 104,296
Five or more family residential and commercial properties 169,668 682 0 0 170,350
Total real estate construction and land development 271,641 2,198 807 0 274,646
Consumer 411,141 0 3,675 524 415,340
Loans receivable $ 3,625,083 $ 48,859 $ 93,413 $ 524 $ 3,767,879

2020.

Potential problem loans are risk rated ~~Special Mention~~SM or worse that are not classified as a performing TDR or nonaccrual loan and are not 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 as of March 31, 2021 and December 31, 2020 were $163.8 million and $182.3 million, respectively.

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Table of Contents

~~terms. Potential problem loans as of September 30, 2020 and December 31, 2019 were $159.8 million and $87.8 million, respectively.~~

(d) Nonaccrual Loans

The following table presents the amortized cost of nonaccrual loans for the dates indicated:


		September 30, 2020						December 31, 2019				March 31, 2021
		Nonaccrual without ACL		Nonaccrual with ACL		Total Nonaccrual		Nonaccrual (1)				Nonaccrual without ACL		Nonaccrual with ACL		Total Nonaccrual
		(In thousands)								(In thousands)
Commercial business:	Commercial business:										Commercial business:
Commercial and industrial	Commercial and industrial	$	23,410	$	3,750	$	27,160	$	33,544		Commercial and industrial	$	17,400	$	12,872	$	30,272
Owner-occupied CRE	Owner-occupied CRE	4,765		11,795		16,560		4,714			Owner-occupied CRE	4,518		11,918		16,436
Non-owner occupied CRE	Non-owner occupied CRE	3,478		3,732		7,210		6,062			Non-owner occupied CRE	1,424		3,623		5,047
Total commercial business	Total commercial business	31,653		19,277		50,930		44,320			Total commercial business	23,342		28,413		51,755
One-to-four family residential		38		119		157		19
Residential real estate											Residential real estate	66		0		66
Real estate construction and land development:	Real estate construction and land development:										Real estate construction and land development:

Five or more family residential and commercial properties		0		1,439		1,439		0
Commercial and multifamily											Commercial and multifamily	0		1,021		1,021

Consumer	Consumer	0		78		78		186			Consumer	26		0		26
Total	Total	$	31,691	$	20,913	$	52,604	$	44,525		Total	$	23,434	$	29,434	$	52,868

~~(1)~~
~~Presentation of December 31, 2019 balances is in accordance with disclosure requirements prior to CECL Adoption.~~


	December 31, 2020
	Nonaccrual without ACL		Nonaccrual with ACL		Total Nonaccrual
	(In thousands)
Commercial business:
Commercial and industrial	$	22,039	$	9,208	$	31,247
Owner-occupied CRE	4,693		13,700		18,393
Non-owner occupied CRE	3,424		3,722		7,146
Total commercial business	30,156		26,630		56,786
Residential real estate	67		117		184
Real estate construction and land development:

Commercial and multifamily	572		450		1,022

Consumer	31		69		100
Total	$	30,826	$	27,266	$	58,092

The following table presents the reversal of interest income on loans due to the write-off of accrued interest receivable upon the initial classification of loans as nonaccrual loans and the interest income recognized due to payment in full of previously classified nonaccrual loans during the following periods:


		Three Months Ended September 30, 2020				Three Months Ended September 30, 2019						Three Months Ended March 31, 2021				Three Months Ended March 31, 2020
		Interest Income Reversed		Interest Income Recognized		Interest Income Reversed			Interest Income Recognized			Interest Income Reversed		Interest Income Recognized		Interest Income Reversed		Interest Income Recognized
		(In thousands)						(In thousands)
Commercial business:	Commercial business:										Commercial business:
Commercial and industrial	Commercial and industrial	$	(59)	$	111	$	(336)		$	37	Commercial and industrial	$	(2)	$	63	$	(16)	$	219
Owner-occupied CRE	Owner-occupied CRE	(219)		29		0			182		Owner-occupied CRE	0		114		0		46
Non-owner occupied CRE	Non-owner occupied CRE	(102)		0		0			181		Non-owner occupied CRE	0		313		0		45
Total commercial business	Total commercial business	(380)		140		(336)			400		Total commercial business	(2)		490		(16)		310
One-to-four family residential		(1)		2		0			0

Real estate construction and land development:	Real estate construction and land development:										Real estate construction and land development:
One-to-four family residential		0		0		0			10
Five or more family residential and commercial properties		(11)		0		0			0
Total real estate construction and land development		(11)		0		0			10
Residential											Residential	0		73		0		0

Consumer											Consumer	0		0		0		10
Total	Total	$	(392)	$	142	$	(336)		$	410	Total	$	(2)	$	563	$	(16)	$	320

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Nine Months Ended
September 30, 2020 Nine months ended
September 30, 2019
Interest Income Reversed Interest Income Recognized Interest Income Reversed Interest Income Recognized
(in thousands)
Commercial business:
Commercial and industrial $ (75) $ 419 $ (394) $ 97
Owner-occupied CRE (219) 89 0 228
Non-owner occupied CRE (102) 67 (32) 181
Total commercial business (396) 575 (426) 506
One-to-four family residential (1) 2 0 0
Real estate construction and land development:
One-to-four family residential 0 0 (3) 33
Five or more family residential and commercial properties (11) 0 0 0
Total real estate construction and land development (11) 0 (3) 33
Consumer 0 47 0 6
Total $ (408) $ 624 $ (429) $ 545

For the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019, no~~0 interest income was recognized subsequent to a loan’s classification as nonaccrual, except as indicated in the tables ~~above.~~above due to payment in full.

(e) Past due loans

The ~~Company~~Bank performs an aging analysis of past due loans using policies consistent with regulatory reporting requirements with categories of 30-89 days past due and 90 or more days past due. The amortized cost of past due loans as of ~~September 30,~~March 31, 2021 and December 31, 2020 were as follows:

September 30, 2020
30-89 Days 90 Days or
Greater Total Past
Due Current Loans Receivable
(In thousands)
Commercial business:
Commercial and industrial $ 2,414 $ 8,415 $ 10,829 $ 739,728 $ 750,557
SBA PPP 0 0 0 867,782 867,782
Owner-occupied CRE 0 403 403 858,935 859,338
Non-owner occupied CRE 754 267 1,021 1,383,952 1,384,973
Total commercial business 3,168 9,085 12,253 3,850,397 3,862,650
One-to-four family residential 32 16 48 131,873 131,921
Real estate construction and land development:
One-to-four family residential 150 0 150 99,500 99,650
Five or more family residential and commercial properties 1,200 0 1,200 214,272 215,472
Total real estate construction and land development 1,350 0 1,350 313,772 315,122
Consumer 883 0 883 356,154 357,037
Total $ 5,433 $ 9,101 $ 14,534 $ 4,652,196 $ 4,666,730

~~Table of Contents~~


	March 31, 2021
	30-89 Days		90 Days or Greater		Total Past Due		Current		Loans Receivable
	(In thousands)
Commercial business:
Commercial and industrial	$	4,393	$	8,178	$	12,571	$	680,968	$	693,539
SBA PPP	0		0		0		886,761		886,761
Owner-occupied CRE	0		0		0		881,168		881,168
Non-owner occupied CRE	482		0		482		1,427,471		1,427,953
Total commercial business	4,875		8,178		13,053		3,876,368		3,889,421
Residential real estate	0		46		46		114,810		114,856
Real estate construction and land development:
Residential	0		0		0		79,878		79,878
Commercial and multifamily	0		571		571		217,244		217,815
Total real estate construction and land development	0		571		571		297,122		297,693
Consumer	739		0		739		293,160		293,899
Total	$	5,614	$	8,795	$	14,409	$	4,581,460	$	4,595,869

~~The following table presents the amortized cost of past due loans as of December 31, 2019 in accordance with disclosure requirements prior to CECL Adoption:~~


		December 31, 2019															December 31, 2020
		30-89 Days		90 Days or Greater		Total Past Due		Current		Total		PCI Loans		Loans Receivable			30-89 Days		90 Days or Greater		Total Past Due		Current		Loans Receivable
		(In thousands)															(In thousands)
Commercial business:	Commercial business:															Commercial business:
Commercial and industrial	Commercial and industrial	$	10,479	$	6,772	$	17,251	$	832,601	$	849,852	$	2,368	$	852,220	Commercial and industrial	$	4,621	$	8,082	$	12,703	$	720,395	$	733,098
SBA PPP																SBA PPP	0		0		0		715,121		715,121
Owner-occupied CRE	Owner-occupied CRE	607		806		1,413		798,907		800,320		4,914		805,234		Owner-occupied CRE	991		403		1,394		855,290		856,684
Non-owner occupied CRE	Non-owner occupied CRE	554		1,843		2,397		1,280,891		1,283,288		5,491		1,288,779		Non-owner occupied CRE	412		1,970		2,382		1,407,921		1,410,303
Total commercial business	Total commercial business	11,640		9,421		21,061		2,912,399		2,933,460		12,773		2,946,233		Total commercial business	6,024		10,455		16,479		3,698,727		3,715,206
One-to-four family residential		797		0		797		127,288		128,085		3,575		131,660
Residential real estate																Residential real estate	765		16		781		121,975		122,756
Real estate construction and land development:	Real estate construction and land development:															Real estate construction and land development:
One-to-four family residential		1,516		0		1,516		102,780		104,296		0		104,296
Five or more family residential and commercial properties		0		0		0		170,350		170,350		0		170,350
Residential																Residential	0		0		—		78,259		78,259
Commercial and multifamily																Commercial and multifamily	2,225		0		2,225		225,229		227,454
Total real estate construction and land development	Total real estate construction and land development	1,516		0		1,516		273,130		274,646		0		274,646		Total real estate construction and land development	2,225		0		2,225		303,488		305,713
Consumer	Consumer	2,071		0		2,071		411,507		413,578		1,762		415,340		Consumer	1,407		30		1,437		323,535		324,972
Total	Total	$	16,024	$	9,421	$	25,445	$	3,724,324	$	3,749,769	$	18,110	$	3,767,879	Total	$	10,421	$	10,501	$	20,922	$	4,447,725	$	4,468,647

There were 0 loans 90 days or more past due that were still accruing interest as of ~~September 30, 2020~~March 31, 2021 or December 31, ~~2019.~~2020.

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(f) Collateral-dependent Loans

The ~~types~~type of collateral securing loans individually evaluated for credit losses and for which the repayment was expected to be provided substantially through the operation or sale of the collateral as of ~~September 30,~~March 31, 2021 and December 31, 2020 were as follows:


		Loans receivable(1)								March 31, 2021
		CRE		Farmland		Single Family Residence		Equipment or Accounts Receivable			Total			CRE(1)		Farmland(1)		Residential Real Estate(1)		Non-real property business assets(1)		Total(1)
		(In thousands)								(In thousands)
Commercial business:	Commercial business:												Commercial business:
Commercial and industrial	Commercial and industrial	$	1,953	$	18,979	$	1,331	$	1,696		$	24,155	Commercial and industrial	$	1,967	$	13,760	$	825	$	592	$	17,144
Owner-occupied CRE	Owner-occupied CRE	4,764		0		0		0			4,764		Owner-occupied CRE	4,517		0		0		0		4,517
Non-owner occupied CRE	Non-owner occupied CRE	5,218		0		0		0			5,218		Non-owner occupied CRE	1,424		0		0		0		1,424
Total commercial business	Total commercial business	11,935		18,979		1,331		1,696			34,137		Total commercial business	7,908		13,760		825		592		23,085
One-to-four family residential		0		0		38		0			38
Residential real estate													Residential real estate	0		0		66		0		66
Real estate construction and land development:	Real estate construction and land development:												Real estate construction and land development:
One-to-four family residential		0		0		1,812		0			1,812

Commercial and multifamily													Commercial and multifamily	571		0		0		0		571

Consumer													Consumer	0		0		30		0		30
Total	Total	$	11,935	$	18,979	$	3,181	$	1,696		$	35,987	Total	$	8,479	$	13,760	$	921	$	592	$	23,752

(1) Balances represent the amortized cost of ~~loans receivable evaluated for credit losses using collateral valuation.~~the loan. If multiple collateral sources ~~secured~~secure the loan, the entire ~~loan receivable~~ balance is presented in the primary collateral ~~category deemed primary, which generally represents~~category.


	December 31, 2020
	CRE(1)		Farmland(1)		Residential Real Estate(1)		Non-real property business assets(1)		Other(1)		Total(1)
	(In thousands)
Commercial business:
Commercial and industrial	$	1,893	$	18,738	$	584	$	774	$	631	$	22,620
Owner-occupied CRE	4,693		0		0		0		0		4,693
Non-owner occupied CRE	3,424		0		0		0		0		3,424
Total commercial business	10,010		18,738		584		774		631		30,737
Residential real estate	0		0		67		0		0		67
Real estate construction and land development:

Commercial and multifamily	572		0		0		0		0		572

Consumer	0		0		30		0		0		30
Total	$	10,582	$	18,738	$	681	$	774	$	631	$	31,406

(1) Balances represent the ~~majority~~amortized cost of the loan. If multiple collateral ~~balance.~~sources secure the loan, the entire balance is presented in the primary collateral category.

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There have been no significant changes to the collateral securing individually evaluated loans for credit losses and for which repayment was expected to be provided substantially through the operation or sale of the collateral during the ~~nine~~three months ended ~~September 30, 2020,~~March 31, 2021, except changes due to payoffs and additions of loans to this classification.

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 and nine months ended September 30, 2019 are similar to the disclosures for impaired loans. Impaired loans include nonaccrual loans, performing TDR loans, and other loans with a specific valuation allowance, excluding PCI loans. The amortized cost of impaired loans as of December 31, 2019 are set forth in the following table:

December 31, 2019
Amortized Cost With
No Specific
Valuation
Allowance Amortized Cost With
Specific
Valuation
Allowance Total
Amortized Cost Outstanding
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 CRE 3,921 2,415 6,336 6,764 426
Non-owner occupied CRE 5,309 1,015 6,324 6,458 146
Total commercial business 39,409 17,059 56,468 58,807 1,944
One-to-four family residential 0 215 215 223 56
Real estate construction and land development:
One-to-four family residential 237 0 237 237 0
Consumer 0 561 561 570 143
Total $ 39,646 $ 17,835 $ 57,481 $ 59,837 $ 2,143

~~The average amortized cost of impaired loans for the three and nine months ended September 30, 2019 are set forth in the following table:~~

Three Months Ended
September 30, 2019 Nine Months Ended
September 30, 2019
(In thousands)
Commercial business:
Commercial and industrial $ 35,017 $ 28,925
Owner-occupied CRE 5,918 5,927
Non-owner occupied CRE 9,790 8,106
Total commercial business 50,725 42,958
One-to-four family residential 221 249
Real estate construction and land development:
One-to-four family residential 676 794
Consumer 600 581
Total $ 52,222 $ 44,582

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(g) Troubled Debt Restructured Loans

The ~~amortized cost and related ACL on loans~~majority of ~~performing and nonaccrual~~the Bank’s TDR loans are a result of granting extensions of maturity on troubled credits which have already been adversely classified. The Bank grants such extensions to reassess the borrower’s financial status and to develop a plan for repayment. The second most prevalent concession was the result of COVID Modifications, including payment deferrals and maturity extensions. The Bank has also accommodated re-amortizing loans over a longer period of time. Each of these modifications were a concession for a borrower that could not obtain similar financing terms from another source other than from the Bank.

The financial effects of each modification will vary based on the specific restructure. The Bank has a policy that it does not forgive principal or accrued interest as modified terms. The Bank’s TDR loans are primarily fully amortizing term loans. If the interest rate is not adjusted and the modified terms are consistent with other similar credits being offered, the Bank may not experience any loss associated with the restructure. If, however, the restructure involves interest rate modifications, the Bank may not collect all interest based on the original contractual terms.

The CARES Act, CA Act and regulatory agencies provided guidance around the modification of loans as a result of the COVID-19 pandemic, and outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined by the guidance 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 were considered current if they were less than 30 days past due on the contractual payments as of ~~September 30, 2020 and~~ December 31, 2019 under the CARES Act and at the time a modification program is implemented under related regulatory guidance. The CA Act extended relief offered under the CARES Act through January 1, 2022 or 60 days after the end of the national emergency declared by the President, whichever is earlier. The Bank elected to apply the temporary relief under the applicable guidance to certain eligible short-term modifications and did not classify the modifications as TDRs for accounting or disclosure purposes. However, COVID Modifications whose payment deferral exceeded 180 days following the loans' initial modification were classified as ~~follows:~~

September 30, 2020 December 31, 2019
Performing
TDR loans Nonaccrual
TDR loans Performing
TDR loans Nonaccrual
TDR loans
(In thousands)
TDR loans $ 19,615 $ 20,468 $ 14,469 $ 26,338
ACL on TDR loans 1,536 348 1,259 218

TDRs based on the Bank's internal policy.

The unfunded commitment to borrowers related to TDR loans was ~~$2.3~~$5.0 million and ~~$736,000~~$2.6 million at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, respectively.

For the three months ended March 31, 2021 and March 31, 2020, the Bank recorded $1.8 million and $608,000, respectively, of interest income related to performing TDR loans.

Loans that were modified as TDR loans ~~during the three and nine months ended September 30, 2020 and 2019~~ are set forth in the following ~~tables:~~table for the periods indicated:

Three months ended September 30,
2020 2019
Number of
Contracts
Amortized Cost (1)
Number of
Contracts
Amortized Cost (1)
(Dollars in thousands)
Commercial business:
Commercial and industrial 12 $ 7,217 15 $ 5,267
Owner-occupied CRE 5 2,312 2 1,214
Non-owner occupied CRE 2 438 3 2,597
Total commercial business 19 9,967 20 9,078
One-to-four family residential 1 22 0 0
Real estate construction and land development:
One-to-four family residential 4 1,812 0 0
Consumer 9 127 3 27
Total 33 $ 11,928 23 $ 9,105


		Nine Months Ended September 30,							Three Months Ended March 31,
		2020			2019				2021			2020
		Number of Contracts (2)	Amortized Cost (1) (2)		Number of Contracts (2)	Amortized Cost (1) (2)			Number of Contracts	Amortized Cost (1) (2)		Number of Contracts	Amortized Cost (1) (2)
		(Dollars in thousands)							(Dollars in thousands)
Commercial business:	Commercial business:							Commercial business:
Commercial and industrial	Commercial and industrial	38	$	18,871	33	$	22,408	Commercial and industrial	24	$	12,102	13	$	3,688
Owner-occupied CRE	Owner-occupied CRE	7	3,227		3	1,612		Owner-occupied CRE	2	4,660		4	2,183
Non-owner occupied CRE	Non-owner occupied CRE	4	2,417		4	5,568		Non-owner occupied CRE	1	1,979		3	2,210
Total commercial business	Total commercial business	49	24,515		40	29,588		Total commercial business	27	18,741		20	8,081
One-to-four family residential		1	22		0	0
Residential real estate								Residential real estate	1	180		0	0
Real estate construction and land development:	Real estate construction and land development:							Real estate construction and land development:
One-to-four family residential		4	1,812		1	560

Residential								Residential	0	0		4	1,516
Commercial and multifamily								Commercial and multifamily	1	450		0	0
Total real estate construction and land development								Total real estate construction and land development	1	450		4	1,516
Consumer	Consumer	20	251		10	158		Consumer	15	379		5	93
Total TDR loans		74	$	26,600	51	$	30,306
Total								Total	44	$	19,750	29	$	9,690

(1)~~Includes~~ Number of contracts and amortized cost represent loans which have balances as of period end, net of subsequent payments after ~~modifications~~modifications. Certain modified loans may have been paid-down or charged-off during the three months ended March 31, 2021 and ~~reflects the balance as of period end.~~ March 31, 2020.

(2) As the Bank did not forgive any principal or interest balance as part of the loan modifications, the Bank’s amortized cost in each loan at

~~Table of Contents~~

the date of modification (pre-modification) did not change as a result of the modification (post-modification).

~~(2)~~The table above ~~Number of contracts~~includes 19 and ~~amortized cost represent~~11 loans ~~which have balances as of period end. Certain modified loans may have been paid-down or charged-off during the nine~~for the three months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019.~~

~~The tables above include 22 and 31 loans, respectively, for the three and nine months ended September 30, 2020 and 7 and 17,~~ respectively, ~~for the three and nine months ended September 30, 2019~~ 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~~extensions. The

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Bank had 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 ACL ~~at September 30, 2020 for~~on loans that were modified as TDR ~~loans during the nine months ended September 30,~~loans of $2.4 million and $644,000 at March 31, 2021 and March 31, 2020, ~~was $1.6 million.~~respectively.

~~Loans~~The following table presents loans that were modified in a troubled debt restructure and subsequently defaulted within twelve months from the modification date during the ~~previous twelve months that subsequently defaulted during the three and nine months ended September 30, 2020 and 2019 are set forth in the following tables:~~periods indicated:

Three months ended September 30,
2020 2019
Number of
Contracts Amortized Cost Number of
Contracts Amortized Cost
(Dollars in thousands)
Commercial business:
Commercial and industrial 1 $ 229 4 $ 2,056
Non-owner occupied CRE 0 0 1 2,971
Total commercial business 1 $ 229 5 $ 5,027
Total 1 $ 229 5 $ 5,027


		Nine Months Ended September 30,							Three Months Ended March 31,
		2020			2019				2021			2020
		Number of Contracts (1)	Amortized Cost (1)		Number of Contracts (1)	Amortized Cost (1)			Number of Contracts (1)	Amortized Cost (1)		Number of Contracts (1)	Amortized Cost (1)
		(Dollars in thousands)							(Dollars in thousands)
Commercial business:	Commercial business:							Commercial business:
Commercial and industrial	Commercial and industrial	4	$	2,152	9	$	3,229	Commercial and industrial	2	$	2,792	2	$	1,873
Owner-occupied CRE		1	431		2	1,101

Non-owner occupied CRE	Non-owner occupied CRE	2	376		2	3,541		Non-owner occupied CRE	0	0		3	590
Total commercial business	Total commercial business	7	2,959		13	7,871		Total commercial business	2	2,792		5	2,463
Real estate construction and land development:
One-to-four family residential		0	0		1	560

Total	Total	7	$	2,959	14	$	8,431	Total	2	$	2,792	5	$	2,463

(1)Number of contracts and amortized cost represent loans which have balances as of period ~~end.~~end, net of subsequent payments after modifications. Certain modified loans may have been paid-down or charged-off during the ~~nine~~three months ended ~~September 30, 2020~~March 31, 2021 and ~~2019.~~ March 31, 2020.

During the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and March 31, 2020 ~~all of the~~these TDR loans ~~in the tables above~~ defaulted because each was past its modified maturity date and the borrower ~~has~~had not subsequently repaid the credits. The Bank chose not to extend further the maturity date on these loans. The Bank had an ACL on loans of ~~$512,000~~$94,000 and $334,000 at ~~September 30,~~March 31, 2021 and March 31, 2020, respectively, related to these TDR loans which defaulted during the ~~nine~~three months ended ~~September 30, 2020.~~

~~During the three and nine months ended September 30, 2019,~~ ~~3 and 12 TDR loans, respectively,~~ defaulted because each was past its modified maturity date and the borrower has not subsequently repaid the credits. The Bank chose not to extend further the maturity date on these loans. In addition, during both the three and nine months ended September 30, 2019, 2 TDR loans defaulted because the borrowers were more than 90 days delinquent on their scheduled loan payments. The Bank had a specific valuat~~ion allowance of $412,000 at September 30, 2019 related to these TDR loans which defaulted during the nine months ended September 30, 2019.~~

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~~For the three and nine months ended September 30, 2020, the Bank recorded $263,000 and~~ ~~$1.1 million~~, respectively, of interest income related to performing TDR loans. For the three and nine months ended September 30, 2019, the Bank recorded $282,000 and $980,000, respectively, of interest income related to performing TDR loans.

~~(h) Purchased Credit Impaired Loans~~

~~Upon CECL Adoption, the Company transitioned PCI loans to PCD loans. The following table reflects the outstanding principal balance and amortized cost of PCI loans at December~~March 31, ~~2019:~~

December 31, 2019
Outstanding Principal Amortized Cost
(In thousands)
Commercial business:
Commercial and industrial $ 4,439 $ 2,368
Owner-occupied CRE 4,925 4,914
Non-owner occupied CRE 7,028 5,491
Total commercial business 16,392 12,773
One-to-four family residential 3,095 3,575
Consumer 1,463 1,762
PCI loans $ 20,950 $ 18,110
2021.

On(h) Accrued interest receivable on loans receivable

Accrued interest receivable on loans receivable totaled $16.0 million and $15.8 million at March 31, 2021 and December 31, 2020, respectively. It is excluded from the ~~acquisition dates, the amount by which the undiscounted expected cash flows~~calculation of the ~~PCI~~ACL on loans exceeded the estimated fair value of the loan was the “accretable yield.” The accretable yield was then measured at each financial reporting date and represented 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~~as interest accrued, but not received, is reversed timely. However, management completed an analysis for an ACL on accrued interest receivable on loans receivable based on the ~~PCI~~significance of loan modifications in accordance with the CARES Act, CA Act and regulatory guidance and concluded no ACL on accrued interest receivable on loans ~~for the three~~should be recorded at March 31, 2021 and ~~nine months ended September 30, 2019:~~

Three Months Ended
September 30, 2019 Nine Months Ended
September 30, 2019
(In thousands)
Balance at the beginning of the period $ 8,572 $ 9,493
Accretion (423) (1,517)
Disposal and other (94) (744)
Reclassification from nonaccretable difference 0 823
Balance at the end of the period $ 8,055 $ 8,055
December 31, 2020.

(4)Allowance for Credit Losses on Loans

Effective January 1, 2020, the Bank adopted ASU 2016-13. ~~CECL Adoption replaced the allowance for loan losses with the ACL on loans and replaced the related provision for loan losses with the provision for credit losses on loans.~~ Risk characteristics by segment considered in the CECL ~~methodology~~model are the same as those disclosed in the ~~2019~~2020 Annual Form 10-K.

The baseline loss rates used to calculate the ACL on loans at ~~January 1, 2020~~March 31, 2021 utilized the Bank's average quarterly historical loss information from December 31, ~~2007 through December 31, 2019. The baseline loss rate for the ACL at September 30, 2020 used historical losses beginning December 31,~~ 2012 through the balance sheet date. ~~The Bank updated~~There were no changes to this assumption during the ~~historical loss period as it believes the economic cycle has~~three months ended ~~as evidenced by certain economic forecasts signaling that a recession has started given the prolonged, profound, and pervasive contraction in economic activities due to COVID-19.~~March 31, 2021. The Bank believes the historic loss rates are viable inputs to the current ~~expected credit loss methodology~~CECL model as the Bank's lending practice and business has remained relatively stable throughout the periods. While the Bank's assets have grown, the credit culture has stayed relatively consistent.

Prepayments included in the CECL model at ~~January 1, 2020 and September 30, 2020~~March 31, 2021 were based on the 48-month rolling historical averages for each segment, which management believes is an accurate representation of

~~Table of Contents~~

future prepayment activity. There were no changes to this ~~methodology~~assumption during the ~~nine~~three months ended ~~September 30, 2020.~~March 31, 2021.

The reasonable and supportable period used in the CECL model ~~at January 1, 2020~~as of March 31, 2021 was ~~four quarters and was increased~~five quarters. There were no changes to ~~five quarters in~~this assumption during the ~~CECL model at September 30, 2020 to include the additional impact of certain macroeconomic factors with lagged periods.~~three months ended March 31, 2021. Management believes that forecasts beyond this five quarter time period tend to diverge in economic assumptions and may be less comparable to actual future events. As the length of the reasonable and supportable period increases, the degree of judgment involved in estimating the allowance will likely increase.

The Bank used a ~~two quarter~~two-quarter reversion period in calculating the ACL on loans as of ~~January 1, 2020 and September 30, 2020~~March 31, 2021 as it believes the historical loss information is relevant to the expected credit losses and recognizes the declining precision and increasing uncertainty of estimating credit losses in those periods beyond which it can make reasonable and supportable forecasts.

The macroeconomic forecast used in the CECL model as of January 1, 2020 predicted continued economic expansion with steady GDP growth of 1.8% and low unemployment rates of 3.5% in 2020, among other factors. The onset of the COVID-19 pandemic resulted in identification of an economic recession There were no changes to this assumption during the ~~second quarter of 2020. The macroeconomic forecast used in~~three months ended March 31, 2021.

During the ~~CECL model as of September 30, 2020 reflected a slow and long recovery from~~three months ended March 31, 2021, the COVID-19 recession. The modeled recovery is expected to last through the end of 2021, including a contraction in GDP of 3.7% for 2020 and a rebound of 3.7% for 2021, and modest increases in GDP in future years. Unemployment rates are expected to average 8.7% during the remainder of 2020 and gradually reduce to 4.0% by 2025.

~~The~~ ACL on loans decreased $6.0 million, or 8.5%, due primarily to a reversal of provision for credit losses on loans of $6.1 million following improvements in the economic forecast at ~~September 30,~~March 31, 2021 as compared to the forecast for the three months ended December 31, 2020 ~~does not include~~and secondarily due to a ~~reserve for~~decrease in total loans receivable, excluding SBA PPP ~~loans as these loans~~which are fully guaranteed by the ~~SBA.~~SBA and not provisioned for in the ACL on loans.

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A summary of the changes in the ACL on loans during the three months ended March 31, 2021 and 2020 is as follows:


	Three Months Ended March 31,
	2021		2020
	(In thousands)
Balance at the beginning of the year	$	70,185	$	36,171
Impact of CECL Adoption	0		1,822
Balance at the beginning of the year, as adjusted	70,185		37,993
Charge-offs	(187)		(1,597)
Recoveries of loans previously charged-off	362		1,180
(Reversal of) provision for loan losses	(6,135)		9,964
Balance at the end of the year	$	64,225	$	47,540

The following tables detail the activity in the ACL on loans disaggregated by segment and class for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020:


		Three Months Ended September 30, 2020											Three Months Ended March 31, 2021
		Beginning Balance		Charge-offs		Recoveries		Provision for Credit Losses		Ending Balance			Beginning Balance		Charge-offs		Recoveries		(Reversal of) Provision for Credit Losses		Ending Balance
		(In thousands)											(In thousands)
Commercial business:	Commercial business:											Commercial business:
Commercial and industrial	Commercial and industrial	$	29,773	$	(507)	$	78	$	1,815	$	31,159	Commercial and industrial	$	30,010	$	(1)	$	205	$	(8,444)	$	21,770
SBA PPP	SBA PPP	0		0		0		0		0		SBA PPP	0		0		0		0		0
Owner-occupied CRE	Owner-occupied CRE	10,003		0		2		3,027		13,032		Owner-occupied CRE	9,486		0		2		976		10,464
Non-owner occupied CRE	Non-owner occupied CRE	10,666		0		0		(124)		10,542		Non-owner occupied CRE	10,112		0		0		2,858		12,970
Total commercial business	Total commercial business	50,442		(507)		80		4,718		54,733		Total commercial business	49,608		(1)		207		(4,610)		45,204
One-to-four family residential		2,223		0		0		(398)		1,825
Residential real estate												Residential real estate	1,591		0		0		(189)		1,402
Real estate construction and land development:	Real estate construction and land development:											Real estate construction and land development:
One-to-four family residential		567		0		139		(42)		664
Five or more family residential and commercial properties		8,557		0		0		70		8,627
Residential												Residential	1,951		0		16		81		2,048
Commercial and multifamily												Commercial and multifamily	11,141		(1)		0		83		11,223
Total real estate construction and land development	Total real estate construction and land development	9,124		0		139		28		9,291		Total real estate construction and land development	13,092		(1)		16		164		13,271
Consumer	Consumer	9,712		(335)		142		(2,028)		7,491		Consumer	5,894		(185)		139		(1,500)		4,348

Total	Total	$	71,501	$	(842)	$	361	$	2,320	$	73,340	Total	$	70,185	$	(187)	$	362	$	(6,135)	$	64,225


		Nine Months Ended September 30, 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			Beginning Balance		Impact of CECL Adoption		Beginning Balance, as Adjusted		Charge-offs		Recoveries		(Reversal of) Provision for Credit Losses		Ending Balance
		(In thousands)															(In thousands)
Commercial business:	Commercial business:															Commercial business:
Commercial and industrial	Commercial and industrial	$	11,739	$	(1,348)	$	10,391	$	(3,418)	$	1,204	$	22,982	$	31,159	Commercial and industrial	$	11,739	$	(1,348)	$	10,391	$	(1,087)	$	1,057	$	3,539	$	13,900
SBA PPP	SBA PPP	0		0		0		0		0		0		0		SBA PPP	0		0		0		0		0		0		0
Owner-occupied CRE	Owner-occupied CRE	4,512		452		4,964		(135)		16		8,187		13,032		Owner-occupied CRE	4,512		452		4,964		(135)		12		1,375		6,216
Non-owner occupied CRE																Non-owner occupied CRE	7,682		(2,039)		5,643		0		0		2,107		7,750
Total commercial business																Total commercial business	23,933		(2,935)		20,998		(1,222)		1,069		7,021		27,866
Residential real estate																Residential real estate	1,458		1,471		2,929		0		3		94		3,026

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Nine Months Ended September 30, 2020
Beginning Balance Impact of CECL Adoption Beginning Balance,
as Adjusted Charge-offs Recoveries Provision for Credit Losses Ending Balance
(In thousands)
Non-owner occupied CRE 7,682 (2,039) 5,643 0 0 4,899 10,542
Total commercial business 23,933 (2,935) 20,998 (3,553) 1,220 36,068 54,733
One-to-four family residential 1,458 1,471 2,929 0 3 (1,107) 1,825
Real estate construction and land development:
One-to-four family residential 1,455 (571) 884 0 160 (380) 664
Five or more family residential and commercial properties 1,605 7,240 8,845 0 0 (218) 8,627
Total real estate construction and land development 3,060 6,669 9,729 0 160 (598) 9,291
Consumer 6,821 (2,484) 4,337 (1,141) 433 3,862 7,491
Unallocated 899 (899) 0 0 0 0 0
Total $ 36,171 $ 1,822 $ 37,993 $ (4,694) $ 1,816 $ 38,225 $ 73,340

The Bank recognized net charge-offs of $2.9 million during the nine months ended September 30, 2020 primarily due to a commercial and industrial charge-off of $1.7 million related to a lending relationship that had been experiencing difficulties. Due to issues surrounding the control of the underlying loan collateral, the Bank determined it appropriate to charge-off the entire balance and pursue an aggressive collection strategy. Net charge-offs also included two commercial and industrial loan relationships totaling $447,000 as a result of impacts from the COVID-19 pandemic and small dollar net charge-offs on a large volume of consumer loans of $708,000. Net charge-offs were offset partially by a full recovery of a commercial and industrial agricultural lending relationship of $963,000 during the nine months ended September 30, 2020, which was charged-off during the three months ended December 31, 2019.

The provision for credit losses on loans of $38.2 million for the nine months ended September 30, 2020 was necessary to build the allowance to account for the current and forecasted economic conditions amidst COVID-19, including the credit losses estimated on collectively and individually evaluated loans.

The following tables detail activity in the allowance for loan losses disaggregated by segment and class for the three and nine months ended September 30, 2019 under the incurred loss methodology, including the ASC 310-30 methodology for PCI loans:

Three Months Ended September 30, 2019
Beginning Balance Charge-offs Recoveries Provision for Loan Losses Ending Balance
(In thousands)
Commercial business:
Commercial and industrial $ 11,993 $ (306) $ 43 $ 449 $ 12,179
Owner-occupied CRE 5,066 0 46 (656) 4,456
Non-owner occupied CRE 8,064 0 292 (525) 7,831
Total commercial business 25,123 (306) 381 (732) 24,466
One-to-four family residential 1,345 (15) 0 81 1,411
Real estate construction and land development:
One-to-four family residential 1,471 0 3 (133) 1,341

~~Table of Contents~~

Three Months Ended September 30, 2019
Beginning Balance Charge-offs Recoveries Provision for Loan Losses Ending Balance
(In thousands)
Five or more family residential and commercial properties 1,060 0 0 229 1,289
Total real estate construction and land development 2,531 0 3 96 2,630
Consumer 6,540 (501) 127 621 6,787
Unallocated 824 0 0 400 1,224
Total $ 36,363 $ (822) $ 511 $ 466 $ 36,518

Nine Months Ended September 30, 2019
Beginning Balance Charge-offs Recoveries Provision for Loan Losses Ending Balance
(In thousands)
Commercial business:
Commercial and industrial $ 11,343 $ (1,183) $ 112 $ 1,907 $ 12,179
Owner-occupied CRE 4,898 0 49 (491) 4,456
Non-owner occupied CRE 7,470 0 441 (80) 7,831
Total commercial business 23,711 (1,183) 602 1,336 24,466
One-to-four family residential 1,203 (45) 0 253 1,411
Real estate construction and land development:
One-to-four family residential 1,240 0 628 (527) 1,341
Five or more family residential and commercial properties 954 0 0 335 1,289
Total real estate construction and land development 2,194 0 628 (192) 2,630
Consumer 6,581 (1,653) 374 1,485 6,787
Unallocated 1,353 0 0 (129) 1,224
Total $ 35,042 $ (2,881) $ 1,604 $ 2,753 $ 36,518

The following table details the allowance for loan losses disaggregated on the basis of the Company's impairment method as of December 31, 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 Losses
(In thousands)
Commercial business:
Commercial and industrial $ 1,372 $ 9,772 $ 595 $ 11,739
Owner-occupied CRE 426 3,558 528 4,512
Non-owner occupied CRE 146 7,064 472 7,682
Total commercial business 1,944 20,394 1,595 23,933
One-to-four family residential 56 1,316 86 1,458
Real estate construction and land development:
One-to-four family residential 0 1,296 159 1,455

~~Table of Contents~~

Loans Individually Evaluated for Impairment Loans Collectively Evaluated for Impairment PCI Loans Total Allowance for Loan Losses
(In thousands)
Five or more family residential and commercial properties 0 1,527 78 1,605
Total real estate construction and land development 0 2,823 237 3,060
Consumer 143 6,327 351 6,821
Unallocated 0 899 0 899
Total $ 2,143 $ 31,759 $ 2,269 $ 36,171

The following table details the amortized cost of the loan receivables disaggregated on the basis of the Company’s impairment method as of December 31, 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 Loans Receivable
(In thousands)
Commercial business:
Commercial and industrial $ 43,808 $ 806,044 $ 2,368 $ 852,220
Owner-occupied CRE 6,336 793,984 4,914 805,234
Non-owner occupied CRE 6,324 1,276,964 5,491 1,288,779
Total commercial business 56,468 2,876,992 12,773 2,946,233
One-to-four family residential 215 127,870 3,575 131,660
Real estate construction and land development:
One-to-four family residential 237 104,059 0 104,296
Five or more family residential and commercial properties 0 170,350 0 170,350
Total real estate construction and land development 237 274,409 0 274,646
Consumer 561 413,017 1,762 415,340
Total $ 57,481 $ 3,692,288 $ 18,110 $ 3,767,879


	Three Months Ended March 31, 2020
	Beginning Balance		Impact of CECL Adoption		Beginning Balance, as Adjusted		Charge-offs		Recoveries		(Reversal of) Provision for Credit Losses		Ending Balance
	(In thousands)
Real estate construction and land development:
Residential	1,455		(571)		884		0		14		(34)		864
Commercial and multifamily	1,605		7,240		8,845		0		0		2,599		11,444
Total real estate construction and land development	3,060		6,669		9,729		0		14		2,565		12,308
Consumer	6,821		(2,484)		4,337		(375)		94		284		4,340
Unallocated	899		(899)		0		0		0		0		0
Total	$	36,171	$	1,822	$	37,993	$	(1,597)	$	1,180	$	9,964	$	47,540

(5)Other Real Estate Owned

Changes in other real estate owned during the ~~three and nine months ended September 30, 2020 and 2019~~periods indicated were as follows:


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019		2020		2019			2021		2020
		(In thousands)									(In thousands)
Balance at the beginning of the period	Balance at the beginning of the period	$	0	$	1,224	$	841	$	1,983	Balance at the beginning of the period	$	0	$	841
Additions	Additions	0		0		270		0		Additions	0		270

Proceeds from dispositions	Proceeds from dispositions	0		(435)		(1,290)		(864)		Proceeds from dispositions	0		(266)
Gain (loss) on sales, net		0		52		179		(227)
Valuation adjustment		0		0		0		(51)
Loss on sale, net										Loss on sale, net	0		(4)

Balance at the end of the period	Balance at the end of the period	$	0	$	841	$	0	$	841	Balance at the end of the period	$	0	$	841

At ~~September 30, 2020,~~March 31, 2021, there were 0 consumer mortgage loans secured by residential real estate properties (included in loans receivable on the ~~one-to-four family residential loans in Note (3) Loans Receivable)~~Condensed Consolidated Statements of Financial Position) for which formal foreclosure proceedings were in process.

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(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 Commercial Bancorp ~~on July 2, 2018;~~and Puget Sound Bancorp ~~on January 16,~~in 2018; Washington Banking Company ~~on May 1,~~in 2014; Valley Community Bancshares ~~on July 15,~~in 2013; Western Washington Bancorp in 2006 and North Pacific Bank in 1998. The Company’s goodwill is assigned to the Bank and is evaluated for impairment at the Bank level (reporting unit).

There were no additions to goodwill during the three ~~and nine~~ months ended ~~September 30, 2020~~March 31, 2021 and ~~2019.~~2020.

Management analyzes its goodwill on an annual basis on December 31 and between annual tests in certain circumstances such as material adverse changes in legal, business, regulatory and economic factors. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The Company performed ~~its~~an annual ~~goodwill~~ impairment test during the fourth quarter of 2019 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 0t considered impaired. Due to the deteriorating financial market and economic conditions as a result of the COVID-19 pandemic, the Company determined a triggering event occurred during the quarter ended June 30, 2020 and consequently performed a quantitative assessment ~~of goodwill~~ as of ~~May~~December 31, 2020. Management estimated the fair value of the reporting unit by weighting results from the market approach and the income approach. Significant assumptions inherent in the valuation methodologies for goodwill were employed and included, but were not limited to, prospective financial information, growth rates, terminal value, discount rates, and comparable multiples from publicly traded companies in our industry. Based on this quantitative test, management determined that the fair value of the reporting unit more likely than not exceeded the carrying value.

~~At September 30,~~ 2020 ~~the Company completed its qualitative assessment of goodwill~~ and concluded that it is more likely than not that the fair value of the reporting unit exceeded the carrying value. 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.there was no impairment.

(b) Other Intangible Assets

Other intangible assets represent core deposit intangibles acquired in business combinations. The useful life of the core deposit ~~intangible~~intangibles was estimated to be ten years for the acquisitions of Premier Commercial Bancorp, Puget Sound Bancorp, Washington Banking Company, and Valley Community Bancshares.

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The following table presents the change in other intangible assets for the periods indicated:


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019		2020		2019			2021		2020
		(In thousands)									(In thousands)
Balance at the beginning of the period	Balance at the beginning of the period	$	14,807	$	18,563	$	16,613	$	20,614	Balance at the beginning of the period	$	13,088	$	16,613

Amortization	Amortization	(860)		(975)		(2,666)		(3,026)		Amortization	(797)		(903)
Balance at the end of the period	Balance at the end of the period	$	13,947	$	17,588	$	13,947	$	17,588	Balance at the end of the period	$	12,291	$	15,710

(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 carrying value of $25.0 million and a total fair value of $18.9 million at the merger date. At ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, the balance of the junior subordinated debentures, net of unaccreted discount, was ~~$20.8~~$21.0 millionand ~~$20.6~~$20.9 million, respectively.

The adjustable rate of the trust preferred securities at ~~September 30,~~March 31, 2021 was and December 31, 2020 was ~~1.79%.~~1.75% and 1.80%, respectively. The ~~following table presents the~~ weighted average rate of the junior subordinated debentures for the ~~periods indicated:~~

Three Months Ended
September 30, Nine Months Ended
September 30,
2020 2019 2020 2019
Weighted average rate (1)
3.75 % 6.43 % 4.51 % 6.72 %

~~(1)~~years ended March 31, 2021, and 2020 was 3.63%, and 5.56%, respectively. The weighted average rate includes the accretion of the discount established at the merger date which is amortized over the life of the trust preferred securities.

~~Table of Contents~~

(8)Securities Sold Under Agreement to Repurchase

The ~~Company~~Bank utilizes securities sold under agreement to repurchase with one day maturities as a supplement to funding sources. Securities sold under agreement to repurchase are secured by pledged investment securities available for sale ~~as a supplement~~and the Bank is required to ~~funding sources.~~maintain an aggregate market value of securities pledged greater than the balance of the securities sold under agreement to repurchase. The Bank is required to pledge additional securities to cover any declines below the balance of the securities sold under agreement to repurchase. For additional information on the total value of investment securities pledged for securities sold under agreement to repurchase see Note (2) Investment Securities.

The following table presents the ~~Company's~~balance of Bank's securities sold under agreement to repurchase obligations by class of collateral pledged at the dates indicated:


		September 30, 2020		December 31, 2019			March 31, 2021		December 31, 2020
		(In thousands)					(In thousands)

Residential CMO and MBS	Residential CMO and MBS	$	3,844	$	8,452	Residential CMO and MBS	$	8,083	$	7,388
Commercial CMO and MBS	Commercial CMO and MBS	25,199		11,717		Commercial CMO and MBS	28,420		28,295
Securities sold under agreement to repurchase		$	29,043	$	20,169
Total						Total	$	36,503	$	35,683

(9)Other Borrowings

(a) FHLB

~~The FHLB functions as a member-owned cooperative providing credit for member financial institutions.~~ At ~~September 30, 2020,~~March 31, 2021, the Bank maintained a credit facility with the FHLB with available borrowing capacity of ~~$891.7~~$926.3 million. At ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, the Bank had 0 FHLB advances outstanding.

~~The following table sets forth the details of FHLB advances during the three and nine months ended September 30, 2020 and 2019:~~

Three Months Ended
September 30, Nine Months Ended
September 30,
2020 2019 2020 2019
(In thousands)
Average balance during the period $ 0 $ 3,755 $ 1,959 $ 15,909
Maximum month-end balance during the period $ 0 $ 0 $ 0 $ 90,700
Weighted average rate during the period 0 % 1.16 % 0.55 % 2.56 %

Advances from the FHLB are collateralized by a blanket pledge on FHLB stock owned by the Bank, deposits at the FHLB, certain commercial and residential real estate loans, and ~~one-to-four family residential loans,~~ 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, Pacific Coast Bankers’ Bank and JP Morgan Chase to purchase federal funds of up to $215.0 million as of ~~September 30, 2020.~~March 31, 2021. The lines generally mature annually or are reviewed annually. As of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, there were 0 federal funds purchased.

The Bank maintains a credit facility with the Federal Reserve Bank with available borrowing capacity of ~~$55.0~~$48.9 million as of ~~September 30, 2020.~~March 31, 2021. There were 0 Federal Reserve Bank borrowings outstanding as of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019.~~2020. Any advances on the credit facility would ~~have to~~ be ~~first~~ secured by certain types of the Bank's ~~investment securities or~~ loans receivable.

(d) PPPLF Facility

The Federal Reserve established the PPPLF under Section 13(3) of the Federal Reserve Act to bolster the effectiveness of the SBA's PPP. Under the PPPLF, the Bank may pledge its PPP loans as collateral at face value to obtain Federal Reserve Bank non-recourse loans. PPPLF advances may be obtained until December 31, 2020. As of September 30, 2020, although theThe Bank was approved to utilize the PPPLF at March 31, 2021 with an available borrowing capacity of $909.7 million, which is the ~~Bank had 0t participated in it.~~

outstanding principal balance of SBA PPP loans that would serve as collateral for any

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extensions of credit from the Federal Reserve. There were 0 PPPLF borrowings outstanding as of March 31, 2021 and December 31, 2020.

(10)Derivative Financial Instruments

The ~~Company~~Bank has entered into certain interest rate swap contracts that are not designated as hedging instruments. The following table presents the notional amounts and estimated fair values of interest rate derivative contracts outstanding at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019:~~2020:


		September 30, 2020				December 31, 2019					March 31, 2021				December 31, 2020
		Notional Amounts		Estimated Fair Value		Notional Amounts		Estimated Fair Value			Notional Amounts		Estimated Fair Value		Notional Amounts		Estimated Fair Value
		(In thousands)									(In thousands)
Non-hedging interest rate derivatives	Non-hedging interest rate derivatives									Non-hedging interest rate derivatives
Interest rate swap asset (1)	Interest rate swap asset (1)	$	296,709	$	30,024	$	221,436	$	8,318	Interest rate swap asset (1)	$	315,681	$	16,955	$	308,126	$	25,740
Interest rate swap liability (1)	Interest rate swap liability (1)	296,709		(30,460)		221,436		(8,318)		Interest rate swap liability (1)	315,681		(17,133)		308,126		(26,162)

(1) The estimated fair value of derivatives with customers was ~~$30.0~~$9.5 million and ~~$8.1~~$25.4 million as of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, respectively. The estimated fair value of derivatives with third parties was ~~$(30.5)~~$(9.7) million and ~~$(8.1)~~$(25.9) million as of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, respectively.

~~The gains and losses due to changes in fair values on the Company's interest rate~~

Credit risk for derivatives ~~including credit valuation adjustments to appropriately reflect nonperformance~~with customers is concentrated within our primary market areas. Credit risk ~~in the fair value measurement, are included in Other income on the Condensed Consolidated Statements of Income. Generally, the gains and losses of the interest rate~~for derivatives offset due to the back-to-back nature of the contracts. However, as of September 30, 2020, the settlement values of the Bank's net derivative assets decreased due to the recognition of a credit valuation adjustment of $436,000 during both the three and nine months ended September 30, 2020. A credit valuation adjustment was not recorded on the Bank's net derivative assets as of December 31, 2019. Various factors impact changes in the credit valuation adjustments over time, including changes in the risk ratings of the parties to the contracts, as well as changes in market rates and volatilities, which affect the total expected exposure of the derivative instruments.with third-parties is concentrated among four well-known broker dealers.

(11)Stockholders’ Equity

(a) Earnings Per Common Share

The following table illustrates the ~~reconciliation~~calculation of weighted average shares used for earnings per common share computations ~~for the three~~at March 31, 2021 and ~~nine months ended September 30, 2020 and 2019:~~March 31, 2020:


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019		2020		2019			2021		2020
		(In thousands, except shares)									(In thousands, except shares)
Net income:	Net income:									Net income:
Net income	Net income	$	16,636	$	17,895	$	22,688	$	50,431	Net income	$	25,344	$	12,191
Dividends and undistributed earnings allocated to participating securities (1)	Dividends and undistributed earnings allocated to participating securities (1)	0		(10)		(5)		(48)		Dividends and undistributed earnings allocated to participating securities (1)	0		(6)
Net income allocated to common shareholders	Net income allocated to common shareholders	$	16,636	$	17,885	$	22,683	$	50,383	Net income allocated to common shareholders	$	25,344	$	12,185
Basic:	Basic:									Basic:
Weighted average common shares outstanding	Weighted average common shares outstanding	35,909,148		36,764,810		36,054,906		36,846,884		Weighted average common shares outstanding	35,926,950		36,357,812
Restricted stock awards	Restricted stock awards	(303)		(21,948)		(5,537)		(34,336)		Restricted stock awards	0		(15,722)
Total basic weighted average common shares outstanding	Total basic weighted average common shares outstanding	35,908,845		36,742,862		36,049,369		36,812,548		Total basic weighted average common shares outstanding	35,926,950		36,342,090
Diluted:	Diluted:									Diluted:
Basic weighted average common shares outstanding	Basic weighted average common shares outstanding	35,908,845		36,742,862		36,049,369		36,812,548		Basic weighted average common shares outstanding	35,926,950		36,342,090
Effect of potentially dilutive common shares (2)	Effect of potentially dilutive common shares (2)	79,889		133,686		144,246		160,476		Effect of potentially dilutive common shares (2)	305,254		254,551
Total diluted weighted average common shares outstanding	Total diluted weighted average common shares outstanding	35,988,734		36,876,548		36,193,615		36,973,024		Total diluted weighted average common shares outstanding	36,232,204		36,596,641
Potentially dilutive shares that were excluded from the computation of diluted earnings per share because to do so would be anti-dilutive (3)										Potentially dilutive shares that were excluded from the computation of diluted earnings per share because to do so would be anti-dilutive (3)	15,538		21,475

(1)Represents dividends paid and undistributed earnings allocated to unvested restricted stock awards.

(2)Represents the effect of the assumed exercise of stock options and vesting of restricted stock awards and units.

(3)

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~~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 nine months ended September 30, 2020, there were 222,818 and 140,217 anti-dilutive shares outstanding, respectively. For the three and nine months ended September 30, 2019, there were 108,501 and 70,372 anti-dilutive shares outstanding, respectively.

(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.

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The following table summarizes the dividend activity ~~for~~during the ~~nine~~three months ended ~~September 30, 2020~~March 31, 2021 and the calendar year ~~2019:~~2020:

Declared

Cash Dividend per Share

Record Date

Paid Date

~~January 23, 2019~~

~~$0.18~~

~~February 7, 2019~~

~~February 21, 2019~~

~~April 24, 2019~~

~~$0.18~~

~~May 8, 2019~~

~~May 22, 2019~~

~~July 24, 2019~~

~~$0.19~~

~~August 8, 2019~~

~~August 22, 2019~~

~~October 23, 2019~~

~~$0.19~~

~~November 7, 2019~~

~~November 21, 2019~~

~~October 23, 2019~~

~~$0.10~~

~~November 7, 2019~~

~~November 21, 2019~~

January 22, 2020

$0.20

February 6, 2020

February 20, 2020

April 29, 2020

$0.20

May 13, 2020

May 27, 2020

July 22, 2020

$0.20

August 5, 2020

August 19, 2020

October 21, 2020

$0.20

November 4, 2020

November 18, 2020

January 27, 2021

$0.20

February 10, 2021

February 24, 2021

* 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 Federal Reserve provides, among other things, that dividends per share on the Company’s common stock generally should not exceed earnings per share, measured over the previous four fiscal quarters. Current regulations allow the Company and the Bank to pay dividends on their common stock if the Company’s or the Bank’s regulatory capital would not be reduced below the statutory capital requirements set by the Federal Reserve and the FDIC.

The Company has had various stock repurchase programs since March 1999. On October 23, 2014. the Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares, or approximately 1,513,000 shares, under the eleventh stock repurchase plan. ~~As of March 2020, all shares have been repurchased under this plan.~~ On March 12, 2020 the Company's Board of Directors additionally authorized the repurchase of up to 5% of the Company's outstanding common shares, or 1,799,054 shares, under the twelfth stock repurchase ~~plan.~~plan after all shares under the eleventh stock repurchase plan had been repurchased. The number, timing and price of shares repurchased under the twelfth stock repurchase plan will depend on business and market conditions and other factors, including opportunities to deploy the Company's capital.

~~NaN~~The following table provides total repurchased shares ~~were repurchased~~and average share prices under the ~~Company's stock repurchase~~applicable plans ~~during~~for the ~~three months ended September 30, 2020 as the Company has suspended repurchases in response to the COVID-19 pandemic.~~periods indicated:

~~During the nine months ended September 30, 2020, the Company~~


	Three Months Ended March 31,
	2021		2020		Plan Total(1)
Eleventh Stock Repurchase Plan
Repurchased shares	0		639,922		1,512,600
Stock repurchase average share price	$	0	$	23.95	$	21.69

Twelfth Stock Repurchase Plan
Repurchased shares	0		155,778		155,778
Stock repurchase average share price	$	0	$	20.34	$	20.34

(1)Represents shares repurchased ~~639,922 shares under the eleventh stock repurchase plan at a weighted~~and average price per share paid during the duration of $23.95 and repurchased 155,778 shares at a weighted average share price of $20.34 under the twelfth stock repurchase plan, which is a total of 795,700 shares under both plans at a weighted average share price of $23.25.

During the three and nine months ended September 30, 2019, the Company repurchased 264,712 and 292,712 shares, respectively, under the eleventh stock repurchase plan at a weighted average price per share of $26.23 and $26.50, respectively.

each plan.

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In addition to the stock repurchases under a stock repurchase plan, the Company repurchases shares to pay withholding taxes on the vesting of restricted stock awards and units. The following table provides total shares repurchased to pay withholding taxes during the periods indicated:


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019		2020		2019			2021		2020
Repurchased shares to pay withholding taxes	Repurchased shares to pay withholding taxes	378		405		28,306		28,434		Repurchased shares to pay withholding taxes	23,246		25,882
Stock repurchase to pay withholding taxes average share price	Stock repurchase to pay withholding taxes average share price	$	19.84	$	27.67	$	21.54	$	30.83	Stock repurchase to pay withholding taxes average share price	$	29.54	$	21.79

(12)Fair Value Measurements

Fair value is the ~~exchange~~ price that would be received ~~for~~to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants onat the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1: Valuations for assets and liabilities traded in active exchange markets, or interest in open-end mutual funds that allow the Company to sell its ownership interest back to the fund at net asset value on a daily basis. Valuations are obtained from readily available pricing sources for market transactions involving identical assets, liabilities, or funds.

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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~~third-party pricing ~~services for comparable assets or liabilities.~~services.

Collateral-Dependent Loans:

Collateral-dependent loans are identified as part of the calculation of the ACL on loans. The fair value used to measure credit loss for this type of loan is commonly based on recent real estate appraisals which are generally obtained at least every 18 months or earlier if there are changes to risk characteristics of the underlying loan. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available. The Bank also incorporates an estimate of cost to sell the collateral when the sale is probable. Such adjustments ~~are usually~~may be significant and ~~typically~~ result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value based on the borrower’s financial statements or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation and management’s expertise and knowledge of the customer and customer’s business (Level 3). Individually evaluated loans are ~~evaluated~~analyzed for credit loss on a quarterly basis and the ACL on loans is adjusted as required based inon the ~~evaluation.~~

~~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

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value less costs to sell. Fair value is commonly based on recent real estate 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.results.

Appraisals ~~for both~~on collateral-dependent 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.~~Bank. Once received, the ~~Company~~Bank 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~~Bank 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), and incorporates credit valuation adjustments to reflect nonperformance risk in the measurement of fair value (Level 3). Although the Bank has determined that the majority of the inputs used to value its interest rate swap derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as borrower risk ratings, to evaluate the likelihood of default by itself and its counterparties. As of ~~September 30,~~March 31, 2021 and December 31, 2020, the Bank assessed the significance of the impact of the credit valuation adjustment on the overall valuation of its interest rate swap derivatives and determined that the credit valuation adjustment was not significant to the overall valuation of its interest rate swap derivatives. As a result, the Bank has classified its interest rate swap derivative valuations in Level 2 of the fair value hierarchy. ~~The Bank did not recognize a credit~~

Branches held for sale:

Branches held for sale are recorded at fair value less costs to sell when transferred from Premises and equipment, net to Prepaid expenses and other assets on the Consolidated Statements of Financial Condition with any valuation adjustment recorded within Other noninterest expense on the Consolidated Statements of Income. The fair value of branches held for sale is determined based on a real estate appraisal or broker price opinion. Adjustments are routinely made in the ~~valuation of its interest rate swap derivatives as of December 31, 2019; therefore,~~appraisal and broker price opinion process by independent appraisers and commercial real estate brokers, respectively, to adjust for differences between the ~~interest rate swap derivatives~~comparable sales and income data available. Such adjustments are ~~also classified~~usually significant and typically result in Level 23 classification of the inputs for determining fair ~~value hierarchy for the comparative period end.~~value.

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Recurring Basis

The following tables summarize the balances of assets and liabilities measured at fair value on a recurring basis ~~as of September 30, 2020 and December 31, 2019:~~at the dates indicated:


		September 30, 2020									March 31, 2021
		Total		Level 1		Level 2		Level 3			Total		Level 1		Level 2		Level 3
		(In thousands)									(In thousands)
Assets	Assets									Assets
Investment securities available for sale:	Investment securities available for sale:									Investment securities available for sale:
U.S. government and agency securities	U.S. government and agency securities	$	51,893	$	0	$	51,893	$	0	U.S. government and agency securities	$	94,857	$	5,000	$	89,857	$	0
Municipal securities	Municipal securities	205,310		0		205,310		0		Municipal securities	227,663		1,632		226,031		0

Residential CMO and MBS	Residential CMO and MBS	222,581		0		222,581		0		Residential CMO and MBS	182,996		0		182,996		0
Commercial CMO and MBS	Commercial CMO and MBS	304,682		0		304,682		0		Commercial CMO and MBS	348,169		0		348,169		0

Corporate obligations	Corporate obligations	20,171		0		20,171		0		Corporate obligations	11,055		0		11,055		0
Other asset-backed securities	Other asset-backed securities	29,855		0		29,855		0		Other asset-backed securities	28,818		0		28,818		0
Total investment securities available for sale	Total investment securities available for sale	834,492		0		834,492		0		Total investment securities available for sale	893,558		6,632		886,926		0
Equity security	Equity security	111		111		0		0		Equity security	180		180		0		0
Derivative assets - interest rate swaps	Derivative assets - interest rate swaps	30,024		0		30,024		0		Derivative assets - interest rate swaps	16,955		0		16,955		0
Liabilities	Liabilities									Liabilities
Derivative liabilities - interest rate swaps	Derivative liabilities - interest rate swaps	$	30,460	$	0	$	30,460	$	0	Derivative liabilities - interest rate swaps	$	17,133	$	0	$	17,133	$	0

~~Table of Contents~~


		December 31, 2019									December 31, 2020
		Total		Level 1		Level 2		Level 3			Total		Level 1		Level 2		Level 3
		(In thousands)									(In thousands)
Assets	Assets									Assets
Investment securities available for sale:	Investment securities available for sale:									Investment securities available for sale:
U.S. government and agency securities	U.S. government and agency securities	$	105,223	$	0	$	105,223	$	0	U.S. government and agency securities	$	45,660	$	0	$	45,660	$	0
Municipal securities	Municipal securities	133,014		0		133,014		0		Municipal securities	209,968		0		209,968		0

Residential CMO and MBS	Residential CMO and MBS	339,608		0		339,608		0		Residential CMO and MBS	201,872		0		201,872		0
Commercial CMO and MBS	Commercial CMO and MBS	327,095		0		327,095		0		Commercial CMO and MBS	303,746		0		303,746		0

Corporate obligations	Corporate obligations	24,194		0		24,194		0		Corporate obligations	11,096		0		11,096		0
Other asset-backed securities	Other asset-backed securities	23,178		0		23,178		0		Other asset-backed securities	29,821		0		29,821		0
Total investment securities available for sale	Total investment securities available for sale	952,312		0		952,312		0		Total investment securities available for sale	802,163		0		802,163		0
Equity Security		148		148		0		0
Equity security										Equity security	131		131		0		0
Derivative assets - interest rate swaps	Derivative assets - interest rate swaps	8,318		0		8,318		0		Derivative assets - interest rate swaps	25,740		0		25,740		0
Liabilities	Liabilities									Liabilities
Derivative liabilities - interest rate swaps	Derivative liabilities - interest rate swaps	$	8,318	$	0	$	8,318	$	0	Derivative liabilities - interest rate swaps	$	26,162	$	0	$	26,162	$	0

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 ~~September 30, 2020 and December 31, 2019 and~~ the ~~net losses recorded in earnings during the three and nine months ended September 30, 2020 and 2019:~~dates indicated:

Fair Value at September 30, 2020 Net Losses
Recorded in
Earnings
During the
Three Months Ended September 30, 2020 Net Losses
Recorded in
Earnings
During the
Nine Months Ended September 30, 2020
Basis(1)
Total Level 1 Level 2 Level 3
(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial $ 42 $ 27 $ 0 $ 0 $ 27 $ 0 $ 10
Total assets measured at fair value on a nonrecurring basis $ 42 $ 27 $ 0 $ 0 $ 27 $ 0 $ 10

~~(1)Basis represents the outstanding principal balance of impaired loans.~~


			Fair Value at March 31, 2021
	Basis(1)		Total		Level 1		Level 2		Level 3
	(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial	$	474	$	424	$	0	$	0	$	424

4230

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Fair Value at December 31, 2019 Net Losses
Recorded in
Earnings
During the Three Months Ended September 30, 2019 Net Losses
Recorded in
Earnings
During the Nine Months Ended September 30, 2019
Basis(1)
Total Level 1 Level 2 Level 3
(In thousands)
Impaired loans:
Commercial business:
Commercial and industrial $ 4,111 $ 3,380 $ 0 $ 0 $ 3,380 $ 249 $ 249
Total assets measured at fair value on a nonrecurring basis $ 4,111 $ 3,380 $ 0 $ 0 $ 3,380 $ 249 $ 249


			Fair Value at March 31, 2021
	Basis(1)		Total		Level 1		Level 2		Level 3
	(In thousands)




Real estate construction and land development:

Commercial and multifamily	991		557		0		0		557




Total assets measured at fair value on a nonrecurring basis	$	1,465	$	981	$	0	$	0	$	981

(1)Basis represents the outstanding principal balance of ~~impaired~~collateral-dependent loans.


			Fair Value at December 31, 2020
	Basis(1)		Total		Level 1		Level 2		Level 3
	(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial	$	1,305	$	1,289	$	0	$	0	$	1,289










Prepaid expenses and other assets:
Branch held for sale (2)	1,330		1,330		0		0		1,330
Total assets measured at fair value on a nonrecurring basis	$	2,635	$	2,619	$	0	$	0	$	2,619

(1) Basis represents the outstanding principal balance of collateral-dependent loans and the carrying value of the branch held for sale.

(2) In October 2020, one branch was reclassified as held for sale in accordance with ASC 360-10. As part of the transfer, the branch was written down to its net realizable value at that time.

The following table represents the net realized losses (gains) recorded in earnings as a result of nonrecurring fair value adjustments recorded during the periods indicated:


	Three Months Ended March 31,
	2021		2020
	(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial	$	34	$	5




Real estate construction and land development:

Commercial and multifamily	14		0
Total	48		5
Prepaid expenses and other assets:
Branch held for sale	(20)		0
Net losses from nonrecurring fair value adjustments	$	28	$	5

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 ~~September 30, 2020 and December 31, 2019:~~the dates indicated:

~~September 30,~~March 31, 2021

Fair
Value

Valuation
Technique(s)

Unobservable Input(s)

Range of Inputs; Weighted
Average

(Dollars in thousands)

Collateral-dependent loans

981

Market approach

Adjustment for differences between the comparable sales

47.0% - (11.0)%; 18.8%

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December 31, 2020

Fair
Value

Valuation
Technique(s)

Unobservable Input(s)

Range of Inputs; Weighted
Average

(Dollars in thousands)

Collateral-dependent loans

271,289

Market approach

Adjustment for differences between the comparable sales

~~N/A(1)~~

~~(1)Quantitative disclosures are not provided for collateral-dependent 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)~~0.6% - (40.1%); (24.1%)

~~Impaired loans~~Branch held for sale

~~3,380~~1,330

Market approach

Adjustment for differences between the comparable sales

~~173.5%~~140.7% - ~~(18.5%~~(40.3%); ~~36.8%~~33.2%

(b) Fair Value of Financial Instruments

Broadly traded markets do not exist for most of the Company’s financial ~~instruments~~instruments; therefore, the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications; therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.

The following tables present the carrying value amount of the Company’s financial instruments and their corresponding estimated fair values at the dates indicated:


	March 31, 2021
	Carrying Value		Fair Value		Fair Value Measurements Using:
					Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash and cash equivalents	$	934,316	$	934,316	$	934,316	$	0	$	0
Investment securities available for sale	893,558		893,558		6,632		886,926		0
Loans held for sale	6,801		7,070		0		0		7,070
Loans receivable, net	4,531,644		4,660,232		0		0		4,660,232
Accrued interest receivable	19,447		19,447		32		3,373		16,042
Banked owned life insurance	108,341		108,341		108,341		0		0
Derivative assets - interest rate swaps	16,955		16,955		0		16,955		0
Equity security	180		180		180		0		0
Financial Liabilities:
Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts	$	5,633,295	$	5,633,295	$	5,633,295	$	0	$	0
Certificates of deposit	386,403		388,488		0		388,488		0

Securities sold under agreement to repurchase	36,503		36,503		36,503		0		0
Junior subordinated debentures	20,960		18,250		0		0		18,250
Accrued interest payable	85		85		39		26		20
Derivative liabilities - interest rate swaps	17,133		17,133		0		17,133		0


	December 31, 2020
	Carrying Value		Fair Value		Fair Value Measurements Using:
					Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash and cash equivalents	$	743,322	$	743,322	$	743,322	$	0	$	0
Investment securities available for sale	802,163		802,163		0		802,163		0
Loans held for sale	4,932		5,156		0		0		5,156

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~~corresponding estimated fair values at September 30, 2020 and December 31, 2019:~~


		September 30, 2020															December 31, 2020
		Carrying Value			Fair Value			Fair Value Measurements Using:									Carrying Value			Fair Value			Fair Value Measurements Using:
							Level 1			Level 2			Level 3									Level 1			Level 2			Level 3
				(In thousands)															(In thousands)
Financial Assets:
Cash and cash equivalents		$	576,242		$	576,242		$	576,242		$	0		$	0
Investment securities available for sale		834,492			834,492			0			834,492			0
Loans held for sale		8,250			8,562			0			0			8,562
Loans receivable, net	Loans receivable, net	4,593,390			4,752,565			0			0			4,752,565		Loans receivable, net	4,398,462			4,556,862			0			0			4,556,862
Accrued interest receivable	Accrued interest receivable	18,888			18,888			9			3,316			15,563		Accrued interest receivable	19,418			19,418			2			3,648			15,768
Bank owned life insurance																Bank owned life insurance	107,580			107,580			107,580			0			0
Derivative assets - interest rate swaps	Derivative assets - interest rate swaps	30,024			30,024			0			30,024			0		Derivative assets - interest rate swaps	25,740			25,740			0			25,740			0
Equity security	Equity security	111			111			111			0			0		Equity security	131			131			131			0			0

Financial Liabilities:	Financial Liabilities:															Financial Liabilities:
Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts	Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts	$	5,245,008		$	5,245,008		$	5,245,008		$	0		$	0	Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts	$	5,198,456		$	5,198,456		$	5,198,456		$	0		$	0
Certificate of deposit accounts		444,040			447,017			0			447,017			0
Certificates of deposit																Certificates of deposit	399,534			402,701			0			402,701			0

Securities sold under agreement to repurchase	Securities sold under agreement to repurchase	29,043			29,043			29,043			0			0		Securities sold under agreement to repurchase	35,683			35,683			35,683			0			0
Junior subordinated debentures	Junior subordinated debentures	20,814			18,500			0			0			18,500		Junior subordinated debentures	20,887			18,500			0			0			18,500
Accrued interest payable	Accrued interest payable	109			109			44			45			20		Accrued interest payable	94			94			42			33			19
Derivative liabilities - interest rate swaps	Derivative liabilities - interest rate swaps	30,460			30,460			0			30,460			0		Derivative liabilities - interest rate swaps	26,162			26,162			0			26,162			0

December 31, 2019
Carrying
Value Fair
Value Fair Value Measurements Using:
Level 1 Level 2 Level 3
(In thousands)
Financial Assets:
Cash and cash equivalents $ 228,568 $ 228,568 $ 228,568 $ 0 $ 0
Investment securities available for sale 952,312 952,312 0 952,312 0
Loans held for sale 5,533 5,704 0 0 5,704
Loans receivable, net 3,731,708 3,791,557 0 0 3,791,557
Accrued interest receivable 14,446 14,446 79 3,668 10,699
Derivative assets - interest rate swaps 8,318 8,318 0 8,318 0
Equity security 148 148 148 0 0
Financial Liabilities:
Noninterest deposits, interest bearing demand deposits, money market accounts and savings accounts $ 4,058,098 $ 4,058,098 $ 4,058,098 $ 0 $ 0
Certificate of deposit accounts 524,578 529,679 0 529,679 0
Securities sold under agreement to repurchase 20,169 20,169 20,169 0 0
Junior subordinated debentures 20,595 20,000 0 0 20,000
Accrued interest payable 199 199 95 64 40
Derivative liabilities - interest rate swaps 8,318 8,318 0 8,318 0

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(13)Cash ~~Requirement~~Restriction

The ~~Company is required to maintain an average reserve balance with~~Bank had restricted cash included in interest earning deposits on the ~~Federal Reserve Bank or maintain such reserve balance in the form~~Condensed Consolidated Statements of ~~cash. Effective~~Financial Condition of $10.5 million and $25.9 million as of 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 September 30, 2020~~31, 2021 and ~~a required balance of $17.1 million at~~ December 31, ~~2019 was met by holding cash and maintaining an average balance~~2020, respectively, relating to collateral required on interest rate swaps from third-parties as discussed in Note (10) Derivative Financial Instruments. The Bank does not have a collateral requirement with ~~the Federal Reserve Bank.~~customers.

(14)Commitments and Contingencies

In the ordinary course of business, the ~~Company~~Bank may enter into various types of transactions that include commitments to extend credit that are not included in its Condensed Consolidated Financial Statements. The Bank applies the same credit standards to these commitments as it uses in all its lending activities and has included these commitments in its lending risk evaluations. The majority of the commitments presented below are variable rate. Loan commitments can be either revolving or ~~nonrevolving.~~non-revolving. The Bank’s exposure to credit and market risk under commitments to extend credit is represented by the amount of these commitments.

The following table presents outstanding commitments to extend credit, including letters of credit, at the dates indicated:


		September 30, 2020		December 31, 2019			March 31, 2021		December 31, 2020
		(In thousands)					(In thousands)
Commercial business:	Commercial business:					Commercial business:
Commercial and industrial	Commercial and industrial	$	637,407	$	584,287	Commercial and industrial	$	627,702	$	640,018
Owner-occupied CRE	Owner-occupied CRE	6,089		17,193		Owner-occupied CRE	4,494		3,488
Non-owner occupied CRE	Non-owner occupied CRE	24,863		35,573		Non-owner occupied CRE	14,523		18,396
Total commercial business	Total commercial business	668,359		637,053		Total commercial business	646,719		661,902

Real estate construction and land development:	Real estate construction and land development:					Real estate construction and land development:
One-to-four family residential		62,300		75,066
Five or more family residential and commercial properties		156,629		230,343
Residential						Residential	60,099		52,453
Commercial and multifamily						Commercial and multifamily	142,432		127,821
Total real estate construction and land development	Total real estate construction and land development	218,929		305,409		Total real estate construction and land development	202,531		180,274
Consumer	Consumer	255,011		269,898		Consumer	269,516		263,249
Total outstanding commitments	Total outstanding commitments	$	1,142,299	$	1,212,360	Total outstanding commitments	$	1,118,766	$	1,105,425

Upon CECL adoption, as described in Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements, the ~~Company~~Bank recorded an increase in the beginning ACL on unfunded commitments of $3.7 million as of January 1, 2020, representing the change in methodology from an estimate of incurred losses

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at the balance sheet date, with an estimated probability of funding, to an estimate of credit losses on future utilization over the entire contractual period.

The following table details the activity in the ACL on unfunded commitments during the ~~three and nine months ended September 30, 2020 and 2019:~~periods indicated:

Three Months Ended Nine months ended
September 30,
2020 September 30,
2019 September 30,
2020 September 30,
2019
(In thousands)
Balance, beginning of period $ 4,612 $ 306 $ 306 $ 306
Impact of CECL Adoption 0 0 3,702 0
Adjusted balance, beginning of period 4,612 306 4,008 306
Provision for credit losses on unfunded commitments 410 0 1,014 0
Balance, end of period $ 5,022 $ 306 $ 5,022 $ 306

~~(15)Income Taxes~~

The Company files a consolidated income tax return using the accrual method of accounting. The effective tax rate was 8.8% for the nine months ended September 30, 2020 compared to an effective tax rate of 16.6% for

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~~the nine months ended September 30, 2019 due primarily to a benefit from net operating losses related to prior acquisitions of $1.0 million from a provision in the CARES Act.~~


	Three Months Ended
	March 31, 2021		March 31, 2020
	(In thousands)
Balance, beginning of period	$	4,681	$	306
Impact of CECL Adoption	0		3,702
Adjusted balance, beginning of period	4,681		4,008
Reversal of provision for credit losses on unfunded commitments	(1,064)		(2,018)
Balance, end of period	$	3,617	$	1,990

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 operations of the Company as of and for the three ~~and nine~~ months ended ~~September 30, 2020.~~March 31, 2021. 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, ~~2019~~2020 audited Consolidated Financial Statements and the accompanying Notes included in our ~~2019~~2020 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 September 30, 2020, we had total assets of $6.69 billion, total liabilities of $5.88 billion and total stockholders’ equity of $803.1 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 to medium sized businesses and their owners in our market areas and attracting deposits from the general public. We also make real estate construction and land development loans and consumer loans. We additionally originate for sale or for investment purposes ~~one-to-four family~~ residential real estate loans on ~~residential~~single family properties located primarily in our markets. During the ~~quarter~~three months ended March 31, 2020, we ceased indirect auto loan originations.

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 Company's interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve. Like most financial institutions, our net interest income is 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.

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 150 basis point reduction in the targeted federal funds rate during the quarter ended March 31, 2020, 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.

Our net income is affected by many factors, including the provision for credit losses on loans. The provision for credit losses on loans is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan portfolio as well as prevailing economic and market conditions. The ACL on loans was impacted during the nine months ended September 30, 2020 due to the CECL Adoption, which estimates losses over the life of the loans as compared to prior GAAP which required estimating incurred losses as of period end, and by forecasted credit deterioration due to the COVID-19 pandemic, as discussed in the COVID-19 Impact section below. Management believes that the ACL on loans reflects the amount that is appropriate to provide for current expected credit losses in our loan portfolio based on our consistent methodology.

Net income is also affected by noninterest income and noninterest expense. Noninterest income primarily consists of service charges and other fees and other income. Noninterest expense consists primarily of compensation and employee benefits, occupancy and equipment, data processing and professional services. Compensation and employee benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits. Occupancy and equipment expenses are the fixed and variable costs of buildings and equipment, and consists primarily of lease expenses, depreciation charges, maintenance and utilities. Data processing consists primarily of processing and network services related to the Bank’s core operating system, including the account processing system, electronic payments processing of

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products and services, and internet and mobile banking ~~channels.~~channels as well as software-as-a-service providers. 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.~~authorities, especially changes resulting from the COVID-19 pandemic and the governmental actions taken to address it. Net income is also impacted by growth of operations and growth in the number of loan and deposit accounts through acquisitions and core banking business growth.

~~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, mortgage and consumer lending 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 initial short-term relief options 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.~~

~~The Bank has implemented a special, streamlined initial 90-day interest only payment modification process for borrowers in certain industries as a result of the COVID-19 "stay at home" orders.~~

Based on the depth and breadth of the COVID-19 pandemic, the Bank will extend similar relief options for a subsequent or second modification to certain commercial borrowers. The Bank has a preference for offering interest only payments on these secondary modifications. The Bank has determined that in most instances, a request for a third payment deferral modification will be considered a TDR loan instead of a modification as the Bank incorporated policies consistent with regulatory guidance.

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.

All commercial loans modified due to COVID-19 will be risk rated "Watch" or worse, 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, or if more severe risk rating is determined appropriate given facts and circumstances of the borrower. 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.

~~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 the initial 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" 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

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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 was included in the borrowers' billing statements between April 1, 2020 and May 30, 2020.

~~Based on the depth and breadth of the~~ COVID-19 pandemic, the Bank will extend similar relief options for a subsequent or second modification to certain consumer borrowers. The Bank has a preference for offering interest only payments, or partial principal and interest payments, on these secondary modifications.

All mortgage and consumer loans modified via the initial streamlined process due to COVID-19 will remain risk rated "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 the borrower does not intend to repay the loan, which may result in a risk rating downgrade and the implementation of further collection efforts. The risk rating will be reviewed for a more severe classification for any secondary modification request.

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.

~~COVID-19 Modifications:~~

During the nine months ended September 30, 2020 and as a direct result of COVID-19 related issues cited by the borrower and the Bank's lending assistance programs described above, the Bank made modifications on loans. These modifications were not classified as TDRs at September 30, 2020 in accordance with the CARES Act and related regulatory guidance.Pandemic Response

The ~~following table details the amortized cost, count,~~Company maintains its commitment to supporting its community and type of modifications by each loan class that were made during the nine months ended September 30, 2020, with amortized costs presented as of March 31, 2020, before the onset of the COVID-19 pandemic:

Interest Only Payment Deferral Other Total
Amortized Cost Count Amortized Cost Count Amortized Cost Count Amortized Cost Count
(Dollars in thousands)
Commercial business:
Commercial and industrial $ 74,561 284 $ 41,301 239 $ 21,939 48 $ 137,801 571
Owner-occupied CRE 116,064 90 82,125 91 1,304 2 199,493 183
Non-owner occupied CRE 130,948 80 75,252 44 22,715 8 228,915 132
Total commercial business 321,573 454 198,678 374 45,958 58 566,209 886
One-to-four family residential 1,704 2 14,905 30 613 3 17,222 35
Real estate construction and land development:
One-to-four family residential 733 1 — — 6,173 23 6,906 24
Five or more family residential and commercial properties 10,390 10 1,632 6 8,260 8 20,282 24
Total real estate construction and land development 11,123 11 1,632 6 14,433 31 27,188 48
Consumer 606 25 25,596 977 55 1 26,257 1,003
Total $ 335,006 492 $ 240,811 1,387 $ 61,059 93 $ 636,876 1,972

Of the modifications presented in the table above that also had loan balances at September 30, 2020, the risk classification of 206 loans totaling $197.5 million were downgraded during the nine months ended September 30, 2020. The majority of the downgrades were to a "Watch" grade and were therefore not classified as potential problem loans.

The following table details the amortized cost, count, and type of modifications by each loan class for any loan that was in active payment modification deferral status as of September 30, 2020, with balances and count at September 30, 2020:

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Interest Only Payment Deferral Total
Amortized Cost Count Amortized Cost Count Amortized Cost Count
(Dollars in thousands)
Commercial business:
Commercial and industrial $ 13,069 33 $ 5,158 22 $ 18,227 55
Owner-occupied CRE 5,712 9 30,071 15 35,783 24
Non-owner occupied CRE 20,839 13 28,441 12 49,280 25
Total commercial business 39,620 55 63,670 49 103,290 104
One-to-four family residential 1,272 1 1,036 4 2,308 5
Real estate construction and land development:
Five or more family residential and commercial properties 7,329 1 450 1 7,779 2
Consumer 588 24 3,115 125 3,703 149
Total $ 48,809 81 $ 68,271 179 $ 117,080 260

Of the loans in active payment modification deferral status at September 30, 2020, $94.5 million, or 80.7%, were on their second loan deferral modification and the risk classification of a majority of these loans were downgraded. The Bank classified $17.2 million of these loans as nonaccrual as of September 30, 2020.

~~COVID-19 Downgrades:~~

The Bank downgraded loans due to heightened risk as a direct result of COVID-19 related issues cited by the borrower. All COVID-19 downgrades, including those with and without a modification, as of September 30, 2020 are as follows:

Pass Watch Special Mention Substandard Total
Amortized Cost Count Amortized Cost Count Amortized Cost Count Amortized Cost Count Amortized Cost Count
(Dollars in thousands)
Commercial business:
Commercial and industrial $ 8,966 58 $ 37,349 122 $ 34,796 47 $ 3,778 20 $ 84,889 247
Owner-occupied CRE 32,091 22 24,775 37 15,570 6 13,316 6 85,752 71
Non-owner occupied CRE 26,526 13 71,340 35 12,971 3 25,913 3 136,750 54
Total commercial business 67,583 93 133,464 194 63,337 56 43,007 29 307,391 372
One-to-four family residential 1,114 8 — — — — — — 1,114 8
Real estate construction and land development:
Five or more family residential and commercial properties 16,205 5 2,029 3 — — 450 1 18,684 9
Total $ 84,902 106 $ 135,493 197 $ 63,337 56 $ 43,457 30 $ 327,189 389

Loans in the table above which were downgraded to Special Mention or worse are classified as potential problem loans, except for loans totaling $17.2 million at September 30, 2020 that were classified as nonaccrual.

~~SBA Paycheck Protection Program~~

~~Beginning April 6, 2020, the Bank began to offer SBA PPP loans to its existing and new~~ customers as a result of the COVID-19 pandemic. SBA PPP loans are designed to provide a direct incentive for small businesses to keep their workers on the payroll. The CARES Act and its subsequent amendments allocated $669.0 billion to the program. Utilizing our internal technology solutions team, the Bank was able to develop an automated platform to control and manage processing for SBA PPP loans and immediately began originations under this program. The

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Bank accepted applications for SBA PPP 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.

The SBA's PPP program ended on August 8, 2020 and the Bank funded 4,642 loans totaling $897.4 million during the program's existence. The average loan balance for funded loans was $193,000. Of the funded loans, approximately 21% of both the number of loans funded and amount originated were to customers with no prior banking relationship to the Bank.

The Bank earns 1% interest on these loans as well as a fee from the SBA to cover processing costs, which is amortized over the life of the loan. The balance of unamortized net deferred fees on SBA PPP loans was $22.0 million at September 30, 2020.

Additionally, the Federal Reserve established the PPPLF under Section 13(3) of the Federal Reserve Act to bolster the effectiveness of the SBA's PPP. Under the PPPLF, the Bank may pledge its PPP loans as collateral at face value to obtain Federal Reserve Bank non-recourse loans. The maturity date of any PPPLF advance (the “Maturity Date”) will be the maturity date of the PPP loan pledged to secure the PPPLF advance. The Maturity Date of any PPPLF advance will be accelerated on and to the extent of (i) the date of any loan forgiveness reimbursement by the SBA for any PPP loan securing the PPPLF advance; or (ii) the date of purchase by the SBA from the Bank of any PPP loan securing the PPPLF loan advance to realize on the SBA’s guarantee of the PPP loan. PPPLF advances may be obtained until December 31, 2020. Although the Bank was approved to utilize the PPPLF, the Bank has chosen not to participate during the nine months ended September 30, 2020.

~~The Bank will begin processing loan forgiveness applications, as allowed under the SBA's PPP during the quarter ended December 31, 2020.~~

~~SBA Relief~~

Heritage is an active SBA lender in the Pacific Northwest and had SBA loans totaling $64.8 million and $64.1 million at September 30, 2020 and December 31, 2019, respectively. During the nine months ended September 30, 2020, Heritage participated in the SBA's Debt Relief Program under the CARES Act. The CARES Act appropriated $17.0 billion to subsidize small business loans. Under this program, the SBA will pay principal and interest for existing current SBA loans for a period of six months, commencing with payments due after March 27, 2020 as well as new SBA 7(a), 504, and microloans disbursed prior to September 27, 2020.

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 borrower can also make other principal-only payments during the six month period.

The Bank did not consider any loans for which the SBA was making the principal and interest payment as a loan with COVID-19 modification as only the source of payment was changed and not the payment terms of the SBA loan.

~~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 branch lobbies were closed in March 2020 with most services processed through the drive-up or by appointment. On June 22, 2020, management elected to open lobbies for its three branches located within Island County, which has moved into Phase 3 as part of Washington State's Phased Approach: Reopening Business and Modifying Physical Distancing Measures, of which the fourth phase is the least restrictive phase ahead of a full reopening. Management believes this initial and limited approach in Island County will provide valuable insights on how to effectively implement the Bank's safety precautions and to better understand any risks or changes that will need to be addressed before considering opening other locations.

•~~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~~remains focused 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.~~

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~~Employee Changes~~

~~Heritage has committed to~~ keeping its employees safe ~~during this COVID-19 pandemic. As a result, many policy changes have been implemented including~~and the Bank running effectively to serve its customers. The Bank is managing branch access and occupancy levels in relation to cases and close contact scenarios, following ~~measures:~~

•~~Heritage follows the~~governmental restrictions and public health authority guidelines, ~~recommended by the Centers~~and encouraging remote work for ~~Disease Control and/or local officials, such as social distancing and maintaining six feet~~its employees. All non-metro, full-service branch lobby locations reopened with normal hours on March 22, 2021, which represents 46 out of ~~separation between employees.~~

•~~Heritage has provided additional cleaning and disinfecting solutions to each location.~~

•~~A 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 were given additional hourly pay.~~

•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.~~53 branches at March 31, 2021.

Earnings Summary

~~Comparison of quarter ended September 30, 2020 to the comparable quarter in the prior year.~~

Net income was ~~$16.6~~$25.3 million, or ~~$0.46~~$0.70 per diluted common share, for the three months ended ~~September 30, 2020~~March 31, 2021 compared to net income of ~~$17.9~~$12.2 million, or ~~$0.48~~$0.34 per diluted common share, for the three months ended ~~September 30, 2019.~~March 31, 2020. Net income ~~decreased $1.3~~ increased $13.2 million, or ~~7.0%~~107.9%, for the three months ended ~~September 30, 2020~~March 31, 2021 compared to the same period in ~~2019~~2020 due primarily ~~due~~ to ~~increases in the ACL for nonperforming loans caused by the COVID-19 pandemic. The~~a reversal of provision for ~~loan~~credit losses of $7.2 million during the three months ended March 31, 2021 compared to a provision for credit losses of $7.9 million for the same period in ~~2019 was estimated under the incurred loss methodology.~~2020.

Net interest income as a percentage of average interest earning assets, or net interest margin, decreased 8355 basis points to ~~3.38%~~3.51% for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~4.21%~~4.06% for the same period in ~~2019.~~ 2020. The decrease in net interest margin was due primarily to the changes in the mix of interest earning assets, including decreases in investment securities, increases in interest earning deposits, and the addition of low-yielding SBA PPP loans, combined with the decreases in yields on ~~adjustable instruments~~adjustable-rate interest earning assets following decreases in short-term market ~~rates.~~rates and the change in the mix of total interest earning assets, including a significant increase in average interest earning deposits to 11.8% of total earning assets at March 31, 2021 compared to 2.6% at March 31, 2020. The decrease in net interest margin was offset partially by decreases in the cost of total interest bearing ~~liabilities following the decreases in the market rates.~~deposits.

The efficiency ratio consists of noninterest expense divided by the sum of net interest income ~~before provision for credit losses~~ plus noninterest income. The Company’s efficiency ratio was ~~62.27%~~61.57% for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~62.55%~~64.20% for the three months ended ~~September 30, 2019. The change in the efficiency ratio was attributable primarily to the decrease in net interest income.~~

~~Comparison of nine months ended September 30, 2020 to the comparable period in the prior year.~~

~~Net income was $22.7 million, or $0.63 per diluted common share, for the nine months ended September 30, 2020 compared to $50.4 million, or $1.36~~ ~~per diluted common share, for the nine months ended September 30, 2019. Net income decreased $27.7 million, or 55.0%, for the~~ ~~nine months ended September 30, 2020~~ compared to the same period in 2019 primarily due to an increase in the provision for credit losses on loans to $38.2 million compared to a provision for loan losses of $2.8 million for the same period in 2019 as a result of estimated credit losses forecasted due to COVID-19 and its impact on the economy, offset partially by a decrease in income tax expense of $7.9 million due to lower pre-tax income as well as a provision in the CARES Act permitting the recognition of a benefit from net operating losses related to prior acquisitions and an increase in noninterest income of $2.5 million, or 10.6%, due primarily to increased gain on sale of loans.

The net interest margin decreased 62 basis points to 3.67% for the nine months ended September 30, 2020 compared to 4.29% for the same period in 2019. The decrease in net interest margin was due primarily to changes in the mix of interest earning assets, including the origination of SBA PPP loans with an average balance of $511.5 million earning a yield of 2.80%, and decreases in yields of interest earning assets as a result of decreases in short-term market interest rates, offset partially by decreases in the cost of interest bearing liabilities during the period.

~~The Company’s efficiency ratio was 63.26% for the nine months ended September 30, 2020 compared to 63.67% for the nine months ended September 30, 2019.~~March 31, 2020. The change in the efficiency ratio was attributable primarily to the increase in ~~noninterest~~net interest income.

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Net Interest Income Overview

One of the Company's key sources of earnings is net interest income. There are several factors that affect net interest income including, but not limited to, the volume, pricing, mix and maturity of interest earning assets and interest bearing liabilities; the volume of noninterest earning assets, noninterest bearing demand deposits, other noninterest bearing liabilities and stockholders' ~~equity;~~equity; 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 March 2020. The following table provides the federal funds target rate history and changes from each period since December 31, 2018:

~~Change Date~~

~~Rate (%)~~

~~Rate Change (%)~~

~~December 31, 2018~~

~~2.25 - 2.50%~~

~~N/A~~

~~July 31, 2019~~

~~2.00 - 2.25%~~

~~-0.25%~~

~~September 18, 2019~~

~~1.75 - 2.00%~~

~~-0.25%~~

~~October 30, 2019~~

~~1.50 - 1.75%~~

~~-0.25%~~

~~March 3, 2020~~

~~1.00 - 1.25%~~

~~-0.50%~~

~~March 16, 2020~~

~~0.00 - 0.25%~~

~~-1.00%~~

~~Comparison of quarter ended September 30, 2020 to the comparable quarter in the prior year.~~

Net interest income ~~decreased $565,000,~~increased $3.7 million, or ~~1.1%~~7.6%, to ~~$49.7~~$52.2 million for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$50.2~~$48.6 million for the same period in ~~2019.~~ 2020.

The following table provides relevant net interest income information for the periods indicated:


		Three Months Ended September 30,													Three Months Ended March 31,
		2020						2019							2021						2020						Change
		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)		Average Balance		Interest Earned/ Paid		Average Yield/ Rate
		(Dollars in thousands)													(Dollars in thousands)
Interest Earning Assets:	Interest Earning Assets:													Interest Earning Assets:
Total loans receivable, net (2) (3)		$	4,605,389	$	47,647	4.12	%	$	3,677,405	$	47,845	5.16	%
Loans receivable, net (2) (3)														Loans receivable, net (2) (3)	$	4,490,499	$	49,524	4.47	%	$	3,748,573	$	46,277	4.97	%	$	741,926	$	3,247	(0.50)	%
Taxable securities	Taxable securities	697,128		3,865		2.21		823,498		5,704		2.75		Taxable securities	674,268		3,534		2.13		815,686		5,633		2.78		(141,418)		(2,099)		(0.65)
Nontaxable securities (3)	Nontaxable securities (3)	163,070		953		2.32		129,061		798		2.45		Nontaxable securities (3)	163,914		958		2.37		122,153		756		2.49		41,761		202		(0.12)
Interest earning deposits	Interest earning deposits	389,653		98		0.10		106,740		537		2.00		Interest earning deposits	713,885		175		0.10		125,357		420		1.35		588,528		(245)		(1.25)
Total interest earning assets	Total interest earning assets	5,855,240		52,563		3.57	%	4,736,704		54,884		4.60	%	Total interest earning assets	6,042,566		54,191		3.64	%	4,811,769		53,086		4.44	%	1,230,797		1,105		(0.80)	%
Noninterest earning assets	Noninterest earning assets	765,740						679,687						Noninterest earning assets	757,059						748,443						8,616
Total assets	Total assets	$	6,620,980					$	5,416,391					Total assets	$	6,799,625					$	5,560,212					$	1,239,413

Interest Bearing Liabilities:														Interest Bearing Liabilities:
Certificates of Deposit														Certificates of Deposit	$	393,268	$	559	0.58	%	$	528,009	$	2,012	1.53	%	$	(134,741)	$	(1,453)	(0.95)	%
Savings accounts														Savings accounts	560,094		95		0.07		434,459		188		0.17		125,635		(93)		(0.10)
Interest bearing demand and money market accounts														Interest bearing demand and money market accounts	2,732,134		1,074		0.16		2,201,921		2,016		0.37		530,213		(942)		(0.21)
Total interest bearing deposits														Total interest bearing deposits	3,685,496		1,728		0.19		3,164,389		4,216		0.54		521,107		(2,488)		(0.35)

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		Three Months Ended September 30,													Three Months Ended March 31,
		2020						2019							2021						2020						Change
		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)		Average Balance		Interest Earned/ Paid		Average Yield/ Rate
Interest Bearing Liabilities:
Certificates of deposit		$	466,920	$	1,133	0.97	%	$	508,092	$	1,861	1.45	%
Savings accounts		514,072		117		0.09		507,533		680		0.53
Interest bearing demand and money market accounts		2,639,511		1,389		0.21		2,040,926		1,709		0.33
Total interest bearing deposits		3,620,503		2,639		0.29		3,056,551		4,250		0.55
															(Dollars in thousands)
Junior subordinated debentures	Junior subordinated debentures	20,766		196		3.75		20,474		332		6.43		Junior subordinated debentures	20,913		187		3.63		20,620		285		5.56		293		(98)		(1.93)
Securities sold under agreement to repurchase	Securities sold under agreement to repurchase	32,856		50		0.61		29,258		48		0.65		Securities sold under agreement to repurchase	40,074		38		0.38		19,246		33		0.69		20,828		5		(0.31)
FHLB advances and other borrowings	FHLB advances and other borrowings	—		—		—		3,755		11		1.16		FHLB advances and other borrowings	—		—		—		989		1		0.41		(989)		(1)		(0.41)
Total interest bearing liabilities	Total interest bearing liabilities	3,674,125		2,885		0.31	%	3,110,038		4,641		0.59	%	Total interest bearing liabilities	3,746,483		1,953		0.21	%	3,205,244		4,535		0.57	%	541,239		(2,582)		(0.36)	%
Noninterest bearing demand deposits	Noninterest bearing demand deposits	1,998,772						1,416,336						Noninterest bearing demand deposits	2,091,359						1,420,247						671,112
Other noninterest bearing liabilities	Other noninterest bearing liabilities	148,345						88,624						Other noninterest bearing liabilities	134,762						128,650						6,112
Stockholders’ equity	Stockholders’ equity	799,738						801,393						Stockholders’ equity	827,021						806,071						20,950
Total liabilities and stockholders’ equity		$	6,620,980					$	5,416,391
Total liabilities and stock-holders’ equity														Total liabilities and stock-holders’ equity	$	6,799,625					$	5,560,212					$	1,239,413
Net interest income	Net interest income			$	49,678					$	50,243			Net interest income			$	52,238					$	48,551					$	3,687
Net interest spread	Net interest spread					3.26	%					4.01	%	Net interest spread					3.43	%					3.87	%					(0.44)	%
Net interest margin	Net interest margin					3.38	%					4.21	%	Net interest margin					3.51	%					4.06	%					(0.55)	%
Average interest earning assets to average interest bearing liabilities	Average interest earning assets to average interest bearing liabilities					159.36	%					152.30	%	Average interest earning assets to average interest bearing liabilities					161.29	%					150.12	%					11.17	%
Cost of total deposits														Cost of total deposits					0.12	%					0.37	%					(0.25)	%

(1) Annualized

(2) The average loan balances ~~presented in the table~~ are net of ~~allowances for credit losses~~ACL 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.

Interest Income

Total interest income decreased $2.3 million, or 4.2%, to $52.6 million for the three months ended September 30, 2020 compared to $54.9 million for the same period in 2019 due primarily to the change in the mix of interest earning assets and decreases in yields on adjustable rate instruments following several decreases in short-term market rates, offset partially by increases in interest earning assets, primarily due to SBA PPP loans. The yield on total interest earning assets decreased 103 basis points to 3.57% for the three months ended September 30, 2020 compared to 4.60% for the three months ended September 30, 2019. ~~The balance of average interest earning assets increased $1.12 billion, or 23.6%, to $5.86 billion for the three months ended September 30, 2020 from $4.74 billion for the three months ended September 30, 2019, including increases in the average balances of SBA PPP loans of $863.1 million and interest earning deposits of $282.9 million. There were no SBA PPP loans outstanding during the three months ended~~ ~~September 30, 2019~~.

Interest and fees on loans ~~decreased $198,000, or 0.4%,~~increased due primarily to ~~$47.6~~an increase in average loans receivable balances and specifically the addition of SBA PPP loans with an average balance of $832.1 million during the three months ended ~~September 30, 2019 compared to $47.8 million for the same period in 2019 due primarily to a decrease in the loan yield,~~March 31, 2021. The increase was offset partially by ~~an increase~~a decrease in ~~the average loan balance.~~ loa~~Loan yiel~~n yields following decreases~~d decreased 104 basis points to 4.12% for the three months ended September 30, 2020 from 5.16% for the three months ended September 30, 2019 due primarily to the multiple and sustained decreases~~ in short-term market ~~rates and secondarily due to the impact of low-yielding SBA PPP loans.~~rates. ~~Loan~~The yield ~~excluding~~on SBA PPP loans ~~and incremental accretion on purchased loans, d~~ecreased 69 basis points to 4.35% for three months ended September 30, 2020 compared to 5.04% for the comparable quarter ended September 30, 2019. Loan yields decreased 31 basis points as result of SBA PPP loans yielding a rate of 2.68%was 4.45%, inclusive of the recognition of the related deferred fee, ~~for~~for the three months ended ~~September 30, 2020.~~ March 31, 2021. The ~~impact of~~ SBA PPP loans onwill impact loan yields ~~will change~~ during any period ~~based on~~due to the recognition of deferred fees due to the volume of prepayments, ~~or amounts forgiven by~~including forgiveness payments from the ~~SBA as certain~~ criteria are met, but is expected to cease completely after maturity of the loans. The average loan balance increased $928.0 million, or 25.2%, to $4.61 billion during the three months ended September 30, 2020 compared to $3.68 billion during the three months ended September 30, 2019 due primarily to SBA PPP loans with an average balance of $863.1 million for the three months ended September 30, 2020.SBA.

~~Table of Contents~~

The following table presents the loan yield and the impacts of the balances and interest and fees earned on SBA PPP loans and the incremental accretion on purchased loans on this financial measure for the periods presented ~~below~~:below:

Three Months Ended
September 30,
2020 2019
(Dollars in thousands)
Non-GAAP reconciliation of loan yield:(1)
Loan yield (GAAP) 4.12 % 5.16 %
Exclude Impact on loan yield from SBA PPP loan interest and fees 0.31 —
Exclude impact on loan yield from incremental accretion on purchased loans(2)
(0.08) (0.12)
Loan yield excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP) 4.35 % 5.04 %


	Three Months Ended
	March 31, 2021		March 31, 2020
Non-GAAP Measure:(1)





Loan yield (GAAP)	4.47	%	4.97	%
Exclude impact from SBA PPP loans	0.01		—
Exclude impact from incremental accretion on purchased loans(2)	(0.12)		(0.11)
Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP)	4.36	%	4.86	%

(1)~~For additional information, see "Non-GAAP~~See Non-GAAP Financial ~~Measures."~~Measures section.

(2) Represents the amount of interest income recorded on purchased loans in excess of the contractual stated interest rate in the individual loan notes due to incremental accretion of purchased discount or premium. Purchased discount or premium is the difference between the contractual loan balance and the fair value of acquired loans at the acquisition date, or as modified by CECL Adoption. The purchased discount is accreted into income over the remaining life of the loan. The impact of incremental accretion on loan yield will change during any period based on the volume of prepayments, but it is expected to decrease over time as the balance of the purchased loans decreases.

Interest income on investment securities ~~decreased $1.7 million, or 25.9%, to $4.8 million~~decrease~~during the three months ended September 30, 2020 from $6.5 million during the three months ended September 30, 2019~~d due primarily to ~~decreases~~a decrease in market interest rates impacting adjustable rate securities and decreases in yields on investment securities purchased ~~lower than~~during the ~~existing investment portfolio. The yield on~~current, low-rate environment. Additionally, the aggregate investment portfolio decreased 48 basis points to 2.23% for the quarter ended September 30, 2020 from 2.71% for the same period in 2019, including decreases of 54 and 13 basis points on the yield on taxable securities and nontaxable securities, respectively. The average balance of investment securities decreased ~~$92.4 million, or 9.7%, to $860.2 millionduring the three months ended September 30, 2020 from $952.6 million~~during the three months ended September 30, 2019. The decrease in the average balance of investment securities included a $126.4 million, or 15.3%, decrease in the average balance of taxable securities, offset partially by a $34.0 million, or 26.4%, increase in the average balance of nontaxable securities.

~~Interest income on interest earning deposits decreased $439,000, or 81.8%, to $98,000 during the three months ended September 30, 2020 from $537,000~~10.6% for the same period in 2019 due primarily to decreases in the yield on interest earning deposits, offset partially by an increase in the average balance. The yield on interest earning deposits decreased 190 basis points to 0.10% during the three months ended September 30, 2020 compared to 2.00% during the same period in 2019 due to decreases in short-term market rates. The average balance of interest earning deposits increased $282.9 million, or 265.05%, to $389.7 million during the three months ended September 30, 2020 compared to $106.7 million during the same period in 2019 due primarily to the increase in deposits.

~~Interest Expense~~

Total interest expense decreased $1.8 million, or 37.8%, to $2.9 million for the three months ended September 30, 2020 compared to $4.6 million for the same period in 2019 due primarily to decreases in market interest rates following decreases in the federal funds target rate mentioned previously, offset partially by an increase in the average balance of total interest bearing liabilities. The cost of total interest bearing liabilities decreased 28 basis points to 0.31% for the three months ended September 30, 2020 from 0.59% for the three months ended September 30, 2019. The balance of average interest bearing liabilities increased $564.1 million, or 18.1%, to $3.67 billion during the three months ended September 30, 2020 compared to $3.11 billion during the same period in 2019.

Interest expense on total interest bearing deposits decreased $1.6 million, or 37.9%, to $2.6 million during the three months ended September 30, 2020 compared to $4.3 million during the same period in 2019 due primarily to decreases in market interest rates following decreases in the federal funds target rate previously mentioned, offset partially by an increase in the average balance of total deposits. ~~The cost of total interest bearing deposits~~ decreased 26 basis points to 0.29% for the three months ended September 30, 2020 from 0.55% for the three months ended September 30, 2019 due primarily to a decrease in the cost of interest bearing demand and money market accounts of 12 basis points, a decrease in cost of certificates of deposit of 48 basis points, and a decrease in the cost of savings accounts of 44 basis points. This decrease was offset partially by an increase in the averagetime periods.

~~Table of Contents~~

balance of total interest bearing deposits of $564.0 million, or 18.5%, to $3.62 billion for the three months ended September 30, 2020 compared to $3.06 billion for the same period in 2019 due primarily to proceeds from SBA PPP loans deposited directly into customer accounts and reduced withdrawals from deposit accounts due to a change in customer spending habits as a result of COVID-19.

The Company's deposit costs were favorably impacted by the increase in the average balance of noninterest bearing demand deposits compared to total interest bearing deposits. The average balance of noninterest bearing demand deposits increased $582.4 million, or 41.1%, to $2.00 billion (or 35.0% of total deposits at September 30, 2020) for the three months ended September 30, 2020 compared to $1.42 billion (or 31.3% of total deposits at September 30, 2019) for the same period in 2019. The increase in the average balance of noninterest bearing deposits contributed to the decrease in the cost of total deposits of 19 basis points to 0.19% for the three months ended September 30, 2020 compared to 0.38% for the same period in 2019.

~~Net Interest Margin~~

~~Net interest~~ margin decreased 83 basis points to 3.38% for the three months ended September 30, 2020 from 4.21% for the same period in 2019 primarily due to the above mentioned changes in asset yields and the mix of interest earning assets, offset partially by a decrease in the cost of interest bearing liabilities. The net interest spread decreased 75 basis points to 3.26% for the three months ended September 30, 2020 from 4.01% for the same period in 2019 primarily due to the decrease in the yield of total interest earning assets, offset partially by a decrease in the cost of total interest bearing liabilities.

~~Comparison of nine months ended September 30, 2020 to the comparable period in the prior year~~

Net interest income decreased $2.0 million, or 1.3%, to $148.5 million for the nine months ended September 30, 2020 compared to $150.6 million for the same period in 2019. The following table provides relevant net interest income information for the dates indicated:

Nine Months Ended September 30,
2020 2019
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)
$ 4,266,598 $ 142,328 4.46 % $ 3,651,659 $ 142,651 5.22 %
Taxable securities 758,941 14,068 2.48 828,254 17,460 2.82
Nontaxable securities (3)
148,560 2,686 2.42 139,312 2,641 2.53
Interest earning deposits 234,040 561 0.32 70,280 1,155 2.20
Total interest earning assets 5,408,139 159,643 3.94 % 4,689,505 163,907 4.67 %
Noninterest earning assets 757,269 672,365
Total assets $ 6,165,408 $ 5,361,870
Interest Bearing Liabilities:
Certificates of deposit $ 502,691 $ 4,955 1.32 % $ 508,177 $ 4,994 1.31 %
Savings accounts 475,091 420 0.12 505,112 2,061 0.55
Interest bearing demand and money market accounts 2,428,148 4,897 0.27 2,036,253 4,815 0.32
Total interest bearing deposits 3,405,930 10,272 0.40 3,049,542 11,870 0.52
Junior subordinated debentures 20,693 699 4.51 20,401 1,026 6.72
Securities sold under agreement to repurchase 25,296 122 0.64 30,512 139 0.61
FHLB advances and other borrowings 1,959 8 0.55 15,909 305 2.56
Total interest bearing liabilities 3,453,878 11,101 0.43 % 3,116,364 13,340 0.57 %

~~Table of Contents~~

Nine Months Ended September 30,
2020 2019
Average
Balance Interest
Earned/
Paid
Average
Yield/
Rate (1)
Average
Balance Interest
Earned/
Paid
Average
Yield/
Rate (1)
Noninterest bearing demand deposits 1,768,260 1,365,134
Other noninterest bearing liabilities 138,837 96,723
Stockholders’ equity 804,433 783,649
Total liabilities and stockholders’ equity $ 6,165,408 $ 5,361,870
Net interest income $ 148,542 $ 150,567
Net interest spread 3.51 % 4.10 %
Net interest margin 3.67 % 4.29 %
Average interest earning assets to average interest bearing liabilities 156.58 % 150.48 %

~~(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 decreased $4.3 million, or 2.6%, to $159.6 million for the nine months ended September 30, 2020 compared to $163.9 million for the same period in 2019 due primarily to decreases in yields on adjustable rate instruments following several decreases in short-term market rates, offset partially by increases in interest earning assets, primarily due to SBA PPP loans. The yield on total interest earning assets decreased 73 basis points to 3.94%, for the nine months ended September 30, 2020 compared to 4.67% for the nine months ended September 30, 2019. The balance of average interest earning assets increased $718.6 million, or 15.3%, to $5.41 billion for the nine months ended September 30, 2020 from $4.69 billion for the nine months ended September 30, 2019, including increases in average balances of SBA PPP loans of $511.5 million and interest earning deposits of $163.8 million.

~~Interest and fees o~~n loans decreased $323,000, or 0.2%, to $142.3 million during the nine months ended September 30, 2020 compared to $142.7 million for the same period in 2019 due primarily to a decrease in the loan yield, offset partially by an increase in the average loan balance. Loan yield decreased 76 basis points to 4.46% for the nine months ended September 30, 2020 from 5.22% for the nine months ended September 30, 2019 due primarily to the multiple and sustained decreases in short-term market rates and secondarily due to the impact of low-yielding SBA PPP loans. L~~oan yield, excluding SBA PPP loans and incremental accretion on purchased loans, decreased 49~~ ~~basis points to 4.59% for nine months ended September 30, 2020 compared to 5.08% for the comparable period ended September 30, 2019. Loan yields decreased 21 basis points as result of SBA PPP loans yielding a rate of 2.80%, inclusive of the related deferred fee, for the nine months ended September 30, 2020.~~ ~~The average loan balance increased~~ ~~$614.9 million, or~~ ~~16.8%, to~~ ~~$4.27 billion~~ ~~during the~~ ~~nine months ended September 30, 2020 compared to $3.65 billion during the nine months ended September 30, 2019 due primarily to the impact of SBA PPP loans with~~ ~~average balance of~~ ~~$511.5 million for the nine months ended September 30, 2020. There were no SBA PPP loans outstanding during the nine months ended September 30, 2019.~~

5636

Table of Contents

Nine Months Ended
September 30,
2020 2019
(Dollars in thousands)
Non-GAAP reconciliation of loan yield:(1)
Loan yield (GAAP) 4.46 % 5.22 %
Exclude Impact on loan yield from SBA PPP loans 0.21 —
Exclude impact on loan yield from incremental accretion on purchased loans(2)
(0.08) (0.14)
Loan yield excluding SBA PPP loans and incremental accretion on purchased loans (non-GAAP) 4.59 % 5.08 %

~~(1)~~ ~~For additional information, see "Non-GAAP Financial Measures."~~

~~(2)~~ Represents the amount of interest income recorded on purchased loans in excess of the contractual stated interest rate in the individual loan notes due to incremental accretion of purchased discount or premium. Purchased discount or premium is the difference between the contractual loan balance and the fair value of acquired loans at the acquisition date, or as modified by the CECL Adoption. The purchased discount is accreted into income over the remaining life of the loan. The impact of incremental accretion on loan yield will change during any period based on the volume of prepayments, but it is expected to decrease over time as the balance of the purchased loans decreases.

Interest income on ~~investment securities~~interest earning deposits decreased ~~$3.3 million, or 16.7%,~~due primarily to $16.8 million during the nine months ended September 30, 2020 from $20.1 million during the nine months ended September 30, 2019 due primarily to decreases in market interest rates impacting adjustable rate securities. The yield on the aggregate investment portfolio decreased 31 points to 2.47% for the nine months ended September 30, 2020 from 2.78% for the same period in 2019, including decreases of 34 basis points and 11 basis points on the yield on taxable securities and nontaxable securities, respectively. Also contributing to the decline in interest income on investment securities was a decrease in average balance of $60.1 million, or 6.2%, to $907.5 million during the nine months ended September 30, 2020 from $967.6 million during the nine months ended September 30, 2019 due primarily to prepayments and calls of securities astheir yield following a ~~result of the currently low interest rate environment. The~~ decrease in the average balance of investment securities included a decrease of $69.3 million, or 8.4%, in the average balance of taxable securities, offset partially by an increase of $9.2 million, or 6.6%, in the average balance of nontaxable securities during the nine months ended September 30, 2020.

~~Interest income on~~short-term market ~~interest earning deposits decreased $594,000, or 51.4%, to $561,000 during the nine months ended September 30, 2020 from $1.2 million during the nine months ended September 30, 2019 due primarily to a~~ ~~decrease~~ ~~in the yield on interest earning deposits,~~rates, offset partially by an increase in the average balance. ~~The yield on interest earning deposits~~ ~~decreased 188 basis points to 0.32% during the~~ ~~nine months ended September 30, 2020~~ ~~compared to 2.20% during the same period in 2019 due to decreases in the short-term market rates. The average~~ interest earning deposits increased $163.8 million, or 233.0%, to $234.0 million during the nine months ended September 30, 2020 compared to $70.3 million during the same period in 2019 due primarily to the increase in deposits.

Interest Expense

Total interest expense decreased $2.2 million, or 16.8%, to $11.1 million for the nine months ended September 30, 2020 compared to $13.3 million for the same period in 2019 due primarily to decreases in market interest rates following decreases in the federal funds target rate mentioned previously, offset partially by an increase in the average balance of total interest bearing liabilities. The cost of total interest bearing liabilities decreased 14 basis points to 0.43% for the nine months ended September 30, 2020 from 0.57% for the nine months ended September 30, 2019. The balance of average interest bearing liabilities increased $337.5 million, or 10.8%, to $3.45 billion for the nine months ended September 30, 2020 compared to $3.12 billion for the same period in 2019.

Interest expense on total interest bearing deposits decreased ~~$1.6 million, or 13.5%, to $10.3 million during the nine months ended September 30, 2020 compared to $11.9 million during the same period in 2019~~ due primarily to ~~decreases~~ the Bank reducing its cost of deposits following the decrease in short-term market ~~interest~~ rates, ~~following decreases in the federal funds target rate previously mentioned,~~ offset partially by an increase in ~~the average balance.~~ ~~The cost of~~ total interest bearing ~~deposits~~ ~~decreased 12 basis points to 0.40% from 0.52% due~~liabilities, which increased primarily toas a ~~decrease in the cost~~result of savings accounts of 43 basis points to 0.12% from 0.55% and secondarily to a decrease in the cost of interest bearing demand and money market accounts of five basis points to 0.27% for the nine months ended September 30, 2020 from 0.32% for the same period in 2019.

~~Table of Contents~~

The decrease in cost of total interest bearing deposits was offset partially by an increase in the average balance of total interest bearing deposits of $356.4 million, or 11.7%, to $3.41 billion for the nine months ended September 30, 2020 compared to $3.05 billion for the same period in 2019 due primarily to proceeds from SBA PPP loans originated during the three months ended March 31, 2021 which were deposited directly into ~~customer accounts and an increase in customer~~the customers' deposit ~~accounts due to a change in spending habits as a result of COVID-19.~~

The Company's deposit costs were favorably impacted by the increase in the average balance of noninterest bearing demand deposits compared to total interest bearing deposits. The average balance of noninterest bearing demand deposits increased $403.1 million, or 29.5%, to $1.77 billion for the nine months ended September 30, 2020 compared to $1.37 billion for the same period in 2019. The increase in the average balance of noninterest bearing deposits caused a decrease in the total cost of deposits of nine basis points to 0.27% for the nine months ended September 30, 2020 from 0.36% for the same period in 2019.

~~Net Interest Margin~~

Net interest margin decreased 62 basis points to 3.67% for the nine months ended September 30, 2020 from 4.29% for the same period in 2019 primarily due to the above mentioned changes in asset yields and the mix of interest earning assets, offset partially by a decrease in the cost of interest bearing liabilities. The net interest spread decreased 59 basis points to 3.51% for the nine months ended September 30, 2020 from 4.10% for the same period in 2019 primarily due to the decrease in the yield of total interest earning assets, offset partially by a decrease in the cost of total interest bearing liabilities.accounts.

Provision for Credit Losses Overview

Effective January 1, 2020, the Bank ~~adopted ASU 2016-13.~~completed the CECL 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. CECL 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.Adoption. 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~~within Accrued expenses and other liabilities.

The following table presents the provision for credit losses for the periods ~~presented below:~~indicated:

Three Months Ended
September 30, Nine Months Ended
September 30,
2020 2019 2020 2019
(In thousands)
Provision for credit losses on loans $ 2,320 $ 466 $ 38,225 $ 2,753
Provision for credit losses on unfunded commitments 410 — 1,014 —
Provision for credit losses $ 2,730 $ 466 $ 39,239 $ 2,753


	Three Months Ended March 31,
	2021		2020		Change		Percentage Change
	(Dollars in thousands)
(Reversal of) provision for credit losses on loans	$	(6,135)	$	9,964	$	(16,099)	(161.6)	%
Reversal of provision for credit losses on unfunded commitments	(1,064)		(2,018)		954		(47.3)
(Reversal of) provision for credit losses	$	(7,199)	$	7,946	$	(15,145)	(190.6)	%

Provision for Credit Losses on Loans

The Bank has established a comprehensive methodology for determining its ACL on loans. The ACL on loans is increased by the provision for credit losses on loans ~~charged to earnings. The amount of the provision expense recognized during the three and nine months ended September 30, 2020 was~~which is calculated based on a thorough review of the loan portfolio ~~and~~ in accordance with the Bank's CECL methodology for determining the current expected credit losses on loans. The amount of the provision expense recognized during the three and nine months ended September 30, 2019 was calculated in accordance with the Bank's incurred loss methodology. For additional information, see the section entitled "Analysis of Allowance for Credit Losses on Loans" below.

loans receivable. The provision for credit 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 the COVID-19 pandemic, could increase future provisions for credit losses on loans and have a material adverse effect on the Company’s net income.

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~~Comparison of quarter ended September 30, 2020 to the comparable quarter in the prior year.~~

The reversal of provision for credit losses on loans ~~increased $1.9 million, or 397.9%, to $2.3 million for~~recognized during the three months ended ~~September 30, 2020 from $466,000~~March 31, 2021 was primarily ~~for the three months ended September 30, 2019~~ due ~~primarily~~ to ~~increases~~improvements in the ~~ACL for nonperforming loans, caused by~~economic forecast at March 31, 2021 compared to the ~~COVID-19 pandemic,~~forecast at December 31, 2020, as further explained in the "Analysis of Allowance for Credit Losses on Loans" below.

~~Comparison of nine months ended September 30, 2020 to the comparable period in the prior year.~~

The provision for credit ~~losse~~slosses on loans ~~increased $35.5 million, or 1288.5%, to $38.2~~of $10.0 million for the ~~nine~~three months ended ~~September 30,~~March 31, 2020 ~~from $2.8 million for the nine months ended September 30, 2019~~was due primarily to the ~~worsening of the~~ economic ~~conditions as a result of~~forecast at that date reflecting the COVID-19 pandemic ~~as explained~~ in addition to the ~~"Analysis~~impact of ~~Allowance for Credit Losses on Loans" below.~~the CECL methodology and life of loan considerations.

Provision for Credit Losses on Unfunded Commitments

The Bank has established a comprehensive methodology for determining its ACL on unfunded commitments, which ~~is similar to~~uses loss rates calculated in the ACL on loans by loan type with an additional ~~considerations for~~estimate of the likelihood of ~~funding over the contractual life~~utilization of the ~~commitment. The ACL on~~unfunded commitment, both applied to the outstanding balance of unfunded commitments ~~is increased~~ by ~~the provision for credit losses recorded through earnings.~~ loan type.

The ~~amount~~reversal of the provision expense recognized during the three and nine months ended September 30, 2020 was calculated based on a thorough review of the loan portfolio and in accordance with the Bank's CECL methodology for determining the current expected credit losses on unfunded commitments. The amount of the provision expense recognized during the three and nine months ended September 30, 2019 was calculated in accordance with the Bank's incurred loss methodology.

~~Comparison of quarter ended September 30, 2020 to the comparable quarter in the prior year.~~

~~The Bank recorded a~~ provision for credit losses on unfunded commitments of ~~$410,000~~recognized during the three months ended ~~September 30, 2020~~March 31, 2021 was primarily due to improvements in the economic forecast reducing the loss rates calculated for the ACL on loans, offset partially by a decrease in utilization ~~rate~~rates during the period.

The reversal of ~~revolving commercial and industrial loans to 23.3%~~ ~~at September 30, 2020 compared to 26.2% at June 30, 2020~~ ~~and worsening economic conditions applied to the commercial and industrial loan segment due to COVID-19.~~

~~Comparison of nine months ended September 30, 2020 to the comparable period in the prior year.~~

~~The Bank recorded a~~ provision for credit losses on ~~unfunded~~unfunded commitments ~~of $1.0 million~~recognized during the ~~nine~~three months ended ~~September 30,~~March 31, 2020 was primarily ~~as a result of~~ ~~worsening economic conditions~~ due to ~~COVID-19~~ ~~and~~ a decrease in the ~~utilization rates for revolving lines~~unfunded commercial construction loan balance, resulting from increased funding of ~~credit to 38.4% at September 30, 2020 compared to 39.3% at December 31, 2019.~~

~~Noninterest Income~~

~~Comparison of quarter ended September 30, 2020 to the comparable quarter in the prior year.~~

~~Total noninterest income decreased $248,000, or 2.9%, to $8.2 million for~~commercial construction projects during the three months ended ~~September 30,~~March 31, 2020, ~~from $8.5 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
September 30,
2020 2019 Change Percentage Change
(Dollars in thousands)
Service charges and other fees $ 4,039 $ 4,779 $ (740) (15.5) %
Gain on sale of investment securities, net 40 281 (241) (85.8)
Gain on sale of loans, net 1,443 993 450 45.3
Interest rate swap fees 396 152 244 160.5
Other income 2,292 2,253 39 1.7
Total noninterest income $ 8,210 $ 8,458 $ (248) (2.9) %

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~~Service charges and other~~ ~~fees decreased of $740,000, or 15.5%, to $4.0 million for the three months ended September 30, 2020 compared to $4.8 million for the same period in 2019 due primarily to a decrease~~ ~~in overdraft fees~~ ~~of $561,000 from changes in customer spending habits during the COVID-19 pandemic.~~

~~The decrease in noninterest income was~~ offset partially by an increase in ~~gain on sale of loans, net, of $450,000, or 45.3%, to $1.4 million~~the loss rates calculated for the three months ended September 30, 2020 compared to $993,000 for the same period in 2019 primarily as a result of an increase in sales due to an increase in origination volume generated by the currently low interest rate environment, offset partially by a lower average loan sale margin. Mortgage loans held for sale originations increased by $19.1 million, or 162.5%, to $44.6 million for the three months ended September 30, 2020 from $25.5 million for the same period in 2019.

~~Comparison of nine months ended September 30, 2020 to the comparable period in the prior year~~

~~Total noninterest income increased $2.5 million, or 10.6%, to $25.9 million for the nine months ended September 30, 2020 compared to $23.5 million for the same period in 2019.~~ ~~The following table presents the change in the key components of noninterest income for the periods noted:~~

Nine Months Ended
September 30,
2020 2019 Change Percentage Change
(Dollars in thousands)
Service charges and other fees $ 12,015 $ 14,109 $ (2,094) (14.8) %
Gain on sale of investment securities, net 1,463 329 1,134 344.7
Gain on sale of loans, net 3,125 1,613 1,512 93.7
Interest rate swap fees 1,461 313 1,148 366.8
Other income 7,880 7,087 793 11.2
Total noninterest income $ 25,944 $ 23,451 $ 2,493 10.6 %

~~Gain~~ACL on ~~sale of loan~~s, net increased $1.5 million, or 93.7%, to $3.1 million for the nine months ended September 30, 2020 compared to $1.6 million for the same period in 2019 primarily as a result of an increase in the volume of loans sold due to an increase in originations reflecting the low interest rate environment during the nine months ended September 30, 2020. Mortgage loan held for sale originations increased by $47.6 million, or 103.7%, to $93.4 million for the nine months ended September 30, 2020 from $45.9 million~~for the nine months ended September 30, 2019.~~

~~Gain on sale of investment se~~curities, net increased $1.1 million, or 344.7%, to $1.5 million for the nine months ended September 30, 2020 from $329,000 during the same period in 2019 as a result of the Bank's active management of the investment portfolio in the current low interest rate environment.

~~Interest rate swap fees increased $1.1 million, or 366.8%, to $1.5 million for the nine months ended September 30, 2020 compared to $313,000 in the same period in 2019 based on customer transactions.~~

Other income increased $793,000, or 11.2%, to $7.9 million for the nine months ended September 30, 2020 compared to $7.1 million for the same period in 2019 due primarily to $653,000 of gain from a bank owned life insurance death benefit paid during the nine months ended September 30, 2020.

The increase in noninterest income was offset partially by a decrease in service charges and other fees of $2.1 million, or 14.8%, to $12.0 million for the nine months ended September 30, 2020 compared to $14.1 million for the same period in 2019 due primarily to a decrease ~~in overdraft fees~~ ~~of $1.4 million from changes in customer spending habits and a decrease in activity-based fees on deposit accounts, in each case due to the COVID-19 pandemic.~~loans.

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Noninterest ~~Expense~~Income Overview

~~Comparison~~The following table presents the key components of ~~quarter ended September 30, 2020 to~~noninterest income and the ~~comparable quarter in~~change for the ~~prior year.~~periods noted:


	Three Months Ended March 31,
	2021		2020		Change		Percentage Change
	(Dollars in thousands)
Service charges and other fees	$	4,000	$	4,376	$	(376)	(8.6)	%
Gain on sale of investment securities, net	29		1,014		(985)		(97.1)
Gain on sale of loans, net	1,370		547		823		150.5
Interest rate swap fees	152		296		(144)		(48.6)
Bank owned life insurance income	656		885		(229)		(25.9)
Other income	2,044		2,368		(324)		(13.7)
Total noninterest income	$	8,251	$	9,486	$	(1,235)	(13.0)	%

~~Noninterest expe~~

Service charges and other~~nse~~ fees decreased ~~$674,000, or 1.8%,~~due primarily to ~~$36.0 million~~a decrease in overdraft fees of $498,000 from changes in customer spending habits during the COVID-19 pandemic.

Gain on sale of investment securities, net decreased due primarily to fewer sales of investment securities during the three months ended ~~September 30, 2020~~ March 31, 2021 as compared to the same period last year.

Gain on sale of loans, net increased from ~~$36.7 million~~the combination of higher origination and sales volumes and higher earned sales margins reflecting an increased demand for residential loans due to the low interest rate environment during the three months ended ~~September 30, 2019.~~ March 31, 2021. Originations of mortgage loans held for sale increased $16.2 million, or 101.3%, to $32.3 million for the three months ended March 31, 2021 from $16.0 million for the three months ended March 31, 2020.

Bank owned life insurance income decreased due primarily to death benefit income of $332,000 recognized during the three months ended March 31, 2020. No death benefits were recognized during the three months ended March 31, 2021.

Other income decreased primarily as a result of the divestiture of our trust department in October 2020, which provided other income of $276,000 during the three months ended March 31, 2020.

Noninterest Expense Overview

The following table presents ~~changes in~~ the key components of noninterest expense and the change for the periods noted:


		Three Months Ended September 30,									Three Months Ended March 31,
		2020		2019		Change		Percentage Change			2021		2020		Change		Percentage Change
		(Dollars in thousands)									(Dollars in thousands)
Compensation and employee benefits	Compensation and employee benefits	$	21,416	$	21,733	$	(317)	(1.5)	%	Compensation and employee benefits	$	22,461	$	22,506	$	(45)	(0.2)	%
Occupancy and equipment	Occupancy and equipment	5,676		5,268		408		7.7		Occupancy and equipment	4,454		4,564		(110)		(2.4)
Data processing	Data processing	2,363		2,333		30		1.3		Data processing	3,812		3,527		285		8.1
Marketing	Marketing	755		816		(61)		(7.5)		Marketing	669		866		(197)		(22.7)
Professional services	Professional services	1,086		1,434		(348)		(24.3)		Professional services	1,331		1,377		(46)		(3.3)
State/municipal business and use tax	State/municipal business and use tax	964		1,370		(406)		(29.6)		State/municipal business and use tax	972		757		215		28.4
Federal deposit insurance premium	Federal deposit insurance premium	848		9		839		9,322.2		Federal deposit insurance premium	589		—		589		100.0
Other real estate owned, net	Other real estate owned, net	—		(35)		35		(100.0)		Other real estate owned, net	—		25		(25)		(100.0)
Amortization of intangible assets	Amortization of intangible assets	860		975		(115)		(11.8)		Amortization of intangible assets	797		903		(106)		(11.7)
Other expense	Other expense	2,077		2,816		(739)		(26.2)		Other expense	2,157		2,735		(578)		(21.1)
Total noninterest expense	Total noninterest expense	$	36,045	$	36,719	$	(674)	(1.8)	%	Total noninterest expense	$	37,242	$	37,260	$	(18)	—	%

The Company completed its plan to consolidate nine branches, including eight branches in January 2021 and one branch in October 2020, integrating them into other branches within its network to create a more efficient branch footprint. These actions are a result of the Company’s increased focus on balancing physical locations and digital banking channels, driven by increased client usage of online and mobile banking and a commitment to improve digital banking technology. The Company started to recognize the benefit from this effort primarily through reduced compensation and employee benefits expense and occupancy and equipment expense during the quarter ended March 31, 2021.

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Federal deposit insurance premium increased as the Bank's FDIC's small bank credit offset the full assessment during the quarter ended March 31, 2020. The remaining credit available at March 31, 2020 was fully utilized during second quarter of 2020.

Other expense decreased ~~$739,000, or 26.2%, to $2.1 million for the three months ended September 30, 2020 from $2.8 million for the same period in 2019~~ due primarily ~~from the~~to a reduction of discretionary expenses, including employee business travel ~~conference, and entertainment expenses related to~~as a result of the ~~Bank's~~Company's suspension of non-essential travel due to ~~COVID-19.~~the COVID-19 pandemic.

State/municipal business and use taxes expense decreased $406,000, or 29.6%, as a result of an assessment in the amount of $537,000 from a Washington State Department of Revenue Business and Occupation audit recognized during the three months ended September 30, 2019.

The decreases in noninterest expense were partially offset by an increase in federal deposit insurance premium expense of $839,000 due primarily to the impact of the decrease in the Bank's Tier 1 leverage ratio on the Bank's assessment rate during the three months ended September 30, 2020 partially offset by the usage of the remainder of the Bank's small bank credit during the quarter ended June 30, 2020. The Bank utilized its small bank credit for the full premium due during the three months ended September 30, 2019.

The ratio of noninterest expense to average total assets (annualized) was ~~2.17%~~2.22% for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~2.69%~~2.70% for the three months ended ~~September 30, 2019.~~March 31, 2020. The decrease in the ratio of noninterest expense to average total assets was primarily due to an increase in average total assets primarily due to the origination of SBA PPP loans ~~originated during 2020.~~and secondarily due to the increase in interest earning deposits.

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~~Comparison of nine months ended September 30, 2020 to the comparable period in the prior year~~Income Tax Expense Overview

~~Noninterest expense decreased $413,000, or 0.4%, to $110.4 million during the nine months ended September 30, 2020 compared to $110.8 million for the nine months ended September 30, 2019.~~ The following table presents ~~changes in~~ the ~~key components of noninterest~~income tax expense and related metrics and the change for the periods noted:

Nine Months Ended
September 30,
2020 2019 Change Percentage Change
(Dollars in thousands)
Compensation and employee benefits $ 65,849 $ 65,629 $ 220 0.3 %
Occupancy and equipment 16,936 16,177 759 4.7
Data processing 7,046 6,615 431 6.5
Marketing 2,317 3,020 (703) (23.3)
Professional services 4,632 3,912 720 18.4
State/municipal business and use tax 2,626 2,977 (351) (11.8)
Federal deposit insurance premium 1,086 720 366 50.8
Other real estate owned, net (145) 340 (485) (142.6)
Amortization of intangible assets 2,666 3,026 (360) (11.9)
Other expense 7,365 8,375 (1,010) (12.1)
Total noninterest expense $ 110,378 $ 110,791 $ (413) (0.4) %


	Three Months Ended March 31,
	2021			2020			Change			Percentage Change
	(Dollars in thousands)
Pre-tax income	$	30,446		$	12,831		$	17,615		137.3	%
Income tax expense	5,102			640			4,462			697.2
Effective tax rate	16.8		%	5.0		%	11.8		%	236.0

Other expense decreased $1.0 million, or 12.1%, to $7.4 million for the nine months ended September 30, 2020 from $8.4 million for the same period in 2019 due substantially from the reduction of employee travel, conference, and entertainment expenses related to the Company's suspension of non-essential travel due to COVID-19.

~~Marketing expense decreased $703,000, or 23.3%, to $2.3 million during the nine months ended September 30, 2020 from $3.0 million during the nine months ended September 30, 2019 due primarily to~~ ~~the delayed timing of~~ ~~contributions for community~~ ~~sponsorships and sponsored events due to COVID-19 restrictions.~~

The decreases in noninterest expense were partially offset by an increase in occupancy and equipment expense of $759,000, or 4.7%, to $16.9 million for the nine months ended September 30, 2020 from $16.2 million during the nine months ended September 30, 2019 due primarily to depreciation expense related to the Southern Operation Cente~~r placed into operation in December 2019.~~

Professional services expense increased $720,000, or 18.4%, to $4.6 million during the nine months ended September 30, 2020 from $3.9 million during the nine months ended September 30, 2019 related primarily to the launch of the new mobile and online commercial banking platform, "Heritage Direct." The implementation of the new banking platform was completed during the second quarter of 2020.

~~Federal deposit insurance p~~remium expense increased $366,000, or 50.8%, to $1.1 million during the nine months ended September 30, 2020 from $720,000 during the nine months ended September 30, 2019 due to the impact of the decrease in the Bank's Tier 1 leverage ratio on the Bank's assessment rate, offset partially by the use of the small bank credit for two quarters during the nine months ended September 30, 2020 compared to one quarter during the same period in 2019.

Compensation and employee benefits increased $220,000, or 0.3%, due primarily to premium pay to certain front-line employees of $408,000 as a result of impacts from COVID-19, an increase in overtime of $226,000 due primarily to SBA PPP loan processing, and an increase in commission expense of $390,000 related to increased mortgage loan sale activity. These increases were offset partially by $928,000 in the deferral of compensation as a result of SBA PPP origination volume recognized during the nine months ended September 30, 2020.

The ratio of noninterest expense to average total assets (annualized) was 2.39% for the nine months ended September 30, 2020, compared to 2.76% for the nine months ended September 30, 2019. The decrease was primarily due to an increase in average total assets, due primarily to SBA PPP loans originated during 2020.

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~~Income Tax Expense~~

~~Comparison of quarter ended September 30, 2020 to the comparable quarter in the prior year.~~

Income tax expense ~~decreased $1.1 million, or 31.6%, to $2.5 million for~~and the ~~three months ended September 30, 2020 from $3.6 million for the three months ended September 30, 2019 primarily due to lower pre-tax income. The~~ effective income tax rate ~~was 13.0% for the three months ended September 30, 2020 compared to 16.8% for the same period in 2019. The decrease in the effective tax rate from the three months ended September 30, 2020 was~~both increased due primarily to the year-over-year decrease in estimated annual pre-tax income, which results in an increased impact for favorable permanent tax items such as tax-exempt investments, investments in bank owned life insurance and low-income housing tax credits.

~~Comparison of nine months ended September 30, 2020 to the comparable period in the prior year.~~

~~Inco~~me tax expense decreased $7.9 million, or 78.3%, to $2.2 million for the nine months ended September 30, 2020 from $10.0 million for the nine months ended September 30, 2019. The effective tax rate was 8.8% for the nine months ended September 30, 2020 compared to 16.6% for the same period in 2019. The decrease in income tax expense and effective tax rate during the nine months ended September 30, 2020 was due primarily to a nonrecurring provision in the CARES Act which permitted the Company to recognize a $1.0 million benefit from net operating losses related to prior acquisitions during the ~~nine~~three months ended ~~September 30, 2020 and secondarily due to a decrease~~March 31, 2020. This tax benefit was not replicated in the current quarter. Additionally, estimated annual pre-tax income ~~and increased~~was higher for the quarter ended March 31, 2021 than the recorded pre-tax income for the quarter ended March 31, 2020 which decreased the impact of favorable permanent tax items such as tax-exempt investments, investments in bank owned life insurance, and low-income housing tax credits. Finally, there are no gross tax credits remaining related to the Company's New Market Tax Credit as these credits were fully utilized during the seven year period ending December 31, 2020.

Consolidated Financial Condition Overview

The table below provides a comparison of the changes in the Company's financial condition from December 31, ~~2019~~2020 to ~~September 30, 2020:~~March 31, 2021:

September 30,
2020 December 31, 2019 Change % Change
(Dollars in thousands)
Assets
Cash and cash equivalents $ 576,242 $ 228,568 $ 347,674 152.1 %
Investment securities available for sale, at fair value, net 834,492 952,312 (117,820) (12.4)
Loans held for sale 8,250 5,533 2,717 49.1
Loans receivable, net 4,593,390 3,731,708 861,682 23.1
Other real estate owned — 841 (841) (100.0)
Premises and equipment, net 89,831 87,888 1,943 2.2
Federal Home Loan Bank stock, at cost 6,661 6,377 284 4.5
Bank owned life insurance 108,311 103,616 4,695 4.5
Accrued interest receivable 18,888 14,446 4,442 30.7
Prepaid expenses and other assets 194,938 164,129 30,809 18.8
Other intangible assets, net 13,947 16,613 (2,666) (16.0)
Goodwill 240,939 240,939 — —
Total assets $ 6,685,889 $ 5,552,970 $ 1,132,919 20.4 %
Liabilities
Deposits $ 5,689,048 $ 4,582,676 $ 1,106,372 24.1 %
Junior subordinated debentures 20,814 20,595 219 1.1
Securities sold under agreement to repurchase 29,043 20,169 8,874 44.0
Accrued expenses and other liabilities 143,855 120,219 23,636 19.7
Total liabilities 5,882,760 4,743,659 1,139,101 24.0
Stockholders' equity
Common stock 570,170 586,459 (16,289) (2.8)
Retained earnings 207,751 212,474 (4,723) (2.2)
Accumulated other comprehensive income, net 25,208 10,378 14,830 142.9
Total stockholders' equity 803,129 809,311 (6,182) (0.8)
Total liabilities and stockholders' equity $ 6,685,889 $ 5,552,970 $ 1,132,919 20.4 %


	March 31, 2021		December 31, 2020		Change		Percentage Change
	(Dollars in thousands)
Assets
Cash and cash equivalents	$	934,316	$	743,322	$	190,994	25.7	%
Investment securities available for sale, at fair value, net	893,558		802,163		91,395		11.4
Loans held for sale	6,801		4,932		1,869		37.9
Loans receivable, net	4,531,644		4,398,462		133,182		3.0
Other real estate owned	—		—		—		n/a
Premises and equipment, net	84,533		85,452		(919)		(1.1)
Federal Home Loan Bank stock, at cost	7,933		6,661		1,272		19.1
Bank owned life insurance	108,341		107,580		761		0.7
Accrued interest receivable	19,447		19,418		29		0.1
Prepaid expenses and other assets	188,589		193,301		(4,712)		(2.4)
Other intangible assets, net	12,291		13,088		(797)		(6.1)
Goodwill	240,939		240,939		—		—
Total assets	$	7,028,392	$	6,615,318	$	413,074	6.2	%

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	March 31, 2021		December 31, 2020		Change		Percentage Change
	(Dollars in thousands)
Liabilities
Deposits	$	6,019,698	$	5,597,990	$	421,708	7.5	%

Junior subordinated debentures	20,960		20,887		73		0.3
Securities sold under agreement to repurchase	36,503		35,683		820		2.3
Accrued expenses and other liabilities	124,080		140,319		(16,239)		(11.6)
Total liabilities	6,201,241		5,794,879		406,362		7.0
Stockholders' equity
Common stock	571,204		571,021		183		—
Retained earnings	242,486		224,400		18,086		8.1
Accumulated other comprehensive income, net	13,461		25,018		(11,557)		(46.2)
Total stockholders' equity	827,151		820,439		6,712		0.8
Total liabilities and stockholders' equity	$	7,028,392	$	6,615,318	$	413,074	6.2	%

Total assets increased ~~$1.13 billion, or 20.4%, to $6.69 billion as of September 30, 2020 compared to $5.55 billion as of December 31, 2019.~~

~~Loans receivable, net, increased $861.7 million, or 23.1%, to $4.59 billion at September 30, 2020 compared to $3.73 billion at December 31, 2019~~ due primarily to ~~SBA PPP~~an increase in loans ~~of $867.8 million originated~~receivable, which is discussed in ~~2020,~~more detail below in the "Lending Activities Overview" section; an increase in cash and increases in non-owner occupied CRE loans of $96.2 million, owner-occupied CRE loans of $54.1 million and real estate construction and land development loans of $40.5 million, offset partially by decreases in commercial and industrial loans of $101.7 million and consumer loans of $58.3 million. The decrease in commercial and industrial loans wascash equivalents due primarily to ~~a decrease~~an increase in ~~the utilization rate of lines of credit to 23.3% at September 30, 2020 from 34.5% at December 31, 2019. The decrease~~total deposits, and an increase in ~~consumer loans was primarily due to the cessation of indirect auto loan originations in March 2020.~~

~~Investment~~investment securities available for sale ~~decreased $117.8 million, or 12.4%, to $834.5 million at September 30, 2020 from $952.3 million at December 31, 2019~~ primarily as a result of ~~calls, maturities, principal payments and sales of investment securities of $252.9 million, offset partially by~~ purchases of ~~$117.5 million~~$166.0 million.

Total liabilities and stockholder's equity increased due primarily to an increase in ~~net unrealized gains of $18.9 million due to a decrease~~deposits, which is discussed in ~~market interest rates during the nine months ended September 30, 2020 that positively impacted the fair value of our bond portfolio.~~

~~Prepaid expenses and other assets increased $30.8 million, or 18.8%, to $194.9 million at September 30, 2020 from $164.1 million at December 31, 2019 primarily as a result of an increase~~more detail in the fair value of interest rate swap contracts of $21.7 million and an investment in a Low Income Housing Tax Credit partnership of $10.2 million, both of which had a nearly corresponding increase in accrued expenses and other liabilities. Accrued expenses and other liabilities increased $23.6 million, or 19.7%, to $143.9 million at September 30, 2020 compared to $120.2 million as of December 31, 2019 due to the changes described for prepaid expenses and other assets, partially offset by a decrease related to capital contributions of Low Income Housing Tax Credit partnership investments of $7.1 million.

Total deposits increased $1.11 billion, or 24.1%, to $5.69 billion at September 30, 2020 from $4.58 billion at December 31, 2019 due primarily to increases in noninterest bearing demand deposits of $542.7 million, or 37.5%, to $1.99 billion, money market accounts of $326.1 million, or 43.3%, to $1.08 billion, and interest bearing demand deposits of $303.8 million, or 22.5%, to $1.65 billion, offset partially by a decrease in certificate of deposit accounts of $80.5 million, or 15.4%, to $444.0 million. The increase in total deposits was due primarily to proceeds from SBA PPP loans deposited directly into customer deposit accounts and an increase in customer deposits due to changes in customer spending habits due to the COVID-19 pandemic. Non-maturity deposits as a percentage of total deposits increased to 92.2% as of September 30, 2020 from 88.6% at December 31, 2019."Deposit Activities Overview" section below.

Lending Activities Overview

Changes by loan type

The Bank is a ~~full service~~full-service commercial bank, which originates a wide variety of loans with a focus on commercial business loans. Loans ~~receivable~~receivable increased ~~$898.9 million, or 23.9%,~~compared to ~~$4.67 billion at September 30, 2020 from $3.77 billion at~~ December 31, ~~2019.~~2020 due primarily to an increase in SBA PPP loans as the Bank originated PPP2 loans, offset partially by a decrease in PPP1 loans as a result of principal forgiveness payments received from the SBA. The increase in loans receivable was offset partially by a decrease in the utilization of commercial and industrial lines of credit and a decrease in consumer loans from continued runoff of the indirect auto loan portfolio following the cessation of this business line during the quarter ended March 31, 2020.

The following table provides ~~information about our~~a comparison of the changes in the Company's loan portfolio by type of loan ~~at the dates indicated and the change between these dates. These balances are net of deferred fees, costs, and are prior~~from December 31, 2020 to ~~deduction for the ACL on loans.~~March 31, 2021:

September 30, 2020 December 31, 2019
Balance (1)
% of Total (2)
Balance (1)
% of Total (2)
Change % of Balance Change
(Dollars in thousands)
Commercial business:
Commercial and industrial $ 750,557 16.1 % $ 852,220 22.6 % $ (101,663) (11.9) %
SBA PPP 867,782 18.6 — — 867,782 100.0
Owner-occupied CRE 859,338 18.4 805,234 21.4 54,104 6.7
Non-owner occupied CRE 1,384,973 29.7 1,288,779 34.2 96,194 7.5
Total commercial business 3,862,650 82.8 2,946,233 78.2 916,417 31.1
One-to-four family residential (3)
131,921 2.8 131,660 3.5 261 0.2

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		September 30, 2020				December 31, 2019									March 31, 2021				December 31, 2020
		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		Percentage Change
		(Dollars in thousands)													(Dollars in thousands)
Commercial business:														Commercial business:
Commercial and industrial														Commercial and industrial	$	693,539	15.1	%	$	733,098	16.4	%	$	(39,559)	(5.4)	%
SBA PPP														SBA PPP	886,761		19.3		715,121		16.0		171,640		24.0
Owner-occupied CRE														Owner-occupied CRE	881,168		19.2		856,684		19.2		24,484		2.9
Non-owner occupied CRE														Non-owner occupied CRE	1,427,953		31.1		1,410,303		31.5		17,650		1.3
Total commercial business														Total commercial business	3,889,421		84.7		3,715,206		83.1		174,215		4.7
Residential real estate (3)														Residential real estate (3)	114,856		2.5		122,756		2.7		(7,900)		(6.4)
Real estate construction and land development:	Real estate construction and land development:													Real estate construction and land development:
One-to-four family residential		99,650		2.1		104,296		2.8		(4,646)		(4.5)
Five or more family residential and commercial properties		215,472		4.6		170,350		4.5		45,122		26.5
Residential														Residential	79,878		1.7		78,259		1.8		1,619		2.1
Commercial and multifamily														Commercial and multifamily	217,815		4.7		227,454		5.1		(9,639)		(4.2)
Total real estate construction and land development	Total real estate construction and land development	315,122		6.7		274,646		7.3		40,476		14.7		Total real estate construction and land development	297,693		6.4		305,713		6.9		(8,020)		(2.6)
Consumer	Consumer	357,037		7.7		415,340		11.0		(58,303)		(14.0)		Consumer	293,899		6.4		324,972		7.3		(31,073)		(9.6)
Loans receivable		$	4,666,730	100.0	%	$	3,767,879	100.0	%	$	898,851	23.9	%
Total														Total	$	4,595,869	100.0	%	$	4,468,647	100.0	%	$	127,222	2.8	%

(1) Balances do not include unfunded loan commitments.

(2) Percent of loans receivable.

(3) Excludes loans held for sale of $~~8.3~~6.8 million and ~~$5.5~~$4.9 million at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, respectively.

Included in the amortized cost of loans are net discounts on loans purchased in mergers and acquisitions. Upon CECL Adoption, 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 $7.4 million at~~ ~~September 30, 2020 compared to $8.4 million at December 31, 2019.~~

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COVID Modifications

The Company continues to accommodate a variety of loan modifications under the CARES Act, CA Act and related regulatory guidance as a direct result of COVID-19 pandemic issues impacting these borrowers. At March 31, 2021, approximately 67 loans totaling $46.7 million were in payment deferral modification status compared to 177 loans totaling $92.5 million at December 31, 2020.

SBA Paycheck Protection Program

On April 6, 2020, the Bank began to offer SBA PPP1 loans to its existing and new customers as a result of provisions in the CARES Act for customers directly impacted by the COVID-19 pandemic. The Bank earns 1% interest on these loans as well as a fee from the SBA to cover processing costs, which is amortized over the life of the loan. The Bank began processing loan forgiveness applications and receiving SBA PPP1 loan forgiveness payments during the three months ended December 31, 2020.

The CA Act extended the SBA's PPP with a second tranche of funding beginning in 2021 and effective until May 31, 2021. As a result, the Bank began originating SBA PPP2 loans starting in January 2021.

The following are key statistics from inception of the SBA's PPP through March 31, 2021:


	As of March 31, 2021
	PPP1		PPP2		Total PPP
	(Dollars in thousands)
Number of funded loans	4,642		2,235		6,877
Total amount funded	$	897,353	$	353,491	$	1,250,844
Average funded loan size	$	193	$	158	$	182
Net fees deferred at funding	$	28,805	$	14,627	$	43,432

The following table summarizes the activity for both tranches of the SBA's PPP as of and for the period indicated:


	As of or for the Three Months Ended
	March 31, 2021
	PPP1		PPP2		Total PPP
	(In thousands)
Net deferred fees recognized during the period	$	6,592	$	448	$	7,040
Net deferred fees unrecognized as of period end	8,814		14,165		22,979
Principal payments received during the period, including forgiveness payments from the SBA	174,264		—		174,264
Principal balance remaining as of period end	556,249		353,491		909,740
Amortized cost as of period end	547,435		339,326		886,761

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:~~dates indicated:

September 30,
2020 December 31, 2019
(Dollars in thousands)
Nonaccrual loans:
Commercial business $ 50,930 $ 44,320
One-to-four family residential 157 19
Real estate construction and land development 1,439 —
Consumer 78 186
Total nonaccrual loans (1)
52,604 44,525
Other real estate owned — 841
Total nonperforming assets $ 52,604 $ 45,366
ACL on loans $ 73,340 $ 36,171
Nonperforming loans to loans receivable 1.13 % 1.18 %
ACL on loans to loans receivable 1.57 0.96
ACL on loans to loans receivable, excluding SBA PPP loans (2)
1.93 0.96
ACL on loans to nonperforming loans 139.42 81.24
Nonperforming assets to total assets 0.79 % 0.82 %
Performing TDR loans:
Commercial business $ 17,179 $ 13,661
One-to-four family residential 190 196
Real estate construction and land development 1,812 237
Consumer 434 375
Total performing TDR loans $ 19,615 $ 14,469
Accruing loans past due 90 days or more $ — $ —
Potential problem loans 159,764 87,788

~~(1)At September 30, 2020 and December 31, 2019,~~ ~~$20.5 million~~ ~~and $26.3 million of nonaccrual loans were considered nonperforming TDR loans, respectively.~~

~~(2)~~ ~~See "Non-GAAP Financial Measures" section.~~

~~Nonaccrual Loans. Nona~~ccrual loans increased $8.1 million to $52.6 million, or 1.13% of loans receivable at September 30, 2020 from $44.5 million, or 1.18% of loans receivable at December 31, 2019. The increase was due primarily to the addition of ~~$19.6 million of loans that were previously modified under the CARES Act and related regulatory guidance and exhibited a contin~~ued decline in credit quality, warranting transfer to nonaccrual status. Within these additions were three commercial lending relationships totaling $17.4 million, including a parking facility, a hotel, and a group of restaurants under common ownership. The Bank is actively working with the borrowers to secure a positive resolution. These additions to nonaccrual loans were offset partially by a principal payment on a significant agricultural lending relationship of $7.8 million and the full payoff of a commercial business relationship of $2.3 million.


	March 31, 2021		December 31, 2020
	(Dollars in thousands)
Nonaccrual loans:
Commercial business	$	51,755	$	56,786
Residential real estate	66		184
Real estate construction and land development	1,021		1,022
Consumer	26		100
Total nonaccrual loans	52,868		58,092
Other real estate owned	—		—
Total nonperforming assets	$	52,868	$	58,092

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	March 31, 2021			December 31, 2020
	(Dollars in thousands)
ACL on loans	$	64,225		$	70,185
Nonperforming loans to loans receivable	1.15		%	1.30		%
ACL on loans to loans receivable	1.40			1.57
ACL on loans to loans receivable, excluding SBA PPP loans (1)	1.73			1.87
ACL on loans to nonperforming loans	121.48			120.82
Nonperforming assets to total assets	0.75		%	0.88		%

Performing TDR loans:
Commercial business	$	54,075		$	49,403
Residential real estate	365			188
Real estate construction and land development	—			1,926
Consumer	1,251			1,355
Total performing TDR loans	$	55,691		$	52,872

Accruing loans past due 90 days or more	$	—		$	—
Potential problem loans (2)	$	163,813		$	182,342

(1) See "Non-GAAP Financial Measures" section.

(2) Potential problem loans are risk rated SM or worse that are not classified as a performing TDR or nonaccrual loan and are not 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.

Nonaccrual Loans

Nonaccrual loans decreased $5.2 million to 1.15% of loans receivable at March 31, 2021 from 1.30% of loans receivable at December 31, 2020 primarily due to a decline in nonaccrual commercial business loans.

The following table reflects the changes in nonaccrual loans during the ~~nine months ended September 30, 2020 and 2019:~~periods indicated:


		Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019			2021		2020
		(In thousands)					(In thousands)
Nonaccrual loans	Nonaccrual loans					Nonaccrual loans
Balance, beginning of period	Balance, beginning of period	$	44,525	$	13,696	Balance, beginning of period	$	58,092	$	44,525
Addition of previously classified pass graded loans	Addition of previously classified pass graded loans	18,132		3,856		Addition of previously classified pass graded loans	24		255
Addition of previously classified potential problem loans		6,547		21,989
Addition of previously classified performing TDR loans and potential problem loans						Addition of previously classified performing TDR loans and potential problem loans	444		2,579

Addition of previously classified TDR loans		—		7,048
Net principal payments and transfer to accruing status		(15,228)		(4,393)

Net principal payments and transfers to accruing status						Net principal payments and transfers to accruing status	(5,690)		(12,300)
Charge-offs	Charge-offs	(1,102)		(699)		Charge-offs	(2)		(626)
Transfer to OREO	Transfer to OREO	(270)				Transfer to OREO	—		(270)
Balance, end of period	Balance, end of period	$	52,604	$	41,497	Balance, end of period	$	52,868	$	34,163

Nonperforming Assets

At September 30, 2020, nonaccrual loans of $20.9 million had a related ACL on loans of $6.4 million and nonaccrual loans of $31.7 million had no related ACL on loans. At December 31, 2019, nonaccrual loans of $4.4 million had a related allowance for loan losses of $763,000 and nonaccrual loans of $40.1 million had no allowance for loan losses.

~~Nonperforming Assets~~. Nonperforming assets consist of nonaccrual loans and other real estate owned. Nonperforming assets ~~increased $7.2 million to $52.6~~decreased $5.2 million, or ~~0.79%~~0.75% of total assets, at ~~September 30, 2020~~March 31, 2021 from ~~$45.4~~$58.1 million, or ~~0.82%~~0.88% of total assets, at December 31, ~~2019~~2020 due to the ~~increase~~decrease in nonaccrual loans discussed ~~above~~above. Nonperforming assets consisted only of nonaccrual loans at March 31, 2021 and ~~the decrease in other real estate owned resulting from the disposition of the two remaining properties at~~ December 31, ~~2019 during the nine months ended September 30,~~ 2020.

Troubled Debt Restructured Loans

. Performing TDR loans are TDRs on accrual status. They may be individually or collectively evaluated for ACL based on criteria outlined in our accounting policies. Performing TDR loans are not considered nonperforming assets as they continue to accrue interest despite the ~~restructured~~restructured status. Performing TDR loans increased ~~$5.1~~$2.8 million, or ~~35.6%~~5.3%, ~~to $19.6 million~~ at ~~September 30, 2020 from $14.5 million at~~March 31, 2021 compared to December 31, ~~2019. The increase was due primarily to three commercial business lending relationships totaling $3.6 million and one residential construction relationship~~2020.

Table of $1.5 million which was previously reported as a potential problem loan. The increase in TDR loans for the nine months ended September 30, 2020 was offset partially by loans paid in full totaling $2.6 million.Contents

The following table reflects the changes in performing TDR loans during the ~~nine months ended September 30, 2020 and 2019:~~periods indicated:


		Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019			2021		2020
		(In thousands)					(In thousands)
Performing TDR loans	Performing TDR loans					Performing TDR loans
Balance, beginning of period	Balance, beginning of period	$	14,469	$	22,744	Balance, beginning of period	$	52,872	$	14,469
Addition of previously classified pass graded loans	Addition of previously classified pass graded loans	4,495		2,631		Addition of previously classified pass graded loans	1,031		1,008
Addition of previously classified potential problem loans	Addition of previously classified potential problem loans	3,014		8,347		Addition of previously classified potential problem loans	4,451		2,660
Loans added formerly nonaccrual		281		—
Transfers of loans to nonaccrual status		—		(7,048)
Charge-offs		—		(20)
Addition of previously classified nonaccrual loans						Addition of previously classified nonaccrual loans	994		177

Net principal payments	Net principal payments	(2,644)		(7,234)		Net principal payments	(3,657)		(266)
Balance, end of period	Balance, end of period	$	19,615	$	19,420	Balance, end of period	$	55,691	$	18,048

The ~~related ACL on loans for~~increase in performing TDR loans ~~was $1.5 million~~reflects further migration of COVID Modifications to TDR status. It is the Bank's policy to classify COVID Modifications where the payment deferral period exceeded 180-days as ~~of September 30, 2020 and $1.3 million as of December 31, 2019.~~a TDR.

~~Table of Contents~~

Potential Problem Loans

Potential ~~Problem Loans~~problem loa~~. Potential problem loans~~ ns are loans ~~risk rated special mention~~classified as SM or worse that are not classified as a TDR or nonaccrual loan and are not 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 increased $72.0~~This classification of loans decreased $18.5 million, or ~~82.0%~~10.2%, ~~to $159.8 million at September 30, 2020~~ compared to ~~$87.8 million at~~ December 31, ~~2019 primarily~~ attributed to risk classification downgrades related to COVID-19. Included in the balance of potential problem loans at September 30, 2020 are $71.4 million of loans that were modified under the CARES Act, including $20.3 million in active payment modification deferral status at September 30, 2020, and $35.4 million that were downgraded due to COVID-19. Loans with COVID-19 issues were classified as potential problem loans if additional factors were identified to cause a more severe risk grade than watch. At September 30, 2020, loans totaling $102.4 million and $57.3 million were rated special mention and substandard, respectively. The increase in potential problem loans for the nine months ended September 30, 2020 was offset partially by net principal payments of $23.0 million, including payment in full of $11.8 million and by transfers of loans to nonaccrual and TDR status.2020.

The following table reflects the changes in potential problem loans during the ~~nine months ended September 30, 2020 and 2019:~~periods indicated:


		Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019			2021		2020
							(in thousands)
Potential problem loans	Potential problem loans					Potential problem loans
Balance, beginning of period	Balance, beginning of period	$	87,788	$	101,320	Balance, beginning of period	$	182,342	$	87,788
Addition of previously classified pass graded loans	Addition of previously classified pass graded loans	114,119		46,274		Addition of previously classified pass graded loans	6,831		31,180

Addition of previously classified nonaccrual loans						Addition of previously classified nonaccrual loans	1,138		—
Upgrades to pass graded loan status	Upgrades to pass graded loan status	(9,540)		(8,816)		Upgrades to pass graded loan status	(2,395)		(476)
Net principal payments	Net principal payments	(23,042)		(22,593)		Net principal payments	(19,208)		(9,824)
Transfers of loans to nonaccrual and TDR status		(9,561)		(30,336)
Charge-offs		—		(510)
Transfers of loans to nonaccrual status						Transfers of loans to nonaccrual status	(444)		(2,579)
Transfers of loans to TDR status						Transfers of loans to TDR status	(4,451)		(2,660)

Balance, end of period	Balance, end of period	$	159,764	$	85,339	Balance, end of period	$	163,813	$	103,429

Analysis of Allowance for Credit Losses on Loans

~~Effective January 1, 2020,~~CECL Adoption, by which the Bank adopted ASU 2016-13. The adoption 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 on the Condensed Consolidated Statements of Income.

~~Management has~~ adopted a historic loss, open pool CECL methodology to calculate the ACL on ~~loans.~~loans, was effective January 1, 2020. 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~~Bank has identified segments of loans with similar risk characteristics that align with its identified loan classes. Nonaccrual loans and certain performing TDR loans are not considered to have similar torisk characteristics as other loans; therefore, they are evaluated for credit loss 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 if applicable, 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, baseline loss rates are separately 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, including prepayment estimates, to determine the baseline loss estimate for each loan. The CECL methodology also 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 reasonable and supportable time frame. The impact of those macroeconomic factors to each segment, positive or negative, using the reasonable and supportable period, are added to the calculated baseline loss ~~rate.~~rate and are used to establish a macroeconomic allowance. After the reasonable and supportable period, the estimated credit losses ~~are reverted~~revert back to historical baseline loss levels under a reversion period on a

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straight-lined, input reversion basis. Management can also consider other qualitative factors to adjust the ACL on loans if internal or external conditions suggest changes to the modeled ACL on loans are appropriate.

~~Table of Contents~~

The following table provides information regarding changes in ~~our~~the ACL on loans ~~and the allowance for loan losses~~ at and for the ~~three and nine months ended September 30, 2020 and 2019, respectively:~~periods indicated:


		Three Months Ended September 30,						Nine Months Ended September 30,							Three Months Ended March 31,
		2020			2019			2020			2019				2021			2020
		(Dollars in thousands)													(Dollars in thousands)
ACL on loans at the beginning of the period	ACL on loans at the beginning of the period	$	71,501		$	36,363		$	36,171		$	35,042		ACL on loans at the beginning of the period	$	70,185		$	36,171
Impact of CECL adoption	Impact of CECL adoption	—			—			1,822			—			Impact of CECL adoption	—			1,822
Adjusted ACL on loans, beginning of the period		71,501			36,363			37,993			35,042

Adjusted ACL on loans, beginning of period														Adjusted ACL on loans, beginning of period	70,185			37,993
Charge-offs:	Charge-offs:													Charge-offs:
Commercial business	Commercial business	(507)			(306)			(3,553)			(1,183)			Commercial business	(1)			(1,222)
One-to-four family residential		—			(15)			—			(45)

Real estate construction and land development														Real estate construction and land development	(1)			—
Consumer	Consumer	(335)			(501)			(1,141)			(1,653)			Consumer	(185)			(375)
Total charge-offs	Total charge-offs	(842)			(822)			(4,694)			(2,881)			Total charge-offs	(187)			(1,597)
Recoveries:	Recoveries:													Recoveries:
Commercial business	Commercial business	80			381			1,220			602			Commercial business	207			1,069
One-to-four family residential		—			—			3			—
Residential real estate														Residential real estate	—			3
Real estate construction and land development	Real estate construction and land development	139			3			160			628			Real estate construction and land development	16			14
Consumer	Consumer	142			127			433			374			Consumer	139			94
Total recoveries	Total recoveries	361			511			1,816			1,604			Total recoveries	362			1,180
Net charge-offs		(481)			(311)			(2,878)			(1,277)

Provision for credit losses on loans		2,320			466			38,225			2,753

ACL on loans at the end of the period		$	73,340		$	36,518		$	73,340		$	36,518
Net recoveries (charge-offs)														Net recoveries (charge-offs)	175			(417)
(Reversal of) provision for credit losses on loans														(Reversal of) provision for credit losses on loans	(6,135)			9,964
ACL on loans at the end of period														ACL on loans at the end of period	$	64,225		$	47,540

ACL on loans to loans receivable	ACL on loans to loans receivable	1.57		%	0.98		%	1.57		%	0.98		%	ACL on loans to loans receivable	1.40		%	1.23		%
ACL on loans to loans receivable, excluding SBA PPP loans (3)		1.93			0.98			1.93			0.98
Net charge-offs on loans to average loans receivable, net (1)		0.04		%	0.03		%	0.09		%	0.05		%
ACL on loans to loans receivable, excluding SBA PPP loans (1)														ACL on loans to loans receivable, excluding SBA PPP loans (1)	1.73			1.23
Net recoveries (charge-offs) on loans to average loans receivable, net (2)														Net recoveries (charge-offs) on loans to average loans receivable, net (2)	0.02		%	(0.04)		%

Loans receivable at the end of the period (2)		$	4,666,730		$	3,731,343		$	4,666,730		$	3,731,343
Loans receivable at the end of the period (3)														Loans receivable at the end of the period (3)	$	4,595,869		$	3,852,376
Average loans receivable, net during the period	Average loans receivable, net during the period	4,605,389			3,677,405			4,266,598			3,651,659			Average loans receivable, net during the period	4,490,499			3,748,573

(1) See "Reconciliations of Non-GAAP Measures" herein.

(2) Annualized.

~~(2)~~(3) Excludes loans held for sale.

~~(3)~~ ~~See NonGAAP Financial Measures herein.~~

The ACL on loans ~~increased $37.2~~decreased $6.0 million, or ~~102.8%~~8.5%, to ~~$73.3~~$64.2 million at ~~September 30, 2020~~March 31, 2021 from ~~$36.2~~$70.2 millionat December 31, ~~2019, and increased $35.3 million, or 93.0%, from~~2020. The decrease in the ~~adjusted beginning balance~~ACL on loans was due primarily to a reversal of ~~$38.0 million. The increase in ACL was primarily the result of the~~ provision for credit losses on loans of ~~$38.2~~$6.1 million ~~recognized~~ recorded during the ~~nine~~three months ended ~~September 30, 2020 due primarily to forecasted credit deterioration reflecting~~March 31, 2021 following improvements in the economic ~~conditions as a result of the COVID-19 pandemic.~~

~~The macroeconomic~~ forecast used in the CECL model at March 31, 2021 as ~~of January 1, 2020 predicted continued economic expansion with steady GDP growth of 1.8% and low unemployment rates of 3.5% in 2020, among other factors. The onset of~~compared to the ~~COVID-19 pandemic resulted in identification of an economic recession during the second quarter of 2020. The macroeconomic~~ forecast used in the CECL model as of September 30, 2020 reflected a slow and long recovery from the COVID-19 recession. The modeled recovery is expected to last through the end of 2021, including a contraction in GDP of 3.7% forat December 31, 2020 and ~~a rebound of 3.7% for 2021, and modest increases in GDP in future years. Unemployment rates are expected to average 8.7% during the remainder of 2020 and gradually reduce to 4.0% by 2025.~~

~~The Company recorded charge-offs of $4.7 million during the nine months ended September 30, 2020 primarily~~secondarily due to ~~one commercial and industrial loan of $1.7 million that had been experiencing financial difficulties.~~

a decrease in total loans receivable, excluding SBA PPP loans. The ACL on loans does not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA.

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~~Due to issues surrounding the control of the underlying loan collateral, the Bank determined it appropriate to charge-off the entire balance and pursue an aggressive collection strategy. C~~harge-offs also included two commercial and industrial loan relationships totaling $447,000 as a result of impacts from the COVID-19 pandemic and small dollar charge-offs on a large volume of consumer loans of $1.1 million. The Company recorded recoveries of $1.8 million during the nine months ended September 30, 2020 primarily due to the full recovery of an agricultural lending relationship of $963,000 which was charged-off during the three months ended December 31, 2019 ~~and small dollar recoveries on a large volume of consumer loans of $433,000.~~

Based on the Bank's established comprehensive CECL methodology, management deemed the ACL on loans ~~of $73.3 million (1.57%~~at March 31, 2021 equal to 1.40% of loans receivable and ~~139.42%~~121.48% of nonperforming ~~loans) at September 30, 2020~~loans is appropriate to provide for current expected cr~~edit~~credit losses in the loan portfolio. ~~This compares to an allowance for loan losses of $36.2 million (0.96%~~The ACL on loans was 1.57% of loans receivable and ~~81.24%~~120.82% of nonperforming ~~loans)~~loans at December 31, ~~2019 under the incurred loss methodology.~~2020.

While we believe we ~~use~~used the best information available to determine the 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 ACL on loans and may adversely affect the Company’s financial condition and results of operations. In addition, the determination of the amount of the ACL 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 ACL 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 ACL on loans is appropriate or that increased provisions will not be necessary should the quality of the loans deteriorate. Any material increase in the ACL on loans ~~would~~could adversely affect the Company’s financial condition and results of operations.

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Deposits and Other Borrowings

Total deposits increased $1.11 billion, or 24.1%, to $5.69 billion at September 30, 2020 from $4.58 billion at December 31, 2019. Non-maturity deposits as a percentage of total deposits increased 3.6% to 92.2% at September 30, 2020 compared to 88.6% at December 31, 2019. Overview

The following table summarizes the Company's deposits ~~as of September 30, 2020 and December 31, 2019:~~at the dates indicated:


		September 30, 2020				December 31, 2019									March 31, 2021				December 31, 2020
		Balance		% of Total		Balance		% of Total		Change		% of Balance Change			Balance		% of Total		Balance		% of Total		Change		Percentage Change
		(Dollars in thousands)													(Dollars in thousands)
Noninterest demand deposits	Noninterest demand deposits	$	1,989,247	35.0	%	$	1,446,502	31.6	%	$	542,745	37.5	%	Noninterest demand deposits	$	2,205,562	36.6	%	$	1,980,531	35.4	%	$	225,031	11.4	%
Interest bearing demand deposits	Interest bearing demand deposits	1,652,661		29.0		1,348,817		29.4		303,844		22.5		Interest bearing demand deposits	1,796,949		29.9		1,716,123		30.7		80,826		4.7
Money market accounts	Money market accounts	1,079,814		19.0		753,684		16.4		326,130		43.3		Money market accounts	1,046,202		17.4		962,983		17.2		83,219		8.6
Savings accounts	Savings accounts	523,286		9.2		509,095		11.2		14,191		2.8		Savings accounts	584,582		9.7		538,819		9.6		45,763		8.5
Total non-maturity deposits	Total non-maturity deposits	5,245,008		92.2		4,058,098		88.6		1,186,910		29.2		Total non-maturity deposits	5,633,295		93.6		5,198,456		92.9		434,839		8.4
Certificates of deposit	Certificates of deposit	444,040		7.8		524,578		11.4		(80,538)		(15.4)		Certificates of deposit	386,403		6.4		399,534		7.1		(13,131)		(3.3)
Total deposits	Total deposits	$	5,689,048	100.0	%	$	4,582,676	100.0	%	$	1,106,372	24.1	%	Total deposits	$	6,019,698	100.0	%	$	5,597,990	100.0	%	$	421,708	7.5	%

The increase in deposits is primarily due to the proceeds from SBA PPP loans originated during the three months ended March 31, 2021 which were deposited directly into the customers' deposit ~~accounts, an increase in customer deposit accounts based on changes in spending habits during the COVID-19 pandemic, and an increase in new deposit~~ accounts. ~~At September 30, 2020, the Bank had approximately 553 deposit accounts with balances of approximately $82.9 million related~~

In addition to ~~new customers that received a SBA PPP loan from the Bank.~~

~~Borrowings~~deposits, 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).~~funds. 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,~~ which are secured by available for sale investment ~~securities. During the latter part of 2019, the Bank made an effort~~securities, as a supplement to ~~transition customers from securities sold under agreement to repurchase to other deposit products.~~its funding sources. As of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, only three customers utilized this product with total balances ~~$29.0~~of $36.5 million at

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~~September 30, 2020, an increase of $8.9~~and $35.7 million, ~~or 44.0%, from $20.2 million at December 31, 2019 due primarily to customer activity during the period.~~respectively.

The Company also has junior subordinated debentures with a par value of $25.0 million which pay quarterly interest based on the three-month LIBOR plus 1.56%~~. The debentures~~ and mature in 2037. The balance of the junior subordinated debentures was ~~$20.8~~$21.0 million at ~~September 30, 2020,~~March 31, 2021, which reflects the fair value of the junior subordinated debentures established as part of the merger with Washington Banking Company on May 1, 2014, adjusted for the accretion of discount from purchase accounting fair value adjustment.

~~At September 30, 2020,~~Additionally, the Bank maintained credit facilities with the FHLB for ~~$891.7~~$926.3 million and credit facilities with the Federal Reserve Bank for ~~$55.0 million. The Company had~~$48.9 million at March 31, 2021 with no borrowings outstanding at both March 31, 2021 and December 31, 2020. There were no FHLB or Federal Reserve Bank advances outstanding ~~at both September 30, 2020 and December~~during the three months ended March 31, ~~2019.~~2021. The average balance of FHLB advances was $989,000 during the three months ended March 31, 2020.

The Bank also maintains lines of credit with five correspondent banks to purchase federal funds totaling $215.0 million as of ~~September 30, 2020.~~March 31, 2021. There were no federal funds purchased as of ~~September 30, 2020 or~~March 31, 2021 and December 31, ~~2019.~~2020 and the lines were not utilized during the three months ended March 31, 2021 and 2020.

The Bank was approved to utilize the PPPLF with the Federal Reserve Bank for $909.7 million, which is the principal balance of SBA PPP loans outstanding at ~~September 30, 2020; however,~~March 31, 2021. There were no PPPLF advances outstanding as of both March 31, 2021 and December 31, 2020.

Our strategy has been to acquire non-maturity deposits from our retail customers, acquire noninterest bearing demand deposits from our commercial customers, and use our available borrowing capacity to fund growth in assets. We anticipate that we will continue to rely on the ~~Bank has chosen not~~same sources of funds in the future and use those funds primarily to ~~participate during the nine months ended September 30, 2020.~~originate loans and purchase investment securities.

Liquidity and Cash Flows

Our primary sources of funds are customer and local government ~~deposits;~~deposits, loan principal and interest ~~payments; maturities, calls,~~payments, loan sales and payments of ~~investment securities including related~~ interest ~~earned;~~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 ~~and investments~~ are a predictable ~~sources~~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 and ~~investments,~~investment securities, the Bank can utilize established credit facilities and lines with correspondent banks totaling $1.2 billion as discussed above or initiate the sale of investment securities. ~~As a result~~

Table of ~~the Federal Reserve Bank response to the COVID-19 pandemic, the Bank’s liquidity can be supplemented through the PPPLF as mentioned above in the "COVID-19 Impact" section above.~~Contents

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 ~~September 30, 2020,~~March 31, 2021, the Company (on an unconsolidated basis) had cash and cash equivalents of ~~$9.5~~$9.0 million.

We are required to maintain an adequate level of liquidity to ensure the availability of sufficient funds for 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 ~~September 30, 2020,~~March 31, 2021, cash and cash equivalents totaled ~~$576.2~~$934.3 million, or ~~8.6%~~13.3% of total ~~assets and the fair value of investment~~assets. Investment securities available for sale totaled ~~$834.5~~$893.6 million, of which ~~$263.7~~$199.3 million were pledged to secure public deposits, borrowing arrangements or ~~borrowing arrangements.~~securities sold under agreement to repurchase. Management considers unpledged investment securities available for sale to be a variable source of liquidity. The fair value of investment securities available for sale that were ~~not pledged~~unpledged totaled ~~$570.7~~$694.3 million, or ~~8.5%~~9.9% of total assets, at ~~September 30, 2020.~~March 31, 2021. The fair value of investment securities available for sale with ~~contractual~~ maturities of one year or less ~~were $63.7~~totaled $49.3 million, or ~~1.0%~~0.7% of total assets, at ~~September 30, 2020.~~March 31, 2021.

Consolidated Cash Flows: As disclosed in the Condensed Consolidated Statements of Cash Flows, net cash provided by operating activities was ~~$76.6~~$9.1 million for the ~~nine~~three months ended ~~September 30, 2020,~~March 31, 2021, and primarily consisted of net income of ~~$22.7~~$25.3 million, ~~and~~offset partially by non-cash adjustments, ~~to reconcile net income to cash provided by operating activities,~~ including reversal of provision for credit losses of ~~$39.2~~$7.2 million and depreciation, amortization, and accretion of ~~$28.3~~$6.8 million. During the ~~nine~~three months ended ~~September 30, 2020,~~March 31, 2021, net cash used by investing activities was ~~$803.5~~$232.7 million, which consisted primarily of net loan originations of ~~$924.9~~$117.9 million ~~including $897.4~~(including SBA PPP2 originations of $353.5 million ~~related to~~and SBA ~~PPP loan originations, offset partially by~~PPP1 principal reduction of $174.3 million) and net activity in investment securities ~~activity~~available for sale of ~~$135.5 million.~~$102.1 million (including $166.1 million of purchases). Net cash provided by financing activities was ~~$1.07 billion~~$414.7 million for the ~~nine~~three months ended ~~September 30, 2020~~March 31, 2021 and primarily consisted of a net increase in deposits of ~~$1.11 billion~~$421.7 million primarily due to the proceeds from SBA PPP loans deposited directly into the customers' deposit accounts, ~~an increase in customer deposit accounts based~~

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~~on changes in spending habits during the COVID-19 pandemic, and an increase in new deposit accounts~~offset partially ~~offset~~ by dividends paid of ~~$21.7 million and repurchases of common stock of $19.1 million during the period.~~$7.2 million.

Stockholders' Equity and Regulatory Capital Requirements Overview

~~Stockholders’ equity was $803.1 million at September 30, 2020 compared to $809.3 million at December 31, 2019.~~ The Company’s stockholders' equity to assets ratio was ~~12.0% as of September 30, 2020~~11.8% and ~~14.6% as of~~12.4% at March 31, 2021 and December 31, ~~2019.~~2020, respectively. The following table reflects the changes to stockholders' equity during the ~~three and nine months ended September 30, 2020 and 2019:~~periods indicated:


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019		2020		2019			2021		2020
		(In Thousands)									(In thousands)
Balance, beginning of period	Balance, beginning of period	$	793,652	$	796,625	$	809,311	$	760,723	Balance, beginning of period	$	820,439	$	809,311
Cumulative effect from change in accounting policy (1)	Cumulative effect from change in accounting policy (1)	—		—		(5,615)		(399)		Cumulative effect from change in accounting policy (1)	—		(5,615)
Net income	Net income	16,636		17,895		22,688		50,431		Net income	25,344		12,191
Dividends declared	Dividends declared	(7,227)		(7,042)		(21,796)		(20,383)		Dividends declared	(7,258)		(7,343)
Other comprehensive income, net of tax		(773)		2,771		14,830		19,980
Other comprehensive (loss) income, net of tax										Other comprehensive (loss) income, net of tax	(11,557)		7,914
Repurchase of common stock	Repurchase of common stock	(7)		(6,954)		(19,105)		(8,635)		Repurchase of common stock	(687)		(19,060)
Other	Other	848		832		2,816		2,410		Other	870		1,040
Balance, end of period	Balance, end of period	$	803,129	$	804,127	$	803,129	$	804,127	Balance, end of period	$	827,151	$	798,438

(1) Effective January 1, 2020, the Company adopted ASU 2016-13, Financial Instruments - Credit Losses~~. Effective January 1, 2019, the Company adopted ASU 2016-02,~~ ~~Leases~~.

No shares were repurchased under the Company's stock repurchase plans during the three months ended ~~September 30, 2020 as the Company suspended repurchases in response to the COVID-19 pandemic.~~

March 31, 2021. During the ~~nine~~three months ended ~~September 30,~~March 31, 2020, the Company repurchased the remaining 639,922 shares available under the eleventh stock repurchase plan at a weighted average price per share of $23.95 and repurchased 155,778 shares at a weighted average share price of $20.34 under the twelfth stock repurchase plan, ~~which is a total of~~totaling 795,700 shares repurchased under both plans at a weighted average share price of $23.25.

~~During~~ In addition to the ~~three and nine months ended September 30, 2019,~~stock repurchases under a plan, the Company ~~repurchased 264,712~~repurchases shares to pay withholding taxes on the vesting of restricted stock awards and ~~292,712 shares, respectively, available under the eleventh stock repurchase plan at a weighted average price per share of $26.23 and $26.50, respectively.~~units.

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~~Board of ~~directors~~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 ~~October~~April 21, ~~2020,~~2021, the Company’s Board of Directors declared a regular quarterly dividend of $0.20 per common share which is payable on ~~November 18, 2020~~May 19, 2021 to shareholders of record on ~~November 4, 2020~~May 5, 2021.

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	Three Months Ended March 31,
	2021			2020
Dividends paid per common share	$	0.20		$	0.20
Dividend payout ratio (1)	28.6		%	58.8		%

(1). Dividend payout ratio is declared dividends per common share divided by diluted earnings per common share.

The Company is a bank holding company under the supervision of the Federal Reserve Bank. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, 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.~~Condensed Consolidated Financial Statements. Management believes that as of ~~September 30, 2020,~~March 31, 2021, the Company and the Bank ~~meet~~met all capital adequacy requirements to which they are subject.

As of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, the most recent regulatory notifications categorized the Bank as ~~well capitalized~~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

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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 September 30, 2020:
As of March 31, 2021:														As of March 31, 2021:
The Company consolidated	The Company consolidated													The Company consolidated
Common equity Tier 1 capital to risk-weighted assets	Common equity Tier 1 capital to risk-weighted assets	$	207,313	4.5	%	N/A		N/A		$	539,440	11.7	%	Common equity Tier 1 capital to risk-weighted assets	$	202,080	4.5	%	N/A		N/A		$	572,953	12.8	%
Tier 1 leverage capital to average assets	Tier 1 leverage capital to average assets	253,978		4.0		N/A		N/A		560,254		8.8		Tier 1 leverage capital to average assets	261,184		4.0		N/A		N/A		593,913		9.1
Tier 1 capital to risk-weighted assets	Tier 1 capital to risk-weighted assets	276,418		6.0		N/A		N/A		560,254		12.2		Tier 1 capital to risk-weighted assets	269,440		6.0		N/A		N/A		593,913		13.2
Total capital to risk-weighted assets	Total capital to risk-weighted assets	368,557		8.0		N/A		N/A		617,914		13.4		Total capital to risk-weighted assets	359,253		8.0		N/A		N/A		649,967		14.5
Heritage Bank	Heritage Bank													Heritage Bank
Common equity Tier 1 capital to risk-weighted assets	Common equity Tier 1 capital to risk-weighted assets	207,134		4.5		$	299,194	6.5	%	547,979		11.9		Common equity Tier 1 capital to risk-weighted assets	201,833		4.5		$	291,537	6.5	%	581,240		13.0
Tier 1 leverage capital to average assets	Tier 1 leverage capital to average assets	253,826		4.0		317,282		5.0		547,979		8.6		Tier 1 leverage capital to average assets	260,991		4.0		326,239		5.0		581,240		8.9
Tier 1 capital to risk-weighted assets	Tier 1 capital to risk-weighted assets	276,179		6.0		368,238		8.0		547,979		11.9		Tier 1 capital to risk-weighted assets	269,111		6.0		358,815		8.0		581,240		13.0
Total capital to risk-weighted assets	Total capital to risk-weighted assets	$	368,238	8.0	%	$	460,298	10.0	%	$	605,609	13.2	%	Total capital to risk-weighted assets	358,815		8.0		448,518		10.0		636,951		14.2

As of December 31, 2019:
As of December 31, 2020:														As of December 31, 2020:
The Company consolidated	The Company consolidated													The Company consolidated
Common equity Tier 1 capital to risk-weighted assets	Common equity Tier 1 capital to risk-weighted assets	$	211,110	4.5	%	N/A		N/A		$	541,154	11.5	%	Common equity Tier 1 capital to risk-weighted assets	$	203,314	4.5	%	N/A		N/A		$	555,644	12.3	%
Tier 1 leverage capital to average assets	Tier 1 leverage capital to average assets	212,578		4.0		N/A		N/A		561,749		10.6		Tier 1 leverage capital to average assets	256,216		4.0		N/A		N/A		576,531		9.0
Tier 1 capital to risk-weighted assets	Tier 1 capital to risk-weighted assets	281,479		6.0		N/A		N/A		561,749		12.0		Tier 1 capital to risk-weighted assets	271,086		6.0		N/A		N/A		576,531		12.8
Total capital to risk-weighted assets	Total capital to risk-weighted assets	375,306		8.0		N/A		N/A		598,226		12.8		Total capital to risk-weighted assets	361,448		8.0		N/A		N/A		633,061		14.0
Heritage Bank	Heritage Bank													Heritage Bank
Common equity Tier 1 capital to risk-weighted assets	Common equity Tier 1 capital to risk-weighted assets	211,017		4.5		$	304,803	6.5	%	538,560		11.5		Common equity Tier 1 capital to risk-weighted assets	203,112		4.5		$	293,383	6.5	%	563,630		12.5
Tier 1 leverage capital to average assets	Tier 1 leverage capital to average assets	211,187		4.0		263,984		5.0		538,560		10.2		Tier 1 leverage capital to average assets	256,051		4.0		320,064		5.0		563,630		8.8
Tier 1 capital to risk-weighted assets	Tier 1 capital to risk-weighted assets	281,356		6.0		375,142		8.0		538,560		11.5		Tier 1 capital to risk-weighted assets	270,815		6.0		361,087		8.0		563,630		12.5
Total capital to risk-weighted assets	Total capital to risk-weighted assets	$	375,142	8.0	%	$	468,927	10.0	%	$	575,037	12.3	%	Total capital to risk-weighted assets	361,087		8.0		451,359		10.0		620,124		13.7

As of ~~September 30,~~both March 31, 2021 and December 31, 2020, the capital measures reflect the revised CECL capital transition provisions adopted by the Federal Reserve and the FDIC that ~~allows us~~allow the Bank 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

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repurchases and discretionary bonuses to executive officers. At ~~September 30, 2020,~~March 31, 2021, the capital conservation buffer was ~~5.4%~~6.5% and ~~5.2%~~6.2% for the Company and the Bank, respectively.

Reconciliations of Non-GAAP ~~Financial~~ Measures

This ~~report~~Form 10-Q contains certain financial ~~information determined by methods other than~~measures not presented in accordance with ~~accounting principles generally accepted~~GAAP in addition to financial measures presented in accordance with GAAP. The Company has presented these non-GAAP financial measures in this Form 10-Q because it believes that they provide useful and comparative information to assess trends in the ~~United States~~Company’s capital reflected in the current quarter and comparable period results and facilitate comparison of ~~America.~~its performance with the performance of its peers. These non-GAAP measures ~~include net interest income, interest~~have inherent limitations, are not required to be uniformly applied and ~~fees on loans, ACL,~~are not audited. They should not be considered in isolation or as a substitute for financial measures presented in accordance with GAAP. These non-GAAP measures may not be comparable to similarly titled measures reported by other companies. Reconciliations of the GAAP and non-GAAP financial measures are presented below.

The Company believes presenting loan yield ~~and net interest margin~~ excluding the effect of ~~the incremental~~discount accretion on purchased loans acquired through mergers and income from SBA PPP loans. 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

~~Table of Contents~~

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. ~~Management believes that~~Similarly, presenting loan yield ~~and net interest margin~~ excluding the effect of ~~the~~ SBA PPP loans is useful in assessing the impact of these special program loans that are anticipated to substantially decrease upon forgiveness by the SBA within a short time frame. ~~These disclosures should not be viewed as substitutes for~~


	Three Months Ended March 31,
	2021			2020
	(Dollars in thousands)
Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, annualized:
Interest and fees on loans (GAAP)	$	49,524		$	46,277
Exclude SBA PPP loan interest and fees	(9,136)			—
Exclude incremental accretion on purchased loans	(1,075)			(1,012)
Adjusted interest and fees on loans (non-GAAP)	$	39,313		$	45,265

Average loans receivable, net (GAAP)	$	4,490,499		$	3,748,573
Exclude average SBA PPP loans	(832,148)			—
Adjusted average loans receivable, net (non-GAAP)	$	3,658,351		$	3,748,573

Loan yield, annualized (GAAP)	4.47		%	4.97		%
Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, annualized (non-GAAP)	4.36		%	4.86		%

The Company considers presenting the ~~results determined~~ratio of ACL on loans to loans receivable, excluding SBA PPP loans, to be a useful measurement in ~~accordance with GAAP, nor~~evaluating the adequacy of the Company's ACL on loans as the balance of SBA PPP loans is significant to the loan portfolio, and since SBA PPP loans are ~~they necessarily comparable to non-GAAP performance measures~~guaranteed by the SBA, the Company has not provided an ACL on loans for SBA PPP loans.


	March 31, 2021			December 31, 2020
	(Dollars in thousands)
ACL on loans to loans receivable, excluding SBA PPP loans:
Allowance for credit losses on loans (GAAP)	$	64,225		$	70,185

Loans receivable (GAAP)	$	4,595,869		$	4,468,647
Exclude SBA PPP loans	886,761			715,121
Loans receivable, excluding SBA PPP (non-GAAP)	$	3,709,108		$	3,753,526

ACL on loans to loans receivable (GAAP)	1.40		%	1.57		%
ACL on loans to loans receivable, excluding SBA PPP loans (non-GAAP)	1.73		%	1.87		%

The Company believes that presenting pre-tax pre-provision income, which reflects its profitability before income taxes and provision for credit losses, is a useful measurement in assessing its operating income and expenses by removing the volatility that may be ~~presented by other companies.~~associated with credit loss provisions. The Company also believes that during a crisis such as the

~~Reconciliations of the GAAP and non-GAAP financial measures are presented below for the three and nine months ended September 30, 2020 and 2019:~~

Three Months Ended
September 30, Nine Months Ended
September 30,
2020 2019 2020 2019
(Dollars in thousands)
Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, annualized:
Interest and fees on loans (GAAP) $ 47,647 $ 47,845 $ 142,328 $ 142,651
Exclude SBA PPP loan interest and fees (5,810) — (10,733) —
Exclude incremental accretion on purchased loans (944) (1,090) (2,651) (3,879)
Adjusted interest and fees on loans (non-GAAP) $ 40,893 $ 46,755 $ 128,944 $ 138,772
Average loans receivable, net $ 4,605,389 $ 3,677,405 $ 4,266,598 $ 3,651,659
Exclude average SBA PPP loans (863,127) — (511,461) —
Adjusted average loans receivable, net (non-GAAP) $ 3,742,262 $ 3,677,405 $ 3,755,137 $ 3,651,659
Loan yield, annualized (GAAP) 4.12 % 5.16 % 4.46 % 5.22 %
Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans, annualized (non-GAAP) 4.35 % 5.04 % 4.59 % 5.08 %

September 30,
2020 December 31,
2019
(Dollars in thousands)
ACL on loans to loans receivable, excluding SBA PPP loans
Allowance for credit losses on loans $ (73,340) $ (36,171)
Loans receivable (GAAP) $ 4,666,730 $ 3,767,879
Exclude SBA PPP loans 867,782 —
Loans receivable, excluding SBA PPP (non-GAAP) $ 3,798,948 $ 3,767,879
ACL on loans to Loans receivable (GAAP) 1.57 % 0.96 %
ACL on loans to Loans receivable, excluding SBA PPP loans (non-GAAP) 1.93 % 0.96 %
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COVID-19 pandemic, this information is useful as the impact of the pandemic on credit loss provisions of various institutions will likely vary based on the geography of the communities served by a particular institution and the decision to adopt or defer CECL.


	Three Months Ended March 31,
	2021		2020
	(Dollars in thousands)
Pre-tax, Pre-provision Income:
Net income (GAAP)	$	25,344	$	12,191
Exclude income tax expense	5,102		640
Exclude (reversal of) provision for credit losses	(7,199)		7,946
Pre-tax, pre-provision income (non-GAAP)	$	23,247	$	20,777

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.

~~Table of Contents~~

As In our opinion, there has not been a ~~result of the COVID-19 pandemic,~~material change in our interest rate risk exposure ~~has changed~~ since the information disclosed in our ~~2019~~2020 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:~~

September 30,
2020 December 31,
2019
(Dollars in thousands)
Up 100
Year 1 $ 13,459 $ 8,149
Year 2 26,015 15,572
Up 200
Year 1 26,726 15,933
Year 2 51,418 29,806
Down 100
Year 1 (2,845) (7,415)
Year 2 $ (7,172) $ (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 nine months ended September 30, 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,~~the Company nor the Bank ~~maintain~~maintains a trading account for any class of financial instrument ~~nor do we,~~ or ~~the Bank, engage~~engages in hedging activities or ~~purchase~~purchases high risk derivative instruments. Moreover, neither ~~we,~~the Company nor the Bank ~~are~~is 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~~procedures (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 ~~September 30, 2020~~March 31, 2021 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~~

~~Table of Contents~~

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 ~~September 30, 2020,~~March 31, 2021, 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

Table of Contents

ITEM 1. LEGAL PROCEEDINGS

~~We, and our~~Neither the Company nor the Bank ~~are not~~is 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 ~~2019~~2020 Annual Form ~~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 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. The ultimate impact of the COVID-19 pandemic will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic. Since the termination of the shelter in place orders in our market areas and phased re-opening of business, the Company has taken steps to resume more normal branch activities with specific guidelines in place to ensure the safety of the Company’s customers and personnel. As of September 30, 2020, all of our branch lobbies remain closed since March 2020 with most services processed through the drive-up or by appointment, except three branches located within Island County which are operating with an open lobby.

Although shelter in place orders have terminated, currently a portion 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

~~Table of Contents~~

values. To date, the COVID-19 pandemic has resulted in declines in loan demand and loan originations other than through government sponsored programs such as the SBA's Payroll Protection Program, 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 the continued low 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.

As of September 30, 2020, we hold and service a portfolio of SBA PPP loans totaling $867.8 million. The SBA PPP loans are subject to the provisions of the CARES Act as well as complex and evolving rules and guidance issued by the SBA and other government agencies.~~We expect that the great majority of our SBA PPP borrowers will seek full or partial forgiveness of their loan obligations.~~We could face additional risks in our administrative capabilities to service our SBA PPP loans, and risk with respect to the determination of loan forgiveness, depending on the final procedures for determining loan forgiveness.

In addition to SBA PPP loans, 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 for 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.

~~Table of Contents~~

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.10-K.

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

(a) Not applicable.

(b) Not applicable.

The following table provides information about repurchases of common stock by the Company ~~has had various~~during the three months ended March 31, 2021:


Period	Total Number of Shares Purchased (1)	Average Price Paid Per Share (1)		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 (2)
January 1, 2021— January 31, 2021	759	$	25.95	8,981,801	1,643,276
February 1, 2021— February 28, 2021	—	—		8,981,801	1,643,276
March 1, 2021— March 31, 2021	22,487	29.66		8,981,801	1,643,276
Total	23,246	$	29.54

(1)Of the common shares repurchased by the Company between January 1, 2021 and March 31, 2021, all of the shares represented the cancellation of stock ~~repurchase programs since March 1999.~~ to pay withholding taxes on vested restricted stock awards or units.

(2)On March 12, 2020 the Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares, or 1,799,054 shares, under the twelfth stock repurchase plan. ~~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.~~

~~No shares were repurchased under the Company's stock repurchase plans during the three months ended September 30, 2020 as the Company suspended repurchases in response to the COVID-19 pandemic.~~

During the nine months ended September 30, 2020, the Company repurchased the remaining 639,922 shares available under the eleventh stock repurchase plan at a weighted average price per share of $23.95 and repurchased 155,778 shares at a weighted average share price of $20.34 under the twelfth stock repurchase plan, which is a total of 795,700 shares under both plans at a weighted average share price of $23.25.

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
September 30, Nine Months Ended
September 30,
2020 2019 2020 2019
Repurchased shares to pay withholding taxes 378 405 28,306 28,434
Stock repurchase to pay withholding taxes average share price $ 19.84 $ 27.67 $ 21.54 $ 30.83

~~The following table sets forth information about the Company’s purchases of its outstanding common stock during the quarter ended September 30, 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
July 1, 2020— July 31, 2020 — $ — 8,981,801 1,643,276
August 1, 2020— August 31, 2020 — — 8,981,801 1,643,276
September 1, 2020— September 30, 2020 378 19.84 8,981,801 1,643,276
Total 378 $ 19.84

~~(1)~~Of the common shares repurchased by the Company between July 1, 2020 and September 30, 2020, all of the shares represented the cancellation of stock to pay withholding taxes on vested restricted stock awards or units.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

~~Table of Contents~~

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

Incorporated by Reference
Exhibit No. Description of Exhibit Form Exhibit Filing Date/Period End Date
3.3.
Amended and Restated Bylaws of the Company
8-K 3.3 06/30/2020
10.37*
Employment Agreement by and between Heritage and Tony Chalfant
8-K 10.1 06/30/2020
10.38*
Deferred Compensation Plan and Participation Agreement by and between Heritage and Tony Chalfant
8-K 10.3 06/30/2020
10.39*
Transitional Retirement Agreement by and between Heritage and David A. Spurling
8-K 10.2 06/30/2020
31.1
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)
31.2
Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)
32.1
Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(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)

Incorporated by Reference

Exhibit No.

Description of Exhibit

Form

Exhibit

Filing Date/Period End Date

10.34*

Form of Split Dollar Agreement, dated May 3, 2021, by and between Heritage and Tony Chalfant(1)

31.1

Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)

31.2

Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)

32.1

Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)

101.INS

XBRL Instance Document (1)

101.SCH

XBRL Taxonomy Extension Schema Document (1)

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document (1)

Table of Contents

101.DEF

XBRL Taxonomy Extension Definition Linkbase Document (1)

101.LAB

XBRL Taxonomy Extension Label Linkbase Document (1)

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document (1)

*Indicates management contract or compensatory plan or ~~arrangement~~arrangement.

(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:
~~November 9, 2020~~May 5, 2021						/S/ JEFFREY J. DEUEL
						Jeffrey J. Deuel
						President and Chief Executive Officer

Date:
~~November 9, 2020~~May 5, 2021						/S/ DONALD J. HINSON
						Donald J. Hinson
						Executive Vice President and Chief Financial Officer

7951


	Three Months Ended September 30, 2019
	Number of common shares	Common stock		Retained earnings		Accumulated other comprehensive income, net		Total stockholders’ equity
Balance at June 30, 2019	36,883	$	591,703	$	195,168	$	9,754	$	796,625

Restricted stock units vested, net of forfeitures of restricted stock awards	1	—		—		—		0
Exercise of stock options	1	2		—		—		2
Stock-based compensation expense	—	830		—		—		830
Common stock repurchased	(267)	(6,954)		—		—		(6,954)
Net income	—	—		17,895		—		17,895
Other comprehensive income, net of tax	—	—		—		2,771		2,771

Cash dividends declared on common stock ($0.19 per share)	—	—		(7,042)		—		(7,042)
Balance at September 30, 2019	36,618	$	585,581	$	206,021	$	12,525	$	804,127


	Nine Months Ended September 30, 2019
	Number of common shares	Common stock		Retained earnings		Accumulated other comprehensive (loss) income, net		Total stockholders’ equity
Balance at December 31, 2018	36,874	$	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 awards	63	—		—		—		0
Exercise of stock options	4	44		—		—		44
Stock-based compensation expense	—	2,366		—		—		2,366
Common stock repurchased	(323)	(8,635)		—		—		(8,635)
Net income	—	—		50,431		—		50,431
Other comprehensive income, net of tax	—	—		—		19,980		19,980

Cash dividends declared on common stock ($0.55 per share)	—	—		(20,383)		—		(20,383)
Balance at September 30, 2019	36,618	$	585,581	$	206,021	$	12,525	$	804,127


	Nine Months Ended September 30, 2020				Nine months ended September 30, 2019
	Interest Income Reversed		Interest Income Recognized		Interest Income Reversed		Interest Income Recognized
	(in thousands)
Commercial business:
Commercial and industrial	$	(75)	$	419	$	(394)	$	97
Owner-occupied CRE	(219)		89		0		228
Non-owner occupied CRE	(102)		67		(32)		181
Total commercial business	(396)		575		(426)		506
One-to-four family residential	(1)		2		0		0
Real estate construction and land development:
One-to-four family residential	0		0		(3)		33
Five or more family residential and commercial properties	(11)		0		0		0
Total real estate construction and land development	(11)		0		(3)		33
Consumer	0		47		0		6
Total	$	(408)	$	624	$	(429)	$	545


	December 31, 2019
	Amortized Cost With No Specific Valuation Allowance		Amortized Cost With Specific Valuation Allowance		Total Amortized Cost		Outstanding 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 CRE	3,921		2,415		6,336		6,764		426
Non-owner occupied CRE	5,309		1,015		6,324		6,458		146
Total commercial business	39,409		17,059		56,468		58,807		1,944
One-to-four family residential	0		215		215		223		56
Real estate construction and land development:
One-to-four family residential	237		0		237		237		0


Consumer	0		561		561		570		143
Total	$	39,646	$	17,835	$	57,481	$	59,837	$	2,143


	September 30, 2020				December 31, 2019
	Performing TDR loans		Nonaccrual TDR loans		Performing TDR loans		Nonaccrual TDR loans
	(In thousands)
TDR loans	$	19,615	$	20,468	$	14,469	$	26,338
ACL on TDR loans	1,536		348		1,259		218


	December 31, 2019
	Outstanding Principal		Amortized Cost
	(In thousands)
Commercial business:
Commercial and industrial	$	4,439	$	2,368
Owner-occupied CRE	4,925		4,914
Non-owner occupied CRE	7,028		5,491
Total commercial business	16,392		12,773
One-to-four family residential	3,095		3,575




Consumer	1,463		1,762
PCI loans	$	20,950	$	18,110


	Loans Individually Evaluated for Impairment		Loans Collectively Evaluated for Impairment		PCI Loans		Total Allowance for Loan Losses
	(In thousands)
Commercial business:
Commercial and industrial	$	1,372	$	9,772	$	595	$	11,739
Owner-occupied CRE	426		3,558		528		4,512
Non-owner occupied CRE	146		7,064		472		7,682
Total commercial business	1,944		20,394		1,595		23,933
One-to-four family residential	56		1,316		86		1,458
Real estate construction and land development:
One-to-four family residential	0		1,296		159		1,455


			Fair Value at September 30, 2020								Net Losses Recorded in Earnings During the Three Months Ended September 30, 2020		Net Losses Recorded in Earnings During the Nine Months Ended September 30, 2020
	Basis(1)		Total		Level 1		Level 2		Level 3
	(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial	$	42	$	27	$	0	$	0	$	27	$	0	$	10









Total assets measured at fair value on a nonrecurring basis	$	42	$	27	$	0	$	0	$	27	$	0	$	10


			Fair Value at December 31, 2019								Net Losses Recorded in Earnings During the Three Months Ended September 30, 2019		Net Losses Recorded in Earnings During the Nine Months Ended September 30, 2019
	Basis(1)		Total		Level 1		Level 2		Level 3
	(In thousands)
Impaired loans:
Commercial business:
Commercial and industrial	$	4,111	$	3,380	$	0	$	0	$	3,380	$	249	$	249









Total assets measured at fair value on a nonrecurring basis	$	4,111	$	3,380	$	0	$	0	$	3,380	$	249	$	249


	Three Months Ended				Nine months ended
	September 30, 2020		September 30, 2019		September 30, 2020		September 30, 2019
	(In thousands)
Balance, beginning of period	$	4,612	$	306	$	306	$	306
Impact of CECL Adoption	0		0		3,702		0
Adjusted balance, beginning of period	4,612		306		4,008		306
Provision for credit losses on unfunded commitments	410		0		1,014		0
Balance, end of period	$	5,022	$	306	$	5,022	$	306


	Interest Only			Payment Deferral			Other			Total
	Amortized Cost		Count	Amortized Cost		Count	Amortized Cost		Count	Amortized Cost		Count
	(Dollars in thousands)
Commercial business:
Commercial and industrial	$	74,561	284	$	41,301	239	$	21,939	48	$	137,801	571

Owner-occupied CRE	116,064		90	82,125		91	1,304		2	199,493		183
Non-owner occupied CRE	130,948		80	75,252		44	22,715		8	228,915		132
Total commercial business	321,573		454	198,678		374	45,958		58	566,209		886
One-to-four family residential	1,704		2	14,905		30	613		3	17,222		35
Real estate construction and land development:
One-to-four family residential	733		1	—		—	6,173		23	6,906		24
Five or more family residential and commercial properties	10,390		10	1,632		6	8,260		8	20,282		24
Total real estate construction and land development	11,123		11	1,632		6	14,433		31	27,188		48
Consumer	606		25	25,596		977	55		1	26,257		1,003
Total	$	335,006	492	$	240,811	1,387	$	61,059	93	$	636,876	1,972


	Pass			Watch			Special Mention			Substandard			Total
	Amortized Cost		Count	Amortized Cost		Count	Amortized Cost		Count	Amortized Cost		Count	Amortized Cost		Count
	(Dollars in thousands)
Commercial business:
Commercial and industrial	$	8,966	58	$	37,349	122	$	34,796	47	$	3,778	20	$	84,889	247

Owner-occupied CRE	32,091		22	24,775		37	15,570		6	13,316		6	85,752		71
Non-owner occupied CRE	26,526		13	71,340		35	12,971		3	25,913		3	136,750		54
Total commercial business	67,583		93	133,464		194	63,337		56	43,007		29	307,391		372
One-to-four family residential	1,114		8	—		—	—		—	—		—	1,114		8
Real estate construction and land development:

Five or more family residential and commercial properties	16,205		5	2,029		3	—		—	450		1	18,684		9


Total	$	84,902	106	$	135,493	197	$	63,337	56	$	43,457	30	$	327,189	389