2013
An nu Al repOrt
Woodinville
13930 ne Mill Place, Suite 112
Woodinville, Wa 98072
56th & South Tacoma Way
5448 South tacoma Way
tacoma, Wa 98409
80th & Pacific
8002 Pacific ave.
tacoma, Wa 98408
88th & South Tacoma Way
8801 South tacoma Way
Lakewood, Wa 98499
CentraL VaLLeY Bank
a DiViSiOn OF Heritage Bank
Downtown Yakima
301 W Yakima ave.
Yakima, Wa 98907
Ellensburg
100 n Main St.
ellensburg, Wa 98926
Nob Hill
3919 W nob Hill Blvd.
Yakima, Wa 98902
Toppenish
537 West 2nd ave.
toppenish, Wa 98948
Union Gap
2205 S First St.
Yakima, Wa 98903
Wapato
507 West 1st St.
Wapato, Wa 98951
WHiDBeY iSLanD Bank
a DiViSiOn OF Heritage Bank
Clinton
8786 Sr 525
Clinton, Wa 98236
Coupeville
401 n Main
Coupeville, Wa 98239
Freeland
5590 S Harbor ave.
Freeland, Wa 98249
Langley
105 1st St., Suite 101
Langley, Wa 98260
Midway–Oak Harbor
675 ne Midway Blvd.
Oak Harbor, Wa 98277
Oak Harbor
450 SW Bayshore Dr.
Oak Harbor, Wa 98277
Dear Fellow Shareholders:
Heritage Financial Corporation, the parent company of Heritage Bank, had a
transformational year. The following accomplishments transpired during 2013:
• Completed the acquisition of Northwest Commercial Bank, adding
$65 million to our company assets.
• Merged the Central Valley Bank charter into the Heritage Bank charter, thus
creating one bank charter— improving the overall efficiency of the company.
• Announced and completed the Valley Bank acquisition, adding $237 million
in assets and four branches in Pierce and South King counties.
• Completed a core system conversion for the entire company, constructing a data processing
platform that allows for greater efficiencies and supports future growth.
• Announced the merger with Washington Banking Company and its subsidiary, Whidbey Island
Bank, resulting in a combined company of approximately $3.4 billion in assets and 67 branches
in Washington and Oregon, doubling our size.
The significant activities over the past year have competitively positioned our company to deliver an
expanded product offering over a substantially increased footprint. These opportunities will allow for
greater organic growth and enhanced profitability starting in 2015.
In October 2013, we announced the merger with Whidbey Island Bank and the transaction received
overwhelming approval from both shareholder groups, resulting in the deal closing on May 1, 2014.
Today we have approximately 800 employees, $3.4 billion in total assets and 67 branches with the
majority of our locations, 61 branches, located on the I-5 corridor from Bellingham, Washington to
Portland, Oregon. The Central Valley Bank region is represented with another six branches in and
near Yakima, Washington.
Additionally, Donald V. Rhodes, our former Heritage Bank CEO and Board Chair, along with
Daryl D. Jensen, our long-time Audit Chair, retired in April 2014. Both Don and Daryl have been integral
members of our Board for more than 25 years. They have given our Board and myself invaluable advice
and service over the years—their guidance and counsel will be missed by all of us. We wish to give
them our sincere thanks for their contribution and best wishes in their retirement endeavors.
We also welcomed seven new directors that formerly served on the Washington Banking Board
which include Anthony B. Pickering, who will serve as Chairman of the Board, Rhoda L. Altom,
Mark D. Crawford, Deborah J. Gavin, Jay T. Lien, Gragg E. Miller and Robert T. Severns. We look
forward to working together as the newly formed 15 member Heritage Financial Corporation Board.
As we look to the remainder of 2014 and into 2015, I remain optimistic about our continued growth
and stronger financial performance. We are privileged to have a strong board, knowledgeable
management team and dedicated staff committed to providing customer satisfaction which will
exceed your expectations.
Sincerely,
Brian L. Vance
President and Chief Executive Officer
Heritage Financial Corporation
2013
F ORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(cid:95) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
OR
(cid:133)
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-29480
HERITAGE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Washington
(State or other jurisdiction of
incorporation or organization)
201 Fifth Avenue SW, Olympia, WA
(Address of principal executive offices)
91-1857900
(I.R.S. Employer
Identification No.)
98501
(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
Common Stock
Name of each exchange on which registered
NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes (cid:133) No (cid:95)
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes (cid:133) No (cid:95)
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 (cid:95) No (cid:133)
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during
the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes (cid:95) No (cid:133)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is
not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (cid:133)
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Large accelerated filer (cid:133) Accelerated filer (cid:95) Non-accelerated filer (cid:133) Smaller reporting company (cid:133)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes (cid:133) No (cid:95)
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was
$208,300,000 and was based upon the last sales price as quoted on the NASDAQ Stock Market for June 30, 2013.
The registrant had 16,216,367 shares of common stock outstanding as of February 25, 2014.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 2014 Annual Meeting of Shareholders will be incorporated by
reference into Part III of this Form 10-K.
HERITAGE FINANCIAL CORPORATION
FORM 10-K
December 31, 2013
TABLE OF CONTENTS
ITEM 1. BUSINESS .............................................................................................................................................
PART I
Page
3
ITEM 1A. RISK FACTORS .....................................................................................................................................
27
ITEM 1B. UNRESOLVED STAFF COMMENTS ....................................................................................................
38
ITEM 2. PROPERTIES ........................................................................................................................................
38
ITEM 3.
LEGAL PROCEEDINGS ........................................................................................................................
38
ITEM 4. MINE SAFETY DISCLOSURES ............................................................................................................
38
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES ............................................................................
39
ITEM 6. SELECTED FINANCIAL DATA ..............................................................................................................
42
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS .....................................................................................................................................
44
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ...................................
65
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ................................................................
66
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE .................................................................................................................
66
ITEM 9A. CONTROLS AND PROCEDURES ........................................................................................................
67
ITEM 9B. OTHER INFORMATION ........................................................................................................................
68
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE .....................................
69
ITEM 11. EXECUTIVE COMPENSATION .............................................................................................................
69
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS ..............................................................................................
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE ................................................................................................................................
69
70
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES .............................................................................
70
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES ............................................................................
71
SIGNATURES ........................................................................................................................................
73
PART IV
2
ITEM 1. BUSINESS
General
PART 1
Heritage Financial Corporation (the “Company” or “Heritage”) is a bank holding company that was incorporated in
the State of Washington in August 1997. We were organized for the purpose of acquiring all of the capital stock of
Heritage Savings Bank upon our reorganization from a mutual holding company form of organization to a stock
holding company form of organization. Effective September 1, 2004, Heritage Savings Bank switched its charter from
a state chartered savings bank to a state chartered commercial bank and changed its legal name from Heritage
Savings Bank to Heritage Bank (the "Bank"). Effective September 1, 2005, Central Valley Bank (acquired by the
Company in March 1999) changed its charter from a nationally chartered commercial bank to a state chartered
commercial bank. In June 2006, the Company completed the acquisition of Western Washington Bancorp and its
wholly owned subsidiary, Washington State Bank, N.A., at which time Washington State Bank, N.A. was merged into
Heritage Bank.
Effective July 30, 2010, Heritage Bank entered into a definitive agreement with the Federal Deposit Insurance
Corporation (the “FDIC”), pursuant to which Heritage Bank acquired certain assets and assumed certain liabilities of
Cowlitz Bank, a Washington state-chartered commercial bank headquartered in Longview, Washington (the “Cowlitz
Acquisition”). The Cowlitz Acquisition included nine branches of Cowlitz Bank, including its division Bay Bank, which
opened as branches of Heritage Bank on August 2, 2010. The acquisition also included the Trust Services Division of
Cowlitz Bank. In 2013, the Company consolidated three of these branches into existing Heritage Bank branches.
Effective November 5, 2010, Heritage Bank entered into a definitive agreement with the FDIC, pursuant to which
Heritage Bank acquired certain assets and assumed certain liabilities of Pierce Commercial Bank, a Washington
state-chartered commercial bank headquartered in Tacoma, Washington (the “Pierce Commercial Acquisition”). The
Pierce Commercial Acquisition included one branch, which opened as a branch of Heritage Bank on November 8,
2010. On September 14, 2012, the Company announced that it had entered into a definitive agreement along with
Heritage Bank, to acquire Northwest Commercial Bank (“NCB”), a full service commercial bank headquartered in
Lakewood, Washington that operated two branch locations in Washington State (the “NCB Acquisition”). The
acquisition of NCB was completed on January 9, 2013, at which time NCB was merged with and into Heritage Bank.
The Lakewood branch was subsequently consolidated with an existing Heritage Bank branch in 2013. On March 11,
2013, the Company entered into a definitive agreement to acquire Valley Community Bancshares, Inc. (“Valley” or
“Valley Community Bancshares”) and its wholly-owned subsidiary, Valley Bank, both headquartered in Puyallup,
Washington (the “Valley Acquisition”) and its eight branches. The Valley Acquisition was completed on July 15, 2013.
Subsequently, four of these branches were consolidated into existing branches and closed as of December 31, 2013.
On April 8, 2013, the Company announced the proposed merger of its two wholly-owned bank subsidiaries
Central Valley Bank and Heritage Bank, with Central Valley Bank merging into Heritage Bank. The common control
merger was completed on June 19, 2013. Central Valley Bank now operates as a division of Heritage Bank.
On October 23, 2013, the Company, along with the Bank, and Washington Banking Company (“Washington
Banking”) and its wholly owned subsidiary bank, Whidbey Island Bank (“Whidbey”), jointly announced the signing of a
merger agreement pursuant to which Heritage and Washington Banking will enter into a strategic merger with
Washington Banking merging into Heritage. Immediately following the merger, Whidbey will merge into the Bank.
Washington Banking branches will adopt the Heritage Bank name in all markets, with the exception of six branches in
Whidbey Island markets which will continue to operate using the Whidbey Island Bank name. The corporate
headquarters of the combined company will be in Olympia, Washington. The merger is anticipated to be completed in
the second quarter of 2014. For additional information on this proposed merger, see Note 22 of the Notes to
Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary Data. ”
We are primarily engaged in the business of planning, directing, and coordinating the business activities of our
wholly owned subsidiary Heritage Bank. The deposits of the Bank are insured by the FDIC. Heritage Bank is
headquartered in Olympia, Washington and conducts business in its thirty-five branch offices located in Washington
and the greater Portland, Oregon area.
Our business consists primarily of lending and deposit relationships with small businesses and their owners in
our market areas, and attracting deposits from the general public. We also make real estate construction and land
development loans, one-to-four family residential loans, and consumer loans. Historically the Bank would originate for
sale purposes first mortgage loans on residential properties but this operation ceased in the second quarter of 2013.
3
The Company was a participant in the U.S. Department of the Treasury’s (“Treasury”) Troubled Asset Relief
Program (“TARP”) Capital Purchase Plan, pursuant to which the Company sold (i) 24,000 shares of the Company’s
Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”) and (ii) a warrant (the
“Warrant”) to purchase 276,074 shares of the Company’s common stock at $13.04 per share for an aggregate
purchase price of $24.0 million in cash. Effective December 22, 2010, the Company redeemed all of the Series A
Preferred Stock held by the Treasury. Effective August 17, 2011, the Company repurchased the Warrant and has no
other obligations under TARP. For additional information, see Note 17 of the Notes to Consolidated Financial
Statements included in “Item 8. Financial Statements and Supplementary Data.”
Market Areas
We offer financial services to meet the needs of the communities we serve through our community-oriented
financial institutions. Headquartered in Olympia, Thurston County, Washington, we conduct business through Heritage
Bank and its thirty-five branch offices located along the I-5 corridor throughout Washington and the greater Portland,
Oregon area. We additionally have offices located in eastern Washington primarily in the Yakima county.
Lending Activities
General. Lending activities are conducted through Heritage Bank. Our focus is on commercial business
lending. We also originate consumer loans, real estate construction and land development loans and one-to-four
family residential loans. Commercial and industrial loans, including owner occupied commercial real estate loans,
totaled $494.4 million, or 50.6% of total originated loans, as of December 31, 2013, and $465.7 million, or 53.3% of
total originated loans, as of December 31, 2012 and non-owner occupied commercial real estate totaled $354.5
million, or 36.3%, as of December 31, 2013 and $265.8 million, or 30.4% of total originated loans, as of December 31,
2012. One-to-four family residential loans totaled $39.2 million, or 4.0% of total originated loans, at December 31,
2013, and $38.8 million, or 4.4% of total originated loans, at December 31, 2012. Real estate construction and land
development loans totaled $63.8 million, or 6.5% of total originated loans, at December 31, 2013, and $77.3 million, or
8.8% of total originated loans, at December 31, 2012.
Our loans are originated under policies that are reviewed and approved annually by our board of directors. In
addition, we have established internal lending guidelines that are updated as needed. These policies and guidelines
address underwriting standards, structure and rate considerations, and compliance with laws, regulations and internal
lending limits. We conduct post-approval reviews on selected loans and routinely perform internal loan reviews of our
loan portfolio to check for credit quality, proper documentation and compliance with laws and regulations.
4
The following table provides information about our originated loan portfolio by type of loan for the dates indicated.
These balances are prior to deduction for the allowance for loan losses.
2013
2012
2011
2010
2009
% of
Total
(4)
Balance
% of
Total
(4)
% of
Total
(4)
% of
Total
(4)
% of
Total
(4)
Balance
Balance
Balance
Balance
December 31,
(Dollars in thousands)
Originated loans:
Commercial business:
Commercial and
industrial(1) .............. $ 494,362 50.6% $ 465,734 53.3% $ 440,471 52.5% $ 392,301 52.8% $ 408,622 52.8%
Non-owner occupied
commercial real
estate(1) ................... 354,451 36.3
Total commercial
business ............... 848,813 86.9
265,835 30.4
251,049 30.0
221,739 29.9
194,613 25.2
731,569 83.7
691,520 82.5
614,040 82.7
603,235 78.0
One-to-four family
residential(2) ................. 39,235
Real estate construction
and land development:
One-to-four family
residential ................. 18,593
Five or more family
residential and
commercial
properties ................. 45,184
Total real estate
construction and
land
development (3) ... 63,777
Consumer......................... 28,130
4.0
38,848
4.4
37,960
4.5
47,505
6.5
53,623 7.0
1.9
25,175
2.9
22,369
2.7
29,377
4.0
46,060 6.0
4.6
52,075
5.9
54,954
6.6
28,588
3.8
49,665 6.4
6.5
2.9
77,250
28,914
8.8
3.3
77,323
32,981
9.3
3.9
57,965
23,832
7.8
3.2
95,725 12.4
2.8
21,261
Gross originated
loans ............................. 979,955 100.3
(0.3)
Less: deferred loan fees ...
(2,670)
876,581 100.2
(0.2)
(2,096)
839,784 100.2
(0.2)
(1,860)
743,342 100.2
(0.2)
(1,323)
773,844 100.2
(0.2)
(1,597)
Total originated
loans ............................. $ 977,285 100.0% $ 874,485 100.0% $ 837,924 100.0% $ 742,019 100.0% $ 772,247 100.0%
(1) Commercial and industrial loans include owner-occupied commercial real estate
(2) Excludes loans held for sale of $0, $1.7 million, $1.8 million, $764,000 and $825,000 as of December 31, 2013,
2012, 2011, 2010 and 2009, respectively.
(3) Balances are net of undisbursed loan proceeds
(4) Percent of total originated loan balance
5
The following table provides information about our purchased covered loan portfolio by type of loan for the years
ended December 31, 2013, 2012, 2011 and 2010. There were no purchased covered loans for the year ended
December 31, 2009. These balances are the recorded investment balance and are prior to deduction for the
allowance for loan losses.
December 31,
2013
2012
2011
2010
% of
Total
(3)
Balance
% of
Total
(3)
Balance
% of
Total
(3)
Balance
% of
Total
(3)
Balance
(Dollars in thousands)
Purchased covered loans:
Commercial business:
Commercial and
industrial(1) ........................ $ 39,056
Non-owner occupied
commercial real
estate(1) ............................ 14,625
Total commercial
business ...................... 53,681
One-to-four family residential .... 4,777
Real estate construction and
land development:
One-to-four family
residential .......................... 1,556
61.3% $ 60,577
68.6% $ 76,674
70.1% $ 92,265
71.7%
22.9
13,028
14.7
15,753
14.4
17,576
13.6
84.2
7.5
73,605
5,027
83.3
5.7
92,427
5,197
84.5
4.8
109,841
6,224
85.3
4.8
2.4
4,433
5.0
5,786
5.3
5,876
4.6
Total real estate
construction and land
development(2) ........... 1,556
Consumer ................................. 3,740
2.4
5.9
4,433
5,265
5.0
6.0
5,786
5,947
5.3
5.4
5,876
6,774
4.6
5.3
Gross purchased covered
loans ...................................... $ 63,754 100.0% $ 88,330
100.0% $ 109,357
100.0% $128,715
100.0%
(1) Commercial and industrial loans include owner-occupied commercial real estate
(2) Balances are net of undisbursed loan proceeds
(3) Percent of total purchased covered loans
6
The following table provides information about our purchased non-covered loan portfolio by type of loan for the
years ended December 31, 2013, 2012, 2011 and 2010. There were no purchased non-covered loans for the year
ended December 31, 2009. These balances are the recorded investment balance and are prior to deduction for the
allowance for loan losses.
December 31,
2013
2012
2011
2010
Balance
% of
Total
(3)
Balance
% of
Total
(3)
Balance
% of
Total
(3)
Balance
% of
Total
(3)
(Dollars in thousands)
Purchased non-covered loans:
Commercial business:
Commercial and
industrial(1) ....................... $123,487
Non-owner occupied
commercial real
estate(1) .......................... 45,528
Total commercial
business ..................... 169,015
3,847
One-to-four family residential ...
Real estate construction and
land development:
One-to-four family
64.7% $ 37,974
59.2% $ 52,659
59.8% $ 77,815
59.4%
23.9
11,019
17.2
12,833
14.5
18,435
14.0
88.6
2.0
48,993
3,040
76.4
4.7
65,492
2,743
74.3
3.1
96,250
4,986
73.4
3.8
residential .........................
1,131
0.6
513
0.8
1,381
1.6
3,816
2.9
Five or more family
residential and
commercial
properties ..........................
3,471
1.8
864
1.4
1,078
1.2
1,244
1.0
Total real estate
construction and land
development(2) ..........
4,602
Consumer ................................. 13,417
2.4
7.0
1,377
10,713
2.2
16.7
2,459
17,420
2.8
19.8
5,060
24,753
3.9
18.9
Gross purchased non-covered
loans ...................................... $190,881 100.0% $ 64,123
100.0% $ 88,114
100.0% $ 131,049
100.0 %
(1) Commercial and industrial loans include owner-occupied commercial real estate
(2) Balances are net of undisbursed loan proceeds
(3) Percent of total purchased non-covered loans
7
The following table presents at December 31, 2013 (i) the aggregate contractual maturities of loans in the named
categories of our originated loan portfolio and (ii) the aggregate amounts of fixed rate and variable or adjustable rate
loans in the named categories that mature after one year.
Maturing
Within
1 year
Over 1-5
years
After
5 years
Total
Commercial business ............................................ $ 141,527
Real estate construction and land development...
53,661
Total ............................................................... $ 195,188
Fixed rate loans, due after 1 year ..............................
Variable or adjustable rate loans, due after 1 year ...
Total ...............................................................
(In thousands)
$ 206,660
5,468
$ 212,128
$ 123,266
88,862
$ 212,128
$ 500,626
4,648
$ 505,274
$ 160,110
345,164
$ 505,274
$ 848,813
63,777
$ 912,590
$ 283,376
434,026
$ 717,402
Commercial Business Lending
We offer different types of commercial business loans, including lines of credit, term equipment financing and
term owner-occupied commercial real estate loans. We also originate loans that are guaranteed by the Small
Business Administration (“SBA”), for which Heritage Bank is a “preferred lender.” Before extending credit to a
business we analyze the borrower’s management ability, financial history, including cash flow of the borrower and all
guarantors, and the liquidation value of the collateral. Emphasis is placed on having a comprehensive understanding
of the borrower’s global cash flow and performing necessary financial due diligence.
At December 31, 2013 we had $848.8 million, or 86.9%, of our total originated loans receivable in commercial
business loans with an average loan size of approximately $303,000, excluding zero outstanding balance loans.
We originate commercial real estate loans within our primary market areas with a preference for loans secured by
owner-occupied properties. Our underwriting standards require that commercial real estate loans not exceed 75% of
the lower of appraised value at origination or cost of the underlying collateral. Cash flow coverage to debt servicing
requirements is generally a minimum of 1.15 times for five or more family residential loans and 1.25 times for
commercial real estate loans. Cash flow coverage is calculated using an “underwriting” interest rate that is higher than
the note rate.
Commercial real estate loans typically involve a greater degree of risk than one-to-four family residential loans.
Payments on loans secured by commercial real estate properties are dependent on successful operation and
management of the properties and repayment of these loans may be affected by adverse conditions in the real estate
market or the economy. We seek to minimize these risks by determining the financial condition of the borrower, the
quality and value of the collateral, and the management of the property securing the loan. We also generally obtain
personal guarantees from the owners of the collateral after a thorough review of personal financial statements. In
addition, we review our commercial real estate loan portfolio annually for performance of individual loans, and stress-
test loans for potential changes in interest rates, occupancy, and collateral values.
See “Item 1A. Risk Factors—Our loan portfolio is concentrated in loans with a higher risk of loss—Repayment of
our commercial business loans consisting of commercial and industrial loans as well as owner-occupied and non-
owner occupied commercial real estate loans, is often dependent on the cash flows of the borrower, which may be
unpredictable, and the collateral securing these loans may fluctuate in value.” See also “Item 1A. Risk Factors—Our
loan portfolio is concentrated in loans with a higher risk of loss—Our non-owner commercial real estate loans, which
includes five or more family residential real estate loans, involve higher principal amounts than other loans and
repayment of these loans may be dependent on factors outside our control or the control of our borrowers.”
8
One-to-Four Family Residential Loans
The majority of our one-to-four family residential loans are secured by single-family residences located in our
primary market areas. Our underwriting standards require that one-to-four family residential loans generally are
owner-occupied and do not exceed 80% of the lower of appraised value at origination or cost of the underlying
collateral. Terms typically range from 15 to 30 years. Until the second quarter of 2013, we sold a significant portion of
our one-to-four family residential loans in the secondary market.
See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—
Asset/Liability Management.”
Real Estate Construction and Land Development
We originate one-to-four family residential construction loans for the construction of custom homes (where the
home buyer is the borrower). We also provide financing to builders for the construction of pre-sold homes and, in
selected cases, to builders for the construction of speculative residential property. Because of the higher risks present
in the residential construction industry, our lending to builders is limited to those who have demonstrated a favorable
record of performance and who are building in markets that management understands.
We further endeavor to limit our construction lending risk through adherence to strict underwriting guidelines and
procedures. Speculative construction loans are short term in nature and priced with a variable rate of interest. We
require builders to have tangible equity in each construction project and have prompt and thorough documentation of
all draw requests, and we inspect the project prior to paying any draw requests.
See “Item 1A. Risk Factors—Our loan portfolio is concentrated in loans with a higher risk of loss—Our real estate
construction and land development loans are based upon estimates of costs and value associated with the completed
project. These estimates may be inaccurate.”
Origination and Sales of One-to-Four Family Residential Loans
Historically, as part of the asset/liability management strategy, we sold a significant portion of our one-to-four
family residential loans into the secondary market. We discontinued this strategy in the second quarter of 2013, which
also set forth a reduction in mortgage department staffing. Currently, all mortgage loan originations are retained in the
Bank's portfolio.
When we sold mortgage loans, we typically sold the servicing of the loans (i.e., collection of principal and interest
payments). However, we serviced a minimal $49,000 and $84,000 in mortgage loans for others as of December 31,
2012 and 2011, respectively. We did not service any mortgage loans for others as of December 31, 2013.
The following table presents summary information concerning our origination and sale of our one-to-four family
residential loans and the gains from the sale of loans.
2013
2012
2011
2010
2009
Years Ended December 31,
(In thousands)
One-to-four family residential loans:
Originated(1) ........................................
Sold ......................................................
Gains on sales of loans, net(2) ...................
$ 18,867
8,460
142
$ 35,730
21,187
295
$ 23,865
15,888
285
$ 18,605
16,187
226
$ 34,183
25,338
288
(1) Includes loans originated for our loan portfolio or for sale in the secondary market.
(2) Excludes gains on sales of SBA loans.
9
Commitments and Contingent Liabilities
In the ordinary course of business, we enter into various types of transactions that include commitments to
extend credit that are not included in our Consolidated Financial Statements. We apply the same credit standards to
these commitments as we use in all our lending activities and have included these commitments in our lending risk
evaluations. Our exposure to credit loss under commitments to extend credit is represented by the amount of these
commitments.
The following table presents outstanding commitments to extend credit, including letters of credit, at the dates
indicated:
December 31,
2013
December 31,
2012
(In thousands)
Commercial business:
Commercial and industrial ..........................................................
Owner-occupied commercial real estate....................................
Non-owner occupied commercial real estate.............................
Total commercial business ..................................................
One-to-four family residential .............................................................
Real estate construction and land development:
One-to-four family residential ......................................................
Five or more family residential and commercial properties .......
Total real estate construction and land development.....
Consumer ......................................................................................
$ 169,079
2,812
2,405
174,296
45
12,236
20,720
32,956
27,480
$ 126,162
2,151
7,006
135,319
—
4,662
26,301
30,963
34,525
Total outstanding commitments ......................................
$ 234,777
$ 200,807
Delinquencies and Nonperforming Assets
Delinquency Procedures. We send a borrower a delinquency notice 15 days after the due date when the
borrower fails to make a required payment on a loan. If the delinquency is not brought current, additional delinquency
notices are mailed at 30 and 45 days for commercial loans. Additional written and oral contacts are made with the
borrower between 60 and 90 days after the due date.
If a real estate loan payment is past due for 45 days or more, the collection manager may perform a review of the
condition of the property. We may negotiate and accept a repayment program with the borrower, accept a voluntary
deed in lieu of foreclosure or, when considered necessary, begin foreclosure proceedings. If foreclosed on, real
property is sold at a public sale and we bid on the property to protect our interest. A decision as to whether and when
to begin foreclosure proceedings is based on such factors as the amount of the outstanding loan relative to the value
of the property securing the original indebtedness, the extent of the delinquency, and the borrower’s ability and
willingness to cooperate in resolving the delinquency.
Real estate acquired by us is classified as other real estate owned until it is sold. When property is acquired, it is
recorded at the estimated fair value (less costs to sell) at the date of acquisition, not to exceed net realizable value,
and any resulting write-down is charged to the allowance for loan losses. Upon acquisition, all costs incurred in
maintaining the property are expensed. Costs relating to the development and improvement of the property, however,
are capitalized to the extent of the property’s net realizable value. If the estimated realizable value of the other real
estate owned property declines after the acquisition date, the adjustment to the value is charged to other real estate
owned expense, net.
Delinquencies in the commercial business loan portfolio are handled by the assigned loan officer. Generally,
notices are sent and personal contact is made with the borrower when the loan is 15 days past due. Loan officers are
responsible for collecting loans they originate or which are assigned to them. Depending on the nature of the loan and
the type of collateral securing the loan, we may negotiate and accept a modified payment program or take other
actions as circumstances warrant.
10
Classification of Loans. Federal regulations require that the Bank periodically evaluates the risks inherent in its
loan portfolio. In addition, the Division of Banks of the Washington State Department of Financial Institutions
(“Division”) and the FDIC have the authority to identify problem loans and, if appropriate, require them to be
reclassified. There are three classifications for problem loans: Substandard, Doubtful, and Loss. Substandard loans
have one or more defined weaknesses and are characterized by the distinct possibility that the institution will sustain
some loss if the deficiencies are not corrected. Doubtful loans have the weaknesses of Substandard loans, with
additional characteristics that the weaknesses make collection or liquidation in full on the basis of currently existing
facts, conditions, and values questionable. There is a high probability of some loss in loans classified as Doubtful. A
loan classified as Loss is considered uncollectible and of such little value that continuance as a loan of the institution
is not warranted. If a loan or a portion of the loan is classified as Loss, the institution must charge-off this amount. We
also have loans we classify as Watch and Other Assets Especially Mentioned (“OAEM”). Loans classified as Watch
are performing assets but have elements of risk that require more monitoring than other performing loans. Loans
classified as OAEM are assets that continue to perform but have shown deterioration in credit quality and require
closer monitoring.
The Bank routinely tests its problem loans for potential impairment. A loan is considered impaired when, based
on current information and events, it is probable that the Bank will be unable to collect all amounts due according to
the original contractual terms of the loan agreement. Problem loans that may be impaired are identified using the
Bank's normal loan review procedures, which include post-approval reviews, monthly reviews by credit administration
of criticized loan reports, scheduled internal reviews, underwriting during extensions and renewals and the analysis of
information routinely received on a borrower’s financial performance.
Impairment is measured using the present value of expected future cash flows, discounted at the loan’s effective
interest rate, unless the loan is collateral dependent, in which case impairment is measured using the fair value of the
collateral after deducting appropriate collateral disposition costs. Furthermore, when it is practically expedient,
impairment is measured by the fair market price of the loan.
Subsequent to an initial measure of impairment, if there is a significant change in the amount or timing of a loan’s
expected future cash flows or a change in the value of collateral or market price of a loan, based on new information
received, the impairment is recalculated. However, the net carrying value of a loan never exceeds the recorded
investment in the loan.
11
Nonperforming Assets. Nonperforming assets consist of nonaccrual loans and other real estate owned. The
following table provides information about our originated nonaccrual loans, restructured loans, and other real estate
owned for the indicated dates.
Nonaccrual originated loans:
Commercial business ...........................
One-to-four family residential ...............
Real estate construction and land
development .....................................
Consumer ............................................
Total nonaccrual originated
loans(1)(2) .................................
December 31,
2013
2012
2011
2010
2009
(Dollars in thousands)
$ 5,524
340
$ 5,492
389
$ 8,266
—
$10,667
—
$ 9,728
—
1,045
6,420
38
157
14,947
125
15,816
—
25,108
—
6,947
12,458
23,338
26,483
34,836
Noncovered other real estate owned ..........
4,377
5,406
3,710
3,030
704
Total nonperforming originated
assets ........................................
$11,324
$17,864
$27,048
$29,513
$ 35,540
Restructured originated performing loans:
Commercial business ...........................
One-to-four family residential ...............
Real estate construction and land
development .....................................
Consumer ............................................
$14,043
252
6,043
101
Total restructured originated
$14,237
422
361
19
$12,606
835
364
—
$ 394
—
$
425
—
—
—
—
—
performing loans(3) ...................
$20,439
$15,039
$13,805
$ 394
$
425
Accruing originated loans past due 90
days or more(4) .......................................
Potential problem originated loans(5) .........
Allowance for loan losses on originated
loans ........................................................
Nonperforming originated loans to total
originated loans(6) ...................................
Allowance for loan losses on originated
loans to total originated loans ..................
Allowance for loan losses on originated
loans to nonperforming originated
loans(6) ....................................................
Nonperforming originated assets to total
originated assets(6) .................................
$
6
$34,504
$ 214
$28,270
$ 1,328
$29,742
$ 1,313
$56,088
$
277
$53,086
$17,153
$19,125
$22,317
$22,062
$ 26,164
0.53%
1.28%
2.57%
3.14%
4.21%
1.76%
2.19%
2.66%
2.97%
3.38%
329.40%
170.44%
103.52%
94.73%
79.34%
0.68%
1.39%
2.14%
2.38%
3.32%
(1) $2.5 million, $8.6 million, $11.7 million, $8.7 million and $17.0 million of originated nonaccrual loans were
considered troubled debt restructures at December 31, 2013, 2012, 2011, 2010 and 2009, respectively.
(2) $1.7 million, $1.2 million, $1.8 million, $3.2 million and $2.3 million of originated nonaccrual loans were
guaranteed by government agencies at December 31, 2013, 2012, 2011, 2010 and 2009, respectively.
(3) $1.2 million, $679,000 and $592,000 of originated performing restructured loans were guaranteed by government
agencies at December 31, 2013, 2012 and 2011. There were no originated performing restructured loans
guaranteed by government agencies at December 31, 2010 and 2009.
(4) There were no accruing originated loans past due 90 days or more that were guaranteed by government
agencies at December 31, 2013, 2012, and 2009. There were accruing originated loans past due 90 days or
more of $6,000 and $92,000 guaranteed by government agencies at December 31, 2011 and 2010, respectively.
(5) $1.8 million, $3.2 million, $2.8 million, $5.4 million and $7.2 million of originated potential problem loans were
guaranteed by government agencies at December 31, 2013, 2012, 2011, 2010 and 2009, respectively.
(6) Excludes portions guaranteed by government agencies.
12
Nonaccrual Loans. Our Consolidated Financial Statements are prepared on the accrual basis of accounting,
including the recognition of interest income on our loan portfolio, unless a loan is placed on nonaccrual status. Loans
are considered to be impaired and are placed on nonaccrual status when there are serious doubts about the
collectability of principal or interest. Our policy is to place a loan on nonaccrual status when the loan becomes past
due for 90 days or more, is less than fully collateralized, and is not in the process of collection. Payments received on
nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected.
Nonaccrual originated loans decreased to $6.9 million, or 0.53% of total originated loans, at December 31, 2013
from $12.5 million, or 1.28% of total originated loans, at December 31, 2012 due to the loan resolution efforts of our
credit department. During the year ended December 31, 2013, approximately $3.9 million in principal payments were
received on the nonaccrual loans and $2.4 million were transferred back to accrual. We also recorded $1.3 million in
net charge-offs of originated nonaccrual loans of which $654,000 related to commercial business and $482,000
related to real estate construction loans. In addition, $663,000 of originated nonaccrual loans were transferred to
other real estate owned during the year ended December 31, 2013. This decrease in total nonaccrual originated loans
was partially offset by $2.7 million in additions to nonperforming originated loans which were outstanding as of
December 31, 2013.
Nonperforming originated assets decreased to $11.3 million, or 0.68% of total originated assets, at December 31,
2013 from $17.9 million, or 1.39% of total originated assets, at December 31, 2012 due to a decrease in
nonperforming originated loans discussed above as well as an overall decrease in the other real estate owned,
noncovered. The other real estate owned balance decreased due to dispositions of $6.3 million offset partially by
additions of $5.3 million ($2.3 million of which were acquired with the NCB Acquisition) during the year ended
December 31, 2013.
Originated restructured performing loans as of December 31, 2013 and December 31, 2012 were $20.4 million
and $15.0 million, respectively. The $5.4 million increase in originated restructured performing loans was primarily due
to the addition of one borrowing relationship totaling $2.5 million at December 31, 2013 which was classified as
performing troubled debt restructured during the second quarter of 2013. This relationship includes one-to-four family
residential real estate construction and land development loans and the related specific valuation allowance on this
relationship was $211,000 at December 31, 2013. The increase in the originated restructured performing loans as of
December 31, 2013 was also due to a $2.4 million loan which was on nonaccrual at December 31, 2012 that was
upgraded to accrual status during the year ended December 31, 2013 as the borrower continued to show sustainable
financial improvement and further loss is not anticipated.
Troubled Debt Restructured Loans. A troubled debt restructured loan (“TDR”) is a restructuring in which the
Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower
that it would not otherwise consider. The majority of the Bank’s TDRs are a result of granting extensions to troubled
credits which have already been adversely classified. We grant such extensions to reassess the borrower’s financial
status and develop a plan for repayment. Certain modifications with extensions also include interest rate reductions,
which is the second most prevalent concession. The interest rate reductions can be for a period of time or over the
remainder of the life of the loan. We may also bifurcate troubled credits into a “good” loan and a “bad” loan, whereas
the good loan continues to accrue under the modified terms. We perform bifurcations to limit potential losses. The
remainder of the Bank's TDRs are the result of converting revolving lines of credits to amortizing loans, changing
amortizing loans to interest-only loans with balloon payments, or re-amortizing the loan over a longer period of time.
These modifications would all be considered a concession for a borrower that could not obtain financing outside of the
Bank. We do not forgive principal for a majority of our TDRs, but in those situations where principal is forgiven, the
entire amount of such principal forgiveness is immediately charged off to the extent not done so prior to the
modification. We sometimes delay the timing on the repayment of a portion of principal (principal forbearance) and
charge-off the amount of forbearance if that amount is not considered fully collectible. We also consider insignificant
delays in payments when determining if a loan should be classified as a TDR.
TDRs are considered impaired and are separately measured for impairment under Financial Accounting
Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310-10-35, whether on accrual or nonaccrual
status. At December 31, 2013 and December 31, 2012, the balance of accruing TDRs was $20.4 million and $15.0
million, respectively. The related allowance for loan losses on the accruing TDRs was $2.2 million as of December 31,
2013 and $2.1 million as of December 31, 2012. At December 31, 2013, non-accruing TDRs were $2.5 million and
had a related allowance for loan losses of $133,000. At December 31, 2012, non-accruing TDRs of $9.3 million had a
related allowance for loan losses of $2.0 million.
13
A loan may have the TDR classification removed if (a) the restructured interest rate was greater than or equal to
the interest rate of a new loan with comparable risk at the time of the restructure, and (b) the loan is no longer
impaired based on the terms of the restructured agreement. The Bank's policy is that the borrower must demonstrate
six consecutive monthly payments in accordance with the modified loan before it can be reviewed for removal of TDR
classification under the second criteria. However, the loan must be reported as a TDR in at least one of the
Company’s Annual Report on Form 10-K. Once a loan has been classified as a TDR, it will continue to be disclosed
as an impaired loan until paid off or charged-off, even if the loan subsequently is no longer disclosed as a TDR.
Potential Problem Loans. Potential problem loans are those loans that are currently accruing interest and are
not considered impaired, but which we are monitoring because the financial information of the borrower causes us
concerns as to their ability to comply with their loan repayment terms. Loans that are past due 90 days or more and
still accruing interest are both well secured and in the process of collection. Originated potential problem loans
increased $6.2 million to $34.5 million at December 31, 2013 from $28.3 million at December 31, 2012.
Analysis of Allowance for Loan Losses
Management maintains an allowance for loan losses (“ALL”) to provide for estimated probable credit losses
inherent in the loan portfolio. The adequacy of the ALL is monitored through our ongoing quarterly loan quality
assessments.
We assess the estimated credit losses inherent in our loan portfolio by considering a number of elements
including:
• Historical loss experience in a number of homogeneous segments of the loan portfolio;
• The impact of environmental factors, including:
• Levels of and trends in delinquencies and impaired loans;
• Levels and trends in charge-offs and recoveries;
• Effects of changes in risk selection and underwriting standards, and other changes in lending policies,
procedures and practices;
• Experience, ability, and depth of lending management and other relevant staff;
• National and local economic trends and conditions;
• External factors such as competition, legal, and regulatory requirements; and
• Effects of changes in credit concentrations.
We calculate an appropriate ALL for the non-classified and classified performing loans in our loan portfolio by
applying historical loss factors for homogeneous classes of the portfolio, adjusted for changes to the above-noted
environmental factors. We may record specific provisions for impaired loans, including loans on nonaccrual status and
TDRs, after a careful analysis of each loan’s credit and collateral factors. Our analysis of an appropriate ALL
combines the provisions made for our non-classified loans, classified loans, and the specific provisions made for each
impaired loan.
While we believe we use the best information available to determine the allowance for loan losses, results of
operations could be significantly affected if circumstances differ substantially from the assumptions used in
determining the allowance. A further decline in local and national economic conditions, or other factors, could result in
a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and
results of operations. In addition, the determination of the amount of the allowance for loan losses is subject to review
by bank regulators, as part of their routine examination process, which may result in the establishment of additional
allowance allocations based upon their judgment of information available to them at the time of their examination.
14
The following table provides information regarding changes in our allowance for originated loan losses at and for
the indicated periods:
2013
2012
2011
2010
2009
Years Ended December 31,
(Dollars in thousands)
Allowance for loan losses on originated loans at
beginning of the year ...................................... $ 19,125
$ 22,317
$ 22,062
$ 26,164
$ 15,423
Provision for loan losses on originated
loans ...............................................................
890
695
5,180
11,990
19,390
Charge-offs:
Commercial business .....................................
One-to-four family residential .........................
Real estate construction and land
development ..............................................
Consumer ......................................................
(2,985)
—
(565 )
(241)
Total charge-offs ....................................
(3,791)
Recoveries:
Commercial business .....................................
One-to-four family residential .........................
Real estate construction and land
development ..............................................
Consumer ......................................................
808
—
32
89
Total recoveries ......................................
929
Net charge-offs .......................
(2,862)
(3,702)
(349)
(1,280 )
(293)
(5,624)
1,579
—
125
33
1,737
(3,887)
(2,690)
(15)
(2,948)
(316)
(5,969)
821
—
201
22
1,044
(4,925)
(8,106)
(169)
(8,344)
(73)
(16,692)
243
15
285
57
600
(2,668)
(189)
(5,774)
(192)
(8,823)
1
1
50
122
174
(16,092)
(8,649)
Allowance for originated loan losses at end of the
year ................................................................. $ 17,153
$ 19,125
$ 22,317
$ 22,062
$ 26,164
Originated loans outstanding at end of the
year(1) ............................................................ $ 977,285
$ 874,485
$ 837,924
$ 742,019
$ 772,247
Average originated loans receivable during the
year(1) ............................................................
948,511
855,923
833,441
717,159
787,527
Ratio of net charge-offs during the year to
average originated loans receivable ...............
(0.30)%
(0.45)%
(0.59)%
(2.24)%
(1.10)%
(1) Excludes loans held for sale.
The following table shows the allocation of the allowance for loan losses for originated loans at the indicated periods. The
allocation is based upon an evaluation of defined loan problems, historical loan loss ratios, and industry wide and other factors that
affect loan losses in the categories shown below:
2013
2012
December 31,
2011
2010
2009
Allowance
for Loan
Losses
% of
Total
(1)
Allowance
for Loan
Losses
% of
Total
(1)
Allowance
for Loan
Losses
% of
Total
(1)
Allowance
for Loan
Losses
% of
Total
(1)
Allowance
for Loan
Losses
% of
Total
(1)
Commercial
business ............. $ 13,962 86.6% $ 12,554 83.5% $ 12,888 82.3% $ 14,350
82.5% $ 12,137 77.8%
(Dollars in thousands)
One-to-four
family
residential ...........
Real estate
construction ........
Consumer ...............
Unallocated ............
Total
564 4.0
637
4.4
416
4.5
500
6.5
550
7.0
1,495 6.5
531 2.9
601 —
4,316
748
870
8.8
3.3
—
7,556
547
910
9.3
3.9
—
5,435
846
931
7.8
3.2
—
12,892 12.4
2.8
—
361
224
allowance
for
originated
loan
losses (1) .... $ 17,153 100.0% $ 19,125 100.0% $ 22,317 100.0% $ 22,062
100.0% $ 26,164 100.0%
(1) Represents total originated loans outstanding in each category as a percent of gross originated loans.
15
Investment Activities
At December 31, 2013, our investment securities portfolio totaled $199.3 million, which consisted of $163.1 million
of securities available for sale and $36.2 million of securities held to maturity. This compares with a total portfolio of
$154.4 million at December 31, 2012, which was comprised of $144.3 million of securities available for sale and $10.1
million of securities held to maturity. The composition of the two investment portfolios by type of security, at each
respective date, is presented in Note 4 to the Notes to Consolidated Financial Statements included in “Item 8. Financial
Statements and Supplementary Data.”
Our investment policy is established by the Board of Directors and monitored by the Audit and Finance Committee
of the Board of Directors. It is designed primarily to provide and maintain liquidity, generate a favorable return on
investments without incurring undue interest rate and credit risk, and complements the Bank's lending activities. The
policy dictates the criteria for classifying securities as either available for sale or held to maturity. The policy permits
investment in various types of liquid assets permissible under applicable regulations, which include U.S. Treasury
obligations, U.S. Government agency obligations, some certificates of deposit of insured banks, mortgage backed and
mortgage related securities, corporate notes, municipal bonds, and federal funds. Investment in non-investment grade
bonds and stripped mortgage backed securities are not permitted under the policy.
The following table provides information regarding our investment securities available for sale at the dates
indicated.
December 31, 2013
December 31, 2012
December 31, 2011
Fair Value
%
of Total
Investments
Fair Value
% of Total
Investments
(Dollars in thousands)
Fair Value
%
of Total
Investments
$ 6,039
49,060
—
3.7%
30.1
—
$ 11,035
47,360
—
7.7%
32.8
—
$ 31,307
33,423
8,097
21.7%
23.1
5.6
108,035
66.2
85,898
59.5
71,775
49.6
U.S. Treasury and U.S.
Government-sponsored
agencies ...............................
Municipal securities ..................
Corporate securities .................
Mortgage backed securities
and collateralized mortgage
obligations-residential:
U.S. Government-sponsored
agencies............................
Total ...........................
$163,134
100.0%
$144,293
100.0%
$144,602
100.0%
16
The following table provides information regarding our investment securities available for sale, by contractual
maturity, at December 31, 2013.
Less Than One
Year
Fair
Value
Weighted
Average
Yield(1)
Over One to Five
Years
Fair
Value
Weighted
Average
Yield(1)
Over Five to Ten
Years
Fair
Value
Weighted
Average
Yield(1)
Over Ten Years
Fair
Value
Weighted
Average
Yield(1)
(Dollars in thousands)
U.S. Treasury and
U.S. Government-
sponsored
agencies ...................
Municipal securities .....
Mortgage backed
securities and
collateralized
mortgage
obligations-
residential:
U.S. Government-
sponsored
agencies ...........
$ 2,025
139
0.19 % $ 2,960
5.57
7,950
1.04%
3.51
$
565
19,094
1.92% $
3.77
21,877
489
1.25%
3.21
—
—
1,978
1.73
27,854
2.19
78,203
2.31
Total ..............
$ 2,164
0.53 % $12,888
2.63% $47,513
2.83% $100,569
2.50%
(1) Taxable equivalent weighted average yield.
The following table provides information regarding our investment securities held to maturity at the dates
indicated.
December 31, 2013
December 31, 2012
December 31, 2011
Amortized
Cost
% of
Total
Investments
Amortized
Cost
% of
Total
Investments
Amortized
Cost
% of
Total
Investments
(Dollars in thousands)
U.S. Treasury and U.S.
Government-sponsored
agencies ................................ $
Municipal securities ..................
Mortgage backed securities
and collateralized mortgage
obligations-residential:
U.S. Government-
sponsored agencies ......
Private residential
collateralized mortgage
obligations .....................
1,687
24,290
4.7%
$
67.2
1,740
2,946
17.2% $
29.2
1,799
3,566
14.9%
29.5
9,129
25.2
4,245
42.0
5,412
44.7
1,048
2.9
1,168
11.6
1,316
10.9
Total ........................... $ 36,154
100.0% $ 10,099
100.0% $ 12,093
100.0%
17
U.S. Treasury and
U.S. Government-
sponsored
agencies ................... $
Municipal securities .....
Mortgage backed
securities and
collateralized
mortgage
obligations-
residential:
U.S. Government-
sponsored
agencies ...........
Private residential
collateralized
mortgage
obligations ........
The following table provides information regarding our investment securities held to maturity, by contractual
maturity, at December 31, 2013.
Less Than One
Year
Over One to Five
Years
Over Five to Ten
Years
Over Ten
Years
Fair
Value
Weighted
Average
Yield(1)
Fair
Value
Weighted
Average
Yield(1)
Fair
Value
Weighted
Average
Yield(1)
Fair
Value
Weighted
Average
Yield(1)
(Dollars in thousands)
73
1,714
4.98% $ —
10,707
1.53
— % $ 1,767
9,883
2.10
3.74% $ —
2,002
3.53
— %
3.95
—
—
47
6.49
3,446
2.99
5,496
2.99
—
—
—
—
—
—
1,205
3.42
Total .............. $ 1,787
1.67% $10,754
2.20% $15,096
3.43% $ 8,703
3.27%
(1) Taxable equivalent weighted average yield.
The Bank is required to maintain an investment in the stock of the Federal Home Loan Bank (“FHLB”) of Seattle
in an amount equal to the greater of $500,000 or 0.50% of residential mortgage loans and pass-through securities or
an advance requirement to be confirmed on the date of the advance and 5.0% of the outstanding balance of
mortgage loans sold to the FHLB of Seattle. At December 31, 2013 the Bank was required to maintain an investment
in the stock of FHLB of Seattle of at least $1.3 million and had an investment in FHLB stock carried at a cost basis
(par value) of $5.7 million.
Consistent with its accounting policy, the Company evaluated its investment in FHLB of Seattle stock for other-
than-temporary impairment. The Company took into consideration that in September 2012, the FHLB of Seattle
announced that it had been reclassified as adequately capitalized by its regulator, the Federal Housing Finance
Agency(“Finance Agency”). Further, during the year ended December 31, 2012, the Finance Agency granted the
FHLB of Seattle authority to repurchase up to $25 million of excess capital stock per quarter at par ($100 per share),
provided they receive a non-objection for each quarter’s repurchase from the Finance Agency. The FHLB of Seattle
has been repurchasing stock throughout 2013.
Based on the Company’s evaluation of the underlying investment, including the long-term nature of the
investment, the liquidity position of the FHLB of Seattle, the actions being taken by the FHLB of Seattle to address its
regulatory situation and the Company’s intent and ability to hold the investment for a period of time sufficient to
recover the par value, the Company did not recognize an other-than-temporary impairment loss on its FHLB of Seattle
stock during the years ended December 31, 2013, 2012 and 2011. Despite improvements in the FHLB of Seattle’s
regulatory situation, any deterioration in the FHLB of Seattle’s financial position may result in future impairment
losses.
Deposit Activities and Other Sources of Funds
General. Our primary sources of funds are deposits, loan repayments and borrowings. Scheduled loan
repayments are a relatively stable source of funds, while deposits and unscheduled loan prepayments, which are
influenced significantly by general interest rate levels, interest rates available on other investments, competition,
18
economic conditions, and other factors are not. Customer deposits remain an important source of funding, but these
balances have been influenced in the past by adverse market conditions in the industry and may be affected by future
developments such as interest rate fluctuations and new competitive pressures. In addition to customer deposits
management may utilize brokered deposits on an as-needed basis.
Borrowings may also be used on a short-term basis to compensate for reductions in other sources of funds (such
as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support
expanded lending activities and match the maturity of repricing intervals of assets. In addition, the Company utilizes
repurchase agreements as a supplement to other funding sources.
During the year ended December 31 2013, non-maturity deposits (total deposits less certificate of deposit
accounts) increased by $260.7 million, or 31.4%, to $1.09 billion. The increase was primarily a result of the non-
maturity deposits acquired in the Northwest and Valley Acquisitions. The percentage of non-maturity deposits to total
deposits increased to 77.9% at December 31, 2013 compared to 74.2% at December 3, 2012. As a result of this
increase, the certificate of deposit accounts to total deposits decreased to 22.1% at December 31, 2013 from 25.8%
at December 31, 2012.
Deposit Activities. We offer a variety of deposit accounts designed to attract both short-term and long-term
deposits. These accounts include noninterest demand accounts, negotiable order of withdrawal (“NOW”) accounts,
money market accounts, savings accounts and certificates of deposit (“CDs”). These accounts, with the exception of
noninterest demand accounts, generally earn interest at rates established by management based on competitive
market factors and management’s desire to increase or decrease certain types or maturities of deposits. The major
categories of deposit accounts are described below.
Noninterest Demand Deposits. Noninterest demand deposits are noninterest bearing and may be charged
service fees based on activity and balances.
NOW Accounts. NOW accounts are interest bearing and may be charged service fees based on activity and
balances. NOW accounts pay interest, but require a higher minimum balance to avoid service charges.
Money Market Accounts. Money market accounts pay a variable interest rate that is tiered depending on the
balance maintained in the account. Minimum opening balances vary.
Savings Accounts. We offer savings accounts that allow for unlimited deposits and withdrawals, provided that
a $100 minimum balance is maintained.
CDs. We offer several types of CDs with maturities ranging from three months to five years, which require a
minimum deposit of $2,500. Negotiable CDs are offered in amounts of $100,000 or more for terms of 30 days to
five years.
The following table provides the balances outstanding for each major category of deposits at the dates indicated:
December 31, 2013
December 31, 2012
December 31, 2011
Amount
Percent
Amount
Percent
Amount
Percent
Noninterest demand deposits .... $ 349,902
NOW accounts ...........................
352,051
Money market accounts .............
232,016
Savings accounts .......................
155,790
25.0%
25.2
16.6
11.1
Total non-maturity
(Dollars in thousands)
$ 247,048
303,487
157,728
120,781
22.1%
27.2
14.1
10.8
$ 230,993
304,818
166,913
103,716
20.4%
26.8
14.7
9.1
deposits ...........................
CDs ............................................
1,089,759
309,430
77.9
22.1
829,044 74.2
288,927
25.8
806,440
329,604
71.0
29.0
Total deposits ...................... $1,399,189
100.0%
$ 1,117,971
100.0%
$ 1,136,044
100.0%
19
The following table provides the average balances outstanding and the weighted average interest rates for each
major category of deposits for the years indicated:
Years Ended December 31,
2013
2012
2011
Average
Balance
Average
Yield/Rate
Average
Balance
Average
Yield/Rate
Average
Balance
Average
Yield/Rate
NOW accounts and money
market accounts ................ $ 541,793
Savings accounts ..................
143,412
0.19%
0.11
$ 466,268
113,119
0.27%
0.18
$ 453,509
103,170
(Dollars in thousands)
307,464
0.81
306,772
0.98
355,167
0.41%
0.35
1.20
CDs .......................................
Total interest bearing
deposits ......................
Noninterest demand
deposits .............................
992,669
0.37
886,159
0.50
911,846
0.71
308,582
—
237,888
—
205,862
—
Total deposits ................. $ 1,301,251
0.28%
$1,124,047
0.40%
$1,117,708
0.58%
The following table shows the amount and maturity of certificates of deposit of $100,000 or more:
December 31,
2013
(In thousands)
Remaining maturity:
Three months or less ......................................................................... $
Over three months through twelve months .......................................
Over twelve months through three years ..........................................
Over three years ................................................................................
44,895
78,144
37,040
11,237
Total ............................................................................................ $
171,316
Borrowings. Deposits are the primary source of funds for our lending and investment activities and our general
business purposes. We rely upon advances from the FHLB to supplement our supply of lendable funds and meet
deposit withdrawal requirements. The FHLB of Seattle serves as one of our secondary sources of liquidity. Advances
from the FHLB of Seattle are typically secured by our first lien single family mortgage loans, commercial real estate loans
and stock issued by the FHLB, which is owned by us. At December 31, 2013, the Bank maintained an uncommitted
credit facility with the FHLB of Seattle of $283.6 million and an uncommitted credit facility with the Federal Reserve Bank
of San Francisco of $56.7 million, of which there were no advances or borrowings outstanding. The Bank also maintains
advance lines with Zions Bank, Wells Fargo Bank, US Bank and Pacific Coast Bankers’ Bank to purchase federal funds
of up to $50.0 million as of December 31, 2013. At December 31, 2013 we had securities sold under agreement to
repurchase of $29.4 million which were secured by available for sale investment securities.
The FHLB functions provide credit for member financial institutions. As a member, we are required to own capital
stock in the FHLB and are authorized to apply for advances on the security of such stock and certain of our mortgage
loans and other assets (principally securities which are obligations of, or guaranteed by, the United States) provided
certain standards related to creditworthiness have been met. Advances are made pursuant to several different
programs. Each credit program has its own interest rate and range of maturities. Depending on the program,
limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth or on the
FHLB’s assessment of the institution’s creditworthiness. Under its current credit policies, the FHLB of Seattle limits
advances to 20% of the Bank's assets.
There were no FHLB advances or federal funds purchased for the years ended December 31, 2013, 2012 or
2011.
20
Supervision and Regulation
We are subject to extensive Federal and Washington State legislation, regulation, and supervision. These laws
and regulations are primarily intended to protect depositors, the FDIC and shareholders. The laws and regulations
affecting banks and bank holding companies have changed significantly particularly in connection with the enactment
of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”). See “—Other
Regulatory Developments—The Dodd-Frank Act” herein for a discussion of this legislation. Any change in applicable
laws, regulations, or regulatory policies may have a material effect on our business, operations, and prospects. We
cannot predict the nature or the extent of the effects on our business and earnings that any fiscal or monetary policies
or new Federal or State legislation may have in the future.
The following is a brief discussion of certain laws and regulations applicable to Heritage Financial and Heritage
Bank which is qualified in its entirety by reference to the actual laws and regulations.
Heritage Financial. As a bank holding company registered with the Board of Governors of the Federal Reserve
System (“Federal Reserve”), we are subject to regulation and supervision under the Bank Holding Company Act of
1956, as amended. This regulation and supervision is generally intended to ensure that we limit our activities to those
allowed by law and that we operate in a safe and sound manner without endangering the financial health of Heritage
Bank. As a bank holding company supervised by the Federal Reserve, we are required to file annual and periodic
reports with the Federal Reserve and provide additional information as the Federal Reserve may require. The
Federal Reserve may examine us, and any of our subsidiaries, and assess us for the cost of such examination.
The Federal Reserve has extensive enforcement authority over bank holding companies, including the ability to
assess civil money penalties and to issue cease and desist or removal orders. The Federal Reserve may also order
termination of non-banking activities by non-banking subsidiaries of bank holding companies, or divestiture of
ownership and control of a non-banking subsidiary by a bank holding company. Some violations may also result in
criminal penalties. The FDIC is authorized to exercise comparable authority under the Federal Deposit Insurance Act
and other statutes for state nonmember banks such as Heritage Bank.
The Federal Reserve has a policy that a bank holding company is required to serve as a source of financial and
managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. The
Dodd-Frank Act and earlier Federal Reserve policy provide that a bank holding company should serve as a source of
strength to its subsidiary banks by having the ability to provide financial assistance to its subsidiary banks during
periods of financial distress. A bank holding company’s failure to meet its obligation to serve as a source of strength to
its subsidiary banks is generally considered by the Federal Reserve to be an unsafe and unsound banking practice or
a violation of the Federal Reserve’s regulations or both. The Dodd-Frank Act codified the source of strength policy and
requires the issuance of implementing regulations. Under the prompt corrective action provisions of the Federal
Deposit Insurance Act, a bank holding company parent of an undercapitalized subsidiary bank must guarantee, within
limitations, the capital restoration plan that is required to be implemented of an undercapitalized subsidiary bank. If an
undercapitalized subsidiary bank fails to file an acceptable capital restoration plan or fails to implement an accepted
plan the Federal Reserve may prohibit the bank holding company parent or the undercapitalized subsidiary bank from
paying any dividend or making any other form of capital distribution without the prior approval of the Federal Reserve.
In addition, the Federal Reserve policy is that a bank holding company should pay cash dividends only to the extent
that the company’s net income for the past year is consistent with the company’s capital needs, asset quality and
overall condition.
We, and any subsidiaries which we may control, are considered “affiliates” within the meaning of the Federal
Reserve Act, and transactions between our bank subsidiary and affiliates are subject to numerous restrictions. With
some exceptions, we and our subsidiaries are prohibited from tying the provision of various products or services, such
as extensions of credit, to other products or services offered by us, or our affiliates.
Bank regulations require bank holding companies and banks to maintain a minimum “leverage” ratio of core
capital to adjusted quarterly average total assets of at least 4%. In addition, banking regulators have adopted risk-
based capital guidelines under which risk percentages are assigned to various categories of assets and off-balance
sheet items to calculate a risk-adjusted capital ratio. Tier 1 capital generally consists of common stockholders’ equity
(which does not include unrealized gains and losses on securities available for sale), less goodwill and certain
identifiable intangible assets. Tier 2 capital includes Tier 1 capital plus the allowance for loan losses and subordinated
21
debt, both subject to some limitations. Regulatory risk-based capital guidelines require Tier 1 capital of 4% of risk-
adjusted assets and minimum total capital ratio (combined Tier 1 and Tier 2) of 8% of risk-adjusted assets. In July
2013, the Federal Reserve and the FDIC approved a new rule that will substantially amend the regulatory risk-based
capital rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act.
For additional information, see “—Capital Adequacy” below.
Subsidiary Bank. Heritage Bank is a Washington-chartered commercial bank, the deposits of which are insured
by the FDIC. Heritage Bank is subject to regulation by the FDIC and the Division.
Applicable Federal and State statutes and regulations which govern a bank’s operations relate to minimum
capital requirements, required reserves against deposits, investments, loans, legal lending limits, mergers and
consolidation, borrowings, issuance of securities, payment of dividends, establishment of branches, and other aspects
of its operations, among other things. The Division and the FDIC also have authority to prohibit banks under their
supervision from engaging in what they consider to be unsafe and unsound practices.
The Bank is required to file periodic reports with the FDIC and the Division, and is subject to periodic
examinations and evaluations by those regulatory authorities. Based upon these evaluations, the regulators may
revalue the assets of an institution and require that it establish specific reserves to compensate for the differences
between the determined value and the book value of such assets. These examinations must be conducted every 12
months, except that well-capitalized banks may be examined every 18 months. The FDIC and the Division may each
accept the results of an examination by the other in lieu of conducting an independent examination.
Dividends paid by the Bank provide substantially all of our cash flow. Applicable Federal and Washington State
regulations restrict capital distributions by our Bank, including dividends. Such restrictions are tied to the institution’s
capital levels after giving effect to such distributions. For an additional discussion of restrictions on the payment of
dividends, see Part II of “Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities” herein.
Capital Adequacy. The Federal Reserve and FDIC have issued substantially similar risk-based and leverage
capital guidelines applicable to bank holding companies and banks. In addition, these regulatory agencies may from
time to time require that a bank holding company or bank maintain capital above the minimum levels, based on its
financial condition or actual or anticipated growth.
The Federal Reserve’s risk-based guidelines for bank holding companies establish a two-tier capital framework.
Tier 1 capital generally consists of common stockholders’ equity (which does not include unrealized gains and losses
on securities available for sale), less goodwill and certain identifiable intangible assets. Tier 2 capital includes Tier 1
capital plus the allowance for loan losses and subordinated debt, both subject to some limitations. The sum of Tier 1
and Tier 2 capital represents qualifying total capital, at least 50% of which must consist of Tier 1 capital.
Risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets. Assets and
off-balance sheet exposures are assigned to one of four categories of risk-weights, based primarily on relative credit
risk. The minimum Tier 1 risk- based capital ratios under these guidelines at December 31, 2013 were 4% and 8%,
respectively. At December 31, 2013, we had consolidated Tier 1 risk-based capital and total risk-based capital of
15.5% and 16.8%, respectively.
The Federal Reserve’s leverage capital guidelines establish a minimum leverage ratio determined by dividing Tier
1 capital by adjusted average total assets. The minimum leverage ratio is 3% for bank holding companies that meet
certain specified criteria, including having the highest regulatory rating. All other bank holding companies generally are
required to maintain a leverage ratio of at least 4%. At December 31, 2013, we had a consolidated leverage ratio of
11.3%.
22
In July 2013, the Federal banking regulators approved a final rule to implement the revised capital adequacy
standards of the Basel Committee on Banking Supervision, commonly called Basel III, and to address relevant
provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). The final rule
strengthens the definition of regulatory capital, increases risk-based capital requirements, makes selected changes to
the calculation of risk-weighted assets, and adjusts the prompt corrective action thresholds. Community banking
organizations, such as the Company and the Bank, become subject to the new rule on January 1, 2015 and certain
provisions of the new rule will be phased in over the period of 2015 through 2019. The final rule:
• Permits banking organizations that had less than $15 billion in total consolidated assets as of December 31,
2009, or were mutual holding companies as of May 19, 2010, to include in Tier 1 capital trust preferred
securities and cumulative perpetual preferred stock that were issued and included in Tier 1 capital prior to
May 19, 2010, subject to a limit of 25% of Tier 1 capital elements, excluding any non-qualifying capital
instruments and after all regulatory capital deductions and adjustments have been applied to Tier 1 capital.
• Establishes new qualifying criteria for regulatory capital, including new limitations on the inclusion of deferred
tax assets and mortgage servicing rights.
• Requires a minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5%.
•
Increases the minimum Tier 1 capital to risk-weighted assets ratio requirement from 4% to 6%.
• Retains the minimum total capital to risk-weighted assets ratio requirement of 8%.
• Establishes a minimum leverage ratio requirement of 4%.
• Retains the existing regulatory capital framework for 1-4 family residential mortgage exposures.
• Permits banking organizations that are not subject to the advanced approaches rule, such as the Company
and the Bank, to retain, through a one-time election, the existing treatment for most accumulated other
comprehensive income, such that unrealized gains and losses on securities available for sale will not affect
regulatory capital amounts and ratios.
•
Implements a new capital conservation buffer requirement for a banking organization to maintain a common
equity capital ratio more than 2.5% above the minimum common equity Tier 1 capital, Tier 1 capital and total
risk-based capital ratios in order to avoid limitations on capital distributions, including dividend payments,
and certain discretionary bonus payments. The capital conservation buffer requirement will be phased in
beginning on January 1, 2016 at 0.625% and will be fully phased in at 2.50% by January 1, 2019. A banking
organization with a buffer of less than the required amount would be subject to increasingly stringent
limitations on such distributions and payments as the buffer approaches zero. The new rule also generally
prohibits a banking organization from making such distributions or payments during any quarter if its eligible
retained income is negative and its capital conservation buffer ratio was 2.5% or less at the end of the
previous quarter. The eligible retained income of a banking organization is defined as its net income for the
four calendar quarters preceding the current calendar quarter, based on the organization’s quarterly
regulatory reports, net of any distributions and associated tax effects not already reflected in net income.
•
Increases capital requirements for past-due loans, high volatility commercial real estate exposures, and
certain short-term commitments and securitization exposures.
• Expands the recognition of collateral and guarantors in determining risk-weighted assets.
• Removes references to credit ratings consistent with the Dodd-Frank Act and establishes due diligence
requirements for securitization exposures.
The FDIC may impose additional restrictions on institutions that are undercapitalized and generally is authorized
to reclassify an institution into a lower capital category and impose the restrictions applicable to such category if the
institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition. An institution is deemed
“well capitalized” if it has at least a 5.0% Tier 1 capital ratio, a 6.0% Tier 1 risk-based capital ratio and 10.0% total risk-
based capital ratio. At December 31, 2013, the Bank was considered a “well capitalized” institution. For a complete
description of the Company’s and the Bank's required and actual capital levels as of December 31, 2013, see Note 19
of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary
Data.”
23
Prompt Corrective Action. Federal statutes establish a supervisory framework based on five capital categories:
well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.
An institution’s category depends upon where its capital levels are in relation to relevant capital measures, which
include a risk-based capital measure, a leverage ratio capital measure and certain other factors. The federal banking
agencies have adopted regulations that implement this statutory framework. Under these regulations, an institution is
treated as well capitalized if its ratio of total capital to risk-weighted assets is 10% or more, its ratio of core capital to
risk-weighted assets is 6% or more, its ratio of core capital to adjusted total assets (leverage ratio) is 5% or more, and
it is not subject to any federal supervisory order or directive to meet a specific capital level. In order to be adequately
capitalized, an institution must have a total risk-based capital ratio of not less than 8%, a core capital to risk-weighted
assets ratio of not less than 4%, and a leverage ratio of not less than 4%. An institution that is not well capitalized is
subject to certain restrictions on brokered deposits, including restrictions on the rates it can offer on its deposits
generally. Any institution which is neither well capitalized nor adequately capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and
restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by
Heritage Bank to comply with applicable capital requirements would, if unremedied, result in progressively more
severe restrictions on its activities and lead to enforcement actions, including, but not limited to, the issuance of a
capital directive to ensure the maintenance of required capital levels and, ultimately, the appointment of the FDIC as
receiver or conservator. Banking regulators will take prompt corrective action with respect to depository institutions
that do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for their
review may be dependent on compliance with capital requirements.
As of December 31, 2013, the Bank met the requirements to be classified as “well-capitalized.”
Federal law generally bars institutions which are not well capitalized from soliciting or accepting brokered
deposits bearing interest rates significantly higher than prevailing market rates.
The recently adopted final rule to strengthen regulatory capital standards will adjust the prompt corrective action
categories accordingly.
Deposit Insurance and Other FDIC Programs. The deposits of the Bank are insured up to applicable limits by
the Deposit Insurance Fund (“DIF”), which is administered by the FDIC. The FDIC is an independent federal agency
that insures the deposits, up to applicable limits, of depository institutions. As insurer of the Bank's deposits, the FDIC
has supervisory and enforcement authority over Heritage Bank and this insurance is backed by the full faith and credit
of the United States government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to
conduct examinations of and to require reporting by institutions insured by the FDIC. It also may prohibit any
institution insured by the FDIC from engaging in any activity determined by regulation or order to pose a serious risk
to the institution and the DIF. The FDIC also has the authority to initiate enforcement actions and may terminate the
deposit insurance if it determines that an institution has engaged in unsafe or unsound practices or is in an unsafe or
unsound condition.
The Dodd-Frank Act requires the FDIC’s deposit insurance assessments to be based on assets instead of
deposits. The FDIC issued rules under which the assessment base for a bank is equal to its total average
consolidated assets less average tangible capital. The FDIC assessment rates range from approximately five basis
points to 35 basis points, depending on applicable adjustments for unsecured debt issued by an institution and
brokered deposits (and to further adjustment for institutions that hold unsecured debt of other FDIC-insured
institutions), until such time as the FDIC’s reserve ratio equals 1.15%. Once the FDIC’s reserve ratio reaches 1.15%
and the reserve ratio for the immediately prior assessment period is less than 2.0%, the applicable assessment rates
may range from three basis points to 30 basis points (subject to adjustments as described above). If the reserve ratio
for the prior assessment period is equal to, or greater than 2.0% and less than 2.5%, the assessment rates may range
from two basis points to 28 basis points and if the prior assessment period is greater than 2.5%, the assessment rates
may range from one basis point to 25 basis points (in each case subject to adjustments as described above. No
institution may pay a dividend if it is in default on its federal deposit insurance assessment.
24
As insurer, the FDIC is authorized to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by
regulation or order to pose a serious threat to the DIF. The FDIC also has the authority to take enforcement actions
against banks and savings associations.
Other Regulatory Developments. Significant federal banking legislation has been enacted in recent years. The
following summarizes some of the recent significant federal banking legislation.
The Dodd-Frank Act: The Dodd-Frank-Act imposes new restrictions and an expanded framework of regulatory
oversight for financial institutions, including depository institutions and implements new capital regulations that we will
become subject to and that are discussed above under “- Capital Adequacy.”
In addition, among other changes, the Dodd-Frank Act requires public companies, like us, to (i) provide their
shareholders with a non-binding vote (a) at least once every three years on the compensation paid to executive
officers and (b) at least once every six years on whether they should have a “say on pay” vote every one, two or three
years; (ii) have a separate, non-binding shareholder vote regarding golden parachutes for named executive officers
when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the
parachute payments; (iii) provide disclosure in annual proxy materials concerning the relationship between the
executive compensation paid and the financial performance of the issuer; and (iv) amend Item 402 of Regulation S-K
to require companies to disclose the ratio of the Chief Executive Officer's annual total compensation to the median
annual total compensation of all other employees. For certain of these changes, the implementing regulations have
not been promulgated, so the full impact of the Dodd-Frank Act on public companies cannot be determined at this
time.
Sarbanes-Oxley Act. On July 30, 2002, the Sarbanes-Oxley Act of 2002 was signed into law in response to
public concerns regarding corporate accountability in connection with various accounting scandals. The stated goals
of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting
and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and
reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all
companies that file or are required to file periodic reports with the Securities and Exchange Commission (“SEC”),
under the Securities Exchange Act of 1934.
The Sarbanes-Oxley Act includes very specific additional disclosure requirements and corporate governance
rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and
other related rules. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to
state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the
relationship between a board of directors and management and between a board of directors and its committees. Our
policies and procedures have been updated to comply with the requirements of the Sarbanes-Oxley Act.
Financial Services Reform Legislation. On November 12, 1999, the Gramm-Leach-Bliley Act (“GLBA”) was
enacted into law. The GLBA removes various barriers imposed by the Glass-Steagall Act of 1933, specifically those
prohibiting banks and bank holding companies from engaging in the securities and insurance business. The GLBA
also expands the bank holding company act framework to permit bank holding companies with subsidiary banks
meeting certain capital and management requirements to elect to become a “financial holding company”.
Financial holding companies may engage in a full range of financial activities, including not only banking,
insurance, and securities activities, but also merchant banking and additional activities determined to be “financial in
nature” or “complementary” to an activity that is financial in nature. The GLBA also provides that the list of permissible
financial activities will be expanded as necessary for a financial holding company to keep abreast of competitive and
technological changes.
In addition, the GLBA expands the activities in which insured state banks may engage. Under the GLBA, insured
state banks are given the ability to engage in financial activities through a subsidiary, as long as the bank and its
affiliates meet and comply with certain requirements. First, each bank must be “well capitalized”. Second, the bank
must comply with certain capital deduction and financial statement requirements provided under the GLBA. Third, the
bank must comply with certain financial and operational safeguards provided under the GLBA. Fourth, the bank must
comply with the limits imposed by the GLBA on transactions with affiliates.
25
Website Access to Company Reports
We post publicly available reports required to be filed with the SEC on our website, www.HF-WA.com, as soon as
reasonably practicable after filing such reports with the SEC. The required reports are available free of charge through
our website.
Code of Ethics
We have adopted Code of Ethics that applies to our principal executive officer, principal financial officer and
controller. We have posted the text of our code of ethics at www.HF-WA.com in the section titled Investor Information:
Corporate Governance. Any waivers of the code of the ethics will be publicly disclosed to shareholders.
Competition
We compete for loans and deposits with other commercial banks, credit unions, mortgage bankers, and other
institutions in the scope and type of services offered, interest rates paid on deposits, pricing of loans, and number and
locations of branches, among other things. Many of our competitors have substantially greater resources than we do.
Particularly in times of high or rising interest rates, we also face significant competition for investors’ funds from short-
term money market securities and other corporate and government securities.
We compete for loans principally through the range and quality of the services we provide, interest rates and loan
fees, and the locations of our Bank's branches. We actively solicit deposit-related clients and compete for deposits by
offering depositors a variety of savings accounts, checking accounts, cash management and other services.
Employees
We had 373 full-time equivalent employees at December 31, 2013. We believe that employees play a vital role in
the success of a service company. Employees are provided with a variety of benefits such as medical, vision, dental
and life insurance, a retirement plan, and paid vacations and sick leave. None of our employees are covered by a
collective bargaining agreement.
Executive Officers
The following table sets forth certain information with respect to the executive officers of the Company at
December 31, 2013.
Name
Brian L. Vance
Jeffrey J. Deuel
Donald J. Hinson
D. Michael Broadhead
David A. Spurling
Age as of
December 31,
2013
59
55
52
68
60
Position
President and Chief Executive
Officer of Heritage; Chief
Executive Officer of Heritage Bank
Executive Vice President, Heritage;
President and Chief Operating
Officer of Heritage Bank
Executive Vice President and Chief
Financial Officer of Heritage and
Heritage Bank
President of Central Valley Bank, a
division of Heritage Bank
Senior Vice President and Chief
Credit Officer of Heritage Bank
Has Served the
Company or
Heritage Bank
Since
1996
2010
2005
1986
1999
26
The business experience of each executive officer is set forth below.
Brian L. Vance is the President and Chief Executive Officer of Heritage and Chief Executive Officer of Heritage
Bank as well as a director of Heritage. Mr. Vance was appointed President and Chief Executive Officer of Heritage
and Heritage Bank in 2006. In 2003, Mr. Vance was appointed President and Chief Executive Officer of Heritage
Bank and in 1998, Mr. Vance was named President and Chief Operating Officer of Heritage Bank. Mr. Vance joined
Heritage Bank in 1996 as its Executive Vice President and Chief Credit Officer. Prior to joining Heritage Bank,
Mr. Vance was employed for 24 years with West One Bank, a bank with offices in Idaho, Utah, Oregon and
Washington. Prior to leaving West One, he was Senior Vice President and Regional Manager of Banking Operations
for the south Puget Sound region.
Jeffrey J. Deuel was promoted to President and Chief Operating Officer of Heritage Bank and Executive Vice
President of Heritage in September 2012. In November 2010, Mr. Deuel was named Executive Vice President and Chief
Operating Officer of Heritage Bank and Executive Vice President of the Company. Mr. Deuel joined Heritage Bank in
February 2010 as Executive Vice President. Mr. Deuel came to the Company with 28 years of banking experience and
most recently held the position of Executive Vice President Commercial Operations with JPMorgan Chase, formerly
Washington Mutual. Prior to joining Washington Mutual Mr. Deuel was based in Philadelphia where he worked for Bank
United, First Union Bank, CoreStates Bank, and First Pennsylvania Bank. During his career Mr. Deuel held a variety of
leadership positions in commercial banking including lending, retail and support services, corporate strategies, credit
administration, and portfolio management. He earned his Bachelor’s degree at Gettysburg College.
Donald J. Hinson became Executive Vice President and Chief Financial Officer of Heritage Bank in September 2012.
In 2007 Mr. Hinson was appointed the Senior Vice President and Chief Financial Officer of Heritage and Heritage Bank.
Mr. Hinson joined Heritage Bank in 2005 as Vice President and Controller. Prior to that, he served in the banking audit
practice of local and national accounting firms of Knight, Vale and Gregory and RSM McGladrey from 1994 to 2005. Mr.
Hinson holds a Bachelors of Science degree in Accounting from Central Washington University and is a licensed Certified
Public Accountant.
D. Michael Broadhead has served as the President of Central Valley Bank since 1990 and in June 2013, Central Valley
Bank merged into Heritage Bank but continues to operate as a division of Heritage Bank. The Company acquired Central
Valley Bank in March 1999, and Mr. Broadhead had been with the bank since 1986. Previously, Mr. Broadhead held
positions with Farmers Home Administration and First Bank and Trust of Idaho where he held the position of Chief
Executive Officer.
David A. Spurling became Executive Vice President and Chief Credit Officer of Heritage Bank in January 2014. Prior to
that, he was the Senior Vice President and Chief Credit Officer of Heritage Bank beginning in 2007. Mr. Spurling joined
Heritage Bank in 2001 as a commercial lender, followed by a role as a commercial team leader. He began his banking
career as a middle market lender at Seafirst Bank, followed by positions as a commercial lender at Bank of America in
Small Business Banking and as a regional manager for Bank of America’s government-guaranteed lending division.
Mr. Spurling holds a Master’s Degree in Business Administration from the University of Washington and is Credit Risk
Certified by the Risk Management Association.
ITEM 1A. RISK FACTORS
We assume and manage a certain degree of risk in order to conduct our business strategy. The following provides a
discussion of certain risks that management believes are specific to our business. This discussion should not be viewed as
an all inclusive list or in any particular order.
Our strategy of pursuing acquisitions and de novo branching exposes us to financial, execution and operational
risks that could adversely affect us.
We are pursuing a strategy of supplementing organic growth by acquiring other financial institutions or their businesses
that we believe will help us fulfill our strategic objectives and enhance our earnings. There are risks associated with this
strategy, however, including the following:
• we may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks, businesses,
assets and liabilities we acquire. If these issues or liabilities exceed our estimates, our results of operations and
financial condition may be materially negatively affected;
27
•
•
prices at which acquisitions can be made fluctuate with market conditions. We have experienced times during
which acquisitions could not be made in specific markets at prices we considered acceptable and expect that
we may continue to experience this condition in the future;
the acquisition of other entities generally requires integration of systems, procedures and personnel of the
acquired entity into our company to make the transaction economically successful. This integration process is
complicated and time consuming and can also be disruptive to the customers of the acquired business. If the
integration process is not conducted successfully and with minimal effect on the acquired business and its
customers, we may not realize the anticipated economic benefits of an acquisition within the expected time
frame, and we may lose customers or employees of the acquired business. We may also experience greater
than anticipated customer losses even if the integration process is successful. These risks are present in our
completed FDIC-assisted transactions involving our assumption of deposits and the acquisition of assets of
Cowlitz Bank (the “Cowlitz Acquisition”) and Pierce Commercial Bank (the “Pierce Commercial Acquisition”),
and together with the Cowlitz Acquisition, the “Cowlitz and Pierce Commercial Acquisitions” in 2010 and in the
recently completed open-bank acquisitions of Northwest Commercial Bank and Valley Community Bancshares
on January 9, 2013 and July 15, 2013, respectively. This risk is also present in the pending merger with
Washington Banking Company;
•
to finance an acquisition, we may borrow funds, thereby increasing our leverage and diminishing our liquidity, or
raise additional capital, which could dilute the interests of our existing shareholders.
• we completed two acquisitions during 2010 and two acquisitions during 2013 that enhanced our rate of growth.
We also announced the merger of Washington Banking Company and its subsidiary, Whidbey Island Bank, in
October 2013, which is currently expected to be completed in the second quarter of 2014. We may not be able
to continue to sustain our past rate of growth or to grow at all in the future;
• we expect our net income will increase following our acquisitions, however, we also expect our general and
administrative expenses and consequently our efficiency ratios will also increase. Ultimately, we would expect
our efficiency ratio to improve; however, if we are not successful in our integration process, this may not occur,
and our acquisitions or branching activities may not be accretive to earnings in the short or long-term; and
•
the purchase and assumption agreement and the shared-loss agreements we entered into with the FDIC in
connection with the Cowlitz and Pierce Commercial Acquisitions, have specific, detailed and cumbersome
compliance, servicing, notification and reporting requirements. Our failure to comply with the terms of the
agreements or to properly service the loans and real estate owned under the requirements of the shared-loss
agreements may cause individual loans or large pools of loans to lose eligibility for loss share payments from
the FDIC. This could result in material losses that are currently not anticipated.
Our business strategy includes significant growth plans, and our financial condition and results of
operations could be negatively affected if we fail to grow or fail to manage our growth effectively.
We intend to pursue a significant growth strategy for our business. We regularly evaluate potential acquisitions and
expansion opportunities. If appropriate opportunities present themselves, we expect to engage in selected acquisitions
of financial institutions in the future, including FDIC-assisted transactions, branch acquisitions, or other business growth
initiatives or undertakings. There can be no assurance that we will successfully identify appropriate opportunities, that we
will be able to negotiate or finance such activities or that such activities, if undertaken, will be successful.
Our growth initiatives may require us to recruit experienced personnel to assist in such initiatives, which will
increase our compensation costs. In addition, the failure to identify and retain such personnel would place significant
limitations on our ability to successfully execute our growth strategy. To the extent we expand our lending beyond our
current market areas, we also could incur additional risk related to those new market areas. We may not be able to
expand our market presence in our existing market areas or successfully enter new markets.
If we do not successfully execute our acquisition growth plan, it could adversely affect our business, financial
condition, results of operations, reputation and growth prospects. In addition, if we were to conclude that the value of
an acquired business had decreased and that the related goodwill had been impaired, that conclusion would result in
an impairment of goodwill charge to us, which would adversely affect our results of operations. While we believe we
have the executive management resources and internal systems in place to successfully manage our future growth,
there can be no assurance that suitable growth opportunities will be available or that we will successfully manage our
growth. See “-If the goodwill we have recorded in connection with acquisitions becomes impaired, our earnings and
capital could be reduced” and “-Our strategy of pursuing acquisitions and de novo branching exposes us to financial,
execution and operational risks that could adversely affect us” for additional risks related to our acquisition strategy.
28
Failure to comply with the terms of the shared-loss agreements with the FDIC may result in significant losses.
In connection with the Cowlitz Bank Acquisition, Heritage Bank entered into shared-loss agreements with the
FDIC that significantly reduce the Bank’s credit loss exposure. The purchase and assumption agreement and the
shared-loss agreements for the Cowlitz Bank Acquisition have specific, detailed and cumbersome compliance,
servicing, notification and reporting requirements. Our failure to comply with the terms of the agreements or to
properly service the loans and other real estate owned under the requirements of the shared-loss agreement may
cause individual loans or large pools of loans to lose eligibility for loss share payments from the FDIC. This could
result in material losses that are currently not anticipated.
We may engage in additional FDIC-assisted transactions, which could present additional risks to our
business.
We may have additional opportunities to acquire the assets and liabilities of failed banks in FDIC-assisted
transactions. Although these FDIC-assisted transactions typically provide for FDIC assistance to an acquirer to
mitigate certain risks, such as sharing exposure to loan losses and providing indemnification against certain liabilities
of the failed institution, we are (and would be in future transactions) subject to many of the same risks we would
experience in acquiring another bank in a negotiated transaction, including risks associated with maintaining customer
relationships and failure to realize the anticipated acquisition benefits in the amounts and within the timeframes we
expect. In addition, because these acquisitions are structured in a manner that would not allow us the time and
access to information normally associated with preparing for and evaluating a negotiated acquisition, we may face
additional risks in FDIC-assisted transactions, including additional pressure on management resources, management
of problem loans, problems related to integration of personnel and operating systems, and the resulting impact to our
capital resources that may require us to raise additional capital. We may not be successful in overcoming these risks
or any other problems encountered in connection with FDIC-assisted transactions. Our inability to overcome these
risks could have a material adverse effect on our business, financial condition and results of operations.
We operate in a highly regulated environment and may be adversely affected by changes in federal and state
laws and regulations.
We are subject to extensive examination, supervision and comprehensive regulation by the Federal Reserve and
Heritage Bank is subject to examination, supervision and comprehensive regulation by the FDIC and the Division. The
Federal Reserve, FDIC and Division govern the activities in which we may engage, primarily for the protection of
depositors and the Deposit Insurance Fund. These regulatory authorities have extensive discretion in connection with
their supervisory and enforcement activities, including the requirement for additional capital, the imposition of
restrictions on an institution’s operations, the reclassification of assets and the adequacy of an institution’s allowance
for loan losses, the determination of the level of deposit insurance premiums assessed and the approval of merger
transactions.
The potential exists for additional Federal or state laws and regulations regarding capital requirements, lending
and funding practices and liquidity standards, and bank regulatory agencies are expected to remain active in
responding to concerns and trends identified in examinations, including the potential issuance of formal enforcement
orders. Actions taken to date, as well as potential actions, may not have the beneficial effects that are intended. In
addition, new laws, regulations, and other regulatory changes could increase our costs of regulatory compliance and
of doing business, and otherwise affect our operations. New laws, regulations, and other regulatory changes, along
with negative developments in the financial industry and the domestic and international credit markets, may
significantly affect the markets in which we do business, the markets for and value of our loans and investments, and
our on-going operations, costs and profitability.
29
The Dodd-Frank Act, among other things, created a new CFPB, tightened capital standards and will continue
to result in new laws and regulations that are expected to increase our costs of operations.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) has
significantly changed the bank regulatory structure and has affected the lending, deposit, investment, trading and
operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal
agencies to adopt a broad range of new rules and regulations, and to prepare numerous studies and reports for
Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and
consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months
or years. However, it is expected that the legislation and implementing regulations may materially increase our
operating and compliance costs.
The Dodd-Frank Act created a new Consumer Financial Protection Bureau (“CFPB”) with broad powers to
supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of
consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair,
deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks and
savings institutions with more than $10 billion in assets. Financial institutions such as Heritage Bank with $10 billion or
less in assets will continue to be examined for compliance with the consumer laws by their primary bank regulators.
Effective July 21, 2011, the Dodd-Frank Act eliminated the federal prohibitions on paying interest on demand
deposits, thus allowing businesses to have interest bearing checking accounts, which could result in an increase in
our interest expense.
The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments are now based on
the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also
permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to
$250,000 per depositor retroactive to January 1, 2009, and non-interest bearing transaction accounts had unlimited
deposit insurance through December 31, 2012. The legislation also increases the required minimum reserve ratio for
the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits, and directs the FDIC to offset the effects of
increased assessments on depository institutions with less than $10 billion in assets.
The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive
compensation and so-called “golden parachute” payments and authorizes the SEC to promulgate rules that would
allow stockholders to nominate their own candidate using a company’s proxy materials. It also provides that the listing
standards of the national securities exchanges shall require listed companies to implement and disclose “clawback”
policies mandating the recovery of incentive compensation paid to executive officers in connection with accounting
restatements. The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive
compensation paid to bank holding company executives, regardless of whether the company is publicly traded.
Effective December 10, 2013, pursuant to the Dodd-Frank Act, federal banking and securities regulators issued
final rules to implement Section 619 of the Dodd-Frank Act (the “Volcker Rule”). Generally, subject to a transition
period and certain exceptions, the Volcker Rule restricts insured depository institutions and their affiliated companies
from engaging in short-term proprietary trading of certain securities, investing in funds with collateral comprised of
less than 100% loans that are not registered with the SEC and from engaging in hedging activities that do not hedge a
specific identified risk. After the transition period, the Volcker Rule prohibitions and restrictions will apply to banking
entities, including the Company, unless an exception applies. We are analyzing the impact of the Volcker Rule on our
investment portfolio and we anticipate changes to our investment strategies, which could negatively affect our
earnings.
The full impact of the Dodd-Frank Act on our business and operations may not be known for years until final
regulations implementing the statute are adopted. The Dodd-Frank Act may have a material impact on our operations,
particularly through increased regulatory burden and compliance costs. Any future legislative changes could have a
material impact on our profitability, the value of assets held for investment or the value of collateral for loans. Future
legislative changes could also require changes to business practices or force us to discontinue businesses and
potentially expose us to additional costs, liabilities, enforcement action and reputational risk.
30
The short-term and long-term impact of the changing regulatory capital requirements and new capital rules is
uncertain.
In July 2013, the FDIC and the Federal Reserve Board approved a new rule that will substantially amend the
regulatory risk-based capital rules applicable to the Company and the Bank. The final rule implements the “Basel III”
regulatory capital reforms and changes required by the Dodd-Frank Act.
The final rule includes new capital requirements under regulations adopted by the federal banking regulators to
implement the Basel III regulatory capital reform and changes required by the Dodd-Frank Act. These new
requirements are effective for the Company and the Bank on January 1, 2015 and establish the following minimum
capital ratios: (1) a common equity Tier 1 (“CET1”) capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 capital
ratio of 6.0% of risk-weighted assets; (3) a total capital ratio of 8.0% of risk-weighted assets; and (4) a leverage ratio
of 4.0%. In addition, there is a new requirement to maintain a capital conservation buffer, comprised of CET1 capital,
in an amount greater than 2.5% of risk-weighted assets over the minimum capital required by each of the minimum
risk-based capital ratios in order to avoid limitations on the organization’s ability to pay dividends, repurchase shares
or pay discretionary bonuses. The capital conservation buffer requirement will be phased in, beginning January 1,
2016, requiring during 2016 a buffer amount greater than 0.625% in order to avoid these limitations, and increasing
the amount each year until beginning January 1, 2019, the buffer amount must be greater than 2.5% in order to avoid
the limitation.
The new regulations also change what qualifies as capital for purposes of meeting these various capital
requirements, as well as the risk-weights of certain assets for purposes of the risk-based capital ratios. Under the new
regulations, in order to be considered well-capitalized for prompt corrective action purposes, Heritage Bank will be
required to maintain the following ratios: (1) a CET1 ratio of at least 6.5% of risk-weighted assets; (2) a Tier 1 capital
ratio of at least 8.0% of risk-weighted assets; (3) a total capital ratio of at least 10.0% of risk-weighted assets; and (4)
a leverage ratio of at least 5.0%.
The application of more stringent capital requirements for us and Heritage Bank could, among other things, result
in lower returns on invested capital, require the raising of additional capital, and result in regulatory actions if we were
to be unable to comply with such requirements. Furthermore, the imposition of liquidity requirements in connection
with the implementation of Basel III could result in our having to lengthen the term of our funding, restructure our
business models, and/or increase our holdings of liquid assets. Implementation of changes to asset risk weightings for
risk based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital
conservation buffers could result in management modifying its business strategy and could limit our ability to make
distributions, including paying out dividends or buying back shares.
New regulations could restrict our ability to originate and sell mortgage loans.
The CFPB has issued a rule designed to clarify for lenders how they can avoid monetary damages under the
Dodd-Frank Act, which would hold lenders accountable for ensuring a borrower’s ability to repay a mortgage. Loans
that meet this “qualified mortgage” definition will be presumed to have complied with the new ability-to-repay standard.
Under the CFPB’s rule, a “qualified mortgage” loan must not contain certain specified features, including:
• excessive upfront points and fees (those exceeding 3% of the total loan amount, less “bona fide discount
points” for prime loans);
•
interest-only payments;
• Negative-amortization; and
•
terms longer than 30 years.
Also, to qualify as a “qualified mortgage,” a borrower’s total debt-to-income ratio may not exceed 43%. Lenders
must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and
underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five
years, taking into account all applicable taxes, insurance and assessments. The CFPB’s rule on qualified mortgages
could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more
expensive/and or time consuming to make these loans, which could limit our growth or profitability.
31
Our loan portfolio is concentrated in loans with a higher risk of loss.
Repayment of our commercial business loans, consisting of commercial and industrial loans as well as owner-
occupied and non-owner occupied commercial real estate loans, is often dependent on the cash flows of the
borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value. We offer
different types of commercial loans to a variety of businesses with a focus on real estate related industries and
businesses in agricultural, healthcare, legal, and other professions. The types of commercial loans offered are
business lines of credit, term equipment financing and term real estate loans. We also originate loans that are
guaranteed by the Small Business Administration, or SBA, and are a “preferred lender” of the SBA. Commercial
business lending involves risks that are different from those associated with real estate lending. Real estate lending is
generally considered to be collateral based lending with loan amounts established on predetermined loan to collateral
values and liquidation of the underlying real estate collateral being viewed as the primary source of repayment in the
event of borrower default. Our commercial business loans are primarily made based on our assessment of the cash
flow of the borrower and secondarily on the underlying collateral provided by the borrower. The borrowers’ cash flow
may be unpredictable, and collateral securing these loans may fluctuate in value. Although commercial business loans
are often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of
collateral in the event of default is often an insufficient source of repayment because accounts receivable may be
uncollectible and inventories may be obsolete or of limited use, among other things. Accordingly, the repayment of
commercial business loans depends primarily on the cash flow and creditworthiness of the borrower and secondarily
on the underlying collateral provided by the borrower. In addition, as part of our commercial business lending
activities, we originate agricultural loans. Payments on agricultural loans are typically dependent on the profitable
operation or management of the related farm property. The success of the farm may be affected by many factors
outside the control of the borrower, including adverse weather conditions that prevent the planting of a crop or limit
crop yields, declines in market prices for agricultural products and the impact of government regulations. In addition,
many farms are dependent on a limited number of key individuals whose injury or death may significantly affect the
successful operation of the farm. If the cash flow from a farming operation is diminished, the borrower’s ability to
repay the loan may be impaired.
At December 31, 2013, our originated commercial business loans (consisting of commercial and industrial loans,
owner-occupied commercial real estate loans and non-owner occupied commercial real estate loans) totaled $848.8
million, or approximately 86.9% of our total originated loan portfolio. Approximately $5.5 million, or 0.7%, of our total
originated commercial business loans were nonperforming at December 31, 2013. The majority of the nonperforming
commercial business loans were commercial and industrial loans.
Our non-owner occupied commercial real estate loans, which includes five or more family residential real estate
loans, involve higher principal amounts than other loans and repayment of these loans may be dependent on factors
outside our control or the control of our borrowers. We originate commercial and five or more family residential real
estate loans for individuals and businesses for various purposes, which are secured by commercial properties. These
loans typically involve higher principal amounts than other types of loans, and repayment is dependent upon income
generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating
expenses and debt service, which may be adversely affected by changes in the economy or local market conditions.
For example, if the cash flow from the borrower’s project is reduced as a result of leases not being obtained or
renewed, the borrower’s ability to repay the loan may be impaired.
Commercial and five or more family residential real estate loans also expose us to greater credit risk than loans
secured by residential real estate because the collateral securing these loans typically cannot be sold as easily as
residential real estate. In addition, many of our commercial and five or more family residential real estate loans are not
fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower
to either sell or refinance the underlying property in order to make the payment, which may increase the risk of default
or non-payment. If we foreclose on a commercial and five or more family residential real estate loan, our holding
period for the collateral typically is longer than for one-to-four family residential mortgage loans because there are
fewer potential purchasers of the collateral. Additionally, commercial and five or more family residential real estate
loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, if we
make any errors in judgment in the collectability of our commercial and five or more family residential real estate
loans, any resulting charge-offs may be larger on a per loan basis than those incurred with our residential or
consumer loan portfolios.
32
As of December 31, 2013, our non-owner occupied commercial real estate loans totaled $354.5 million, or 36.3%
of our total originated loan portfolio.
Our real estate construction and land development loans are based upon estimates of costs and value
associated with the completed project. These estimates may be inaccurate. Construction lending can involve a
higher level of risk than other types of lending because funds are advanced partially based upon the value of the
project, which is uncertain prior to the project’s completion. Because of the uncertainties inherent in estimating
construction costs as well as the market value of a completed project and the effects of governmental regulation of
real property, our estimates with regards to the total funds required to complete a project and the related loan-to-value
ratio may vary from actual results. As a result, construction loans often involve the disbursement of substantial funds
with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or
lease the property or refinance the indebtedness. If our estimate of the value of a project at completion proves to be
overstated, it may have inadequate security for repayment of the loan and may incur a loss.
As of December 31, 2013, our originated real estate construction and land development loans totaled $63.8
million, or 6.5% of our total originated loan portfolio. Of these loans, $18.6 million, or 1.9% of our total originated loan
portfolio, were one-to-four family residential construction related and $45.2 million, or 4.6% of our total originated loan
portfolio, were five-or-more family residential and commercial construction related. Approximately $1.0 million, or
1.6%, of our total originated construction loans were nonperforming at December 31, 2013.
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
Lending money is a substantial part of our business. Every loan carries a certain risk that it will not be repaid in
accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is
affected by, among other things:
•
•
•
•
•
cash flow of the borrower and/or the project being financed;
the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
the character and creditworthiness of a particular borrower;
changes in economic and industry conditions; and
the duration of the loan.
We maintain an allowance for loan losses on our loans, which is a reserve established through a provision for
loan losses charged against income, which we believe is appropriate to provide for probable losses in our loan
portfolio. The amount of this allowance is determined by our management through a periodic review and consideration
of several factors, including, but not limited to:
• our general reserve, based on our historical default and loss experience;
• our specific reserve, based on our evaluation of nonperforming loans and their underlying collateral or
discounted cash flows; and
•
current macroeconomic factors and management’s expectation of future events.
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of
subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may
undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information
regarding existing loans, identification of additional problem loans and other factors, both within and outside of our
control, may require an increase in the allowance for loan losses. If current weak conditions in the housing and real
estate markets continue, we expect we will continue to experience further delinquencies and credit losses. In addition,
bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the
provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than
those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses we will need
additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will
result in a decrease in net income and possibly capital, and may have a material adverse effect on our financial
condition and results of operations.
33
If our allowance for loan losses is not adequate, we may be required to make further increases in our
provision for loan losses and to charge-off additional loans, which could adversely affect our results of
operations and our capital.
For the year ended December 31, 2013 we recorded a total provision for loan losses of $3.7 million compared to
$2.0 million for the year ended December 31, 2012. The provision related to the originated portfolio was $890,000 and
$695,000 for the years ended December 31, 2013 and 2012, respectively. Our provision for loan losses on purchased
loans was $2.8 million and $1.3 million for the years ended December 31, 2013 and 2012, respectively. We recorded
net loan charge-offs of $3.4 million for the year ended December 31, 2013 compared to $4.3 million for the year
ended December 31, 2012. The net charge-offs related to the originated portfolio was $2.9 million and $3.9 million for
the years ended December 31, 2013 and 2012, respectively. Recently, we have been experiencing decreasing loan
delinquencies and decreasing loan charge-offs. Generally, our nonperforming loans and assets reflect operating
difficulties of individual borrowers resulting from weakness in the local economy. The deterioration in the general
economy has been a significant contributing factor to our current level of delinquencies and nonperforming loans. The
economy has significantly impacted our commercial and industrial loan portfolio, which represented 64.7% of our
nonaccrual originated loans at December 31, 2013. Slower sales and excess inventory in the housing market has
been the primary cause of the increase in foreclosures for one-to-four family residential construction loans, which
represented 15.0% of our nonperforming originated loans at December 31, 2013. At December 31, 2013 our total
nonperforming originated loans were $6.9 million, or 0.53% of total originated loans, compared to $12.5 million or
1.28% of total originated loans at December 31, 2012. If economic conditions deteriorate, we expect that we could
experience significantly higher delinquencies and loan charge-offs. As a result, we may be required to make further
increases in our provision for loan losses in the future, which could adversely affect our financial condition and results
of operations, perhaps materially.
The current economic condition in the market areas we serve may continue to adversely impact our earnings
and could increase the credit risk associated with our loan portfolio.
Substantially all of our loans are to businesses and individuals in the states of Washington and Oregon, and a
continuing decline in the economies of our primary market areas of the Pacific Northwest could have a material
adverse effect on our business, financial condition, results of operations and prospects. In particular, in the current
downturn, the Puget Sound and Portland, Oregon areas have experienced substantial home price declines, increased
foreclosures and above-average unemployment rates. Many large Pacific Northwest businesses have implemented
substantial employee layoffs and scaled back plans for future growth. The Yakima Valley also has similarly
experienced an increased unemployment rate and a continued decline in housing prices.
Continued weakness or a further deterioration in economic conditions in the market areas we serve could result
in the following consequences, any of which could have a materially adverse impact on our business, financial
condition and results of operations:
•
loan delinquencies, problem assets and foreclosures may increase;
• we may increase our provision for loan losses;
• demand for our products and services may decline possibly resulting in a decrease in our total loans;
•
•
collateral for loans made may decline further in value, exposing us to increased risk of loss on existing loans;
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;
and
•
the amount of our deposits may decrease and the composition of our deposits may be adversely affected.
34
If the goodwill we have recorded in connection with acquisitions becomes impaired, our earnings and capital
could be reduced.
Accounting standards require that we account for acquisitions using the purchase method of accounting. Under
purchase accounting, if the purchase price of an acquired company exceeds the fair value of its net assets, the
excess is carried on the acquirer’s balance sheet as goodwill. In accordance with generally accepted accounting
principles, our goodwill is evaluated for impairment on an annual basis or more frequently if events or circumstances
indicate that a potential impairment exists. Such evaluation is based on a variety of factors, including the quoted price
of our common stock, market prices of common stock of other banking organizations, common stock trading multiples,
discounted cash flows, and data from comparable acquisitions. At December 31, 2013, we had goodwill with a
carrying amount of $29.4 million.
Declines in our stock price or a prolonged weakness in the operating environment of the financial services
industry may result in a future impairment charge. Any such impairment charge could have a material adverse affect
on our operating results and capital.
Fluctuating interest rates can adversely affect our profitability.
Our profitability is dependent to a large extent upon net interest income, which is the difference (or “spread”)
between the interest earned on loans, securities and other interest-earning assets and the interest paid on deposits,
borrowings, and other interest-bearing liabilities. Because of the differences in maturities and repricing characteristics
of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent
changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities.
Accordingly, fluctuations in interest rates could adversely affect our interest rate spread, and, in turn, our profitability.
Although management believes it has implemented effective asset and liability management strategies to reduce
the potential effects of changes in interest rates on our results of operations, any substantial, unexpected or prolonged
change in market interest rates could have a material adverse effect on our financial condition and results of
operations. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the
impact of actual interest rate changes on our balance sheet.
Historically low interest rates may adversely affect our net interest income and profitability.
During the past four years it has been the policy of the Federal Reserve Board to maintain interest rates at
historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a
result, market rates on the loans we have originated and the yields on securities we have purchased have been at
lower levels than available prior to 2008. As a general matter, our interest-bearing liabilities reprice or mature more
quickly than our interest-earning assets, which has been one factor contributing to the increase in our interest rate
spread as interest rates decreased. However, our ability to lower our interest expense will be limited at these interest
rate levels while the average yield on our interest-earning assets may continue to decrease. The Federal Reserve
Board has recently indicated its intention to maintain low interest rates through at least late 2014. Accordingly, our net
interest income may be adversely affected and may decrease, which may have an adverse effect on our profitability.
The tightening of available liquidity could limit our ability to replace deposits and fund loan demand, which
could adversely affect our earnings and capital levels.
A tightening of the credit markets and the inability to obtain adequate funding to replace deposits and fund
continued loan growth may negatively affect asset growth and, consequently, our earnings capability and capital
levels. In addition to any deposit growth, maturity of investment securities and loan payments, we rely from time to
time on advances from the Federal Home Loan Bank of Seattle, or FHLB, and certain other wholesale funding
sources to fund loans and replace deposits. In the event of a further downturn in the economy, these additional
funding sources could be negatively affected which could limit the funds available to us. Our liquidity position could be
significantly constrained if we were unable to access funds from the FHLB or other wholesale funding sources.
35
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be
available when it is needed or the cost of that capital may be very high; further, the resulting dilution of our
equity may adversely affect the market price of our common stock.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our
operations. At some point we may need to raise additional capital to support continued internal growth and growth
through acquisitions. Our ability to raise additional capital, however, will depend on conditions in the capital markets at
that time, which are outside our control, and on our financial condition and performance. If we are able to raise capital
it may not be on terms that are acceptable to us. If we cannot raise additional capital when needed, our ability to
further expand our operations through internal growth and acquisitions could be materially impaired and our financial
condition and liquidity could be materially and adversely affected. Accordingly, we cannot make assurances that we
will be able to raise additional capital when needed.
We are not restricted from issuing additional common stock or preferred stock, including any securities that are
convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any
substantially similar securities. The market price of our common stock could decline as a result of sales of a large
number of shares of common stock or preferred stock or similar securities in the market or from the perception that
such sales could occur.
Our board of directors is authorized generally to cause us to issue additional common stock, as well as series of
preferred stock, without any action on the part of our shareholders except as may be required under the listing
requirements of the NASDAQ Stock Market. In addition, the board has the power, without shareholder approval, to set
the terms of any such series of preferred stock that may be issued, including voting rights, dividend rights and
preferences over the common stock with respect to dividends or upon the liquidation, dissolution or winding-up of our
business and other terms.
In addition, if we issue preferred stock in the future that has a preference over the common stock with respect to
the payment of dividends or upon liquidation, dissolution or winding-up, or if we issue preferred stock with voting rights
that dilute the voting power of the common stock, the rights of holders of the common stock or the market price of the
common stock could be adversely affected.
Deterioration in the financial position of the Federal Home Loan Bank of Seattle may result in future
impairment losses of our investment in Federal Home Loan Bank stock.
At December 31, 2013, we owned $5.7 million of stock of the FHLB of Seattle. As a condition of membership at
the FHLB, we are required to purchase and hold a certain amount of FHLB stock. Our stock purchase requirement is
based, in part, upon the outstanding principal balance of advances from the FHLB and is calculated in accordance
with the Capital Plan of the FHLB. Our FHLB stock has a par value of $100, is carried at cost, and is subject to
impairment testing pursuant to applicable accounting standards. In December 2008, the FHLB announced that it had
a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency, or the FHFA, its primary
regulator, and that it would suspend future dividends and the repurchase and redemption of outstanding common
stock. As a result, on October 25, 2010, the FHLB received a consent order from the FHFA, which it has been
operating under since that time. In September 2012, the FHLB of Seattle announced that its financial condition had
improved and that the FHFA had authorized the FHLB Seattle to repurchase up to $25 million of excess capital stock
per quarter at par ($100 per share) as long as its financial condition does not deteriorate. After receiving FHFA
approval, the FHLB of Seattle repurchased $24.1 million in excess capital stock in late September 2012. In July 2013
the FHLB announced that, based on its second quarter 2013 financial results, their Board of Directors had declared a
$0.025 per share cash dividend. This represented the first dividend in a number of years and represents a significant
milestone in FHLB's return to normal operations. Subsequently, the FHLB declared an additional dividend of $0.025
per share based on its third quarter 2013 financial results. In addition, the FHLB of Seattle repurchased $74.0 million
in excess capital stock from January 1, 2013 to September 30, 2013. As a result of the FHLB of Seattle's improved
financial condition, we have not recorded an impairment on our investment in FHLB stock. Further deterioration in the
FHLB's financial position may, however, result in future impairment in the value of those securities. We will continue
to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of our investment.
36
New or changing tax, accounting, and regulatory rules and interpretations could significantly impact strategic
initiatives, results of operations, cash flows, and financial condition.
The financial services industry is extensively regulated. Federal and state banking regulations are designed
primarily to protect the deposit insurance funds and consumers, not to benefit a company’s stockholders. Regulatory
authorities have extensive discretion in connection with their supervisory and enforcement activities, including the
imposition of restrictions on the operation of an institution, the classification of assets by the institution and the
adequacy of an institution’s allowance for loan losses. Additionally, actions by regulatory agencies or significant
litigation against us could require us to devote significant time and resources to defending our business and may lead
to penalties that materially affect us. These regulations, along with the currently existing tax, accounting, securities,
insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by
which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial
reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly
evolving and may change significantly over time. For information regarding the significant federal and state banking
regulations that affect us, see “Item 1. Business—Supervision and Regulation.”
We rely heavily on the proper functioning of our technology.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or
breach in security of these systems could result in failures or disruptions in our customer relationship management,
general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit
the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any
such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately
addressed. The occurrence of any failures, interruptions or security breaches of our information systems could
damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us
to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial
condition and results of operations.
We rely on third-party service providers for much of our communications, information, operating and financial
control systems technology. If any of our third-party service providers experience financial, operational or
technological difficulties, or if there is any other disruption in our relationships with them, we may be required to locate
alternative sources of such services, and we cannot assure that we could negotiate terms that are as favorable to us,
or could obtain services with similar functionality, as found in our existing systems, without the need to expend
substantial resources, if at all. Any of these circumstances could have an adverse effect on our business.
Changes in accounting standards may affect how we record and report our performance.
Our accounting policies and methods are fundamental to how we record and report our financial condition and
results of operations. From time to time there are changes in the financial accounting and reporting standards that
govern the preparation of our financial statements. These changes can be difficult to predict and can materially impact
how we report and record our financial condition and results of operations. In some cases, we could be required to
apply a new or revised standard retroactively, resulting in a retrospective adjustment to prior financial statements.
We are dependent on key personnel and the loss of one or more of those key personnel may materially and
adversely affect our prospects.
Competition for qualified employees and personnel in the banking industry is intense and there are a limited
number of qualified persons with knowledge of, and experience in, the community banking industry where we conduct
our business. The process of recruiting personnel with the combination of skills and attributes required to carry out our
strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified
management, loan origination, finance, administrative, marketing and technical personnel and upon the continued
contributions of our management and personnel. In particular, our success has been and continues to be highly
dependent upon the abilities of key executives, including our President and Chief Executive Officer, Mr. Brian L.
Vance, and certain other employees. The loss of key personnel could adversely affect our ability to successfully
conduct our business.
37
ITEM 1B. UNRESOLVED STAFF COMMENTS
The Company has no unresolved staff comments from the Securities and Exchange Commission ("SEC") as it
relates to the Company's financial information as reported on Form 10-K.
ITEM 2. PROPERTIES
Our executive offices and the main office of Heritage Bank are located in approximately 22,000 square feet of the
headquarters building and adjacent office space and main branch office which are owned by Heritage Bank and
located in downtown Olympia. The Company's branch network at December 31, 2013 is comprised of 35 branches
located throughout Washington and Oregon counties. The number of branches per county, as well as occupancy
type, is detailed in the following table.
Occupancy Type
County
Pierce ...............................
King ..................................
Thurston ...........................
Yakima .............................
Cowlitz .............................
Clark ................................
Multnomah .......................
Mason ..............................
Kittitas ..............................
Number of Branches
13
6
5
5
2
1
1
1
1
Total .................................
35
Owned
8
2
5
5
2
—
—
1
1
24
Leased
5
4
—
—
—
1
1
—
—
11
One Thurston County branch and the one Kittitas County branch have land leases, which are not included in the
leased section above as the building is owned.
For additional information concerning our premises and equipment and lease obligations, see Notes 9 and 20,
respectively, to the Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary Data.”
ITEM 3. LEGAL PROCEEDINGS
We, and our Bank, are not a party to any material pending legal proceedings other than ordinary routine litigation
incidental to the business of the Bank, other than the matters described below.
Washington Banking, its directors and Heritage are named as defendants in two lawsuits pending in the Superior
Court for the State of Washington in King County, Washington, which have been consolidated under the caption In Re
Washington Banking Company Shareholder Litigation, Lead Case No. 13-2-38689-5 SEA. The consolidated litigation
generally alleges that Washington Banking’s directors breached their fiduciary duties to Washington Banking and its
shareholders by agreeing to the proposed merger at an unfair price and without an adequate sales process, because
they have interests in the merger different from shareholders and by agreeing to deal protection provisions in the
merger agreement that are alleged to prevent bids by third parties. The consolidated litigation also alleges that the
disclosures in connection with the merger are misleading in various respects. Heritage is alleged to have aided and
abetted the directors’ alleged breaches of their fiduciary duties. The consolidated litigation seeks, among other things,
an order enjoining the defendants from consummating the proposed merger, as well as attorneys’ and experts’ fees
and certain other damages.
Heritage believes that the aiding and abetting claim against it lacks merit. Washington Banking and its directors
and Heritage separately filed motions to dismiss the claims against them.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable
38
PART II
ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the NASDAQ Global Select Market under the symbol HFWA. At December 31,
2013, we had approximately 1,302 shareholders of record (not including the number of persons or entities holding
stock in nominee or street name through various brokerage firms) and 16,210,747 outstanding shares of common
stock. This total does not reflect the number of persons or entities who hold stock in nominee or “street” name through
various brokerage firms. The last reported sales price on February 25, 2014 was $17.50 per share. The following
table provides sales information per share of our common stock as reported on the NASDAQ Global Select Market for
the indicated quarters.
High ...................................................... $
Low....................................................... $
15.22
13.84
$
$
14.65
13.25
March 31
June 30
September 30
$
$
16.45
14.75
December 31
$
$
17.48
15.01
2013 Quarter ended,
For the interim period subsequent to the 2013 fiscal year through the last reported sales price on February 25,
2014, the high and low sales information price per share of our common stock as reported on the NASDAQ Global
Selected Market was $18.48 and $16.18, respectively.
High ...................................................... $
Low....................................................... $
14.56
12.25
$
$
14.65
12.37
March 31
June 30
September 30
15.57
$
13.44
$
December 31
$
$
15.23
13.50
2012 Quarter ended,
Quarterly, the Company reviews the potential payment of cash dividends to common shareholders. The timing
and amount of cash dividends paid on our common stock depends on the Company’s earnings, capital requirements,
financial condition and other relevant factors.
The dividend activities for the years ended December 31, 2013 and 2012 and subsequent through the date of this
filing are listed below:
Declared
February 1, 2012
April 26, 2012
June 26, 2012
July 25, 2012
October 30, 2012
November 30, 2012
January 30, 2013
April 24, 2013
July 23, 2013
October 23, 2013
January 29, 2014
Cash
Dividend per Share
Record Date
Paid
$0.06
$0.08
$0.20
$0.08
$0.08
$0.30
$0.08
$0.08
$0.18
$0.08
$0.08
February 10, 2012
May 10, 2012
July 10, 2012
August 14, 2012
November 9, 2012
November 26, 2012
February 8, 2013
May 10, 2013
August 6, 2013
November 5, 2013
February 10, 2014
February 24, 2012
May 24, 2012
July 24, 2012
August 24, 2012
November 21, 2012
December 6, 2012
February 22, 2013
May 24, 2013
August 15, 2013
November 15, 2013
February 24, 2014
The primary source for dividends paid to our shareholders is dividends paid to us from Heritage Bank. There are
regulatory restrictions on the ability of our subsidiary bank to pay dividends. Under federal regulations, the dollar
amount of dividends the bank may pay depends upon its capital position and recent net income. Generally, if an
institution satisfies its regulatory capital requirements, it may make dividend payments up to the limits prescribed
under state law and FDIC regulations. However, an institution that has converted to a stock form of ownership, as
Heritage Bank has done, may not declare or pay a dividend on, or repurchase any of, its common stock if the effect
thereof would cause the regulatory capital of the institution to be reduced below the amount required for the liquidation
account which was established in connection with the mutual stock conversion.
39
As a bank holding company, our ability to pay dividends is subject to the guidelines of the Federal Reserve Board
regarding capital adequacy and dividends. The Federal Reserve Board’s policy is that a bank holding company should
pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividends
and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall
financial condition, and that it is inappropriate for a bank holding company experiencing serious financial problems to
borrow funds to pay dividends. Under Washington law, we are prohibited from paying a dividend if, after making such
dividend payment, we would be unable to pay our debts as they become due in the usual course of business, or if our
total liabilities, plus the amount that would be needed, in the event we were to be dissolved at the time of the dividend
payment, to satisfy preferential rights on dissolution of holders of preferred stock ranking senior in right of payment to
the capital stock on which the applicable distribution is to be made exceed our total assets.
The Company has had various stock repurchase programs since March 1999. On August 30, 2012, the Board of
Directors approved the Company’s tenth stock repurchase plan, authorizing the repurchase of up to 5% of the
Company’s outstanding shares of common stock, or approximately 757,000 shares. There is no time limit on the
tenth plan. On August 30, 2011, the Board of Directors approved the Company's ninth stock repurchase plan,
authorizing the repurchase of up to 5% of the Company's outstanding share of common stock, or approximately
782,000 shares over a set period of twelve months.
The following table provides total repurchased shares and average share prices under the applicable Plans and
years:
Years Ended December 31,
2013
2012
Plan Total
Ninth Plan
Repurchased shares ...............................................................
Stock repurchase average share price....................................
389,627
590,832
—
— $ 13.45 $ 12.83
Tenth Plan
Repurchased shares ...............................................................
Stock repurchase average share price....................................
544,000
$ 15.88
52,900
596,900
$ 13.88 $ 15.70
During the years ended December 31, 2013 and 2012, the Company repurchased 13,138 and 3,419 shares at an
average price of $14.29 and $14.08 to pay withholding taxes on restricted stock that vested during the years ended
December 31, 2013 and 2012, respectively.
The following table sets forth information about the Company’s purchases of its outstanding common stock during
the quarter ended December 31, 2013.
Period
October 1, 2013—October 31, 2013 ..............
November 1, 2013—November 30, 2013 ......
December 1, 2013—December 31, 2013 ......
Total Number of
Shares
Purchased(1)
Average Price
Paid Per Share(1)
16.06
—
16.72
277 $
—
52
Total Number of
Shares
Purchased as
Part of Publicly
Announced Plans
or Programs
7,205,348
7,205,348
7,205,348
Total .......................................................
329 $
16.16
7,205,348
Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs
160,100
160,100
160,100
160,100
(1) Common shares repurchased by the Company between October 1, 2013 and December 31, 2013 included solely
the cancellation of 329 shares of restricted stock to pay withholding taxes at an average price per share of
$16.16.
The information regarding the Company’s equity compensation plan is contained under Part III, “Item 12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” of this Form 10-K and is
incorporated by reference herein.
40
Stock Performance Graph
The chart shown below depicts total return to stockholders during the period beginning December 31, 2008 and
ending December 31, 2013. Total return includes appreciation or depreciation in market value of the Company’s
common stock as well as actual cash and stock dividends paid to common stockholders. Indices shown below, for
comparison purposes only, are the Total Return Index for the NASDAQ Stock Market (U.S. Companies), which is a
broad nationally recognized index of stock performance by publicly traded companies and the NASDAQ Bank Index,
which is an index that contains securities of NASDAQ-listed companies classified according to the Industry
Classification Benchmark as banks. The chart assumes that the value of the investment in Heritage’s common stock
and each of the three indices was $100 on December 31, 2008, and that all dividends were reinvested in Heritage
common stock.
Heritage Financial Corporation
Total Return Performance
Heritage Financial Corporation
NASDAQ Composite
NASDAQ Bank
350
300
250
200
150
100
50
l
e
u
a
V
x
e
d
n
I
0
12/31/08
12/31/09
12/31/10
12/31/11
12/31/12
12/31/13
Year Ended December 31,
2013
2012
2011
106.78 $ 132.13 $ 158.12
281.22
200.63
170.38
143.84
101.50
85.52
Index
Heritage Financial Corporation ........ $
NASDAQ Composite ........................
NASDAQ Bank .................................
2008
100.00 $
100.00
100.00
2009
113.44 $
145.36
83.70
2010
114.60 $
171.74
95.55
41
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain information concerning our consolidated financial position and results of
operations at and for the dates indicated and have been derived from our audited Consolidated Financial Statements.
The information below is qualified in its entirety by the detailed information included elsewhere herein and should be
read along with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations”
and “Item 8. Financial Statements and Supplementary Data.”
Operations Data:
Interest income ............................................. $
Interest expense ...........................................
Net interest income .......................................
Provision for loan losses ...............................
Noninterest income .......................................
Noninterest expense .....................................
Income tax expense (benefit) .......................
Net income ....................................................
Net income (loss) applicable to common
shareholders ..............................................
Earnings (loss) per common share(1)
Basic .....................................................
Diluted ..................................................
Dividend payout ratio to common
Years Ended December 31,
2013
2012
2011
2010
2009
(Dollars in thousands, except per share amounts)
71,428
3,724
67,704
3,672
9,651
59,515
4,593
9,575
$
$
69,109
4,534
64,575
2,016
7,272
50,392
6,178
13,261
$ 74,120
6,582
67,538
14,430
5,746
49,703
2,633
6,518
$ 59,522
8,511
51,011
11,990
18,779
38,011
6,435
13,354
9,575
13,261
6,518
11,668
0.61
0.61
0.87
0.87
0.42
0.42
1.05
1.04
53,341
11,645
41,696
19,390
5,988
28,216
(503)
581
(739)
(0.10)
(0.10)
shareholders(2)..........................................
68.9%
92.0%
90.5%
— %
(100.0)%
Performance Ratios:
Net interest spread(3) ...................................
Net interest margin(4) ...................................
Efficiency ratio(5) ..........................................
Return on average assets .............................
Return on average common equity ...............
4.69%
4.80
76.94
0.62
4.58
5.03%
5.17
70.14
0.98
6.52
5.23%
5.41
67.82
0.48
3.17
4.56%
4.78
54.46
1.16
8.15
4.25%
4.57
59.17
0.06
(0.72)
42
December 31,
2013
2012
2011
2010
2009
(Dollars in thousands)
$ 1,345,540
855,360
$ 1,368,985 $ 1,367,684
719,957
815,607
$1,014,859
746,083
Balance Sheet Data:
Total assets .............................................. $ 1,659,038
Originated loans receivable, net...............
960,132
Purchased covered loans receivable,
net .........................................................
57,587
Purchased noncovered loans receivable,
net .........................................................
185,377
59,006
83,479
131,049
83,978
105,394
128,715
—
—
Loans receivable, net ............................... 1,203,096
—
Loans held for sale ...................................
FDIC indemnification asset ......................
4,382
Deposits ................................................... 1,399,189
Securities sold under agreement to
repurchase ............................................
Stockholders’ equity .................................
Book value per common share ................
Equity to assets ratio ................................
Capital Ratios:
Total risk-based capital ratio .....................
Tier 1 risk-based capital ratio ...................
Leverage ratio ..........................................
Asset Quality Ratios:
Nonperforming originated loans to total
29,420
215,762
13.31
13.0%
16.8%
15.5
11.3
998,344
1,676
7,100
1,117,971
16,021
198,938
13.16
14.8%
19.9%
18.7
13.6
1,004,480
1,828
10,350
1,136,044
979,721
764
16,071
1,136,276
746,083
825
—
840,128
23,091
202,520
13.10
19,027
10,440
202,279
12.99
158,498
12.21
14.8%
14.8%
15.6%
20.3%
19.0
13.8
21.5%
20.2
13.9
20.7%
19.4
14.6
originated loans (6) ...............................
0.53%
1.28%
2.57%
3.14%
4.21%
Allowance for loan losses on originated
loans to total originated loans (6) ..........
Allowance for loan losses on originated
loans to nonperforming originated
loans (6) ................................................
Nonperforming originated assets to total
originated assets (6) .............................
Other Data:
Number of banking offices .......................
Number of full-time equivalent
employees .............................................
1.76
2.19
2.66
2.97
3.38
329.40
170.44
103.52
94.73
79.34
0.68
35
373
1.39
33
363
2.14
33
354
2.38
3.32
31
20
321
222
(1) Effective January 1, 2009, the Company adopted FASB ASC 03-6-1.
(2) Dividend payout ratio is declared dividends per common share divided by basic earnings (loss) per common
share.
(3) Net interest spread is the difference between the average yield on interest earning assets and the average cost of
interest bearing liabilities.
(4) Net interest margin is net interest income divided by average interest earning assets.
(5) The efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.
(6) Nonperforming originated loan balances exclude portions guaranteed by governmental agencies of $1.7 million,
$1.2 million, $1.8 million, $3.2 million and $2.3 million as of December 31, 2013, 2012, 2011, 2010 and 2009,
respectively.
43
ITEM 7. MANGEMENT'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. The information contained in this section should be read with the December 31, 2013 audited
Consolidated Financial Statements and notes to those financial statements included in this Form 10-K.
This Form 10-K may contain forward-looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995. Forward-looking statements often include the words “believes,” “expects,” “anticipates,”
“estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar
expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” These forward-looking
statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to
differ materially from the results anticipated, including:
• our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel
we have acquired, including those from Cowlitz Bank, Pierce Commercial Bank, Northwest Commercial
Bank, Valley Community Bancshares and the proposed Washington Banking Company transactions
described in this Form 10-K, or may in the future acquire, into our operations and our ability to realize related
revenue synergies and cost savings within expected time frames or at all, and any goodwill charges related
thereto and costs or difficulties relating to integration matters, including but not limited to customer and
employee retention, which might be greater than expected;
•
•
•
•
•
•
the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-
offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by
deterioration in the housing and commercial real estate markets, which may lead to increased losses and
non-performing assets in our loan portfolio, and may result in our allowance for loan losses not being
adequate to cover actual losses, and require us to increase our allowance for loan losses;
changes in general economic conditions, either nationally or in our market areas;
changes in the levels of general interest rates, and the relative differences between short and long term
interest rates, deposit interest rates, our net interest margin and funding sources;
risks related to acquiring assets in or entering markets in which we have not previously operated and may
not be familiar;
fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in
real estate values in our market areas;
results of examinations of us by the Federal Reserve and of our bank subsidiary by the FDIC, the Division or
other regulatory authorities, including the possibility that any such regulatory authority may, among other
things, require us to increase our allowance for loan losses, write-down assets, change our regulatory capital
position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect
our liquidity and earnings;
•
legislative or regulatory changes that adversely affect our business including changes in regulatory policies
and principles, or the interpretation of regulatory capital or other rules as a result of Basel III;
• our ability to control operating costs and expenses;
•
•
•
the impact of the Dodd-Frank Act and implementing regulations;
further increases in premiums for deposit insurance;
the use of estimates in determining fair value of certain of our assets, which estimates may prove to be
incorrect and result in significant declines in valuation;
• difficulties in reducing risk associated with the loans on our consolidated statement of financial condition;
•
staffing fluctuations in response to product demand or the implementation of corporate strategies that affect
our workforce and potential associated charges;
•
failure or security breach of computer systems on which we depend;
• our ability to retain key members of our senior management team;
44
•
costs and effects of litigation, including settlements and judgments;
• our ability to implement our expansion strategy of pursuing acquisitions and de novo branching;
• our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel
we have acquired or may in the future acquire into our operations and our ability to realize related revenue
synergies and cost savings within expected time frames and any goodwill charges related thereto;
•
•
•
increased competitive pressures among financial service companies;
changes in consumer spending, borrowing and savings habits;
the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory
actions;
• adverse changes in the securities markets;
•
•
inability of key third-party providers to perform their obligations to us;
changes in accounting policies and practices, as may be adopted by the financial institution regulatory
agencies or the FASB, including additional guidance and interpretation on accounting issues and details of
the implementation of new accounting methods; and
• other economic, competitive, governmental, regulatory, and technological factors affecting our operations,
this
elsewhere
described
products
services
other
risks
and
and
the
in
pricing,
Form 10-K.
Some of these and other factors are discussed in this Form 10-K under the caption “Item 1A. Risk Factors” and
elsewhere in this Form 10-K. Such developments could have a material adverse impact on our business, financial
position and results of operations.
Any forward-looking statements are based upon management’s beliefs and assumptions at the time they are
made. We undertake no obligation to publicly update or revise any forward-looking statements included in this Form
10-K or to update the reasons why actual results could differ from those contained in such statements, whether as a
result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, you should
not put undue reliance on any forward-looking statements discussed in this Form 10-K.
Critical Accounting Policies
The Company’s Consolidated Financial Statements have been prepared in accordance with accounting principles
generally accepted in the United States of America. Companies may apply certain critical accounting policies requiring
management to make subjective or complex judgments, often as a result of the need to estimate the effect of matters
that are inherently uncertain.
The Company considers its most critical accounting estimates to be the allowance for loan losses, estimations of
expected cash flows related to purchased impaired loans, business combinations, other than temporary impairments
in the market value of investments and consideration of potential impairment of goodwill.
Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses
charged against earnings. The balance of the allowance for loan losses is maintained at the amount management
believes will be appropriate to absorb known and inherent losses in the loan portfolio at the balance sheet date. The
allowance for loan losses is determined by applying estimated loss factors to the credit exposure from outstanding
loans.
We assess the estimated credit losses inherent in our non-classified and classified loan portfolio by considering a
number of elements including:
• historical loss experience in the portfolio;
•
•
levels of and trends in delinquencies and impaired loans;
levels and trends in charge-offs and recoveries;
45
• effects of changes in risk selection and underwriting standards, and other changes in lending policies,
procedures and practices;
• experience, ability, and depth of lending management and other relevant staff;
• national and local economic trends and conditions;
• external factors such as competition, legal, and regulatory; and
• effects of changes in credit concentrations.
We calculate an allowance for the non-classified and classified portion of our loan portfolio based on an
appropriate percentage loss factor that is calculated based on the above-noted elements and trends. We may record
specific provisions for each impaired loan after a careful analysis of that loan’s credit and collateral factors. Our
analysis of an allowance combines the provisions made for our non-classified loans, classified loans, and the specific
provisions made for each impaired loan.
While we believe we use the best information available to determine the allowance for loan losses, our results of
operations could be significantly affected if circumstances differ substantially from the assumptions used in
determining the allowance. A further decline in local and national economic conditions, or other factors, could result in
a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and
results of operations. In addition, the determination of the amount of the allowance for loan losses is subject to review
by bank regulators, as part of their routine examination process, which may result in the establishment of additional
allowance for loan losses based upon their judgment of information available to them at the time of their examination.
For additional information regarding the allowance for loan losses, its relation to the provision for loan losses, risk
related to asset quality and lending activity, see “—Results of Operations for the Years Ended December 31, 2013 and
2012—Provision for Loan Losses” below, Part I of “Item 1. Business—Analysis of Allowance for Loan Losses” as well
as Note 6 of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and
Supplementary Data.”
Estimated Expected Cash Flows related to Purchased Impaired Loans. Loans purchased with evidence of
credit deterioration since origination for which it is probable that all contractually required payments will not be
collected are accounted for under FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit
Quality, formerly AICPA SOP 03-3 Accounting for Certain Loans or Debt Securities Acquired in a Transfer. In
situations where such loans have similar risk characteristics, loans may be aggregated into pools to estimate cash
flows. A pool is accounted for as a single asset with a single interest rate, cumulative loss rate and cash flow
expectation.
The cash flows expected over the life of the loan or pool are estimated using an internal cash flow model that
projects cash flows and calculates the carrying values of the pools, book yields, effective interest income and
impairment, if any, based on pool level events. Assumptions as to default rates, loss severity and prepayment speeds
are utilized to calculate the expected cash flows.
Expected cash flows at the acquisition date in excess of the fair value of loans are considered to be accretable
yield, which is recognized as interest income over the life of the loan or pool using a level yield method if the timing
and amounts of the future cash flows of the pool are reasonably estimable. Subsequent to the acquisition date, any
increases in cash flow over those expected at purchase date in excess of fair value are recorded as interest income
prospectively. Any subsequent decreases in cash flow over those expected at purchase date are recognized by
recording an allowance for loan losses. Any disposals of loans, including sales of loans, payments in full or
foreclosures result in the removal of the loan from the loan pool at the carrying amount.
Business Combinations. The Company applies the acquisition method of accounting for business combinations.
Under the acquisition method, the acquiring entity in a business combination recognizes all of the identifiable assets
acquired and liabilities assumed at their acquisition date fair values. Management utilizes prevailing valuation
techniques appropriate for the asset or liability being measured in determining these fair values. Any excess of the
purchase price over amounts allocated to assets acquired, including identifiable intangible assets, and liabilities
assumed is recorded as goodwill. Where amounts allocated to assets acquired and liabilities assumed is greater than
the purchase price, a bargain purchase gain is recognized. Acquisition-related costs are expensed as incurred unless
they are directly attributable to the issuance of the Company's common stock in a business combination.
46
Other-Than-Temporary Impairments in the Market Value of Investments. Unrealized losses on investment
securities available for sale and held to maturity securities are evaluated at least quarterly to determine whether
declines in value should be considered “other than temporary” and therefore be subject to immediate loss recognition
in income. Although these evaluations involve significant judgment, an unrealized loss in the fair value of a debt
security is generally deemed to be temporary when the fair value of the security is below the carrying value primarily
due to changes in interest rates, there has not been significant deterioration in the financial condition of the issuer,
and it is not more likely than not that the Company will be required to sell the security before the anticipated recovery
of its remaining carrying value. An unrealized loss in the value of an equity security is generally considered temporary
when the fair value of the security is below the carrying value primarily due to current market conditions and not
deterioration in the financial condition of the issuer and it is not more likely than not that the Company will be required
to sell the security before the anticipated recovery of its remaining carrying value. Other factors that may be
considered in determining whether a decline in the value of either a debt or an equity security is “other than
temporary” include ratings by recognized rating agencies; actions of commercial banks or other lenders relative to the
continued extension of credit facilities to the issuer of the security; the financial condition, capital strength and near-
term prospects of the issuer and recommendations of investment advisors or market analysts. Therefore, continued
deterioration of market conditions could result in additional impairment losses recognized within the investment
portfolio.
Goodwill. Goodwill represents the excess of the purchase price over the net assets acquired in the purchases
of Valley Community Bancshares, Western Washington Bancorp and North Pacific Bank. The Company’s goodwill is
assigned to Heritage Bank and is evaluated for impairment at the Heritage Bank level (reporting unit). Goodwill is not
amortized, but is reviewed for impairment annually and between annual tests if an event occurs or circumstances
change that might indicate the Company’s recorded value is more than its implied value. Such indicators may include,
among others: a significant adverse change in legal factors or in the general business climate; significant decline in
the Company’s stock price and market capitalization; unanticipated competition; and an adverse action or assessment
by a regulator. Any adverse changes in these factors could have a significant impact on the recoverability of goodwill
and could have a material impact on the Company’s Consolidated Financial Statements.
When required, the goodwill impairment test involves a two-step process. The first test for goodwill impairment is
done by comparing the reporting unit’s aggregate fair value to its carrying value. Absent other indicators of
impairment, if the aggregate fair value exceeds the carrying value, goodwill is not considered impaired and no
additional analysis is necessary. If the carrying value of the reporting unit were to exceed the aggregate fair value, a
second test would be performed to measure the amount of impairment loss, if any. To measure any impairment loss
the implied fair value would be determined in the same manner as if the reporting unit were being acquired in a
business combination. If the implied fair value of goodwill is less than the recorded goodwill an impairment charge
would be recorded for the difference.
During 2011, ASU 2011-08 Intangibles—Goodwill and Other (Topic 350) was issued. Under the ASU, an entity is
not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that
its fair value is less than its carrying amount. In other words, before the first step of the existing guidance, the entity
has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads
to a determination that the fair value of goodwill is less than carrying value. The qualitative assessment includes
adverse events or circumstances identified that could negatively affect the reporting units’ fair value as well as positive
and mitigating events. If, after assessing the totality of events or circumstances, an entity determines it is not more
likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step
process is unnecessary. While the Company adopted the ASU in 2011, for the year ended December 31, 2013, the
Company completed step one of the two-step process and concluded that the reporting unit’s fair value was greater
than its carrying value and there was no impairment of goodwill.
47
Our Strategy
Our primary objective is to be a well-capitalized, profitable community banking organization, with balanced growth
while emphasizing lending and deposit relationships with small and medium size businesses along with their owners
and the general public. We consider ourselves to be an innovative team providing financial services focusing on the
success of our customers. Our stated mission is: “Continuously Improve Customer Satisfaction, Employee
Empowerment and Shareholder Value.” We will seek to achieve our objective through the following strategies:
Expand geographically as opportunities present themselves. We are committed to continuing the controlled
expansion of our franchise through strategic acquisitions designed to increase our market share and enhance
franchise value. We believe that consolidation across the community bank landscape will continue to take place and
further believe that, with our capital and liquidity positions, our approach to credit management and extensive
acquisition experience, we are well positioned to take advantage of acquisitions or other business opportunities in our
market areas. In markets where we wish to enter or expand our business, we will also consider opening de novo
branches. In the past, we have successfully integrated acquired institutions and opened de novo branches. We will
continue to be disciplined and opportunistic as it pertains to future acquisitions and de novo branching focusing on the
Pacific Northwest markets we know and understand.
Focus on Asset Quality. A strong credit culture is a high priority for us. We have a well-developed credit
approval structure that has enabled us to maintain a standard of asset quality that we believe is conservative while at
the same time maintaining our lending objectives. We will continue to focus on loan types and markets that we know
well and where we have a historical record of success. We focus on loan relationships that are well diversified in both
size and industry types. With respect to commercial business lending, which is our predominant lending activity, we
view ourselves as cash-flow lenders obtaining additional support from realistic collateral values, personal guarantees
and secondary sources of repayment. We have a problem loan resolution process that is focused on quick detection
and feasible solutions. We seek to maintain strong internal controls and subject our loans to periodic internal loan
reviews.
Maintain Strong Balance Sheet. In addition to our focus on underwriting, we believe that the strength of our
balance sheet has allowed us to endure the economic downturn afflicting the Pacific Northwest better than many of
our competitors. As of December 31, 2013, the ratio of our allowance for loan losses on originated loans to total
originated loans was 1.76% and the ratio of the allowance for loan losses on originated loans to nonperforming
originated loans was 329.40%. Our liquidity position is also strong, with $130.4 million in cash and cash equivalents
as of December 31, 2013. As of December 31, 2013, the regulatory capital ratios of our subsidiary bank was well in
excess of the levels required for “well-capitalized” status, and our consolidated total risk-based capital, Tier 1 risk-
based capital and leverage capital ratios were 16.8%, 15.5% and 11.3%, respectively.
Deposit Growth. Our strategic focus is to continuously grow deposits with emphasis on total relationship
banking with our business and retail customers. We continue to seek to increase our market share in the communities
we serve by providing exceptional customer service, focusing on relationship development with local businesses and
strategic branch expansion. Our primary focus is to maintain a high level of non-maturity deposits to internally fund
our loan growth with a low reliance on maturity (certificate) deposits. At December 31, 2013, as a percentage of our
total deposits, non-maturity deposits were 77.9%. We maintain state-of-the-art technology-based products, including
on-line personal financial management, business cash management, and business remote deposit products that
enable us to compete effectively with banks of all sizes. Our retail management team is well-seasoned and has strong
ties to the communities we serve with a strong focus on relationship building and customer service.
Emphasize business relationships with a focus on commercial lending. We will continue to provide primarily
commercial business, commercial real estate and residential construction loans with an emphasis on owner occupied
commercial real estate and commercial business lending, and the deposit balances that accompany these
relationships. Our seasoned lending staff has extensive knowledge and can add value through a focused advisory
role that we believe strengthens our customer relationships and develops loyalty. We currently have and will seek to
maintain a diversified portfolio of lending relationships without concentrations in any industry.
48
Recruit and retain highly competent personnel to execute our strategies. Our compensation and staff
development programs are aligned with our strategies to grow our loans and core deposits while maintaining our
focus on asset quality. Our incentive systems are designed to achieve balanced high quality asset growth while
maintaining appropriate mechanisms to reduce or eliminate incentive payments when appropriate. Our equity
compensation programs and retirement benefits are designed to build and encourage employee ownership at all
levels of the Company and we align employee performance objectives with corporate growth strategies and
shareholder value. We have a strong corporate culture, which is supported by our commitment to internal
development and promotion from within as well as the retention of management and officers in key roles.
Financial Overview
Heritage Financial Corporation is a bank holding company which primarily engages in the business activities of
our wholly owned subsidiary, Heritage Bank. We provide financial services to our local communities with an ongoing
strategic focus on our commercial banking relationships, market expansion and asset quality.
The Company has focused on expanding business over the past five years. In 2010, the Company completed
two FDIC-assisted transactions of Cowlitz Bank in July 2010 and Pierce Commercial Bank in November 2010. In
2013, the Company completed two open-bank acquisitions of Northwest Commercial Bank in January 2013 and
Valley Community Bancshares in July 2013. In October 2013, the Company announced its proposed merger with
Washington Banking Company. These acquisitions, together with organic growth of the business, has significantly
increased the Company's net assets.
During the period from December 31, 2009 through December 31, 2013 our total assets have increased $644.2
million, or 63.5%, to $1.66 billion as of December 31, 2013 from $1.01 billion at December 31, 2009. The purchased
loans receivable, net grew $243.0 million during this five year period due to the Company's acquisition focus. The
originated loans receivable, net grew $214.0 million, or 28.7%, to $960.1 million as of December 31, 2013 from
$746.1 million at December 31, 2009. Our emphasis in growing our commercial business loan portfolio resulted in an
increase in originated commercial business loans of $245.6 million, or 40.7%, since December 31, 2009. Loan
increases have benefited from both our emphasis in increasing our lending in our market areas, and also from the
acquisitions of Valley, Northwest Commercial Bank, Pierce Commercial Bank and Cowlitz Bank.
Deposits increased $559.1 million, or 66.5%, to $1.40 billion at December 31, 2013 from $840.1 million at
December 31, 2009. From December 31, 2009 to December 31, 2013, non-maturity deposits (total deposits less
certificate of deposit accounts) increased $553.5 million, or 103.2% to $1.09 billion at December 31, 2013. As a result,
the percentage of certificate of deposit accounts to total deposits decreased to 22.1% at December 31, 2013 from
36.1% at December 31, 2009.
Stockholders’ equity has increased by $57.3 million to $215.8 million at December 31, 2013 from $158.5 million
at December 31, 2009 due primarily to a combination of earnings and issuances of common stock, partially offset by
redemption of preferred stock, repurchases of common stock and declaration of cash dividends. Our annual net
income increased by 1,548.0%, or $9.0 million, to $9.6 million for the year ended December 31, 2013 from $581,000
for the year ended December 31, 2009 due primarily to an increase of $26.0 million in net interest income that
exceeded an increase in noninterest expense of $31.3 million, and a decrease in the provision for loan losses of
$15.7 million.
Our core profitability depends primarily on our net interest income, which is the difference between the income we
receive on our loan and investment portfolios, and our cost of funds, which consists of interest paid on deposits and
borrowed funds. Like most financial institutions, our interest income and cost of funds are affected significantly by
general economic conditions, particularly changes in market interest rates and government policies.
Changes in net interest income result from changes in volume, net interest spread, and net interest margin.
Volume refers to the average dollar amounts of interest earning assets and interest bearing liabilities. Net interest
spread refers to the difference between the average yield on interest earning assets and the average cost of interest
bearing liabilities. Net interest margin refers to net interest income divided by average interest earning assets and is
influenced by the level and relative mix of interest earning assets and interest bearing and noninterest bearing
liabilities.
49
The following table provides relevant net interest income information for selected periods. The average daily loan
balances presented in the table are net of allowances for loan losses. Nonaccrual loans have been included in the
tables as loans carrying a zero yield. Yields on tax-exempt securities and loans have not been presented on a tax-
equivalent basis.
Years Ended December 31,
2013
2012
2011
Average
Balance
Interest
Earned/
Paid
Average
Yield/
Rate
Average
Balance
Interest
Earned/
Paid
Average
Yield/
Rate
Average
Balance
Interest
Earned/
Paid
Average
Yield/
Rate
(Dollars in thousands)
Interest Earning
Assets:
Loans, net .................. $1,124,828 $ 67,630
Taxable securities ......
117,132 1,918
Nontaxable
6.01% $ 996,186
118,124
1.64
$ 65,588
2,195
6.58% $ 981,848 $ 70,114
2,912
129,217
1.86
7.14%
2.25
securities ................
64,018 1,539
2.40
42,272
1,097
2.60
25,122
821
3.27
Other interest earning
assets .....................
104,770
341
0.33
92,324
229
0.25
111,430
273
0.24
Total interest
earning
assets ................. $ 1,410,748 $ 71,428
Noninterest earning
assets .....................
129,324
Total assets ....... $1,540,072
Interest Bearing
Liabilities:
Certificates of
deposit .................... $ 307,464 $ 2,478
164
143,412
Savings accounts ......
Interest bearing
5.06 % $ 1,248,906
$ 69,109
5.53% $1,247,617 $ 74,120
5.94%
105,166
$1,354,072
102,691
$1,350,308
0.81 % $ 306,772
113,119
0.11
$ 3,016
204
0.98% $ 355,167 $ 4,274
103,170
0.18
361
1.20%
0.35
demand and money
market accounts .....
Total interest
bearing
deposits ..............
FHLB advances and
other borrowings ....
Securities sold under
agreement to
repurchase .............
¤
541,793 1,031
0.19
466,268
1,249
0.27
453,509
1,868
0.41
992,669 3,673
0.37
886,159
4,469
0.50
911,846
6,503
0.71
—
—
—
—
—
—
1
—
0.30
19,102
51
0.26
18,314
65
0.35
19,301
79
0.41
Total interest
bearing
liabilities .......... $ 1,011,771 $ 3,724
Demand and other
noninterest bearing
deposits ..................
Other noninterest
bearing liabilities .....
Stockholders’ equity ...
308,582
10,543
209,176
Total liabilities
and stock-
holders’
equity ............ $ 1,540,072
0.37 % $ 904,473
$ 4,534
0.50% $ 931,148 $ 6,582
0.71%
237,888
8,310
203,401
205,862
7,795
205,503
$ 1,354,072
$1,350,308
Net interest
income ....................
Net interest
spread ....................
Net interest margin ....
Average interest
earning assets to
average interest
bearing liabilities .....
$ 67,704
$ 64,575
$ 67,538
4.69 %
4.80%
5.03%
5.17%
5.23%
5.41%
139.43 %
138.08%
133.99%
50
The following table provides the amount of change in our net interest income attributable to changes in volume
and changes in interest rates. Changes attributable to the combined effect of volume and interest rates have been
allocated proportionately for changes due specifically to volume and interest rates.
Year Ended December 31,
2013 Compared to 2012
Increase (Decrease) Due to
2012 Compared to 2011
Increase (Decrease) Due to
Volume
Rate
Total
Volume
Rate
Total
(In thousands)
Interest Earning Assets:
Loans ............................................. $
Taxable securities ..........................
Nontaxable securities ....................
Other interest earning assets .........
Interest income .............................. $
Interest Bearing Liabilities:
Certificates of deposit .................... $
Savings accounts ...........................
Interest bearing demand and
money market accounts .............
Total interest bearing deposits .......
FHLB advances and other
borrowings ..................................
Securities sold under agreement
to repurchase ..............................
Interest expense ............................ $
7,735
(16)
523
40
8,282
5
35
144
184
—
2
186
Net Interest Income ........................ $
8,096
$
$
$
$
$
(5,693) $
(261)
(81)
72
(5,963) $
2,042
(277)
442
112
2,319
$
$
944 $
(139)
388
(50)
1,143 $
(578)
(112)
6
(5,470) $(4,526)
(717)
276
(45)
(6,154) $(5,012)
(543) $
(75)
(538) $
(40)
(475) $
18
(783) $(1,258)
(156)
(174)
(362)
(980)
—
(16)
(996) $
(218)
(796)
—
(14)
(810) $
34
(423)
—
(653)
(1,610)
(619)
(2,033)
— —
(4)
(427) $
(11)
(15)
(1,621) $(2,048)
(4,967) $
3,129
$
1,570 $
(4,533) $(2,964)
Results of Operations for the Years Ended December 31, 2013 and 2012
Earnings Summary. Net income applicable to common shareholders of $0.61 per diluted common share was
recorded for the year ended December 31, 2013 compared to $0.87 per diluted common share for the year ended
December 31, 2012. Net income for the year ended December 31, 2013 was $9.6 million compared to net income of
$13.3 million for the same period in 2012. The $3.7 million decrease was primarily the result of a $9.1 million increase
in noninterest expense and a $1.7 million increase in the provision for loan losses, partially offset by a $2.3 million
increase in interest income, a $2.4 million increase in noninterest income, a $1.6 million decrease in income tax
expense and a $810,000 decrease in interest expense. The Company’s efficiency ratio increased to 76.9% for the
year ended December 31, 2013 from 70.1% for the year ended December 31, 2012 primarily due to increases in the
noninterest expense of $5.1 million related to the 2013 Company initiatives including the acquisitions and system
conversions of Northwest Commercial Bank and Valley Bank, the merger of Central Valley Bank, the core system
conversion, the consolidation of existing branches and the proposed Washington Banking Company merger. The
details of these expenses are included in the "Noninterest Expense" section below.
Net Interest Income. Net interest income increased $3.1 million, or 4.8%, to $67.7 million for the year ended
December 31, 2013 compared to $64.6 million for the previous year. The increase in net interest income was due
primarily to increases in average interest earning assets, substantially attributable to the NCB and Valley Acquisitions,
and the results of the positive effects of the discount accretion on the acquired loan portfolios for the year ended
December 31, 2013. The increase in net interest income was partially offset by the decrease in the net interest
margins due primarily to lower contractual loan note rates in the current lending environment. Net interest income as
a percentage of average interest earning assets (net interest margin) for the year ended December 31, 2013
decreased 37 basis points to 4.80% from 5.17% for the previous year. Our net interest spread for the year ended
December 31, 2013 decreased to 4.69% from 5.03% for the prior year.
51
Total interest income increased $2.3 million, or 3.4%, to $71.4 million for the year ended December 31, 2013,
from $69.1 million for the year ended December 31, 2012. The increase in interest income was due primarily to the
effects of the NCB and Valley Acquisitions and the positive effects of the accretable discount, offset partially by lower
yields on interest earning assets. During the year ended December 31, 2013, the Company recorded approximately
$2.7 million of discount accretion into interest income that related to the NCB and Valley Acquisitions. This income
would be in addition to the acquired loans' contractual interest income. The balance of average interest earning
assets (including nonaccrual loans) increased $161.9 million, or 13.0%, to $1.41 billion for the year ended
December 31, 2013 from $1.25 billion for the year ended December 31, 2012. The majority of this increase in interest
earning assets was a result of the NCB and Valley Acquisitions. The Company acquired combined fair value at
respective acquisition dates of $14.9 million in interest earning deposits, $57.1 million in investment securities and
$168.6 million in noncovered loans. The Company additionally generated organic growth by increasing the originated
loan receivable balance by $102.8 million, or 11.8%, to $977.3 million at December 2013 from $874.5 million at
December 2012.
The yield on interest earning assets decreased 47 basis points to 5.06% for the year ended December 31, 2013
from 5.53% for the year ended December 31, 2012. The decrease in the yield on interest earning assets for the year
ended December 31, 2013 reflects the decreased loan yields due primarily to lower contractual note rates as well as
the effects of the overall discount accretion on all the acquired loan portfolios. The effect of discount accretion on net
interest margin for the year ended December 31, 2013 and December 31, 2012 is as follows:
Net interest margin, excluding incremental accretion on purchased loans (1)............
Impact on net interest margin from incremental accretion on purchased loans (1).....
Net interest margin .......................................................................................................
Years Ended
December 31,
2013
2012
4.32%
0.48
4.80%
4.67%
0.50
5.17%
(1) The incremental accretion income represents the amount of income recorded on the purchased loans above the
contractual stated interest rate in the individual loan notes. This income results from the discount established at
the time these loan portfolios were acquired and modified as a result of quarterly cash flow re-estimation.
Yield on interest earning assets was additionally reduced by nonaccruing loans. For the years ended
December 31, 2013 and December 31, 2012, originated nonaccruing loans reduced the yield on interest earning
assets by approximately five basis points and seven basis points, respectively. Originated nonaccrual loans totaled
$6.9 million at December 31, 2013 compared to $12.5 million at December 31, 2012.
Interest income on taxable and nontaxable investment securities increased $165,000 to $3.5 million for the year
ended December 31, 2013 from $3.3 million for the year ended December 31, 2012 due primarily to an increase in the
average investment securities as a result of the NCB and Valley Acquisitions offset by lower yields earned on the
investment securities in 2013 as a result of declining interest rates. The changes in average balances and interest
income on interest earning deposits and FHLB stock and Pacific Coast Bankers Bank ("PCBB") stock had minimal
impact on net interest margins for the years ended December 31, 2013 and 2012.
Total interest expense decreased by $810,000, or 17.9%, to $3.7 million for the year ended December 31, 2013
from $4.5 million for the year ended December 31, 2012. The decrease in interest expense was due to lower rates
paid on interest bearing liabilities, reflecting the relatively low interest rate environment. The average rate paid on
interest bearing liabilities decreased to 0.37% for the year ended December 31, 2013 from 0.50% for the year ended
December 31, 2012. Total average interest bearing liabilities increased by $107.3 million, or 11.9%, to $1.012 billion
for the year ended December 31, 2013 from $904.5 million for the year ended December 31, 2012. The increase in
average interest bearing liabilities was due primarily to the NCB and Valley Acquisitions which had a combined fair
value at the acquisitions dates of $267.5 million, offset by deposit run-off anticipated from the acquisitions and
consolidation of existing bank branches.
52
Provision for Loan Losses. The provision for loan losses increased $1.7 million, or 82.1%, to $3.7 million for the
year ended December 31, 2013 from $2.0 million for the year ended December 31, 2012. The Bank has established a
comprehensive methodology for determining the allowance for loan losses and related provision for loan losses on
originated loans. On a quarterly basis, the Bank performs an analysis taking into consideration pertinent factors
underlying the quality of the loan portfolio. These factors include changes in the amount and composition of the loan
portfolio, historical loss experience for various loan classes, changes in economic conditions, delinquency rates, a
detailed analysis of individual loans on nonaccrual status, and other factors to determine the level of the allowance for
loan losses and the related provision for loan losses.
The provision for loan losses on originated loans increased $195,000, or 28.1%, to $890,000 for the year ended
December 31, 2013 from $695,000 for the year ended December 31, 2012. The increase in provision expense for
originated loans was due to the default of one significant borrower offset by an improvement in the environmental
factors as well as lower net charge-offs on originated loans during the year ended December 31, 2013 compared the
prior year.
The Bank had net charge-offs on originated loans of $2.9 million for the year ended December 31, 2013
compared to $3.9 million for the year ended December 31, 2012. The ratio of net charge-offs to average total
originated loans outstanding was 0.30% for the year ended December 31, 2013 and 0.45% for the year ended
December 31, 2012. For the year ended December 31, 2013, the Company had $3.8 million of gross charge-offs of
which $1.6 million related to one borrower. At December 31, 2012, the Bank had not provided for a related specific
valuation allowance for this borrower and had generally reserved (based on ALL allocation) $389,000, resulting in an
estimated provision expense of $1.2 million during 2013 based on the unfavorable resolution of this loan. Total
originated loans at December 31, 2013 and 2012 were $980.0 million and $876.6 million, respectively. The general
allowance as a percentage of non-impaired loans was 1.48% and 1.74% at December 31, 2013 and 2012,
respectively. The decrease in the percentage during the noted periods is due to reduction in the historical loss
factors, change in the mix of loans, and a general improvement in the credit environment.
The following table outlines the allowance for loan losses and related outstanding loan balances at December 31,
2013 and 2012:
December 31, 2013
December 31, 2012
(Dollars in thousands)
General Valuation Allowance:
Allowance for loan losses ............................................................. $
Gross originated loan balance of non-impaired loans ..................
Percentage ....................................................................................
Specific Valuation Allowance:
Allowance for loan losses ............................................................. $
Gross originated loan balance of impaired loans..........................
Percentage ....................................................................................
Total Allowance for Loan Losses:
Allowance for loan losses ............................................................. $
Gross originated loan balance ......................................................
Percentage ....................................................................................
$
$
$
14,054
952,569
1.48%
3,099
27,386
11.32%
17,153
979,955
1.75%
14,766
849,084
1.74%
4,359
27,497
15.85%
19,125
876,581
2.18%
53
The allowance for loan losses on originated loans decreased by $2.0 million, or 10.3%, to $17.2 million at
December 31, 2013 from $19.1 million at December 31, 2012. As of December 31, 2013, the Bank identified $6.9
million of originated nonperforming loans and $20.4 million of originated performing restructured loans for a total
of$27.4 million of impaired loans. Of these impaired loans, $16.5 million have no allowances for credit losses as their
estimated collateral value or expected cash flow is equal to or exceeds their carrying costs. The remaining $10.9
million have related allowances for credit losses totaling $3.1 million. Based on the comprehensive methodology,
management deemed the allowance for loan losses on originated loans of $17.2 million at December 31, 2013 (1.76%
of total originated loans and 329.4% of nonperforming originated loans, excluding government guarantees)
appropriate to provide for probable incurred losses based on an evaluation of known and inherent risks in the loan
portfolio at that date.
The provision for loan losses on purchased loans increased $1.5 million, or 110.6%, to $2.8 million for the year
ended December 31, 2013 compared to $1.3 million for the year ended December 31, 2012. As of the acquisition
date, purchased loans were recorded at their estimated fair value, incorporating our estimate of future expected cash
flows until the ultimate resolution of these credits. To the extent actual or remaining projected cash flows are less than
originally estimated, additional provisions for loan losses on the purchased loan portfolios will be recognized.
However, provisions on the purchased covered loans would be primarily offset by a corresponding increase in the
FDIC indemnification asset recognized within noninterest income. To the extent actual or remaining projected cash
flows are more than originally estimated, the increase in cash flows is recognized prospectively in interest income.
The provision for loan losses on purchased loans recorded for the year ended December 31, 2013 was a result of
several specific loan events. The Bank resolved one significant covered loan which generated approximately
$585,000 in provision expense. There was also the default of three large borrowers which caused $950,000 in
provision expense. The Bank also experienced significant collateral deficiency on one borrower which added an
additional $1.1 million in provision expense. The impact of these events was partially offset by the general
improvements in the remaining loans' expected cash flows. The balance of the purchased other impaired loans
(loans which showed credit quality issues after acquisition) increased to $6.7 million at December 31, 2013 from $2.2
million at December 31, 2012. The Bank recorded charge-offs of $580,000 for the purchased other loans for the year
ended December 31, 2013 as compared to $450,000 for the year ended December 31, 2012.
The allowance for loan losses on purchased loans increased $2.2 million, or 23.3% to $11.7 million at
December 31, 2013 from $9.5 million at December 31, 2012. The increase was primarily the result of the specific
purchased loans described above, offset by the general improvements in the expected cash flow of the purchased
loans. To the extent that the loan pools have allowance for loan losses, the yields on the loan pools will generally
remain constant until such time that the pool's estimated cash flows become greater than the allowance.
While the Bank believes it has established its existing allowance for loan losses in accordance with GAAP, there
can be no assurance that regulators, in reviewing the Bank's loan portfolios, will not request the Bank to increase
significantly its allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot
be predicted with certainty, there can be no assurance that the existing allowance for loan losses is appropriate or that
increased provisions will not be necessary should the quality of the loans deteriorate. Any material increase in the
allowance for loan losses would adversely affect the Company’s financial condition and results of operations. For
additional information, see “Item 1. Business—Analysis of Allowance for Loan Losses.”
54
Noninterest Income. Total noninterest income increased $2.4 million, or 32.7%, to $9.7 million for the year
ended December 31, 2013 compared to $7.3 million for the prior year. The components of the noninterest income and
the changes from prior year are as follows:
Years Ended December 31,
2013
2012
Change
2013 vs.
2012
Percentage
Change
(Dollars in thousands)
Bargain purchase gain on bank acquisition ......... $
Service charges and other fees ...........................
Merchant Visa income, net ..................................
FDIC loss sharing income, net .............................
Other income........................................................
399
5,936
862
(181)
2,635
$
—
5,516
685
(1,033)
2,104
$
399
420
177
852
531
100.0%
7.6
25.8
82.5
25.2
Total noninterest income ...................................... $
9,651
$
7,272
$
2,379
32.7%
The FDIC loss sharing income, net includes amortization of the FDIC indemnification asset and increases to the
FDIC indemnification asset as a result of decreases in projected remaining cash flows of the purchased covered
loans. The increase in net FDIC loss sharing income was primarily due to the $609,000 decrease in amortization
expense of $1.3 million for the year ended December 31, 2013 compared to $1.9 million for the year ended December
31, 2012. The decrease in the amortization expense was primarily due to the declining indemnification asset balance.
The balance of the indemnification asset at December 31, 2013 was $4.4 million compared to $7.1 million at
December 31, 2012. The net FDIC loss sharing income also increased due to an increase in the FDIC share of
additional estimated losses which was an increase of income of $1.1 million for the year ended December 31, 2013
compared to $878,000 in prior year. Under the symmetrical accounting for acquired covered loans, an increase in the
provision for loan losses on covered loans will generally have a related increase in the FDIC share of additional
estimated losses. The provision for loan losses on covered loans was $1.9 million for the year ended December 31,
2013 compared to $446,000 for the year ended December 31, 2012.
Other income increased $531,000, or 25.2%, to $2.6 million for the year ended December 31, 2013 from $2.1
million for the year ended December 31, 2012 primarily due to the gain on sale of a bank branch of $596,000. The
$420,000 increase in service charges and other fees to $5.9 million for the year ended December 31, 2013 compared
to $5.5 million for the prior year was primarily the result of increased deposits and an expanded customer base.
Deposits at December 31, 2013 increased to $1.40 billion at December 31, 2013 from $1.12 billion at December 31,
2012 primarily as a result of the NCB and Valley Acquisitions. The bargain purchase gain on bank acquisition of
$399,000 for the year ended December 31, 2013 was the result of the NCB Acquisition in January 2013. See Note 2
of the Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data" for additional
information on the NCB Acquisition.
Noninterest Expense. Noninterest expense increased $9.1 million or 18.1% to $59.5 million for the year ended
December 31, 2013 compared to $50.4 million for the year ended December 31, 2012.
55
The following table presents the key components of noninterest expense and the change from prior year:
Years Ended December 31,
2013
2012
Change 2013
vs. 2012
Percentage
Change
$
Compensation and employee benefits .....
Occupancy and equipment .......................
Data processing .........................................
Marketing ...................................................
Professional services .................................
State and local taxes .................................
Impairment loss on investment
securities, net ..........................................
Federal deposit insurance premium .........
Other real estate owned, net .....................
Other expense ...........................................
$
31,612
9,724
4,806
1,598
3,936
1,150
38
1,001
309
5,341
$
(Dollars in thousands)
29,020
7,365
2,555
1,517
2,543
1,226
2,592
2,359
2,251
81
1,393
(76)
78
1,002
316
4,770
(40)
(1)
(7)
571
Total noninterest expense .........................
$
59,515
$
50,392
$
9,123
8.9%
32.0
88.1
5.3
54.8
(6.2)
(51.3)
(0.1)
(2.2)
12.0
18.1%
The increase in total noninterest expense for the year ended December 31, 2013 was due primarily to increased
expenses related to 2013 Company initiatives. These initiatives include the NCB and Valley Acquisitions, the merger
of Central Valley Bank and the proposed merger of Washington Banking Company, all of which are discussed in
Notes 1 and 2 to the Consolidated Financial Statements in "Item. 8 Financial Statements and Supplementary Data".
Additionally, a core system conversion occurred in fourth quarter of 2013 whereby after 18 years of using FiServ's
Total Plus core system, the Company converted to FiServ's DNA platform which provides a variety of efficiencies in all
operation areas of the Bank. The consolidation of existing branches also occurred in the fourth quarter of 2013 with
the Company consolidating three Heritage branch locations to nearby branches. The table below includes each of
the Company's major initiatives as well as the direct costs associated with the initiatives for the years ended
December 31, 2013 and 2012. The amounts include identifiable costs paid to third party providers as well as any
retention bonuses or severance payment made in conjunction with these initiatives. The amounts do not include
costs of additional staffing required to be maintained or utilized during a period of time in order to complete the
initiatives.
Years Ended December 31,
2013
2012
(In thousands)
Company Initiatives:
NCB Acquisition ......................................................................... $
CVB Merger ...............................................................................
Valley Acquisition .......................................................................
Core system conversion ............................................................
Consolidation of existing branches............................................
Proposed Washington Banking merger.....................................
$
794
220
2,118
842
238
890
Total noninterest expense .......................................................... $
5,102
$
616
—
—
—
—
—
616
56
The following table further segregates the Company initiative costs by financial statement caption.
Years Ended December 31,
2013
2012
(In thousands)
Expense Caption:
Compensation and employee benefits ...................................... $
Occupancy and equipment ........................................................
Data processing .........................................................................
Marketing ...................................................................................
Professional services .................................................................
Other expense ...........................................................................
$
475
1,328
1,291
34
1,876
98
Total noninterest expense .......................................................... $
5,102
$
—
—
—
—
610
6
616
The types of expenses associated with the significant expense categories in the table above are summarized as
follows:
• Compensation and employee benefits expense consisted substantially of retention bonus and severances
packages paid to transition employees.
• Occupancy and equipment expense consisted primarily of lease termination costs.
• Data processing expense consisted of costs relating to the Company’s core system conversion as well as
conversions of Northwest Commercial Bank and Valley Bank.
• Professional services expense related to fees paid to: (1) financial advisors for the NCB Acquisition, the
Valley Acquisition and the proposed Washington Banking Merger, (2) attorney, accountant and consultant
fees related to mergers and acquisitions, and (3) consultant fees relating to the core system conversion.
Other expense includes, but is not limited to, items such as amortization of intangible assets, courier services,
travel expenses, investor relations, and certain employee-related costs such as travel and meals. The increase in
other expense for the year ended December 31, 2013 as compared to the year ended December 31, 2012 was partly
due to the increase in amortization of intangible assets of approximately $116,000 as a result of the NCB and Valley
Acquisitions. The investor relations expense increased $115,000 as a result of the NCB and Valley Acquisitions as
well as the proposed Washington Banking merger. The remaining increases in other expense are the result of a
general increase due to the growth of the Company during the year ended December 31, 2013 which is demonstrated
by the increase in total assets from $1.35 billion at December 31, 2012 to $1.66 billion at December 31, 2013.
The efficiency ratio for the year ended December 31, 2013 was 76.9% compared to 70.1% for the same period in
the prior year. The efficiency ratio consists of noninterest expense divided by the sum of net interest income before
provision for loan losses plus noninterest income. The increase in the ratio for the year ended December 31, 2013
was primarily related to the increase in noninterest expense as described above. While growth strategies are being
executed, the Company expects to incur higher noninterest expenses as evidenced by the current increasing
efficiency ratio. Noninterest expenses are expected to be more in line with income when these growth strategies begin
producing long term results.
Income Tax Expense. The provision for income taxes decreased by $1.6 million to an expense of $4.6 million
for the year ended December 31, 2013 from an expense of $6.2 million for the year ended December 31, 2012. The
Company’s effective income tax rate was 32.4% for the year ended December 31, 2013 compared to 31.8% for the
same period in 2012. The increase in the Company’s effective income tax rate from the prior year was primarily due to
increased non-deductible acquisition expenses.
57
Results of Operations for the Years Ended December 31, 2012 and 2011
Earnings Summary. Net income applicable to common shareholders was $0.87 per diluted common share for
the year ended December 31, 2012 compared to $0.42 per diluted common share for the year ended December 31,
2011. Net income for the year ended December 31, 2012 was $13.3 million compared to net income of $6.5 million for
the same period in 2011. The $6.7 million increase was primarily the result of a $12.4 million decrease in the provision
for loan losses and a $2.0 million decrease in interest expense, partially offset by a $5.0 million decrease in interest
income and a $3.5 million increase in income tax expense. The Company’s efficiency ratio increased to 70.1% for the
year ended December 31, 2012 from 67.8% for the year ended December 31, 2011 partially due to increases in the
compensation and employee benefits expense and expenses related to the acquisition of Northwest Commercial
Bank which closed in January 2013.
Net Interest Income. Net interest income decreased $3.0 million, or 4.4%, to $64.6 million for the year ended
December 31, 2012 compared to $67.5 million for the previous year. The decrease in net interest income was due to
the decline in net interest margins. Net interest income as a percentage of average earning assets (net interest
margin) for the year ended December 31, 2012 decreased 24 basis points to 5.17% from 5.41% for the previous year.
The decline in net interest margin was due to a combination of lower contractual note rates and the overall lessening
impact of the discount accretion on the acquired loan portfolios. Our net interest spread for the year ended
December 31, 2012 decreased to 5.03% from 5.23% for the prior year.
Total interest income decreased $5.0 million, or 6.8%, to $69.1 million for the year ended December 31, 2012,
from $74.1 million for the year ended December 31, 2011. The decrease in interest income was due primarily to lower
yields on interest earning assets. The balance of average interest earning assets (including nonaccrual loans)
increased $1.2 million, or 0.1%, from $1.248 billion for the year ended December 31, 2011 to $1.249 billion for the
year ended December 31, 2012. The yield on interest earning assets decreased 41 basis points from 5.94% for the
year ended December 31, 2011 to 5.53% for the year ended December 31, 2012. The decrease in the yield on
earning assets for the year ended December 31, 2012 reflects the decreased loan yields due primarily to lower
contractual note rates as well as the effects of the discount accretion on the acquired loan portfolios. The effect of
discount accretion on net interest margin for the year ended December 31, 2012 and December 31, 2011 was
approximately 50 basis points and 62 basis points, respectively. For the years ended December 31, 2012 and
December 31, 2011, originated nonaccruing loans reduced the yield on interest earning assets by approximately
seven basis points and 11 basis points, respectively. Originated nonaccrual loans totaled $12.5 million at
December 31, 2012 compared to $23.3 million at December 31, 2011. Interest income on taxable and nontaxable
investment securities decreased $441,000 to $3.3 million for the year ended December 31, 2012 from $3.7 million for
the year ended December 31, 2011 due primarily to lower yields earned on the investment securities in 2012 as a
result of declining interest rates.
Total interest expense decreased by $2.0 million, or 31.1%, to $4.5 million for the year ended December 31, 2012
from $6.6 million for the year ended December 31, 2011. The decrease in interest expense was due to a combination
of lower balances of average interest bearing liabilities and lower rates paid on interest bearing liabilities. The average
rate paid on interest bearing liabilities decreased to 0.50% for the year ended December 31, 2012 from 0.71% for the
year ended December 31, 2011. Total average interest bearing liabilities decreased by $26.7 million, or 2.9%, to
$904.5 million for the year ended December 31, 2012 from $931.1 million for the year ended December 31, 2011. The
decrease in average interest bearing liabilities was due primarily to the $48.4 million decrease in certificates of
deposits to $306.8 million for the year ended December 31, 2012 from $355.2 million for the year ended
December 31, 2011. Deposit interest expense decreased $2.0 million, or 31.3%, to $4.5 million for the year ended
December 31, 2012 compared to $6.5 million for the prior year. The decrease in deposit interest expense for the year
ended December 31, 2012 is primarily a result of a 21 basis point decrease in the average cost of interest-bearing
deposits, reflecting the relatively low interest rate environment.
Provision for Loan Losses. The provision for loan losses decreased $12.4 million, or 86.0%, to $2.0 million for
the year ended December 31, 2012 from $14.4 million for the year ended December 31, 2011.
58
The provision for loan losses on originated loans decreased $4.5 million, or 86.6%, to $695,000 for the year
ended December 31, 2012 from $5.2 million for the year ended December 31, 2011. The Bank had net charge-offs on
originated loans of $3.9 million for the year ended December 31, 2012 compared to $4.9 million for the year ended
December 31, 2011. The decrease in provision expense for originated loans was substantially due to an improvement
in the environmental factors as well as lower net charge-offs on originated loans during the year ended December 31,
2012 compared to the prior year. The ratio of net charge-offs to average total originated loans outstanding was 0.45%
for the year ended December 31, 2012 and 0.59% for the year ended December 31, 2011.
The allowance for loan losses on originated loans decreased by $3.2 million, or 14.3%, to $19.1 million at
December 31, 2012 from $22.3 million at December 31, 2011. As of December 31, 2012, the Bank identified $12.5
million of originated impaired loans and $15.0 million of originated performing restructured loans. Of those impaired
and performing restructured loans, $12.6 million have no allowances for credit losses as their estimated collateral
value or expected cash flow is equal to or exceeds their carrying costs. The remaining $14.9 million have related
allowances for credit losses totaling $4.4 million. Based on the comprehensive methodology, management deemed
the allowance for loan losses on originated loans of $19.1 million at December 31, 2012 (2.19% of total originated
loans and 170.44% of nonperforming originated loans, excluding government guarantees) appropriate to provide for
probable incurred losses based on an evaluation of known and inherent risks in the loan portfolio at that date.
The provision for loan losses on purchased loans for the year ended December 31, 2012 totaled $1.3 million
compared to $9.3 million for the year ended December 31, 2011. As of the acquisition date, purchased loans were
recorded at their estimated fair value, incorporating our estimate of future expected cash flows until the ultimate
resolution of these credits. To the extent actual or remaining projected cash flows are less than originally estimated,
additional provisions for loan losses on the purchased loan portfolios will be recognized. However, provisions on the
purchased covered loans would be primarily offset by a corresponding increase in the FDIC indemnification asset
recognized within noninterest income. To the extent actual or remaining projected cash flows are more than originally
estimated, the increase in cash flows is recognized prospectively in interest income. The decrease in the provision for
the year ended December 31, 2012 as compared to the year ended December 31, 2011 is a result of less decreases
in remaining projected cash flows on purchased loans, offset partially by specific loans that were charged-off during
the year which caused decreases in projected cash flows.
The allowance for loan losses on purchased loans increased $871,000, or 10.1% to $9.5 million at December 31,
2012 from $8.6 million at December 31, 2011. The increase was the result of specific purchased loans that had
remaining expected cash flows less than previously expected, which was usually the result of a charge-off.
Noninterest Income. Total noninterest income increased $1.5 million, or 26.6%, to $7.3 million for the year
ended December 31, 2012 compared to $5.7 million for the prior year. The components of the noninterest income
and the changes from prior year are as follows:
Years Ended December 31,
2012
2011
Change 2012
vs. 2011
Percentage
Change
(Dollars in thousands)
Service charges and other fees ........................... $
Merchant Visa income, net ..................................
FDIC loss sharing income, net .............................
Other income .......................................................
5,516
685
(1,033)
2,104
$
5,419
556
(2,250)
2,021
$
97
129
1,217
83
1.8%
23.2
54.1
4.1
Total noninterest income ...................................... $
7,272
$
5,746
$
1,526
26.6%
59
The increase in noninterest income was due primarily to an increase in the net FDIC loss sharing income, which
was a reduction of income of $2.3 million for the year ended December 31, 2012 compared to a reduction of income
of $1.0 million for the year ended December 31, 2011. The FDIC loss sharing income, net includes amortization of the
FDIC indemnification asset and increases to the FDIC indemnification asset as a result of decreases in projected
remaining cash flows of the purchased covered loans. For the year ended December 31, 2012, the amortization
expense for the indemnification asset decreased to $1.9 million from $4.4 million for the year ended December 31,
2011. The FDIC share of additional estimated losses decreased to $878,000 for the year ended December 31, 2012
compared to $2.2 million for the same period in prior year.
Noninterest Expense. Noninterest expense increased $689,000 or 1.4% to $50.4 million for the year ended
December 31, 2012 compared to $49.7 million for the year ended December 31, 2011.
The following table presents the key components of noninterest expense and the change from prior year:
Years Ended December 31,
2012
2011
Change 2012
vs. 2011
Percentage
Change
(Dollars in thousands)
Compensation and employee benefits ............................ $ 29,020
Occupancy and equipment ..............................................
7,365
2,555
Data processing ...............................................................
1,517
Marketing .........................................................................
2,543
Professional services .......................................................
1,226
State and local taxes........................................................
78
Impairment loss on investment securities, net.................
1,002
Federal deposit insurance premium ................................
316
Other real estate owned, net ...........................................
4,770
Other expense .................................................................
$ 27,109
7,127
2,628
1,361
2,062
1,336
98
1,558
921
5,503
$
1,911
238
(73)
156
481
(110)
(20)
(556)
(605)
(733)
Total noninterest expense ................................................ $ 50,392
$ 49,703
$
689
7.0%
3.3
(2.8)
11.5
23.3
(8.2)
(20.4)
(35.7)
(65.7)
(13.3)
1.4%
The increase in noninterest expense was due primarily to increased compensation and employee benefits
expense in the amount of $1.9 million as the Company's full-time equivalent employees increased from 354 at
December 31, 2011 to 363 at December 31, 2012 and the Company paid more in incentive plans during the year
ended December 31, 2012 as compared to prior year based on the Company's performance. The $481,000 increase
in professional services was primarily the result of costs related to the NCB Acquisition of approximately $610,000.
The increase to noninterest expense was partially offset by decreases of $605,000 in net other real estate owned
expense as a result of net gains on sales of the assets of $587,000 during the year ended December 31, 2012
compared to net losses of $71,000 during the year ended December 31, 2011. The other expense decreased
$733,000 from the year ended December 31, 2011 due primarily to a decrease in other loan expenses recorded
primarily during resolution of nonperforming loans.
The efficiency ratio for the year ended December 31, 2012 was 70.1% compared to 67.8% for the same period in
the prior year. The increase in the ratio for the year ended December 31, 2012 was primarily related to the increase in
noninterest expense and the decrease in net interest income. The net interest income was reduced because of the
low interest rate environment. Additionally, while growth strategies are being executed, the Company expects to incur
higher noninterest expenses as evidenced by the current increasing efficiency ratio. Noninterest expenses are
expected to be more in line with revenue when these growth strategies begin producing long term results. The
efficiency ratio consists of noninterest expense divided by the sum of net interest income before provision for loan
losses plus noninterest income.
60
Income Tax Expense. The provision for income taxes increased by $3.5 million to an expense of $6.2 million for
the year ended December 31, 2012 from an expense of $2.6 million for the year ended December 31, 2011. The
Company’s effective tax rate was 31.8% for the year ended December 31, 2012 compared to 28.8% for the same
period in 2011. The increase in the Company’s income tax expense from the prior year was primarily due to increases
in pre-tax income. The increase in the Company’s effective tax rate for the year ended December 31, 2012 is due
substantially to increases in the level of net income before income taxes relative to the more modest amount of
increase in the amount of tax-exempt income.
Liquidity and Capital Resources
Our primary sources of funds are customer and local government deposits, loan principal and interest payments,
loan sales, interest earned on and proceeds from sales and maturities of investment securities, and advances from
the FHLB of Seattle. These funds, together with retained earnings, equity and other borrowed funds, are used to
make loans, acquire investment securities and other assets, and fund continuing operations. While maturities and
scheduled amortization of loans are a predictable source of funds, deposit flows and loan prepayments are greatly
influenced by the level of interest rates, economic conditions, and competition.
We must maintain an adequate level of liquidity to ensure the availability of sufficient funds to fund loan
originations and deposit withdrawals, satisfy other financial commitments, and fund operations. We generally maintain
sufficient cash and short-term investments to meet short-term liquidity needs. At December 31, 2013, cash and cash
equivalents totaled $130.4 million, or 7.9% of total assets. Other interest earning deposits totaled $15.7 million at
December 31, 2013. These assets are easily converted to liquidity. Available for sale investment securities totaled
$163.1 million at December 31, 2013; however, management generally does not consider those with maturities
beyond one year to be a viable source of liquidity given that many available for sale securities are pledged to secure
borrowing arrangements. The fair value of investment securities classified as either available for sale or held to
maturity with maturities of one year or less amounted to $4.0 million, or 0.2% of total assets. At December 31, 2013,
the Bank maintained credit facilities with the FHLB of Seattle for $283.6 million and credit facilities with the Federal
Reserve Bank of San Francisco for $56.7 million, of which there were no borrowings outstanding as of December 31,
2013. The Banks also maintain advance lines with Zions Bank, Wells Fargo Bank, US Bank and Pacific Coast
Bankers’ Bank to purchase federal funds totaling $50.0 million as of December 31, 2013. As of December 31, 2013,
there were no overnight federal funds purchased.
61
During 2013 total assets increased $313.5 million, or 23.3%, to $1.66 billion at December 31, 2013 from $1.35
billion at December 31, 2012. The increase was primarily due to the assets acquired in the NCB and Valley
Acquisitions. The components of the change in assets and the fair value of assets acquired at effective dates are
included in the following table:
December 31,
2013
December 31,
2012
Change 2013 vs.
2012
(Dollars in thousands)
Fair Value of
NCB and Valley
Bank at
respective
Acquisition
Dates
$
Cash and cash equivalents ......................................... $
Other interest earning deposits ...................................
Investment securities available for sale .......................
Investment securities held to maturity .........................
Loans held for sale ......................................................
Originated loans receivable, net ..................................
Purchased covered loans receivable, net ....................
Purchased non-covered loans receivable, net ............
FDIC indemnification asset .........................................
Other real estate owned ..............................................
Premises and equipment, net ......................................
FHLB stock, at cost .....................................................
Accrued interest receivable .........................................
Prepaid expenses and other assets ............................
Other intangible assets, net .........................................
Goodwill ......................................................................
130,400
15,662
163,134
36,154
—
960,132
57,587
185,377
4,382
4,559
34,348
5,741
5,462
25,120
1,615
29,365
$
104,268
2,818
144,293
10,099
1,676
855,360
83,978
59,006
7,100
5,666
24,755
5,495
4,821
22,107
1,086
13,012
$
26,132
12,844
18,841
26,055
(1,676 )
104,772
(26,391 )
126,371
(2,718 )
(1,107 )
9,593
246
641
3,013
529
16,353
Total assets ......................................................... $ 1,659,038
$ 1,345,540
$
313,498
$
43,355
14,869
34,197
22,908
—
—
—
168,580
—
2,279
6,772
454
697
7,135
1,072
16,353
318,671
Our strategy has been to acquire core deposits (which we define to include all deposits except public funds,
brokered CDs and other wholesale deposits) from our retail accounts, acquire noninterest bearing demand deposits
from our commercial customers, and use our available borrowing capacity to fund growth in assets. We anticipate that
we will continue to rely on the same sources of funds in the future and use those funds primarily to make loans and
purchase investment securities.
Stockholders’ equity was $215.8 million at December 31, 2013 and $198.9 million at December 31, 2012. During
the year ended December 31, 2013, we issued 1.5 million shares of common stock valued at $24.2 million for the
purpose of acquiring Valley Community Bancshares, realized net income of $9.6 million, paid common stock
dividends of $6.7 million, repurchased $8.8 million in common stock, recorded $3.0 million in net unrealized losses on
securities available for sale, net of tax, recorded $59,000 of accretion of market loss related to other than temporary
impairment on securities held to maturity, net of tax, and realized the effects of exercising stock options, stock option
compensation and restricted and unrestricted stock shares totaling $1.5 million.
The Company and the Bank are subject to various regulatory capital requirements. As of December 31, 2013, the
Company and the Bank were classified as “well capitalized” institutions under the criteria established by the Federal
Deposit Insurance Act.
Quarterly, the Company reviews the potential payment of cash dividends to common shareholders. The timing
and amount of cash dividends paid on our common stock depends on the Company’s earnings, capital requirements,
financial condition and other relevant factors. Dividends on common stock from the Company depend substantially
upon receipt of dividends from the Bank, which is the Company’s predominant sources of income. On January 29,
2014, the Company’s Board of Directors declared a dividend of $0.08 per share payable on February 24, 2014 to
shareholders of record on February 10, 2014.
62
Our capital levels were also modestly impacted by our 401(k) Employee Stock Ownership Plan and Trust
(“KSOP”). The Employee Stock Ownership Plan (“ESOP”) purchased 2% of the common stock issued in the January
1998 stock offering and borrowed from the Company to fund the purchase of the Company’s common stock. The loan
to the ESOP was repaid in full as of December 31, 2012. While outstanding, the loan was repaid principally from the
Bank’s contributions to the ESOP. The Bank's contributions were sufficient to service the debt over the 15 year loan
term at the interest rate of 8.5%. As the debt was repaid, shares were released, and allocated to plan participants
based on the proportion of debt service paid during the year. As shares were released, compensation expense was
recorded equal to the then current market price of the shares, our capital was increased, and the shares became
outstanding for earnings per common share calculations. For the year ended December 31, 2013, the Company did
not allocate or commit to be released to the ESOP any shares and the Company has no unearned, restricted shares
remaining to be released.
Contractual Obligations
The following table provides the amounts due under specified contractual obligations for the periods indicated as
of December 31, 2013:
December 31, 2013
Less than
1 year
Over 1-3
years
Over 3-5
years
More
than
5 years
Other (1)
Total
(In thousands)
Contractual payments by
period:
Deposits .................................. $ 222,817
1,755
Operating leases .....................
Total contractual
obligations .................... $ 224,572
$ 67,787
3,358
$ 18,826
2,522
$
— $ 1,089,759 $ 1,399,189
11,586
—
3,951
$ 71,145
$ 21,348
$ 3,951 $ 1,089,759 $ 1,410,775
(1) Represents interest bearing and noninterest bearing checking, money market and checking accounts which can
generally be withdrawn on demand and thereby have an undefined maturity
Asset/Liability Management
Our primary financial objective is to achieve long term profitability while controlling our exposure to fluctuations in
market interest rates. To accomplish this objective, we have formulated an interest rate risk management policy that
attempts to manage the mismatch between asset and liability maturities while maintaining an acceptable interest rate
sensitivity position. The principal strategies which we employ to control our interest rate sensitivity are: originating
commercial loans and residential construction loans at variable interest rates repricing for terms generally one year or
less; and offering noninterest bearing demand deposit accounts to businesses and individuals. The longer-term
objective is to increase the proportion of noninterest bearing demand deposits, low-rate interest bearing demand
deposits, money market accounts, and savings deposits relative to certificates of deposit to reduce our overall cost of
funds.
Our asset and liability management strategies have resulted in a positive 0-3 month “gap” of 21.7% and a
negative 4-12 month “gap” of 4.2% as of December 31, 2013. These “gaps” measure the difference between the
dollar amount of our interest earning assets and interest bearing liabilities that mature or reprice within the designated
period (three months and 4-12 months) as a percentage of total interest earning assets, based on certain estimates
and assumptions as discussed below. We believe that the implementation of our operating strategies has reduced the
potential effects of changes in market interest rates on our results of operations. The positive gap for the 0-3 month
period indicates that decreases in market interest rates may adversely affect our results over that period.
63
The following table provides the estimated maturity or repricing and the resulting interest rate sensitivity gap of
our interest earning assets and interest bearing liabilities at December 31, 2013 based upon estimates of expected
deposit run off rates consistent with national trends. The amounts in the table are derived from our internal data. We
used certain assumptions in presenting this data so the amounts may not be consistent with other financial
information prepared in accordance with generally accepted accounting principles. The amounts in the tables also
could be significantly affected by external factors, such as changes in prepayment assumptions, early withdrawal of
deposits and competition.
December 31, 2013
Estimated Maturity or Repricing Within
0-3
months
Over 3
months-12
months
1-5
years
Over 5
years -15
years
Over
15 years
Total
(Dollars in thousands)
Interest Earnings Assets:
Loans(1) ................................. $244,230
86,847
Investment securities .............
5,741
FHLB stock ............................
Interest earning deposits .......
90,238
Other interest earning
$ 68,174
20,643
—
—
$ 439,147
23,006
—
—
$164,968
25,230
—
—
$
$ 63,436
43,562
—
—
979,955
199,288
5,741
90,238
497
5,698
9,467
—
—
15,662
deposits ..............................
Total interest earning
assets .......................... $427,553
$ 94,515
$ 471,620
$190,198
$ 106,998
$ 1,290,884
Percentage of interest-
earning assets ....................
33.1%
7.3%
36.6%
14.7%
8.3%
100.0%
Interest Bearing Liabilities:
Total interest bearing
deposits(2) .......................... $ 118,620
Total securities sold under
$ 148,177
$ 782,490
$ —
$
—
$ 1,049,287
agreement to
repurchase ..........................
Total interest bearing
29,420
—
—
—
—
29,420
liabilities ...................... $148,040
$ 148,177
$ 782,490
$ —
$
—
$ 1,078,707
Interest-bearing liabilities, as
a percentage of total
interest earning assets .......
11.5%
11.5%
60.6%
— %
— %
83.6%
Interest rate sensitivity
Interest rate sensitivity gap,
as a percentage of total
interest earning assets .......
Cumulative interest rate
gap ..................................... $279,513
$ (53,662)
$(310,870)
$190,198
$ 106,998
$
212,177
21.7%
(4.2)%
(24.1)%
14.7%
8.3%
16.4%
sensitivity gap ..................... $279,513
$ 225,851
$ (85,019)
$105,179
$ 212,177
Cumulative interest rate
sensitivity gap, as a
percentage of total interest
earning assets ....................
21.7%
17.5%
(6.6)%
8.1%
16.4%
(1) Originated loans receivable, excluding deferred loan fees.
(2) Adjustable-rate liabilities are included in the period in which interest rates are next scheduled to adjust rather than
in the period they are due to mature. Although regular savings, demand, NOW, and money market deposit
accounts are subject to immediate withdrawal, based on historical experience management considers a
substantial amount of such accounts to be core deposits having significantly longer maturities. For the purpose
of the gap analysis, these accounts have been assigned decay rates to reflect their longer effective maturities. If
all of these accounts had been assumed to be short-term, the 0-3 month cumulative gap of interest-sensitive
assets would have been $(416.4) million, or (32.3%) of total interest earning assets at December 31, 2013.
64
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example,
although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on some types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in
market interest rates. Additionally, some assets, such as adjustable rate mortgages, have features, which restrict
changes in the interest rates of those assets both on a short-term basis and over the lives of such assets. Further, if a
change in market interest rates occurs, prepayment, and early withdrawal levels could deviate significantly from those
assumed in calculating the tables. Finally, the ability of many borrowers to service their adjustable rate debt may
decrease if market interest rates increase substantially.
Impact of Inflation and Changing Prices
Inflation affects our operations by increasing operating costs and indirectly by affecting the operations and cash
flow of our customers. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution
are monetary in nature. As a result, changes in interest rates generally have a more significant impact on a financial
institution’s performance than the effects of general levels of inflation. Although interest rates do not necessarily move
in the same direction or the same extent as the prices of goods and services, increases in inflation generally have
resulted in increased interest rates.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to interest rate risk through our lending and deposit gathering activities. For a discussion of how
this exposure is managed and the nature of changes in our interest rate risk profile during the past year, see “Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operation—Asset/Liability
Management.”
Neither we, nor the Bank, maintain a trading account for any class of financial instrument, nor do we, or the Bank,
engage in hedging activities or purchase high risk derivative instruments. Moreover, neither we, nor the Bank, are
subject to foreign currency exchange rate risk or commodity price risk.
65
The table below provides information about our originated financial instruments that are sensitive to changes in
interest rates as of December 31, 2013. The table presents principal cash flows and related weighted average interest
rates by expected maturity dates. The expected maturity is the contractual maturity or earlier call date of the
instrument. The data in this table may not be consistent with the amounts in the preceding table, which represents
amounts by the repricing date or maturity date (whichever occurs sooner) adjusted by estimates such as mortgage
prepayments and deposit reduction or early withdrawal rates.
By Expected Maturity Date
Year Ended December 31,
0-3
months
Over 3
months-12
months
1-5
years
Over 5
years -15
years
Over
15 years
Total
Fair Value
(Dollars in thousands)
Investment
Securities(1)
Amounts maturing:
Fixed rate .............. $ 1,004
Weighted average
interest rate .......
Adjustable rate ...... $
Weighted average
interest rate .......
2.4%
—
— %
$ 2,463
$ 15,087 $
30,111
$ 43,563
$ 92,228
4.3%
470
2.9%
3.8%
3.6%
3.6%
$ 8,444 $ 59,603
$ 38,543
$107,060
$
4.2%
4.0%
4.1%
4.3%
4.1%
Total ............... $ 1,004
$ 2,933
$ 23,531 $ 89,714
$ 82,106
$199,288
$199,474
Loans(2)
Amounts maturing:
Fixed rate .............. $ 14,640
Weighted average
interest rate .......
5.2%
Adjustable rate ...... $229,591
Weighted average
interest rate .......
5.2%
$ 27,141
$126,571 $ 137,009
$ 63,435
$368,796
5.3%
5.0%
4.6%
$ 41,034
$312,575 $ 27,959
$
4.6%
— $611,159
4.8%
5.5%
4.9%
4.2%
— %
4.8%
Total ............... $244,231
$ 68,175
$439,146 $ 164,968
$ 63,435
$979,955
$985,952
Certificates of
Deposit
Amounts maturing:
Fixed rate .............. $ 74,640
Weighted average
interest rate .......
0.5%
$148,177
$ 86,613 $
—
$
— $309,430
$311,064
0.6%
1.3%
— %
— %
0.8%
(1) Balances represent carrying value.
(2) Originated loans receivable, excluding deferred loan fees.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
For financial statements, see the Index to Consolidated Financial Statements on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WTIH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
On February 27, 2012, the Audit Committee of Heritage Financial Corporation (the “Company”), on behalf of the
Company and its subsidiaries, Heritage Bank and Central Valley Bank, notified KPMG LLP that they would be
dismissed as the Company’s independent public accountants upon completion of the audit for the fiscal year ended
December 31, 2011. The decision to change independent accountants was approved by the Audit Committee.
66
During the fiscal year ended December 31, 2011, and the subsequent interim period through March 2, 2012,
there were no disagreements with KPMG LLP on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedures, which disagreements, if not resolved to the satisfaction of KPMG LLP,
would have caused them to make reference to such disagreements in their report on the financial statements for such
years. During the fiscal year ended December 31, 2011 and the subsequent period through March 2, 2012, there were
no reportable events (as defined in Regulation S-K Item 304 (a)(1)(v)). The audit report of KPMG LLP on the
Company’s Consolidated Financial Statements as of and for the years ended December 31, 2011 and 2010 did not
contain an adverse opinion or a disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope
or accounting principles.
On February 27, 2012, the Audit Committee engaged the firm of Crowe Horwath LLP as independent certified
public accountants of the Company and its subsidiaries for the fiscal year ending December 31, 2012. During the
years ended December 31, 2013 and 2012, there were no disagreements with Crowe Horwath LLP, and the audit
reports of Crowe Horwath LLP on the Company’s Consolidated Financial Statements as of and for the years ended
December 31, 2013 and 2012 did not contain an adverse opinion or a disclaimer of opinion and were not qualified or
modified as to uncertainty, audit scope or accounting principles. The audit report of Crowe Horwath LLP on the
effectiveness of internal control over financial reporting as of December 31, 2013 did not contain any adverse opinion
or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principles.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures.
Our disclosure controls and procedures are designed to ensure that information the Company must disclose in its
reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded,
processed, summarized, and reported on a timely basis. Our management has evaluated, with the participation and
under the supervision of our chief executive officer (“CEO”) and chief financial officer (“CFO”), the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end
of the period covered by this report. Based on this evaluation, our CEO and CFO have concluded that, as of such
date, the Company’s disclosure controls and procedures are effective in ensuring that information relating to the
Company, including its consolidated subsidiaries, required to be disclosed in reports that it files under the Exchange
Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and
forms, and (2) accumulated and communicated to our management, including our CEO and CFO, as appropriate to
allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting.
(a) Management’s report on internal control over financial reporting.
The Company’s management is responsible for establishing and maintaining adequate internal control over
financial reporting. The Company’s internal control system is designed to provide reasonable assurance to our
management and the board of directors regarding the preparation and fair presentation of published financial
statements. Nonetheless, all internal control systems, no matter how well designed, have inherent limitations. Even
systems determined to be effective as of a particular date can provide only reasonable assurance with respect to
financial statement preparation and presentation and may not eliminate the need for restatements.
The Company’s management assessed the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2013. In making this assessment, management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission in the 1992 Internal Control—Integrated
Framework. Based on our assessment, we believe that, as of December 31, 2013, the Company’s internal control
over financial reporting is effective based on these criteria.
Crowe Horwath LLP, an independent registered public accounting firm, has audited the effectiveness of our
internal control over financial reporting as of December 31, 2013, and their report is included in “Item 8. Financial
Statements and Supplementary Data.”
67
(b) Attestation report of the registered public accounting firm.
See “Item 8. Financial Statements and Supplementary Data.”
(c) Changes in internal control over financial reporting.
There were no significant changes in the Company’s internal control over financial reporting during the
Company’s most recent fiscal year that have materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None
68
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning directors of the registrant is incorporated by reference to the section entitled “Election of
Directors” of our definitive proxy statement for the annual meeting of shareholders to be held on April 14, 2014
(“Proxy Statement”).
For information regarding the executive officers of the Company, see “Item 1. Business—Executive Officers.”
The required information with respect to compliance with Section 16(a) of the Exchange Act is incorporated by
reference to the section entitled “Security Ownership of Certain Beneficial Owners and Management” of the Proxy
Statement.
The Company has adopted a written Code of Ethics that applies to our directors, officers and employees. The
Code of Ethics can be accessed electronically by visiting the Company’s website at www.hf-wa.com.
The Audit and Finance Committee of our Board of Directors retains our independent auditors, reviews and
approves the scope and results of the audits with the auditors and management, monitors the adequacy of our system
of internal controls and reviews the annual report, auditors’ fees and non-audit services to be provided by the
independent auditors. The members of our audit committee are Daryl D. Jensen, chair of the committee, John A.
Clees, Jeffrey S. Lyon, Donald V. Rhodes, Ann Watson and Gary B. Christensen, all of whom are considered
“independent” as defined by the SEC. Our Board of Directors has determined that Mr. Jensen meets the definition of
an audit committee financial expert, as determined by the requirements of the SEC.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive and director compensation and certain matters regarding participation in the
Company’s compensation committee required by this item is incorporated by reference to the headings “Executive
Compensation”, “Directors’ Compensation,” and “Report of the Compensation Committee” of the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNEERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
The following table summarizes the consolidated activity within the Company’s stock option plans as of
December 31, 2013, all of which were approved by shareholders.
Plan Category
Equity compensation plans, all of which are approved by
Number of
securities
to be issued
upon exercise of
outstanding
options and
awards
Weighted-
average
exercise
price of
outstanding
options
Number of
securities
remaining
available for
future issuance
under equity
compensation
plans
security holders ....................................................................
397,421
$
15.82
110,436
Information concerning security ownership of certain beneficial owners and management is incorporated by
reference to the section entitled “Security Ownership of Certain Beneficial Owners and Management” of the Proxy
Statement.
69
ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information concerning certain relationships and related transactions is incorporated by reference to the section
entitled “Meetings and Committees of the Board of Directors and Corporate Governance” of the Proxy Statement.
Our common stock is listed on the NASDAQ Global Select Market. In accordance with NASDAQ requirements, at
least a majority of our directors must be independent directors. The Board of Directors has determined that eight of
our ten directors are independent. Directors Charneski, Christensen, Clees, Ellwanger, Jensen, Lyon, Rhodes and
Watson are all independent. Only Brian L. Vance, who serves as President and Chief Executive Officer of Heritage
Financial Corporation and Chief Executive Officer of Heritage Bank, and David H. Brown, former Chief Executive
Officer of Valley Community Bancshares, Inc. and Valley Bank, were not independent.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information concerning principal accounting fees and services is incorporated by reference to the section entitled
“Proposal 3—Ratification of the Appointment of Registered Public Accounting Firm—Audit Fees” in the Proxy
Statement.
70
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
PART IV
(a)(1) Financial Statements: The Consolidated Financial Statements are contained as listed on the “Index to
Consolidated Financial Statements” on page F-1.
(2) Financial Statements Schedules: All schedules are omitted because they are not required or applicable,
or the required information is shown in the Consolidated Financial Statements or notes.
(3) Exhibits: Included in schedule below.
Exhibit
No.
2.1 & 2.2
Purchase and Assumption Agreements for Cowlitz & Pierce—reference Q3 2012 Form 10-Q
Exhibits (1)
3.1
3.2
4.2
Articles of Incorporation (2)
Bylaws of the Company (3)
Warrant for purchase (4)
10.1
1998 Stock Option and Restricted Stock Award Plan (5)
10.2
1997 Stock Option and Restricted Stock Award Plan (6)
10.3
10.4
10.5
10.6
2002 Incentive Stock Option Plan, Director Nonqualified Stock Option Plan, and Restricted Stock
Option Plan (7)
2006 Incentive Stock Option Plan, Director Nonqualified Stock Option Plan, and Restricted Stock
Option Plan (8)
Employment Agreement between Central Valley Bank and D. Michael Broadhead, effective
December 3, 2010 (9)
Letter of Understanding between Heritage Financial Corporation and Donald V. Rhodes dated
August 18, 2009 (10)
10.7
Annual Incentive Compensation Plan (11)
10.8
2010 Omnibus Equity Plan (12)
10.9
Deferred Compensation Plan and Participation Agreements for Brian L. Vance, Jeffrey J. Deuel and
Donald J. Hinson (13)
10.10
Employment Agreements for Brian L. Vance, Jeffrey J. Deuel and Donald J. Hinson (13)
10.12
Change in Control Agreement by and between Heritage Bank and David A. Spurling (14)
11
Statement regarding computation of earnings per share (15)
14.0
Code of Ethics and Conduct Policy (16)
21.0
Subsidiaries of the Company
23.1
Consent of Independent Registered Public Accounting Firm—Crowe Horwath LLP
23.2
Consent of Independent Registered Public Accounting Firm—KPMG LLP
24.0
Power of Attorney
71
Exhibit
No.
31.1
31.2
32.1
101
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
The following materials from Heritage Financial Corporation’s Annual Report on Form 10-K for the
year ended December 31, 2013, formatted in Extensible Business Reporting Language (“XBRL”): (i)
Consolidated Statements of Financial Condition, (ii) Consolidated Statements of Income; (iii)
Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Stockholders'
Equity; (v) Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial
Statements (17)
(1) Incorporated by reference to the Current Report on Form 10-Q dated November 7, 2012.
(2) Incorporated by reference to the Registration Statement on Form S-1 (Reg. No. 333-35573) declared effective on
November 12, 1997; as amended, said Amendment being incorporated by reference to the Amendment to the
Articles of Incorporation of Heritage Financial Corporation filed with the Current Report on Form 8-K dated
November 25, 2008.
(3) Incorporated by reference to the Current Report on Form 8-K dated November 29, 2007.
(4) Incorporated by reference to the Current Report on Form 8-K dated November 25, 2008.
(5) Incorporated by reference to the Registration Statement on Form S-8 (Reg. No. 333-71415).
(6) Incorporated by reference to the Registration Statement on Form S-8 (Reg. No. 333-57513).
(7) Incorporated by
the Registration Statements on Form S-8
reference
to
(Reg. No. 333-88980;
333-88982; 333-88976).
(8) Incorporated by
reference
to
the Registration Statements on Form S-8
(Reg. No. 333-134473;
333-134474; 333-134475).
(9) Incorporated by reference to the Quarterly Report on Form 10-Q dated May 1, 2007.
(10) Incorporated by reference to the Current Report on Form 8-K dated August 20, 2009.
(11) Incorporated by reference to the Annual Report on Form 10-K dated March 2, 2010.
(12) Incorporated by reference to the Registration Statement on Form S-8 (Reg. No. 33-167146).
(13) Incorporated by reference to the Current Report on Form 8-K dated September 7, 2012.
(14) Incorporated by reference to the Annual Report on Form 10-K dated March 6, 2013.
(15) Reference is made to Note 17—Stockholders' Equity in the Selected Notes to Consolidated Financial Statements
under Item 8 herein.
(16) Registrant elects to satisfy Regulation S-K §229.406(c) by posting its Code of Ethics on its website at
www.HF-WA.com in the section titled Investor Information: Corporate Governance.
(17) Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration
statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933 or Section 18 of the
Securities Exchange Act of 1934, as amended, and otherwise not subject to liability under those sections.
72
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange act of of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 11th day
of March 2014.
SIGNATURES
HERITAGE FINANCIAL CORPORATION
(Registrant)
/S/ BRIAN L. VANCE
Brian L. Vance
President and Chief Executive Officer
73
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by
the following persons on behalf of the registrant and in the capacities indicated on the 11th day of March 2014.
Principal Executive Officer:
/S/ BRIAN L. VANCE
Brian L. Vance
President and Chief Executive Officer
Principal Financial Officer:
/S/ DONALD J. HINSON
Donald J. Hinson
Executive Vice President and Chief Financial Officer
Remaining Directors:
*David H. Brown
*Brian S. Charneski
*Gary B. Christensen
*Kimberly T. Ellwanger
*Daryl D. Jensen
*Jeffrey S. Lyon
*Donald V. Rhodes
*Ann Watson
*By
/S/ BRIAN L. VANCE
Brian L. Vance
Attorney-in-Fact
74
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIY
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm .................................................................................
F-2
Report of Independent Registered Public Accounting Firm .................................................................................
F-3
Consolidated Statements of Financial Condition—December 31, 2013 and December 31, 2012 .....................
F-4
Consolidated Statements of Income—Years ended December 31, 2013, 2012 and 2011 .................................
F-5
Consolidated Statements of Comprehensive Income—Years ended December 31, 2013, 2012 and 2011 .......
F-6
Consolidated Statements of Stockholders’ Equity—Years ended December 31, 2013, 2012 and 2011 ............
F-7
Consolidated Statements of Cash Flows—Years ended December 31, 2013, 2012 and 2011 ..........................
F-8
Notes to Consolidated Financial Statements ......................................................................................................
F-10
F-1
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Heritage Financial Corporation and subsidiary
Olympia, Washington
We have audited the accompanying consolidated statements of financial condition of Heritage Financial
Corporation and subsidiary (the “Company”) as of December 31, 2013 and 2012, and the related consolidated
statements of income, comprehensive income, stockholders’ equity, and cash flows for the years then ended. We also
have audited the Company’s internal control over financial reporting as of December 31, 2013, based on criteria
established in the 1992 Internal Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial
statements, for maintaining effective internal control over financial reporting, and for its assessment of the
effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on
Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and
an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about
whether the financial statements are free of material misstatement and whether effective internal control over financial
reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating the overall financial statement
presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the
design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing
such other procedures as we considered necessary in the circumstances. We believe that our audits provide a
reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company’s internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies
or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
financial position of Heritage Financial Corporation and subsidiary as of December 31, 2013 and 2012, and the results
of their operations and their cash flows for the years then ended in conformity with accounting principles generally
accepted in the United States of America. Also in our opinion, Heritage Financial Corporation and subsidiary
maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based
on criteria established in the 1992 Internal Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
/s/ Crowe Horwath LLP
San Francisco, California
March 11, 2014
F-2
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Heritage Financial Corporation:
We have audited the accompanying consolidated statements of income, comprehensive income, stockholders’ equity,
and cash flows of Heritage Financial Corporation and subsidiary for the year ended December 31, 2011. These
consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to
express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
results of operations and cash flows of Heritage Financial Corporation and subsidiary for the year ended
December 31, 2011, in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Seattle, Washington
March 2, 2012
F-3
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 2013 and 2012
(Dollars in thousands)
December 31,
2013
December 31,
2012
ASSETS
Cash on hand and in banks .....................................................................................
Interest earning deposits ..........................................................................................
$
40,162 $
90,238
Cash and cash equivalents .......................................................................
Other interest earning deposits ................................................................................
Investment securities available for sale, at fair value ..............................................
Investment securities held to maturity (fair value of $36,340 and $11,010).............
Loans held for sale ...................................................................................................
Originated loans receivable, net ...............................................................................
Less: Allowance for loan losses ...............................................................................
130,400
15,662
163,134
36,154
—
977,285
(17,153)
37,180
67,088
104,268
2,818
144,293
10,099
1,676
874,485
(19,125)
Originated loans receivable, net of allowance for loan losses ..................
960,132
855,360
Purchased covered loans receivable, net of allowance for loan losses of
($6,167 and $4,352) .............................................................................................
Purchased non-covered loans receivable, net of allowance for loan losses of
($5,504 and $5,117) .............................................................................................
Total loans receivable, net .........................................................................
Federal Deposit Insurance Corporation (“FDIC”) indemnification asset ..................
Other real estate owned ($182 and $260 covered by FDIC shared-loss,
respectively)..........................................................................................................
Premises and equipment, net ..................................................................................
Federal Home Loan Bank (“FHLB”) stock, at cost ...................................................
Accrued interest receivable ......................................................................................
Prepaid expenses and other assets .........................................................................
Other intangible assets, net .....................................................................................
Goodwill ....................................................................................................................
57,587
185,377
1,203,096
4,382
4,559
34,348
5,741
5,462
25,120
1,615
29,365
83,978
59,006
998,344
7,100
5,666
24,755
5,495
4,821
22,107
1,086
13,012
Total assets ................................................................................................
$1,659,038 $
1,345,540
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits ...................................................................................................................
Securities sold under agreement to repurchase ......................................................
Accrued expenses and other liabilities .....................................................................
$1,399,189 $
29,420
14,667
1,117,971
16,021
12,610
Total liabilities .............................................................................................
1,443,276
1,146,602
Stockholders’ equity:
Preferred stock, no par value, 2,500,000 shares authorized; no shares
issued and outstanding at December 31, 2013 and 2012 ............................
Common stock, no par value, 50,000,000 shares authorized; 16,210,747
and 15,117,980 shares issued and outstanding at December 31, 2013 and
2012, respectively .........................................................................................
Retained earnings .............................................................................................
Accumulated other comprehensive (loss) income, net.....................................
—
—
138,659
78,265
(1,162)
121,832
75,362
1,744
Total stockholders’ equity ...........................................................................
215,762
198,938
Total liabilities and stockholders’ equity.....................................................
$1,659,038 $
1,345,540
See accompanying Notes to Consolidated Financial Statements.
F-4
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2013, 2012 and 2011
(Dollars in thousands, except per share amounts)
Years Ended December 31,
2013
2012
2011
INTEREST INCOME:
Interest and fees on loans ...............................................................
Taxable interest on investment securities........................................
Nontaxable interest on investment securities..................................
Interest and dividends on other interest earning assets..................
Total interest income .........................................................
$67,630
1,918
1,539
341
71,428
INTEREST EXPENSE:
Deposits ...........................................................................................
Other borrowings .............................................................................
Total interest expense .......................................................
Net interest income ...........................................................
Provision for loan losses on originated loans .........................................
Provision for loan losses on purchased loans ........................................
Net interest income after provision for loan losses..........................
NONINTEREST INCOME:
Bargain purchase gain on bank acquisition.....................................
Service charges and other fees .......................................................
Merchant Visa income, net ..............................................................
Change in FDIC indemnification asset ............................................
Other income ...................................................................................
Total noninterest income ...................................................
NONINTEREST EXPENSE:
Impairment loss on investment securities .......................................
Less: Portion recorded as other comprehensive loss .....................
Impairment loss on investment securities, net .........................
Compensation and employee benefits ............................................
Occupancy and equipment ..............................................................
Data processing ...............................................................................
Marketing .........................................................................................
Professional services .......................................................................
State and local taxes .......................................................................
Federal deposit insurance premium ................................................
Other real estate owned, net ...........................................................
Other expense .................................................................................
Total noninterest expense .................................................
Income before income taxes ...........................................................
Income tax expense ........................................................................
3,673
51
3,724
67,704
890
2,782
64,032
399
5,936
862
(181)
2,635
9,651
38
—
38
31,612
9,724
4,806
1,598
3,936
1,150
1,001
309
5,341
59,515
14,168
4,593
$65,588
2,195
1,097
229
69,109
4,469
65
4,534
64,575
695
1,321
62,559
—
5,516
685
(1,033)
2,104
7,272
130
(52)
78
29,020
7,365
2,555
1,517
2,543
1,226
1,002
316
4,770
50,392
19,439
6,178
$70,114
2,912
821
273
74,120
6,503
79
6,582
67,538
5,180
9,250
53,108
—
5,419
556
(2,250)
2,021
5,746
118
(20)
98
27,109
7,127
2,628
1,361
2,062
1,336
1,558
921
5,503
49,703
9,151
2,633
Net income ........................................................................
$ 9,575
$13,261
$ 6,518
Basic earnings per common share .........................................................
Diluted earnings per common share .......................................................
Dividends declared per common share ..................................................
$ 0.61
$ 0.61
$ 0.42
$ 0.87
$ 0.87
$ 0.80
$ 0.42
$ 0.42
$ 0.38
See accompanying Notes to Consolidated Financial Statements.
F-5
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Years Ended December 31, 2013, 2012 and 2011
(Dollars in thousands)
Years Ended December 31,
2013
2012
2011
$ 9,575
$13,261
$
6,518
(2,965)
(63)
1,233
—
—
59
—
(34)
105
14
(13)
125
$
$
1,359
7,877
Comprehensive Income
Net income ...............................................................................................
Change in fair value of securities available for sale, net of tax of
$(1,596), $(34) and $663 ..............................................................
Reclassification adjustment of net gain from sale of available for
sale securities included in income, net of tax of $0, $0 and $8 ....
Other-than-temporary impairment on securities held to maturity,
net of tax of $0, $(18) and $(7) .....................................................
Accretion of other-than-temporary impairment on securities held
to maturity, net of tax of $31, $57 and $68 ....................................
Other comprehensive (loss) income ..........................................
$ (2,906)
$
8
Comprehensive income ...........................................................................
$ 6,669
$13,269
See accompanying Notes to Consolidated Financial Statements.
F-6
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2013, 2012 and 2011
(In thousands, except per share amounts)
Number of
common
shares
Common
stock
Unearned
Compensation -
ESOP
Retained
earnings
Accumulated
other
comprehensive
income
(loss), net
Total
stock-
holders’
equity
$ 128,436
$
(182)
$ 73,648
$
377
$
202,279
Balance at December 31, 2010 .............. 15,568
Restricted and unrestricted stock
Balance at December 31, 2011 .............. 15,456
Restricted and unrestricted stock
awards issued, net of forfeitures ........
Stock option compensation expense .....
Exercise of stock options (including
excess tax benefits from
nonqualified stock options) ................
Restricted stock compensation
expense .............................................
Excess tax benefits from restricted
stock ..................................................
Common stock repurchased and
retired ................................................
Net income .............................................
Other comprehensive income, net of
tax ......................................................
Repurchase of warrant issued to US
Treasury .............................................
Cash dividends declared on common
stock ($0.38 per share) ......................
awards issued, net of forfeitures ........
Stock option compensation expense .....
Exercise of stock options (including
excess tax benefits from
nonqualified stock options) ................
Restricted stock compensation
expense .............................................
Excess tax benefits from restricted
stock ..................................................
Common stock repurchased and
retired ................................................
Net income .............................................
Other comprehensive income, net of
tax ......................................................
Cash dividends declared on common
stock ($0.80 per share) ......................
Balance at December 31, 2012 ..............
Restricted and unrestricted stock
awards issued, net of forfeitures ........
Stock option compensation expense .....
Exercise of stock options (including
excess tax benefits from
nonqualified stock options) ................
Restricted stock compensation
expense .............................................
Excess tax benefits from restricted
stock ..................................................
Common stock repurchased and
retired ................................................
Net income .............................................
Other comprehensive loss, net of tax .....
Common stock issued in acquisition ......
Cash dividends declared on common
stock ($0.42 per share) ......................
76
—
5
8
—
(201 )
—
—
—
—
86
—
12
10
—
(446 )
—
—
—
—
165
50
767
(4)
(2,342)
—
—
(450)
—
$ 126,622
$
—
106
129
1,091
(93)
(6,023)
—
—
—
15,118
121,832
100
—
17
—
—
—
71
176
1,223
(13)
(557 )
—
—
1,533
(8,825)
—
—
24,195
—
—
Balance at December 31, 2013 ..............
16,211
$ 138,659
$
—
—
—
88
—
—
—
—
—
—
(94)
—
—
—
94
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
6,518
—
—
(5,910)
—
—
—
—
—
—
—
1,359
—
—
$ 74,256
$
1,736
—
—
—
—
—
—
13,261
—
(12,155)
75,362
—
—
—
—
—
—
9,575
—
—
(6,672)
—
—
—
—
—
—
—
8
—
1,744
—
—
—
—
—
—
—
(2,906)
—
—
—
165
50
855
(4)
(2,342)
6,518
1,359
(450)
(5,910)
202,520
—
106
129
1,185
(93)
(6,023)
13,261
8
(12,155)
198,938
—
71
176
1,223
(13)
(8,825)
9,575
(2,906)
24,195
(6,672)
$ 78,265
$
(1,162)
$
215,762
See accompanying Notes to Consolidated Financial Statements.
F-7
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2013, 2012 and 2011
(Dollars in thousands)
Cash flows from operating activities:
Net income ................................................................................................................................ $
Adjustments to reconcile net income to net cash provided by operating activities:
9,575
$ 13,261 $
6,518
Years Ended December 31,
2013
2012
2011
Depreciation and amortization .........................................................................................
Changes in net deferred loan fees, net of amortization ...................................................
Provision for loan losses ..................................................................................................
Net change in accrued interest receivable, prepaid expenses and other assets,
accrued expenses and other liabilities ........................................................................
Recognition of compensation related to ESOP shares and share based payment .........
Stock option compensation expense ...............................................................................
Tax provision realized from stock options exercised, share based payment and
dividends on unallocated ESOP shares ......................................................................
Amortization of intangible assets .....................................................................................
Bargain purchase gain on bank acquisition .....................................................................
Gain on sales of investment securities ............................................................................
Impairment loss on investment of securities ....................................................................
Origination of loans held for sale .....................................................................................
Gain on sale of loans .......................................................................................................
Proceeds from sale of loans ............................................................................................
Valuation adjustment on other real estate owned ............................................................
(Gain) loss on other real estate owned, net .....................................................................
(Gain) loss on sale of premises and equipment, net........................................................
5,411
574
3,672
8,977
1,223
71
13
543
(399 )
—
38
(6,784 )
(142 )
8,602
371
(264 )
(584 )
4,290
236
2,016
5,798
1,185
106
93
427
—
—
78
(21,035)
(295)
21,482
824
(587)
3
Net cash provided by operating activities................................................................
30,897
27,882
Cash flows from investing activities:
Loans originated, net of principal payments ....................................................................
Maturities of other interest earning deposits ....................................................................
Maturities of investment securities available for sale.......................................................
Maturities of investment securities held to maturity .........................................................
Purchase of other interest earning deposits ....................................................................
Purchase of investment securities available for sale .......................................................
Purchase of investment securities held to maturity..........................................................
Purchase of premises and equipment .............................................................................
Proceeds from sales of other real estate owned..............................................................
Proceeds from sales of investment securities available for sale......................................
Proceeds from redemption of FHLB stock .......................................................................
Proceeds for sale of premises and equipment.................................................................
Net cash received from acquisitions ................................................................................
(43,140 )
1,987
51,443
4,192
—
(43,627 )
(7,414 )
(5,205 )
6,003
—
208
700
18,260
(2,790)
—
61,751
2,177
(2,232)
(63,903)
—
(3,859)
5,255
—
99
—
—
Net cash used in investing activities .......................................................................
(16,593 )
(3,502)
Cash flows from financing activities:
Net increase (decrease) in deposits ................................................................................
Common stock cash dividends paid ................................................................................
Net increase (decrease) in securities sold under agreement to repurchase....................
Proceeds from exercise of stock options, including excess tax benefits from
nonqualified stock options ...........................................................................................
Tax provision realized from stock options exercised, share based payment and
dividends on unallocated ESOP shares ......................................................................
Repurchase of common stock .........................................................................................
Repurchase of common stock warrant ............................................................................
13,763
(6,672 )
13,399
(18,073)
(12,155)
(7,070)
176
129
(13 )
(8,825 )
—
(93)
(6,023)
—
Net cash provided by (used in) financing activities .................................................
11,828
(43,285)
2,185
537
14,430
(4,224)
855
165
4
440
—
(23)
98
(18,016)
(316)
17,268
871
71
8
20,871
(45,379)
10
35,196
2,221
(496)
(53,590)
(271)
(3,127)
3,257
412
—
2
—
(61,765)
(232)
(5,910)
4,064
50
(4)
(2,342)
(450)
(4,824)
Net increase (decrease) in cash and cash equivalents...........................................
Cash and cash equivalents at beginning of period ............................................................................
26,132
104,268
(18,905)
123,173
(45,718)
168,891
Cash and cash equivalents at end of period ...................................................................................... $
130,400
$ 104,268 $
123,173
F-8
Years Ended December 31,
2013
2012
2011
Supplemental disclosures of cash flow information:
Cash paid for interest ....................................................................................................... $
Cash paid for income taxes .............................................................................................
Seller-financed sale of other real estate owned...............................................................
Loans transferred to other real estate owned ..................................................................
Stock issued for acquisition .............................................................................................
Assets acquired (liabilities assumed) in acquisitions:
3,678
3,574
250
2,974
24,195
$ 4,608 $
10,713
—
7,406
—
6,724
9,998
—
5,653
—
Other interest earning deposits ...............................................................................
Investment securities available for sale ..................................................................
Investment securities held to maturity .....................................................................
Purchased non-covered loans receivable ...............................................................
Other real estate owned ..........................................................................................
Premises and equipment.........................................................................................
FHLB stock ..............................................................................................................
Accrued interest receivable .....................................................................................
Prepaid expenses and other assets ........................................................................
Core deposit intangible ...........................................................................................
Deposits ..................................................................................................................
Accrued expenses and other liabilities ....................................................................
14,869
34,197
22,908
168,580
2,279
6,772
454
697
7,135
1,072
(267,455 )
(1,528 )
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
See accompanying Notes to Consolidated Financial Statements.
F-9
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2013, 2012 and 2011
(1) Description of Business, Basis of Presentation and Significant Accounting Policies
(a) Description of Business
Heritage Financial Corporation (the “Company”) is a bank holding company that was incorporated in the State of
Washington in August 1997. The Company is primarily engaged in the business of planning, directing and
coordinating the business activities of its wholly-owned subsidiary Heritage Bank (the “Bank”). The Bank is a
Washington-chartered commercial bank and its deposits are insured by the FDIC under the Deposit Insurance Fund
(“DIF”). The Bank is headquartered in Olympia, Washington and conducts business from its thirty-five branch offices
located throughout Washington state and the greater Portland, Oregon area. The Bank’s business consists primarily
of lending and deposit relationships with small businesses and their owners in its market areas and attracting deposits
from the general public. The Bank also makes real estate construction and land development loans and consumer
loans and originates first mortgage loans on residential properties located in western and central Washington State
and the greater Portland, Oregon area.
The Company has expanded its footprint through acquisitions beginning with the FDIC-assisted acquisition of
Cowlitz Bank, a Washington chartered commercial bank headquartered in Longview, Washington effective on July 30,
2010. Heritage Bank entered into a definitive agreement with the FDIC, pursuant to which Heritage Bank acquired
certain assets and assumed certain liabilities of Cowlitz Bank (the “Cowlitz Acquisition”). The Cowlitz Acquisition
included nine branches of Cowlitz Bank, including its division Bay Bank, which opened as branches of Heritage Bank
on August 2, 2010. It also included the Trust Services Division of Cowlitz Bank.
Effective November 5, 2010, Heritage Bank entered into a definitive agreement with the FDIC, pursuant to which
Heritage Bank acquired certain assets and assumed certain liabilities of Pierce Commercial Bank, a Washington
chartered commercial bank headquartered in Tacoma, Washington (the “Pierce Commercial Acquisition”). The Pierce
Commercial Acquisition included one branch, which opened as a branch of Heritage Bank as of November 8, 2010.
On September 14, 2012, the Company and the Bank entered into a definitive agreement to acquire Northwest
Commercial Bank (“NCB”), a Washington chartered commercial bank headquartered in Lakewood, Washington (the
“NCB Acquisition”). The NCB Acquisition was completed on January 9, 2013, with the merger of NCB into Heritage
Bank. See Note 2, “Business Combinations” for additional information.
On March 11, 2013, the Company entered into a definitive agreement to acquire Valley Community Bancshares,
Inc. ("Valley" or "Valley Community Bancshares") and its wholly-owned subsidiary, Valley Bank, both headquartered in
Puyallup, Washington (the “Valley Acquisition”). The Valley Acquisition was completed on July 15, 2013. See Note 2,
“Business Combinations” for additional information.
On April 8, 2013, the Company announced the proposed merger of its two wholly-owned bank subsidiaries
Central Valley Bank and Heritage Bank, with Central Valley Bank merging into Heritage Bank. The common control
merger was completed on June 19, 2013 and on a consolidated basis had no accounting impact on the Company.
Central Valley Bank now operates as a division of Heritage Bank.
On October 23, 2013, the Company, along with the Bank, and Washington Banking Company (“Washington
Banking”) and its wholly owned subsidiary bank, Whidbey Island Bank ("Whidbey") jointly announced the signing of a
merger agreement under which Heritage and Washington Banking will enter into a strategic merger with Washington
Banking merging into Heritage. Immediately following the merger, Whidbey will merge into the Bank. Washington
Banking branches will adopt the Heritage Bank name in all markets, with the exception of six branches in Whidbey
Island markets which will continue to operate using the Whidbey Island Bank name. The corporate headquarters of
the combined company will be in Olympia, Washington. The merger is anticipated to be completed in the second
quarter of 2014. See "Note 22 - Proposed Merger" for additional information.
F-10
(b) Basis of Presentation
The accounting and reporting policies of the Company and its subsidiary confirm to U.S. Generally Accepted
Accounting Principles (“GAAP”). In preparing the Consolidated Financial Statements management makes estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of financial statements and the reported amounts of income and expenses during the reporting
periods. Material estimates that are particularly susceptible to significant change relate to the determination of the
allowance for loan losses, other than temporary impairments in the fair value of investment securities, expected cash
flows of purchased loans and related indemnification asset, fair value measurements, stock-based compensation,
impairment of goodwill and other intangible assets and income taxes. Actual results could differ from these estimates.
The accompanying Consolidated Financial Statements include the accounts of the Company and its wholly
owned subsidiary. All significant intercompany balances and transactions among the Company and its subsidiary have
been eliminated in consolidation.
Certain prior year amounts have been reclassified to conform to the current period’s presentation.
Reclassifications had no effect on prior year net income or stockholders’ equity.
(c) Significant Accounting Policies
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents includes cash on hand and in banks, interest
earning deposits with original maturities of 90 days or less, and federal funds sold. Net cash flows are reported for
customer loan and deposit transactions, other interest bearing deposits, federal funds sold and repurchase
agreements.
Investment Securities
The Company identifies investments as held to maturity or available for sale at the time of acquisition. Securities
are classified as held to maturity when the Company has the ability and positive intent to hold them to maturity.
Securities classified as available for sale are available for future liquidity requirements and may be sold prior to
maturity.
Investment securities held to maturity are recorded at cost, adjusted for amortization of premiums or accretion of
discounts using the interest method. Securities available for sale are carried at fair value. Unrealized gains and losses
on securities available for sale are excluded from earnings and are reported in other comprehensive income, net of
related income taxes. Realized gains and losses on sale of investment securities are computed on the specific
identification method.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and
more frequently when economic or market conditions warrant such an evaluation. Although these evaluations involve
significant judgment, an unrealized loss in the fair value of a debt security is generally deemed to be temporary when
the fair value of the security is below the carrying value primarily due to changes in interest rates, there has not been
significant deterioration in the financial condition of the issuer, and it is not more likely than not that the Company will
be required to sell the security before the anticipated recovery of its remaining carrying value. If any of these criteria is
not met, the impairment is split into two components as follows: 1) OTTI related to credit loss, which must be
recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive
income. 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. An unrealized loss in the value of an equity security is generally considered
temporary when the fair value of the security is below the carrying value primarily due to current market conditions
and not deterioration in the financial condition of the issuer, and it is not more likely than not that the Company will be
required to sell the security before the anticipated recovery of its remaining carrying value. Other factors that may be
considered in determining whether a decline in the value of either a debt or an equity security is “other than
temporary” include ratings by recognized rating agencies; actions of commercial banks or other lenders relative to the
continued extension of credit facilities to the issuer of the security; the financial condition, capital strength and near-
term prospects of the issuer and recommendations of investment advisors or market analysts. If any of these criteria
F-11
is not met, the entire difference between amortized cost and fair value is recognized as impairment through earnings,
and a new cost basis is established for the security. Continued deterioration of market conditions could result in
additional impairment losses recognized within the investment portfolio.
Loans Receivable and Loans Held for Sale
Loans Held for Sale:
Mortgage loans held for sale are carried at the lower of amortized cost or market value determined on an
aggregate basis. Any loan that management determines will not be held to maturity is classified as held for sale at the
time of origination, purchase or securitization, or when such decision is made. Unrealized losses on such loans are
included in income.
Originated Loans:
Originated loans are generally recorded at their outstanding principal balance adjusted for charge-offs, the
allowance for loan losses and deferred fees and costs. Interest on loans is calculated using the simple interest
method based on the daily balance of the principal amount outstanding and is credited to income as earned. Loans
are considered past due or delinquent when principal or interest payments are past due 30 days or more. Loans on
which the accrual of interest has been discontinued are designated as nonaccrual loans. Delinquent loans may
remain on accrual status between 30 days and 89 days past due. The accrual of interest is discontinued at the time
the loan is 90 days delinquent unless the credit is well secured and in the process of collection. Loans are placed on
nonaccrual at an earlier date if collection of the contractual principal or interest is doubtful. All interest accrued but not
collected on loans deemed nonaccrual during the period is reversed against interest income in that period. The
interest payments received on nonaccrual loans is accounted for on the cost-recovery method whereby the interest
payment is applied to the principal balances. Loans may be returned to accrual status when improvements in credit
quality eliminate the doubt as to the full collectability of both interest and principal and a period of sustained
performance has occurred. Substantially all loans that are nonaccrual are also impaired. Income recognition on
impaired loans conforms to that used on nonaccrual loans.
Loans are charged-off if collection of the contractual principal or interest as scheduled in the loan agreement is
doubtful. Credit card loans and other consumer loans are typically charged-off no later than 180 days past due.
Purchased Covered and Purchased Non-Covered Loans:
Loans acquired in a business combination are designated as “purchased” loans. These loans are recorded at
their fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan.
Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date. Purchased loans
subject to FDIC shared-loss agreements are identified as “covered” on the Consolidated Statements of Financial
Condition, while purchased loans not subject to FDIC shared-loss agreements are referred to as “non-covered”. The
covered loans have an additional evaluation separate from originated and purchased non-covered loans as they have
shared-loss attributes which may reduce the Bank’s risk of loss. For further information see Note 7, “FDIC
Indemnification Asset”.
Loans purchased with evidence of credit deterioration since origination for which it is probable that all
contractually required payments will not be collected are accounted for under Financial Accounting Standards Board
(“FASB”) Accounting Standards Codification (“FASB ASC”) 310-30, Loans and Debt Securities Acquired with
Deteriorated Credit Quality, formerly AICPA SOP 03-3 Accounting for Certain Loans or Debt Securities Acquired in a
Transfer. These loans are identified as “purchased impaired” loans. In situations where such loans have similar risk
characteristics, loans may be aggregated into pools to estimate cash flows. A pool is accounted for as a single asset
with a single interest rate, cumulative loss rate and cash flow expectation. Expected cash flows at the acquisition date
in excess of the fair value of loans are considered to be accretable yield, which is recognized as interest income over
the life of the loan or pool using a level yield method if the timing and amount of the future cash flows of the pool is
reasonably estimable.
The cash flows expected over the life of the purchased impaired loan or pool are estimated quarterly using an
internal cash flow model that projects cash flows and calculates the carrying values of the pools, book yields, effective
interest income and impairment, if any, based on pool level events. Assumptions as to default rates, loss severity and
F-12
prepayment speeds are utilized to calculate the expected cash flows. To the extent actual or projected cash flows are
less than previously estimated, additional provisions for loan losses on the purchased loan portfolios will be
recognized immediately into earnings. To the extent actual or projected cash flows are more than previously
estimated, the increase in cash flows is recognized immediately as a recapture of provision for loan losses up to the
amount of any provision previously recognized for that pool of loans, if any, then prospectively recognized in interest
income as a yield adjustment. Any disposals of loans, including sales of loans, and payments in full or foreclosures
result in the removal of the loan from the loan pool at the carrying amount.
Loans accounted for under FASB ASC 310-30 are generally considered accruing and performing loans as the
loans accrete interest income over the estimated life of the loan when cash flows are reasonably estimable.
Accordingly, purchased impaired loans that are contractually past due are still considered to be accruing and
performing loans. If the timing and amount of cash flows is not reasonably estimable, the loans may be classified as
nonaccrual loans and interest income may be recognized on a cash basis or as a reduction of the principal amount
outstanding.
Loans purchased that are not accounted for under FASB ASC 310-30 are accounted for under FASB ASC 310-
20, Receivables—Nonrefundable fees and Other Costs, formerly SFAS 91 Nonrefundable fees and Other Costs,
which considers the contractual cash flows. These loans are identified as “purchased other” loans, and are initially
recorded at their fair value, which is estimated using an internal cash flow model and assumptions similar to the FASB
ASC 310-30 loans. The difference between the estimated fair value and the unpaid principal balance at acquisition
date is recognized as interest income over the life of the loan using an effective interest method for non-revolving
credits or a straight-line method, which approximates the effective interest method, for revolving credits. Any
unrecognized discount for a loan that is subsequently repaid or fully charged-off will be recognized immediately into
income.
Impaired Loans and Troubled Debt Restructures
Impaired Loans:
A loan is considered impaired when, based on current information and events, it is probable the Company will be
unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the
loan agreement. Factors considered by management in determining impairment include payment status, collateral
value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience
insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines
the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the
circumstances surrounding the loan and the borrowers, including length of the delay, the reasons for the delay, the
borrower’s prior payment record, and the amounts of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted
at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral (less cost to
sell) if the loan is collateral dependent.
Troubled Debt Restructures:
A troubled debt restructured loan (“TDR”) is a restructuring in which the Bank, for economic or legal reasons
related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider.
These concessions may include changes of the interest rate, forbearance of the outstanding principal or accrued
interest, extension of the maturity date, delay in the timing of the regular payment, or any other actions intended to
minimize potential losses. The Bank does not forgive principal for a majority of their TDRs, but in those situations
where principal is forgiven, the entire amount of such principal forgiveness is immediately charged off to the extent not
done so prior to the modification. The Bank also considers insignificant delays in payments when determining if a loan
should be classified as a TDR.
A loan that has been placed on nonaccrual status that is subsequently restructured will usually remain on
nonaccrual status until the borrower is able to demonstrate repayment performance in compliance with the
restructured terms for a sustained period, typically for six months. A restructured loan may return to accrual status
sooner based on other significant events or mitigating circumstances. A loan that has not been placed on nonaccrual
status may be restructured and such loan may remain on the accrual status after such restructuring. In these
circumstances, the borrower has made payments before and after the restructuring. Generally, this restructuring
F-13
involves a reduction in the loan interest rate and/or a change to interest-only payments for a period of time. The
restructured loan is considered impaired despite the accrual status and a specific valuation allowance is calculated
similar to the impaired loans.
A TDR is considered defaulted if, during the 12-month period after the restructure, the loan has not performed in
accordance to the restructured terms. Defaults include loans whose payments are 90 days or more past due and
loans whose revised maturity date passed and no further modifications will be granted for that borrower.
A loan may subsequently be excluded from the TDR disclosures if (i) the restructured interest rate was greater
than or equal to the interest rate of a new loan with comparable risk at the time of the restructure, and (ii) the loan is
no longer impaired based on the terms of the restructured agreement. The Bank's policy is that the borrower must
demonstrate a sustained period, typically six consecutive months, of payments in accordance with the modified loan
before it can be reviewed for removal from the TDR disclosure under the second criteria. However, the loan must be
reported as a TDR in at least one annual report on Form 10-K. Once a loan has been classified as a TDR, it will
continue to be disclosed as an impaired loan until paid off or charged-off, even if the loan subsequently is no longer
disclosed as a TDR.
Loan Fees
Loan origination fees and certain direct origination costs are deferred and amortized as an adjustment of the
yields of the loans over their contractual lives, adjusted for prepayment of the loans, using the effective interest
method or the straight-line method, which approximates the effective interest method. In the event loans are sold, the
net deferred loan origination fees or costs are recognized as a component of the gains or losses on the sales of loans.
Allowance for Loan Losses
Allowance for Loan Losses on Originated Loans:
The allowance for loan losses is a reserve established through a provision for loan losses charged to expense,
which represents management’s best estimate of probable losses that have been incurred within the existing portfolio
of originated loans. For further information on the policy on purchased loans, see “Allowance for Loan Losses on
Purchased Loans” below. The allowance, in the judgment of management, is necessary to reserve for estimated loan
losses and risks inherent in the loan portfolio. The Company’s allowance for loan losses methodology includes
allowance allocations calculated in accordance with FASB ASC 310, Receivables and allowance allocations
calculated in accordance with FASB ASC 450, Contingencies. Accordingly, the methodology is based on historical
loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss
allocations, with adjustments for current events and conditions. The Company’s process for determining the
appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The
provision for loan losses reflects loan quality trends, including the levels of and trends related to nonaccrual loans,
past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The
provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words,
the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly
identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any
necessary increases or decreases in required allowances for specific loans or loan pools. Losses are charged against
the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries,
if any, are credited to the allowance.
The level of the allowance reflects management’s continuing evaluation of known and inherent risks in the loan
portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for
any credit that, in management’s judgment, should be charged off.
The Company’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined
in accordance with FASB ASC 310 based on probable losses on specific loans; (ii) historical loss factor determined in
accordance with FASB ASC 450 based on historical loan loss experience for similar loans with similar characteristics
and trends; and (iii) an environmental loss factor to reflect the impact of current conditions, as determined in
accordance with FASB ASC 450 based on general economic conditions and other qualitative risk factors both internal
and external to the Company. The historical loss factor and environmental loss factor are combined and multiplied
against the outstanding principal balance of loans in the pool of similar loans with similar characteristics. The
Company’s pools of similar loans are grouped by class of loan.
F-14
The allowances established for probable losses on specific loans are based on a regular analysis and evaluation
of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other
things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and
industry in which the borrower operates. This analysis is performed at the loan officer level for all loans. When a loan
is performing but has an assigned risk grade greater than pass, the loan officer analyzes the loan to determine an
appropriate monitoring and collection strategy. When a loan is nonperforming or has been classified as a nonaccrual
loan, a member from the special assets department will analyze the loan to determine if it is impaired. If the loan is
considered impaired, the special asset department will evaluate the need for a specific valuation allowance on the
loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed,
collateral deficiencies and economic conditions affecting the borrower’s industry, among other things.
Historical loss factors are calculated based on the historical loss experience and recovery experience of specific
classes of loans. The Company calculates historical loss ratios for the classes of loans based on the proportion of
actual charge-offs and recoveries experienced to the total population of loans in the pool for a rolling twelve quarter
average.
Environmental loss factors are based on general economic conditions and other qualitative risk factors both
internal and external to the Company. In general, such valuation allowances are determined by evaluating, among
other things: (i) levels of and trend in delinquencies and impaired loans; (ii) levels and trends in charge-offs and
recoveries; (iii) effects of changes in risk selection and underwriting standards, and other changes in lending policies,
procedures, and practices; (iv) experience, ability, and depth of lending management and other relevant staff;
(v) national and local economic trends and conditions; (vi) external factors such as competition, legal, and regulatory
and; (vii) effects of changes in credit concentrations. Management evaluates the degree of risk that each one of these
components has on the quality of the loan portfolio on a quarterly basis. Each component is determined to be on a
scale of risk. The results are then utilized in a matrix to determine an appropriate environmental loss factor for each
class of loan. An additional environmental factor is added after the calculated matrix factor if the specific loan is risk
graded greater than watch.
The allowance for loan loss evaluation is inherently subjective, as it requires estimates that are susceptible to
significant revision as more information becomes available. While management utilizes its best judgment and
information available to recognize losses on loans, future additions to the allowance may be necessary based on
declines in local and national economic conditions. In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank
to make adjustments to the allowance based on their judgments about information available to them at the time of
their examinations. The Company believes the allowance for loan losses is appropriate given all the above
considerations.
The Bank is also party to financial instruments with off-balance sheet risk in the normal course of business to
meet the financing needs of its customers. These financial instruments include commitments to extend credit and
standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the
amount recognized in the consolidated balance sheet. The Company has a policy in which it evaluates the risk on a
quarterly basis, and provides for an allowance for credit losses, as necessary. The methodology is similar to the
allowance for loan losses, and includes an estimate of the probability of drawdown of the loan commitment. Based on
its analysis, the Company has recorded an allowance for off-balance sheet financial instruments of $110,000 and
$75,000 as of December 31, 2013 and 2012, respectively.
Allowance for Loan Losses on Purchased Loans:
The purchased loans acquired in all the Acquisitions are subject to the Company’s internal and external credit
review. Under the accounting guidance of FASB ASC 310-30, the allowance for loan losses on purchased impaired
loans is measured at each financial reporting period, or measurement date, based on expected cash flows. If and
when credit deterioration, or decreases in expected cash flows initially estimated, occurs subsequent to the
acquisition date, a provision for loan losses for purchased loans will be charged to earnings as of the measurement
date. For the purchased covered loans, a provision for loan losses will be charged to earnings for the full amount
without regard to the FDIC shared-loss agreement, and the portion of the loss reimbursable from the FDIC is recorded
in noninterest income and increases the FDIC indemnification asset.
F-15
The purchased other loans not accounted for under FASB ASC 310-30 and the balances funded on purchased
loans after the acquisition date, called “subsequent advances”, are also subject to the Company’s credit reviews. An
allowance for loan loss is estimated in a similar manner as the originated loan portfolio, and a provision for loan loss is
charged to earnings as necessary. Management also reviews historical and environmental factors specific to the
purchased portfolios which may be slightly different than the originated loan portfolio.
FDIC Indemnification Asset
The FDIC indemnification asset was measured at estimated fair value at acquisition date on the same basis as
the purchased covered loans, and represents the present value of the estimated losses on covered loans to be
reimbursed by the FDIC. The present value was calculated using the shorter of the shared-loss agreement terms or
the life of the loan. Under the terms of the FDIC shared-loss agreements, the FDIC will absorb 80% of losses and
receive 80% of loss recoveries for the covered loans. The FDIC indemnification asset will be reduced as losses are
recognized on covered loans and shared-loss payments are received from the FDIC. Since the FDIC indemnification
asset was initially recorded at estimated fair value using a discount rate, a portion of the discount is taken into
noninterest income at each reporting date.
The FDIC indemnification asset is evaluated quarterly. Realized losses in excess of prior estimates will
immediately increase the FDIC indemnification asset by a credit to noninterest income. Conversely, if realized losses
are less than prior estimates, the FDIC indemnification asset will be reduced by a charge to noninterest income on a
prospective basis, and any change in value would be limited to the contractual terms of the shared-loss agreement.
Mortgage Banking Operations
Until the second quarter of 2013, the Company sold one-to-four family residential mortgage loans on a servicing
released basis and recognized a cash gain or loss. A cash gain or loss was recognized to the extent that the sales
proceeds of the mortgage loans sold exceeded or were less than the net book value at the time of sale. Income from
mortgage loans brokered to other lenders was recognized into income on date of loan closing.
Commitments to sell one-to-four family residential mortgage loans were made primarily during the period
between the taking of the loan application and the closing of the mortgage loan. The timing of making these sale
commitments was dependent upon the timing of the borrower’s election to lock-in the mortgage interest rate and fees
prior to loan closing. Most of these sale commitments were made on a best-efforts basis whereby the Bank was only
obligated to sell the mortgage if the mortgage loan was approved and closed by the Bank. Commitments to fund
mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future
delivery of these mortgage loans were accounted for as free standing derivatives. Fair values of these mortgage
derivatives were estimated based on changes in mortgage interest rates from the date the interest on the loan was
locked. The Company entered into forward commitments for the future delivery of mortgage loans when interest rate
locks were entered into, in order to hedge the change in interest rates resulting from its commitments to fund the
loans. Changes in the fair values of these derivatives were included in gains on sales of loans. As there were no
loans held for sale at December 31, 2013, there was no associated derivative. The fair value of these derivative
instruments was not significant at December 31, 2012 and 2011.
Other Real Estate and Other Assets Owned
Other real estate acquired by the Company in satisfaction of debt are held for sale and recorded at fair value at
time of foreclosure. When property is acquired, it is recorded at the estimated fair value (less the costs to sell) at the
date of acquisition, not to exceed net realizable value, and any resulting write-down is charged to the allowance for
loan losses. Upon acquisition, all costs incurred in maintaining the property are expensed. Costs relating to the
development and improvement of the property, however, are capitalized to the extent of the property’s net realizable
value.
Premises and Equipment
Premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the lease
period, whichever is shorter. The estimated useful lives used to compute depreciation and amortization for buildings
F-16
and building improvements is 15 to 39 years; and for furniture, fixtures and equipment is three to seven years. The
Company reviews buildings, leasehold improvements and equipment for impairment whenever events or changes in
the circumstances indicate that the undiscounted cash flows for the property are less than its carrying value. If
identified, an impairment loss is recognized through a charge to earnings based on the fair value of the property.
Other Intangible Assets
The other intangible assets represents the Core Deposit Intangible (“CDI”) acquired in business combinations.
The fair value of the CDI stemming from any given business combination is based on the present value of the
expected cost savings attributable to the core deposit funding, relative to an alternative source of funding. The CDI is
amortized over an estimated useful life which approximates the existing deposit relationships acquired on an
accelerated method. The Company evaluates such identifiable intangibles for impairment when an indication of
impairment exists.
Goodwill
The Company’s goodwill represents the excess of the purchase price over the fair value of net assets acquired in
the purchases of Valley Community Bancshares in 2013, Western Washington Bancorp in 2006 and North Pacific
Bank in 1998. The Company’s goodwill is assigned to Heritage Bank and is evaluated for impairment at the Heritage
Bank level (reporting unit).
In accordance with Accounting Standards Update ("ASU") 2011-08 Intangibles — Goodwill and Other (Topic 350),
an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely
than not that its fair value is less than its carrying amount. In other words, before the first step of the existing
guidance, the entity has the option to first assess qualitative factors to determine whether the existence of events or
circumstances leads to a determination that the fair value of goodwill is less than carrying value. The qualitative
assessment includes adverse events or circumstances identified that could negatively affect the reporting units’ fair
value as well as positive and mitigating events. Such indicators may include, among others: a significant change in
legal factors or in the general business climate; significant change in the Company’s stock price and market
capitalization; unanticipated competition; and an action or assessment by a regulator. If, after assessing the totality of
events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less
than its carrying amount, then performing the two-step process is unnecessary. The entity has the option to bypass
the qualitative assessment step for any reporting unit in any period and proceed directly to the first step of the exiting
two-step process. The entity can resume performing the qualitative assessment in any subsequent period.
The first step of the goodwill impairment test is performed, when considered necessary, by comparing the
reporting unit’s aggregate fair value to its carrying value. Absent other indicators of impairment, if the aggregate fair
value exceeds the carrying value, goodwill is not considered impaired and no additional analysis is necessary. If the
carrying value of the reporting unit were to exceed the aggregate fair value, a second step would be performed to
measure the amount of impairment loss, if any. To measure any impairment loss the implied fair value would be
determined in the same manner as if the reporting unit were being acquired in a business combination. If the implied
fair value of goodwill is less than the recorded goodwill, an impairment charge would be recorded for the difference.
Income Taxes
The Company and its subsidiary file a United States consolidated federal income tax return and an Oregon State
income tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to
differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates applicable to taxable
income in the periods in which those temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the
enactment date.
The Company’s policy is to recognize interest and penalties on unrecognized tax benefits in “income taxes” in the
Consolidated Statements of Income as the amounts are generally insignificant each year.
F-17
Employee Stock Ownership Plan
The Company sponsored an Employee Stock Ownership Plan (ESOP). The ESOP purchased 2% of the common
stock issued in a January 1998 stock offering and borrowed $1.3 million from the Company in order to fund the
purchase of the Company’s common stock. The loan to the ESOP was repaid in full as of December 31, 2012. When
outstanding, the loan was repaid principally from the Bank's contributions to the ESOP. The Bank's contributions were
sufficient to service the debt over the 15-year loan term at the interest rate of 8.5%. As the debt was repaid, shares
were released and allocated to plan participants based on the proportion of debt service paid during the year. As
shares were released, compensation expense was recorded equal to the then current market price of the shares and
the shares became outstanding for earnings per common share calculations. Cash dividends on allocated shares
were recorded as a reduction of retained earnings and paid or distributed directly to participants’ accounts. Cash
dividends on unallocated shares were recorded as a reduction of debt and accrued interest.
Stock-Based Compensation
The Company maintains a number of stock-based incentive programs, which are discussed in more detail in Note
15, "Stock-Based Compensation." Compensation cost is recognized for stock options and restricted stock awards
issued to employees and directors, based on the fair value of these awards at the date of grant. The Company did not
grant stock option awards for the years ended December 31, 2013, 2012 or 2011. The fair value of stock options
granted would be estimated on the date of grant using the Black-Scholes-Merton option pricing model. The market
price of the Company’s common stock at the date of grant is used for the restricted stock awards. Compensation cost
is recognized over the required service period, generally defined as the vesting period, on a straight-line basis.
Deferred Compensation Plans
The Company has adopted a Deferred Compensation Plan and has entered into arrangements with certain
executive officers. Under the Plan, participants are permitted to elect to defer compensation and the Company has the
discretion to make additional contributions to the Plan on behalf of any participant based on a number of factors. Such
discretionary contributions are generally approved by the Compensation Committee of the Company's Board of
Directors. The notional account balances of participants under the Plan earn interest on an annual basis. The
applicable interest rate is the Moody’s Seasoned Aaa Corporate Bond Yield as of January 1 of each year. Generally, a
participant’s account is payable upon the earliest of the participant’s separation from service with the Company, the
participant’s death or disability, or a specified date that is elected by the participant in accordance with applicable rules
of the Internal Revenue Code. The Company’s obligation to make payments under the Plan is a general obligation of
the Company and is to be paid from the Company’s general assets. As such, participants are general unsecured
creditors of the Company with respect to their participation under the Plan. The Company records a liability within
accrued expenses and other liabilities on the Consolidated Statements of Financial Condition in a systematic and
rationale manner. Since the amounts earned are generally based on the Company’s annual performance, the
Company records deferred compensation expense each year for an amount calculated based on that year’s financial
performance.
Earnings per Share
Basic earnings per common share is net income available to common shareholders divided by the weighted
average number of common shares outstanding during the period. ESOP shares are considered outstanding for this
calculation unless unearned. All outstanding unvested share-based payment awards that contain rights to
nonforfeitable dividends are considered participating securities for this calculation. Diluted earnings per common
share includes the dilutive effect of additional potential common shares issuable under stock options. Earnings and
dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial
statements.
F-18
Operating Segments
While the Company’s chief decision-makers monitor the revenue streams of the various products and services,
operations are managed and financial performance is evaluated on a Company-wide basis. Operating segments are
aggregated into one as operating results for all segments are similar. Accordingly, all of the financial service
operations are considered by management to be aggregated in one reportable operating segment.
(d) Recently Issued Accounting Pronouncements
FASB ASU 2011-11, Disclosures about Offsetting Assets and Liabilities, was issued in December 2011 to require
an entity to disclose information about offsetting and related arrangements to enable users of its financial statements
to understand the effect of those arrangements on its financial position. An entity is required to apply the amendments
for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods.
An entity should provide the disclosures required by those amendments retrospectively for all comparative periods
presented. The adoption of the Update did not have a material effect on the Company’s Consolidated Financial
Statements at the date of its adoption.
FASB ASU 2012-6, Business Combinations (Topic 805): Subsequent Accounting for an Indemnification Asset
Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution, was
issued in October 2012. The objective of the Update was to address the diversity in practice about how to interpret the
terms “on the same basis” and “contractual limitations” when subsequently measuring an indemnification asset. This
Update was effective for fiscal years and interim periods beginning on or after December 15, 2012. Early adoption
was permitted, and adoption was to be applied prospectively to indemnification assets existing as of the date of
adoption. The adoption of this Update did not have a material effect on the Company’s Consolidated Financial
Statements at the date of adoption as the Company previously accounted for its indemnification asset in a manner
consistent with the Update.
FASB ASU 2013-2, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, was
issued in February 2013. The Update requires an entity to provide information about the amounts reclassified out of
accumulated other comprehensive income (loss) by component and to present either on the face of the statement
where net income is presented, or in the notes, significant amounts reclassified out of accumulated other
comprehensive income (loss) by the respective line items of net income, but only if the amount reclassified is required
to be reclassified to net income in its entirety in the same reporting period. The amendments became effective for
annual and interim reporting periods beginning on or after December 15, 2012. The adoption of this Update did not
have a material effect on the Company’s Consolidated Financial Statements. The additional disclosures are included
in Note 18, “Accumulated Other Comprehensive (Loss) Income.”
FASB ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, A
Similar Tax Loss, or a Tax Credit Carryforward Exists, was issued in July 2013. This Update provides that an
unrecognized tax benefit, or a portion thereof, be presented in the financial statements as a reduction to a deferred
tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent that
a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date to
settle any additional income taxes that would result from disallowance of a tax position, or the tax law does not require
the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, then the unrecognized
tax benefit should be presented as a liability. These amendments are effective for interim and annual reporting
periods beginning after December 15, 2013. Early adoption and retrospective application is permitted. The Company
is currently evaluating the impact of this amendment on the Consolidated Financial Statements.
F-19
(2) Business Combinations
During the year ended December 31, 2013, the Company completed the acquisitions of Northwest Commercial
Bank and Valley Community Bancshares, referred to jointly as the "NCB and Valley Acquisitions." There were no
acquisitions completed during the years ended December 31, 2012 and 2011.
Northwest Commercial Bank
On September 14, 2012, the Company and Heritage Bank entered into a definitive agreement to acquire NCB
headquartered in Lakewood, Washington. NCB was a full service commercial bank that operated two branch locations
in Lakewood and Auburn, Washington. Prior to the closing of the transaction, NCB redeemed its outstanding preferred
stock of approximately $2.0 million issued to the U.S. Department of Treasury in connection with its participation in the
Troubled Asset Relief Program Capital Purchase Plan. The NCB Acquisition was completed on January 9, 2013 with
the merger of NCB with and into Heritage Bank. After the NCB Acquisition, the NCB Lakewood branch was
consolidated into one of Heritage Bank’s full service banking offices in Lakewood, Washington.
In connection with the NCB Acquisition, the Company paid cash consideration of $3.0 million, or $5.50 per NCB
share, to NCB shareholders on January 9, 2013. In addition, pursuant to the merger agreement, the NCB
shareholders had the ability to potentially receive an additional cash payment based on an earn-out structure from the
sale of a NCB asset included in “other real estate owned.” This contingent payment was factored into the NCB
liabilities assumed by Heritage Bank as of the January 9, 2013 acquisition date. This asset was sold by Heritage Bank
in June 2013, and the $491,000 of proceeds from the sale were paid to the NCB shareholders in July 2013. The
payment of these proceeds did not impact the recorded bargain purchase gain on bank acquisition of $399,000.
During the years ended December 31, 2013 and 2012, the Company incurred NCB Acquisition-related costs
(including conversion costs) of approximately $794,000 and $616,000, respectively.
Valley Community Bancshares
On March 11, 2013, the Company entered into a definitive agreement to acquire Valley Community Bancshares
and its wholly-owned subsidiary, Valley Bank, both headquartered in Puyallup, Washington. The Valley Acquisition
was completed on July 15, 2013. Valley operated eight branches prior to acquisition, of which only four were
maintained by Heritage Bank. Of the four other branches, three leases were terminated during the fourth quarter of
2013 and one owned branch building was considered held for sale at the time of acquisition.
Pursuant to the terms of the merger agreement, the shareholders of Valley common stock received $19.50 per
share in cash and 1.3611 shares of Heritage common stock per Valley share. The merger consideration for Valley
consisted of cash and stock, with $22.0 million paid in cash by the Company and 1,533,267 shares of the Company’s
common stock being issued with fair value of $24.2 million. The Company also recognized $157,000 in capitalized
acquisition costs related to the issuance of its securities.
The Valley Acquisition resulted in $16.4 million of goodwill. This goodwill is not deductible for tax purposes.
During the year ended December 31, 2013, the Company incurred Valley Acquisition-related costs (including
conversion costs) of approximately $2.1 million.
Business Combination Accounting
The NCB and Valley Acquisitions constitute business acquisitions as defined by FASB ASC 805, Business
Combinations. FASB ASC 805 establishes principles and requirements for how the acquirer of a business recognizes
and measures in its financial statements the identifiable assets acquired and the liabilities assumed. Accordingly, the
estimated fair values of the acquired assets, including the identifiable intangible assets, and the assumed liabilities in
the acquisition were measured and recorded as of the acquisition dates.
F-20
The fair value of the assets acquired and liabilities assumed in the NCB and Valley Acquisitions were as follows:
Valley
July 15, 2013
NCB
January 9, 2013
(In thousands)
Assets
Cash and cash equivalents ....................................................
Other interest earning deposits ..............................................
Investment securities available for sale ..................................
Investment securities held to maturity ....................................
Purchased non-covered loans receivable ..............................
Other real estate owned .........................................................
Premises and equipment ........................................................
FHLB stock .............................................................................
Accrued interest receivable ....................................................
Core deposit intangible ...........................................................
Prepaid expenses and other assets .......................................
Deferred income taxes, net ....................................................
$
40,643
13,866
31,444
22,908
117,071
—
6,558
366
465
916
3,172
(85)
Total assets acquired .......................................................
$ 237,324
Liabilities
Deposits ..................................................................................
Accrued expenses and other liabilities ...................................
$ 207,013
342
Total liabilities assumed ...................................................
207,355
$
$
$
2,712
1,003
2,753
—
51,509
2,279
214
88
232
156
1,175
2,873
64,994
60,442
1,186
61,628
Net assets acquired ................................................................
$
29,969
$
3,366
Summaries of the net assets purchased and the estimated fair value adjustments and resulting bargain purchase
gain or goodwill recognized from the NCB and Valley Acquisitions were as follows:
Cost basis of net assets on acquisition date .......................
Consideration transferred ....................................................
Fair value adjustments:
Other interest earning deposits ....................................
Investment securities ....................................................
Purchased non-covered loans, net ..............................
Other real estate owned ...............................................
Premises and equipment..............................................
Core deposit intangible .................................................
Prepaid expenses and other assets .............................
Deferred income tax, net ..............................................
Certificates of deposit ...................................................
Accrued expenses and other liabilities .........................
Valley
July 15, 2013
NCB
January 9, 2013
(In thousands)
$ 29,720
$
(46,323)
162
—
(3,003)
—
1,837
916
323
(125)
(9)
149
6,113
(2,967)
7
(2)
(3,299)
(1,301)
(69)
156
(479)
2,873
(11)
(622)
(Goodwill) bargain purchase gain recognized
from the acquisition ...........................................
$ (16,353)
$
399
F-21
Goodwill on bank acquisition represents the excess of the consideration transferred over the estimated fair value
of the net assets acquired and liabilities assumed. A bargain purchase gain on bank acquisition represents the
excess of the estimated fair value of the net assets acquired and liabilities assumed over the value of the
consideration paid. The bargain purchase gain in the NCB Acquisition was influenced significantly by the net deferred
tax asset acquired. NCB had significant net operating losses and as a result of its estimate of whether or not it was
more likely than not that the net deferred tax asset would be realized, had recorded a full valuation allowance on the
net deferred tax asset. The Company, however, has reviewed the net deferred tax asset and determined it is more
likely than not that the net deferred tax asset would be realized by the Company.
The operating results of the Company for the year ended December 31, 2013 include the operating results
produced by the net assets acquired from the NCB Acquisition since the January 9, 2013 acquisition date and from
the Valley Acquisition since the July 15, 2013 acquisition date. The Company has considered the requirement of
FASB ASC 805 related to the contribution of the NCB and Valley Acquisitions to the Company’s results of operations.
The table below presents only the significant results for the acquired businesses from the acquisition dates.
Interest income: Interest and fees on loans (1) .......................................
Interest income: Interest and fees on loans (2) .......................................
Interest income: Securities and other interest earning assets ...............
Interest expense: Deposits ......................................................................
Provision for loan losses on purchased loans .........................................
Noninterest income ..................................................................................
Noninterest expense ................................................................................
Year Ended December 31, 2013 (3)
NCB
Valley
Total
$ 2,495
1,853
42
(277)
(1,175)
608
(1,477)
(In thousands)
$ 1,974
840
304
(100)
—
391
(2,721)
$ 4,469
2,693
346
(377)
(1,175)
999
(4,198)
Net effect, pre-tax .............................................................................
$ 2,069
$ 688
$ 2,757
(1) Includes the contractual interest income on the purchased loans.
(2) Includes the accretion of the accretable yield on the purchased impaired loans and the accretion of the discount
on the purchased other loans.
(3) The NCB Acquisition was completed on January 9, 2013 and the Valley Acquisition was completed on July 15,
2013.
The Company also considered the pro forma requirements of FASB ASC 805 and deemed it not necessary to
provide pro forma financial statements as required under the standard as the NCB and Valley Acquisitions were not
material to the Company. The Company believes that the historical NCB and Valley operating results are not
considered of enough significance to be meaningful to the Company’s results of operations.
(3) Cash and Cash Equivalents
Since the fourth quarter of 2013, the Company has been required to maintain an average reserve balance
with the Federal Reserve Bank or maintain such reserve balance in the form of cash. The average required reserve
balance for the year ended December 31, 2013 was approximately $46.3 million and was met by holding cash and
maintaining an average balance with the Federal Reserve Bank. The Company did not have a cash reserve
requirement for the year ended December 31, 2012.
(4) 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.
Securities are classified as either available for sale or held to maturity when acquired.
F-22
(a) Securities by Type and Maturity
The amortized cost, gross unrealized gains and losses, and fair values of investment securities at the dates
indicated were as follows:
Securities Available for Sale
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
(In thousands)
6,098
49,989
$
3
806
$
(62)
(1,735)
$
6,039
49,060
December 31, 2013
U.S. Treasury and U.S. Government-sponsored
agencies ................................................................... $
Municipal securities ......................................................
Mortgage backed securities and collateralized
mortgage obligations-residential:
U.S. Government-sponsored agencies ................
108,466
898
(1,329)
108,035
Total ............................................................... $
164,553
$ 1,707
$ (3,126)
$
163,134
December 31, 2012
U.S. Treasury and U.S. Government-sponsored
agencies ................................................................... $
Municipal securities ......................................................
Mortgage backed securities and collateralized
mortgage obligations-residential:
11,016
45,537
$
19
1,943
$ —
(120)
$
11,035
47,360
U.S. Government agencies ..................................
84,598
1,593
(293)
85,898
Total ............................................................... $
141,151
$ 3,555
$
(413)
$
144,293
Amortized
Cost
Securities Held to Maturity
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(In thousands)
Fair
Value
1,687 $
24,290
153
200
$ —
(184)
$
1,840
24,306
December 31, 2013
U.S. Treasury and U.S. Government-sponsored
agencies .................................................................... $
Municipal securities .......................................................
Mortgage backed securities and collateralized
mortgage obligations-residential:
U.S. Government-sponsored agencies .................
Private residential collateralized mortgage
obligations ..........................................................
9,129
144
1,048
185
(284)
(28)
8,989
1,205
Total ................................................................ $
36,154
$
682
$
(496)
$
36,340
December 31, 2012
U.S. Treasury and U.S. Government-sponsored
agencies .................................................................... $
Municipal securities .......................................................
Mortgage backed securities and collateralized
mortgage obligations-residential:
1,740 $
2,946
284
212
$ —
—
$
2,024
3,158
U.S. Government-sponsored agencies .................
Private residential collateralized mortgage
obligations ..........................................................
4,245
277
1,168
193
—
(55)
4,522
1,306
Total ................................................................ $
10,099
$
966
$
(55)
$
11,010
F-23
There were no securities classified as trading at December 31, 2013 or December 31, 2012.
The amortized cost and fair value of securities at December 31, 2013, by contractual maturity, are set forth below.
Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay
obligations with or without call or prepayment penalties.
Securities Available for Sale
Securities Held to Maturity
Amortized
Cost
Fair
Value
Amortized
Cost
Fair Value
(In thousands)
Due in one year or less ...........................................
Due after one year through three years ..................
Due after three years through five years ................
Due after five years through ten years ....................
Due after ten years .................................................
$
2,161
3,961
8,603
47,912
101,916
$ 2,164
4,046
8,842
47,513
100,569
$ 1,773
5,346
5,297
15,078
8,660
$ 1,787
5,408
5,346
15,096
8,703
Total .................................................................
$164,553
$163,134
$ 36,154
$ 36,340
(b) Unrealized Losses and Other-Than-Temporary Impairments
Available for sale investment securities with unrealized losses as of December 31, 2013 and December 31, 2012
were as follows:
Less than 12 Months
December 31, 2013
12 Months or
Longer
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
(In thousands)
21,471
$
(62)
(1,242)
$ —
4,644
$ —
(493)
$ 3,031
26,115
$
(62)
(1,735)
U.S. Treasury and U.S.
Government-sponsored
agencies ......................................... $ 3,031
Municipal securities............................
Mortgage backed securities and
collateralized mortgage
obligations-residential:
U.S. Government-sponsored
agencies ..................................
56,327
(1,184)
7,758
(145)
64,085
(1,329)
Total ................................................... $ 80,829
$ (2,488)
$12,402
$ (638)
$ 93,231
$ (3,126)
Less than 12 Months
Fair
Value
Unrealized
Losses
December 31, 2012
12 Months or
Longer
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
(In thousands)
$ 7,843
$ (120)
$ —
$ —
$ 7,843
$
(120)
31,197
(248)
3,779
(45)
34,976
(293)
Municipal securities ...........................
Mortgage backed securities and
collateralized mortgage
obligations-residential:
U.S. Government-sponsored
agencies .................................
Total ...................................................
$ 39,040
$ (368)
$3,779
$
(45)
$ 42,819
$
(413)
F-24
Held to maturity investment securities with unrealized losses as of December 31, 2013 and December 31, 2012
were as follows:
Less than 12 Months
Fair
Value
Unrealized
Losses
December 31, 2013
12 Months or
Longer
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
(In thousands)
$10,967
$
(184)
$ —
$
—
$10,967
$ (184)
4,869
(284)
—
—
4,869
(284)
211
(5)
124
(23 )
335
(28)
Municipal securities ..........................
Mortgage backed securities and
collateralized mortgage
obligations-residential:
U.S. Government-sponsored
agencies .................................
Private residential collateralized
mortgage obligations .............
Total ..................................................
$16,047
$
(473)
$124
$
(23 )
$16,171
$ (496)
December 31, 2012
Less than 12 Months
12 Months or Longer
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
(In thousands)
Mortgage backed securities and
collateralized mortgage
obligations-residential:
Private residential
collateralized mortgage
obligations .........................
$ —
Total ..............................................
$ —
$
$
—
$ 317
—
$ 317
$
$
(55)
(55)
$ 317
$ 317
$
$
(55 )
(55 )
The Company has evaluated these securities and has determined that, other than certain private residential
collateralized mortgage obligations discussed below, the decline in their value is temporary. The unrealized losses are
primarily due to increases in market interest rates and larger spreads in the market for mortgage-related products.
The fair value of these securities is expected to recover as the securities approach their maturity date and/or as the
pricing spreads narrow on mortgage-related securities. The Company has the ability and intent to hold the
investments until recovery of the market value which may be the maturity date of the securities.
To analyze the unrealized losses, the Company estimated expected future cash flows of the private residential
collateralized mortgage obligations by estimating the expected future cash flows of the underlying collateral and
applying those collateral cash flows, together with any credit enhancements such as subordination interests owned by
third parties, to the security. The expected future cash flows of the underlying collateral are determined using the
remaining contractual cash flows adjusted for future expected credit losses (which considers current delinquencies
and nonperforming assets, future expected default rates and collateral value by vintage and geographic region) and
prepayments. The expected cash flows of the security are then discounted at the interest rate used to recognize
interest income on the security to arrive at a present value amount. The average discount interest rates used in the
valuations of the present value as of December 31, 2013 and 2012 were 6.4% and 7.2%, respectively, and the
average prepayment rate for each period was 6.0%.
F-25
For the year ended December 31, 2013, there were eight private residential collateralized mortgage obligations
determined to be other-than-temporarily impaired. All unrealized losses for the year ended December 31, 2013 were
deemed to be credit related, and the Company recorded the impairment in earnings. For the year ended
December 31, 2012, there were eight private residential collateralized mortgage obligations determined to be other-
than-temporarily impaired. The portion of the impairment for the year ended December 31, 2012 and 2011 that was
credit related was recorded in earnings and the portion of the impairment not related to credit losses was recorded
through other comprehensive (loss) income. The following table summarizes activity for the years ended
December 31, 2013, 2012 and 2011 related to the amount of impairments on held to maturity securities:
Life-to-Date
Gross Other-
Than-Temporary
Impairments
December 31, 2010 .......................
Initial impairments ..................
Subsequent impairments ........
December 31, 2011 .......................
December 31, 2011 .......................
Subsequent impairments ........
December 31, 2012 .......................
December 31, 2012 .......................
Subsequent impairments ........
December 31, 2013 .......................
$
$
$
$
$
$
2,317
7
111
2,435
2,435
130
2,565
2,565
38
2,603
Life-to-Date
Other-Than-
Temporary
Impairments
Included in
Other
Comprehensive
(Loss)
Income
(In thousands)
$
1,080
—
20
$
$
$
$
$
1,100
1,100
52
1,152
1,152
—
1,152
Life-to-Date
Net Other-
Than-
Temporary
Impairments
Included in
Earnings
$
$
$
$
$
$
1,237
7
91
1,335
1,335
78
1,413
1,413
38
1,451
(c) Redemption-in-Kind
In May 2008, the Board of Trustees of the AMF Ultra Short Mortgage Fund (“Fund”) decided to activate the
Fund’s redemption-in-kind provision because of the uncertainty in the mortgage backed securities market. Exiting
participants in the Fund were allowed to redeem and receive up to $250,000 in cash per quarter or receive 100% of
their investment in “like-kind” securities equal to their proportional ownership in the Fund. The Company elected to
receive the like-kind securities.
Details of private residential collateralized mortgage obligation securities received from the redemption-in-kind
election as of December 31, 2013 were as follows:
Type of
Security
Par
Value
Amortized
Cost
Fair
Value
(2)
Aggregate
Unrealized
Gain
Year-to- date
Change in
Unrealized
Gain
Year-to-
date
Impairment
Charge
Life-to- date
Impairment
Charge (1)
243 $ 258 $
15 $
(Dollars in thousands)
28
$
$
26
682
Alt-A ................ $ 750 $
Prime ..............
1,241
Current Ratings
AAA
AA
A
BBB
— %
— %
— % — %
Below
Investment
Grade
100%
93%
805
947
142
(7)
10
769
— %
— %
— % 7%
Totals ..... $ 1,991 $ 1,048 $ 1,205 $
157 $
19
$
38
$ 1,451
— %
— %
— % 6%
94%
(1) Life-to-date impairment charge represents impairment charges recognized in earnings subsequent to redemption
of the Fund.
(2) Level two valuation assumptions were used to determine the fair value of held to maturity securities in the Fund.
F-26
(d) Pledged Securities
The following table summarizes the amortized cost and fair value of available for sale and held to maturity
securities that are pledged as collateral for the following obligations at December 31, 2013 and December 31, 2012:
December 31, 2013
December 31, 2012
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
(In thousands)
Washington and Oregon state to secure public
deposits ....................................................................
Federal Reserve Bank and FHLB to secure borrowing
arrangements ............................................................
Repurchase agreements .................................................
$ 80,386
$ 80,881
$ 53,642
$ 56,300
—
34,170
—
33,893
6,231
17,479
6,245
17,705
Total..........................................................................
$ 114,556
$114,774
$ 77,352
$80,250
(5) Loans Receivable
The Company originates loans in the ordinary course of business. These loans are identified as “originated”
loans. Disclosures related to the Company’s recorded investment in originated loans receivable generally exclude
accrued interest receivable and net deferred loan origination fees and costs because they are insignificant. The
Company has also acquired loans through FDIC-assisted and open bank transactions. Loans acquired in a business
acquisition are designated as “purchased” loans. The Company refers to the purchased loans subject to the FDIC
shared-loss agreements as “covered” loans, and those loans without shared-loss agreements are referred to as “non-
covered” loans. Loans purchased with evidence of credit deterioration since origination for which it is probable that not
all contractually required payments will be collected are accounted for under FASB ASC 310-30, Loans and Debt
Securities Acquired with Deteriorated Credit Quality. These loans are identified as “purchased impaired” loans. Loans
purchased that are not accounted for under FASB ASC 310-30 are accounted for under FASB ASC 310-20,
Receivables—Nonrefundable Fees and Other Costs. These loans are identified as “purchased other” loans.
(a) Loan Origination/Risk Management
The Company originates loans in one of the four segments of the total loan portfolio: commercial business, real
estate construction and land development, one-to-four family residential and consumer. Within these segments are
classes of loans to which management monitors and assesses credit risk in the loan portfolios. The Company has
certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level
of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system
supplements the review process by providing management with frequent reports related to loan production, loan
quality, concentrations of credit, loan delinquencies, and nonperforming and potential problem loans. The Company
also conducts internal loan reviews and validates the credit risk assessment on a periodic basis and presents the
results of these reviews to management. The loan review process complements and reinforces the risk identification
and assessment decisions made by loan officers and credit personnel, as well as the Company’s policies and
procedures.
A discussion of the risk characteristics of each loan portfolio segment is as follows:
Commercial Business:
There are three significant classes of loans in the commercial portfolio segment, including commercial and
industrial loans, owner-occupied commercial real estate and non-owner occupied commercial real estate. The owner
and non-owner occupied commercial real estate are both considered commercial real estate loans. As the commercial
and industrial loans carry different risk characteristics than the commercial real estate loans, they are discussed
separately below.
F-27
Commercial and industrial. Commercial and industrial loans are primarily made based on the identified cash
flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of
borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most
commercial and industrial loans are secured by the assets being financed or other business assets such as accounts
receivable or inventory and may include a personal guarantee; however, some short-term loans may be made on an
unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of
these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
Commercial real estate. The Company originates commercial real estate loans within its primary market areas.
These loans are subject to underwriting standards and processes similar to commercial and industrial loans, in
addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans
secured by real estate. Commercial real estate involves more risk than other classes of loans in that the lending
typically involves higher loan principal amounts, and payments on loans secured by real estate properties are
dependent on successful operation and management of the properties. Repayment of these loans may be more
adversely affected by conditions in the real estate market or the economy.
One-to-Four Family Residential:
The majority of the Company’s one-to-four family residential loans are secured by single-family residences
located in its primary market areas. The Company’s underwriting standards require that single-family portfolio loans
generally are owner-occupied and do not exceed 80% of the lower of appraised value at origination or cost of the
underlying collateral. Terms of maturity typically range from 15 to 30 years. Until second quarter 2013, the Company
sold most single-family loans in the secondary market and retained a smaller portion in its loan portfolio. After the
second quarter of 2013, the Company only originated single-family loans for its loan portfolio.
Real Estate Construction and Land Development:
The Company originates construction loans for one-to-four family residential and for five or more family
residential and commercial properties. The one-to-four family residential construction loans generally include
construction of custom homes whereby the home buyer is the borrower. The Company also provides financing to
builders for the construction of pre-sold homes and, in selected cases, to builders for the construction of speculative
residential property. Substantially all construction loans are short-term in nature and priced with variable rates of
interest. Construction lending can involve a higher level of risk than other types of lending because funds are
advanced partially based upon the value of the project, which is uncertain prior to the project’s completion. Because of
the uncertainties inherent in estimating construction costs as well as the market value of a completed project and the
effects of governmental regulation of real property, the Company’s estimates with regards to the total funds required to
complete a project and the related loan-to-value ratio may vary from actual results. As a result, construction loans
often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate
project and the ability of the borrower to sell or lease the property or refinance the indebtedness. If the Company’s
estimate of the value of a project at completion proves to be overstated, it may have inadequate security for
repayment of the loan and may incur a loss if the borrower does not repay the loan. Sources of repayment for these
types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property
or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely
monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their
ultimate repayment being sensitive to successful completion of the construction project, interest rate changes,
governmental regulation of real property, general economic conditions and the availability of long-term financing.
Consumer:
The Company originates consumer loans and lines of credit that are both secured and unsecured. The
underwriting process for these loans ensures a qualifying primary and secondary source of repayment. Underwriting
standards for home equity loans are significantly influenced by statutory requirements, which include, but are not
limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower
can have at one time and documentation requirements. To monitor and manage consumer loan risk, policies and
procedures are developed and modified, as needed. The majority of consumer loans are for relatively small amounts
disbursed among many individual borrowers which reduces the credit risk for this type of loan. To further reduce the
risk, trend reports are reviewed by management on a regular basis.
F-28
Originated loans receivable at December 31, 2013 and December 31, 2012 consisted of the following portfolio
segments and classes:
December 31, 2013
December 31, 2012
(In thousands)
Commercial business:
Commercial and industrial ............................................................................. $
Owner-occupied commercial real estate .......................................................
Non-owner occupied commercial real estate ................................................
Total commercial business .....................................................................
One-to-four family residential ................................................................................
Real estate construction and land development:
One-to-four family residential .........................................................................
Five or more family residential and commercial properties ...........................
Total real estate construction and land development .............................
Consumer ..............................................................................................................
Gross originated loans receivable ..........................................................
Net deferred loan fees ...........................................................................................
Originated loans receivable, net .............................................................
Allowance for loan losses ......................................................................................
283,075 $
211,287
354,451
848,813
39,235
18,593
45,184
63,777
28,130
979,955
(2,670)
977,285
(17,153)
Originated loans receivable, net of allowance for loan losses ............... $
960,132 $
277,240
188,494
265,835
731,569
38,848
25,175
52,075
77,250
28,914
876,581
(2,096)
874,485
(19,125)
855,360
The recorded investment of purchased covered loans receivable at December 31, 2013 and December 31, 2012
consisted of the following portfolio segments and classes:
December 31, 2013
December 31, 2012
(In thousands)
Commercial business:
Commercial and industrial ............................................................................ $
Owner-occupied commercial real estate ......................................................
Non-owner occupied commercial real estate ...............................................
Total commercial business ....................................................................
One-to-four family residential ...............................................................................
Real estate construction and land development:
One-to-four family residential .......................................................................
Five or more family residential and commercial properties..........................
Total real estate construction and land development............................
Consumer ............................................................................................................
Gross purchased covered loans receivable..........................................
Allowance for loan losses ....................................................................................
14,690 $
24,366
14,625
53,681
4,777
1,556
—
1,556
3,740
63,754
(6,167)
Purchased covered loans receivable, net ............................................. $
57,587 $
25,781
34,796
13,028
73,605
5,027
4,433
—
4,433
5,265
88,330
(4,352)
83,978
The December 31, 2013 and December 31, 2012 gross recorded investment balance of purchased impaired
covered loans accounted for under FASB ASC 310-30 was $38.9 million and $59.0 million, respectively. The gross
recorded investment balance of purchased other covered loans was $24.9 million and $29.3 million at December 31,
2013 and December 31, 2012, respectively. At December 31, 2013 and December 31, 2012, the recorded investment
balance of purchased covered loans which are no longer covered under the FDIC shared-loss agreements was $2.6
million and $3.5 million, respectively.
F-29
Funds advanced on the purchased covered loans subsequent to acquisition, referred to as “subsequent
advances,” are included in the purchased covered loan balances as these subsequent advances are covered under
the shared-loss agreements. These subsequent advances are not accounted for under FASB ASC 310-30. The total
balance of subsequent advances on the purchased covered loans was $4.7 million and $6.9 million as of
December 31, 2013 and December 31, 2012, respectively.
The recorded investment of purchased non-covered loans receivable at December 31, 2013 and December 31,
2012 consisted of the following portfolio segments and classes:
December 31, 2013
December 31, 2012
(In thousands)
Commercial business:
Commercial and industrial ............................................................................
Owner-occupied commercial real estate ......................................................
Non-owner occupied commercial real estate ...............................................
Total commercial business ....................................................................
One-to-four family residential ...............................................................................
Real estate construction and land development:
One-to-four family residential .......................................................................
Five or more family residential and commercial properties..........................
Total real estate construction and land development............................
Consumer ............................................................................................................
Gross purchased non-covered loans receivable...................................
Allowance for loan losses ....................................................................................
$ 53,465
70,022
45,528
169,015
3,847
1,131
3,471
4,602
13,417
190,881
(5,504)
$ 24,763
13,211
11,019
48,993
3,040
513
864
1,377
10,713
64,123
(5,117)
Purchased non-covered loans receivable, net......................................
$185,377
$ 59,006
The December 31, 2013 and December 31, 2012 gross recorded investment balance of purchased impaired non-
covered loans accounted for under FASB ASC 310-30 was $36.0 million and $42.0 million, respectively. The recorded
investment balance of purchased other non-covered loans was $154.9 million and $22.1 million at December 31,
2013 and December 31, 2012, respectively.
The loans purchased in the NCB and Valley Acquisitions on January 9, 2013 and July 15, 2013, respectively, are
included in the purchased non-covered loans receivable balances shown above as of December 31, 2013. The
estimated fair value of the purchased non-covered loans at the acquisition dates totaled $51.5 million and $117.1
million for NCB and Valley, respectively. The gross recorded investment balance of the NCB purchased impaired
loans and the NCB purchased other loans was $2.9 million and $34.3 million at December 31, 2013, respectively. The
gross recorded investment balance of the Valley purchased impaired loans and the Valley purchased other loans was
$2.7 million and $103.7 million at December 31, 2013, respectively.
(b) Concentrations of Credit
Most of the Company’s lending activity occurs within Washington State, and to a lesser extent Oregon State. The
Company’s primary market areas include Thurston, Pierce, King, Mason, Cowlitz, Yakima, Kittitas and Clark counties
in Washington and Multnomah County in Oregon, as well as other contiguous markets. The majority of the Company’s
loan portfolio consists of (in order of balances at December 31, 2013) non-owner occupied commercial real estate,
commercial and industrial and owner-occupied commercial real estate. As of December 31, 2013 and December 31,
2012, there were no concentrations of loans related to any single industry in excess of 10% of the Company’s total
loans.
F-30
(c) Credit Quality Indicators
As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks
certain credit quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified
loans, (iii) net charge-offs, (iv) nonperforming loans, and (v) the general economic conditions of the United States of
America, and specifically the states of Washington and Oregon. The Company utilizes a risk grading matrix to assign
a risk grade to each of its loans. Loans are graded on a scale of 0 to 9, and a “W.” A description of the general
characteristics of the risk grades is as follows:
•
•
•
•
•
•
Grades 0 to 5: These grades are considered “pass grade” and includes loans with negligible to above
average but acceptable risk. These borrowers generally have strong to acceptable capital levels and
consistent earnings and debt service capacity. Loans with the higher grades within the “pass” category may
include borrowers who are experiencing unusual operating difficulties, but have acceptable payment
performance to date. Increased monitoring of financials and/or collateral may be appropriate. Loans with this
grade show no immediate loss exposure.
Grade “W”: This grade is considered “pass grade” and includes loans on management’s “watch list” and is
intended to be utilized on a temporary basis for pass grade borrowers where a potentially significant risk-
modifying action is anticipated in the near term.
Grade 6: This grade includes “Other Assets Especially Mentioned” (“OAEM”) loans in accordance with
regulatory guidelines, and is intended to highlight loans with elevated risks. Loans with this grade show signs
of deteriorating profits and capital, and the borrower might not be strong enough to sustain a major setback.
The borrower is typically higher than normally leveraged, and outside support might be modest and likely
illiquid. The loan is at risk of further decline unless active measures are taken to correct the situation.
Grade 7: This grade includes “Substandard” loans in accordance with regulatory guidelines, for which the
Company has determined have a high credit risk. These loans also have well-defined weaknesses which
make payment default or principal exposure likely, but not yet certain. The borrower may have shown serious
negative trends in financial ratios and performance. Such loans may be dependent upon collateral
liquidation, a secondary source of repayment or an event outside of the normal course of business. Loans
with this grade can be placed on accrual or nonaccrual status based on the Company’s accrual policy.
Grade 8: This grade includes “Doubtful” loans in accordance with regulatory guidelines, and the Company
has determined these loans to have excessive credit risk. Such loans are placed on nonaccrual status and
may be dependent upon collateral having a value that is difficult to determine or upon some near-term event
which lacks certainty. Additionally, these loans generally have a specific valuation allowance.
Grade 9: This grade includes “Loss” loans in accordance with regulatory guidelines, and the Company has
determined these loans have the highest risk of loss. Such loans are charged-off or charged-down when
payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined.
“Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way
imply that there has been a forgiveness of debt.
Loan grades for all commercial business loans and real estate construction and land development loans are
established at the origination of the loan. One-to-four family residential loans and consumer loans (“non-commercial
loans”) are not graded with a 0 to 9 at origination date as these loans are determined to be “pass graded” loans.
These non-commercial loans may subsequently require a 0-9 risk grade if the credit department has evaluated the
credit and determined it necessary to classify the loan. Loan grades are reviewed on a quarterly basis, or more
frequently if necessary, by the credit department. 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.
F-31
The 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 inherent losses in the portfolios, but to a lesser extent than the other loan grades.
These pass graded loans may also have a zero percent loss based on historical experience and current market
trends. The OAEM loan grade is transitory in that the Company is waiting on additional information to determine the
likelihood and extent of the potential loss. The likelihood of loss for OAEM graded loans, however, is greater than
Watch graded loans because there has been measurable credit deterioration. Loans with a Substandard grade are
generally loans for which the Company has individually analyzed for potential impairment. For Doubtful and Loss
graded loans, the Company is almost certain of the losses, and the unpaid principal balances are generally charged-
off to the realizable value.
The following tables present the balance of the originated loans receivable by credit quality indicator as of
December 31, 2013 and December 31, 2012.
Pass
OAEM
Substandard
Doubtful
Total
December 31, 2013
(In thousands)
Commercial business:
Commercial and industrial ............................. $259,071
202,440
Owner-occupied commercial real estate .......
Non-owner occupied commercial real
estate .........................................................
340,732
$ 8,367
3,393
$
14,368
5,454
$ 1,269
—
$283,075
211,287
7,927
5,792
—
354,451
Total commercial business .....................
One-to-four family residential ................................
Real estate construction and land development:
One-to-four family residential ........................
Five or more family residential and
802,243
38,330
19,687
269
25,614
636
1,269
—
848,813
39,235
10,608
4,159
3,826
—
18,593
commercial properties ................................
42,780
—
2,404
—
45,184
Total real estate construction and land
development .......................................
Consumer ..............................................................
53,388
27,986
4,159
—
6,230
144
—
—
63,777
28,130
Gross originated loans ........................... $921,947
$24,115
$
32,624
$ 1,269
$979,955
Commercial business:
Commercial and industrial ......................
Owner-occupied commercial real
Pass
OAEM
Substandard
Doubtful
Total
December 31, 2012
(In thousands)
$254,593
$ 3,908
$
18,157
$
582
$277,240
estate ..................................................
181,630
2,658
4,206
—
188,494
Non-owner occupied commercial real
estate ..................................................
256,077
4,132
692,300
37,239
10,698
920
5,257
27,620
689
369
265,835
951
—
731,569
38,848
Total commercial business ..............
One-to-four family residential .........................
Real estate construction and land
development:
One-to-four family residential .................
Five or more family residential and
commercial properties .........................
Total real estate construction and
16,446
1,795
6,934
—
25,175
48,718
—
3,357
—
52,075
land development ........................
Consumer .......................................................
65,164
28,748
1,795
—
10,291
156
—
10
77,250
28,914
Gross originated loans ....................
$823,451
$13,413
$
38,756
$
961
$876,581
F-32
The tables above include $27.4 million and $27.5 million of originated impaired loans as of December 31, 2013
and December 31, 2012, respectively, as detailed in the impaired loans section below. These impaired loans have
been individually reviewed for probable incurred losses and have a specific valuation allowance, as necessary. The
tables above also include potential problem loans. Potential problem loans are those loans that are currently accruing
interest and are not considered impaired, but which management is monitoring because the financial information of
the borrower causes concern as to their ability to meet their loan repayment terms. Potential problem originated loans
as of December 31, 2013 and December 31, 2012 were $34.5 million and $28.3 million, respectively. The balance of
potential problem originated loans guaranteed by a governmental agency, which reduces the Company's credit
exposure, was $1.8 million and $3.2 million as of December 31, 2013 and December 31, 2012, respectively.
The following tables present the recorded invested balance of the purchased covered and purchased noncovered
loans receivable by credit quality indicator as of December 31, 2013 and December 31, 2012.
December 31, 2013
Pass
OAEM
Substandard
Doubtful
Total
(In thousands)
Commercial business:
Commercial and industrial ............................................ $ 55,404
87,774
Owner-occupied commercial real estate ......................
47,157
Non-owner occupied commercial real estate ...............
Total commercial business ....................................
One-to-four family residential ...............................................
Real estate construction and land development:
One-to-four family residential .......................................
Five or more family residential and commercial
190,335
5,654
$
$4,703
2,739
1,165
8,607
882
7,183 $ 865
256
3,619
4,269
7,562
18,364
2,088
5,390
—
$ 68,155
94,388
60,153
222,696
8,624
1,672
—
1,015
—
2,687
3,471
properties ..................................................................
2,552
—
919
—
Total real estate construction and land
development ......................................................
Consumer .............................................................................
4,224
14,562
—
354
1,934
2,241
—
—
6,158
17,157
Gross purchased covered and noncovered
loans .................................................................. $214,775 $9,843 $ 24,627 $ 5,390
$ 254,635
December 31, 2012
Pass
OAEM
Substandard
Doubtful
Total
(In thousands)
Commercial business:
Commercial and industrial ............................................ $ 40,577
40,676
Owner-occupied commercial real estate ......................
11,419
Non-owner occupied commercial real estate ...............
Total commercial business ....................................
One-to-four family residential ...............................................
Real estate construction and land development:
One-to-four family residential .......................................
Five or more family residential and commercial
properties ..................................................................
Total real estate construction and land
$
$1,753
2,390
2,404
6,547
903
6,809 $ 1,405
265
4,676
5,418
4,806
16,291
1,105
7,088
—
$ 50,544
48,007
24,047
122,598
8,067
92,672
6,059
136
—
1,051
3,759
4,946
420
—
444
—
864
development ......................................................
Consumer .............................................................................
556
11,785
—
157
1,495
4,004
3,759
32
5,810
15,978
Gross purchased covered and noncovered
loans .................................................................. $ 111,072 $7,607 $ 22,895 $10,879
$ 152,453
F-33
The tables above include $6.7 million and $2.2 million of purchased other impaired loans as of December 31,
2013 and December 31, 2012, respectively, as detailed in the impaired loans section below. These purchased other
impaired loans have been individually reviewed for potential losses and have a specific valuation allowance, as
necessary.
(d) Nonaccrual loans
Originated nonaccrual loans, segregated by segments and classes of loans, were as follows as of December 31,
2013 and December 31, 2012:
December 31,
2013 (1)
December 31,
2012 (1)
(In thousands)
Commercial business:
Commercial and industrial ............................................................................
Owner-occupied commercial real estate ......................................................
Non-owner occupied commercial real estate ...............................................
$
Total commercial business ....................................................................
One-to-four family residential ...............................................................................
Real estate construction and land development:
One-to-four family residential .......................................................................
Five or more family residential and commercial properties ..........................
Total real estate construction and land development ............................
Consumer .............................................................................................................
Gross originated nonaccrual loans ........................................................
$
4,497
1,024
3
5,524
340
1,045
—
1,045
38
6,947
$
4,560
563
369
5,492
389
3,063
3,357
6,420
157
$
12,458
(1) $1.7 million and $1.2 million of nonaccrual originated loans were guaranteed by governmental agencies at
December 31, 2013 and December 31, 2012, respectively.
The recorded investment balance of purchased other nonaccrual loans, segregated by segments and classes of
loans, were as follows as of December 31, 2013 and December 31, 2012:
December 31,
2013 (1)
December 31,
2012 (1)
(In thousands)
Commercial business:
Commercial and industrial ............................................................................
Owner-occupied commercial real estate ......................................................
Non-owner occupied commercial real estate ...............................................
$
Total commercial business ....................................................................
One-to-four family residential ...............................................................................
Consumer .............................................................................................................
Gross purchased other nonaccrual loans .............................................
$
151
—
—
151
—
647
798
$
$
—
139
437
576
61
163
800
(1) $7,000 and $39,000 of purchased other nonaccrual loans were covered by the FDIC shared-loss agreements at
December 31, 2013 and December 31, 2012, respectively.
F-34
(e) Past due loans
The Company performs an aging analysis of past due loans using the categories of 30-89 days past due and 90
or more days past due. This policy is consistent with regulatory reporting requirements.
The balances of originated past due loans, segregated by segments and classes of loans, as of December 31,
2013 and December 31, 2012 were as follows:
December 31, 2013
30-89 Days
90 Days or
Greater
Total Past
Due
Current
Total
(In thousands)
90 Days
or More
and Still
Accruing
Commercial business:
Commercial and industrial ................ $
Owner-occupied commercial real
estate ............................................
Non-owner occupied commercial
real estate .....................................
Total commercial business ........
One-to-four family residential ...................
Real estate construction and land
development:
One-to-four family residential ...........
Five or more family residential and
commercial properties ...................
Total real estate construction
and land development ...........
Consumer ................................................
2,253
$
3,446
$ 5,699
$277,376
$283,075 $ —
325
951
3,529
89
821
—
821
211
849
1,174
210,113
211,287 —
9
960
353,491
354,451
4,304
—
7,833
89
840,980
39,146
848,813
39,235
1,045
1,866
16,727
18,593
6
6
—
—
—
—
45,184
45,184 —
1,045
—
1,866
211
61,911
27,919
63,777 —
28,130
—
Gross originated loans .............. $
4,650
$
5,349
$ 9,999
$969,956
$979,955 $
6
December 31, 2012
30-89 Days
90 Days or
Greater
Total Past
Due
Current
Total
(In thousands)
90 Days
or More
and Still
Accruing
2,768
$
2,014
$ 4,782
$272,458
$277,240 $
25
Commercial business:
Commercial and industrial ................ $
Owner-occupied commercial real
estate .............................................
Non-owner occupied commercial
real estate ......................................
Total commercial business ........
One-to-four family residential ...................
Real estate construction and land
development:
One-to-four family residential ............
Five or more family residential and
commercial properties ...................
Total real estate construction
and land development ............
Consumer .................................................
920
92
3,780
239
847
—
847
68
112
369
2,495
375
3,242
3,018
6,260
146
1,032
187,462
188,494 —
461
265,374
265,835 —
6,275
614
725,294
38,234
731,569
38,848
25
—
4,089
21,086
25,175
179
3,018
49,057
52,075 —
7,107
214
70,143
28,700
77,250
28,914
179
10
214
Gross originated loans ............... $
4,934
$
9,276
$ 14,210
$862,371
$876,581 $
F-35
The balances of purchased past due loans, segregated by segments and classes of loans, as of December 31,
2013 and December 31, 2012 are as follows:
December 31, 2013
30-89 Days
90 Days or
Greater
Total Past
Due
Current
Total
(In thousands)
90 Days
or More
and Still
Accruing
966
$
2,089
$ 3,055
$ 65,100
$ 68,155 $ —
Commercial business:
Commercial and industrial ................ $
Owner-occupied commercial real
estate .............................................
Non-owner occupied commercial
real estate .....................................
Total commercial business ........
One-to-four family residential ...................
Real estate construction and land
development:
One-to-four family residential ............
Five or more family residential and
commercial properties ...................
Total real estate construction
and land development ...........
Consumer .................................................
511
210
1,687
595
213
384
597
66
147
3,710
5,946
509
644
453
658
93,730
94,388 —
3,920
56,233
60,153 —
7,633
1,104
215,063
7,520
222,696
8,624
857
837
1,830
2,687
2,634
3,471 —
—
—
—
1,097
91
1,694
157
4,464
17,000
6,158 —
—
17,157
Gross purchased loans.............. $ 2,945
$
7,643
$ 10,588
$244,047
$254,635 $ —
December 31, 2012
30-89 Days
90 Days or
Greater
Total Past
Due
Current
Total
(In thousands)
90 Days
or More
and Still
Accruing
406
$
3,187
$ 3,593
$ 46,951
$ 50,544 $ —
Commercial business:
Commercial and industrial ............... $
Owner-occupied commercial real
estate ...........................................
Non-owner occupied commercial
real estate ....................................
Total commercial business .......
One-to-four family residential ..................
Real estate construction and land
development:
One-to-four family residential ..........
Five or more family residential and
commercial properties ..................
Total real estate construction
and land development ..........
Consumer ...............................................
700
289
1,395
912
509
—
509
118
761
1,461
46,546
48,007 —
4,034
7,982
141
4,323
19,724
24,047 —
9,377
1,053
113,221
7,014
122,598
8,067
3,415
3,924
1,022
4,946
444
444
420
864 —
3,859
883
4,368
1,001
1,442
14,977
5,810 —
15,978
—
—
—
135
135
Gross purchased loans ............ $ 2,934
$ 12,865
$ 15,799
$136,654
$152,453 $
F-36
(f) Impaired loans
Originated impaired loans (including troubled debt restructured loans) as of December 31, 2013 and
December 31, 2012 are set forth in the following tables.
December 31, 2013
Recorded
Investment With
No Specific
Valuation
Allowance
Recorded
Investment With
Specific
Valuation
Allowance
Total
Recorded
Investment
(In thousands)
Unpaid
Contractual
Principal
Balance
Related
Specific
Valuation
Allowance
Commercial business:
Commercial and industrial ........ $
Owner-occupied commercial
real estate ..............................
Non-owner occupied
commercial real estate ..........
Total commercial
business .........................
One-to-four family residential ...........
Real estate construction and land
development:
One-to-four family residential ....
Five or more family residential
and commercial properties ....
Total real estate
construction and land
development...................
Consumer .........................................
5,713 $
3,980 $
9,693
$
13,889
$
1,891
1,092
2,780
9,585
592
3,773
2,404
6,177
100
1,880
4,123
2,972
6,903
9,983
—
19,568
592
911
—
911
38
4,684
2,404
7,088
138
3,686
6,757
24,332
849
6,402
2,385
8,787
140
595
364
2,850
—
211
—
211
38
Gross originated loans ....... $
16,454 $
10,932 $
27,386
$
34,108
$
3,099
F-37
December 31, 2012
Recorded
Investment With
No Specific
Valuation
Allowance
Recorded
Investment With
Specific
Valuation
Allowance
Unpaid
Contractual
Principal
Balance
Related
Specific
Valuation
Allowance
Total Recorded
Investment
(In thousands)
Commercial business:
Commercial and industrial ........ $
Owner-occupied commercial
real estate ..............................
Non-owner occupied
commercial real estate ..........
Total commercial
business .........................
One-to-four family residential ...........
Real estate construction and land
development:
One-to-four family residential ....
Five or more family residential
and commercial properties ....
Total real estate
construction and land
development ..................
Consumer .........................................
7,797 $
2,643 $
10,440
$
10,741
$
858
633
1,418
3,031
4,226
2,051
7,257
11,461
422
8,287
389
19,748
811
700
—
2,724
3,357
700
47
6,081
110
3,424
3,357
6,781
157
2,134
7,257
20,132
811
4,597
3,397
7,994
157
509
1,386
2,753
46
792
658
1,450
110
Gross originated loans ....... $
12,630 $
14,867 $
27,497
$
29,094
$
4,359
The Company had governmental guarantees of $3.0 million and $1.9 million related to the originated impaired
loan balances at December 31, 2013 and December 31, 2012, respectively.
The average recorded investment of originated impaired loans (including TDRs) for the years ended
December 31, 2013, 2012 and 2011 are set forth in the following table.
Commercial business:
Commercial and industrial .................................................
Owner-occupied commercial real estate...........................
Non-owner occupied commercial real estate....................
Total commercial business .........................................
One-to-four family residential ...................................................
Real estate construction and land development:
One-to-four family residential ............................................
Five or more family residential and commercial
properties .......................................................................
Years Ended December 31,
2013
2012
2011
(In thousands)
$11,390
2,056
7,500
20,946
965
$13,083
2,633
7,793
23,509
1,249
$ 9,918
1,350
3,120
14,388
335
4,237
4,381
6,972
2,839
5,415
9,258
Total real estate construction and land
development ...........................................................
Consumer .................................................................................
7,076
144
9,796
150
16,230
88
Gross originated impaired loans .......................................
$31,978
$31,857
$31,041
F-38
Purchased other loans generally become impaired when classified as nonaccrual or when its modification results
in a TDR. Purchased other impaired loans (including TDRs) as of December 31, 2013 and December 31, 2012 are set
forth in the following tables.
December 31, 2013
Recorded
Investment With
No Specific
Valuation
Allowance
Recorded
Investment With
Specific
Valuation
Allowance
Total
Recorded
Investment
(In thousands)
Unpaid
Contractual
Principal
Balance
Related
Specific
Valuation
Allowance
Commercial business:
Commercial and industrial ........ $
Owner-occupied commercial
real estate .............................
Non-owner occupied
commercial real estate ..........
Total commercial
business .........................
One-to-four family residential ...........
Consumer .........................................
Gross purchased other
impaired loans ................ $
437 $
4,621
$
5,058
$
5,564
$
1,454
26
520
983
—
7
—
—
4,621
450
640
26
520
5,604
450
647
153
1,401
7,118
428
648
—
—
1,454
31
115
990 $
5,711
$
6,701
$
8,194
$ 1,600
December 31, 2012
Recorded
Investment With
No Specific
Valuation
Allowance
Recorded
Investment With
Specific
Valuation
Allowance
Total
Recorded
Investment
(In thousands)
Unpaid
Contractual
Principal
Balance
Related
Specific
Valuation
Allowance
Commercial business:
Commercial and industrial ........ $
Owner-occupied commercial
real estate .............................
Non-owner occupied
commercial real estate ..........
Total commercial
business .........................
One-to-four family residential ...........
Consumer .........................................
Gross purchased other
impaired loans ................ $
330 $
106
$
436
$
434
$
—
437
767
—
—
139
536
781
527
163
139
973
1,548
527
163
135
926
1,495
489
173
14
7
18
39
105
157
767 $
1,471
$
2,238
$
2,157
$
301
F-39
The average recorded investment of purchased other impaired loans (including TDRs) for years ended
December 31, 2013, 2012 and 2011 are set forth in the following table.
Years Ended December 31,
2013
2012
2011
(In thousands)
Commercial business:
Commercial and industrial ....................................... $
Owner-occupied commercial real estate.................
Non-owner occupied commercial real estate ..........
Total commercial business ...............................
One-to-four family residential .........................................
Consumer .......................................................................
$
1,815
149
1,079
3,043
476
55
$
98
85
673
856
199
303
Gross impaired purchased other loans ................... $
3,574
$
1,358
$
—
—
—
—
—
124
124
For the years ended December 31, 2013, 2012 and 2011 no interest income was recognized subsequent to a
loan’s classification as impaired.
(g) Troubled Debt Restructured Loans
A troubled debt restructured loan is a restructuring in which the Bank, for economic or legal reasons related to a
borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. TDRs are
considered impaired and are separately measured for impairment under FASB ASC 310-10-35, whether on accrual or
nonaccrual status.
The recorded investment balance and related allowance for loan losses of accruing and non-accruing TDRs as of
December 31, 2013 and December 31, 2012 were as follows:
December 31, 2013
December 31, 2012
Accruing
TDRs
Non-Accruing
TDRs
Accruing
TDRs
Non-Accruing
TDRs
Originated TDRs ............................................................... $
Allowance for loan losses on originated TDRs .................
Purchased other TDRs ......................................................
Allowance for loan losses on purchased other TDRs .......
20,439 $
2,187
5,903
1,430
(In thousands)
2,532
$
133
110
57
$
15,039
2,131
1,437
76
9,311
1,994
7
2
The unfunded commitment to borrowers related to originated TDRs was $1.5 million at both December 31, 2013
and December 31, 2012. There were $17,000 and $0 unfunded commitments to borrowers related to the purchased
other TDRs as of December 31, 2013 and December 31, 2012, respectively.
F-40
Originated loans that were modified as TDRs during the years ended December 31, 2013 and 2012 are set
forth in the following table:
Commercial business:
Commercial and industrial ...................................
Owner-occupied commercial real estate .............
Non-owner occupied commercial real estate.......
Total commercial business............................
One-to-four family residential ......................................
Real estate construction and land development:
One-to-four family residential ...............................
Five or more family residential and commercial
properties ..........................................................
Total real estate construction and land
development ..............................................
Consumer ....................................................................
Total originated TDRs ...................................
Years Ended December 31,
2013
2012
Number of
Contracts
(1)
Outstanding
Principal Balance
(1)(2)
Number of
Contracts
(1)
(Dollars in thousands)
Outstanding
Principal
Balance
(1)(2)
25 $
4
2
31
1
24
1
25
2
59 $
5,324
511
192
6,027
252
3,639
2,404
6,043
139
12,461
26 $
5
1
32
—
1
1
2
—
4,632
1,641
94
6,367
—
180
339
519
—
34 $
6,886
(1) Number of contracts and outstanding principal balance represent loans which have balances as of year end as
certain loans may have been paid-down or charged-off during the years ended December 31, 2013 and 2012.
(2) Includes subsequent payments after modifications and reflects the balance as of the end of the year. As the
Bank did not forgive any principal or interest balance as part of the loan modification, the Bank’s recorded
investment in each loan at the date of modification (pre-modification) did not change as a result of the
modification (post-modification), except when the modification was the initial advance on a one-to-four family
residential real estate construction and land development loan under a master guidance line. During the year
ended December 31, 2013, the Company's initial advance at the time of modification on these construction loans
totaled $1.1 million and the total commitment amount was $4.3 million. There were no construction loans under a
master guidance line that were modified as TDRS during the year ended December 31, 2012.
A significant portion of the loans modified during the year ended December 31, 2013 (24 loans totaling $3.4
million at December 31, 2013) relate to a speculative construction home builder. As the builder completes and sells
the units, the Bank will advance funds for the construction of another unit. The builder's loans for each separate unit
were considered troubled debt restructured loans during the second quarter of 2013. Two of this borrower's 24 loans
outstanding as of December 31, 2013 totaling $865,000 were nonaccrual. The related specific valuation allowance on
this relationship is approximately $211,000 at December 31, 2013. The Bank closely monitors the activity of this
borrower for potential losses.
Of the 59 loans modified during the year ended December 31, 2013, twelve loans with a total outstanding
principal balance of $5.1 million were previously reported as TDRs as of December 31, 2012. Of the 34 loans
modified during the year ended December 31, 2012, nine loans with a total outstanding principal balance of $2.4
million were previously reported as TDRs as of December 31, 2011. The Bank typically grants shorter extension
periods to continually monitor the troubled credits despite the fact that the extended date might not be the date the
Bank expects the cash flow. The Company does not consider these modifications a subsequent default of a TDR as
new loan terms, specifically maturity dates, were granted. The potential losses related to these loans would have
been considered in the period the loan was first reported as a TDR and adjusted, as necessary, in the current periods
based on more recent information. The related specific valuation allowance for TDRs that were modified during the
year ended December 31, 2013 was $1.4 million at December 31, 2013. The related specific valuation allowance for
those TDRs that were previously reported as TDRs as of December 31, 2012 was $111,000 and the general
allowance for loan losses for TDRs that were modified during the year ended December 31, 2013 that were not
previously reported as TDRs was $274,000 as of December 31, 2012.
F-41
Purchased other loans that were modified as TDRs during the years ended December 31, 2013 and 2012 are set
forth in the following table:
Years Ended December 31,
2013
2012
Number of
Contracts (1)
Outstanding
Principal Balance
(1)(2)
Number of
Contracts (1)
Outstanding
Principal Balance
(1)(2)
Commercial business:
Commercial and industrial .................................
Owner occupied commercial real
estate ..............................................................
Non-owner occupied commercial real estate ....
Total commercial business .........................
One-to-four family residential ....................................
Consumer ..................................................................
(Dollars in thousands)
11 $
5,007
7 $
1
—
12
—
1
26
—
5,033
—
3
5,036
—
1
8
1
—
435
—
536
971
466
—
Total purchased other TDRs .......................
13 $
9 $
1,437
(1) Number of contracts and outstanding principal balance represent loans which have balances as of year end as
certain loans may have been paid-down or charged-off during the years ended December 31, 2013 and 2012.
(2) Includes subsequent payments after modifications and reflects the balance as of the end of the year. The Bank’s
initial recorded investment in each loan at the date of modification (pre-modification) did not change as a result of
the modification (post-modification) as the Bank did not forgive any principal or interest balance as part of the
loan modification.
The majority of the Bank’s TDRs are a result of granting extensions to troubled credits which have already been
adversely classified. We grant such extensions to reassess the borrower’s financial status and to develop a plan for
repayment. Certain modifications with extensions also include interest rate reductions, which is the second most
prevalent concession. Certain TDRs were additionally re-amortized over a longer period of time. The Bank additionally
advanced funds to a troubled speculative home builder to complete established projects as mentioned above. These
modifications would all be considered a concession for a borrower that could not obtain similar financing terms from
another source other than from the Bank.
The financial effects of each modification will vary based on the specific restructure. For the majority of the Bank’s
TDRs, the loans were interest-only with a balloon payment at maturity. If the interest rate is not adjusted and the
modified terms are consistent with other similar credits being offered, the Bank may not experience any loss
associated with the restructure. If, however, the restructure involves forbearance agreements or interest rate
modifications, the Bank may not collect all the principal and interest based on the original contractual terms. The Bank
estimates the necessary allowance for loan losses on TDRs using the same guidance as used for other impaired
loans.
There were three originated commercial and industrial TDRs with a principal balance totaling $918,000 that had
been modified during the previous twelve months ended that subsequently defaulted during the year ended
December 31, 2013. Two of these loans defaulted because they were past their modified maturity date while one
defaulted due to a payment being past due 90 days or more. The Bank recorded a $63,000 related specific valuation
allowance for these defaulted TDRs as of December 31, 2013.
There were no originated TDRs that had been modified during the previous twelve months ended that
subsequently defaulted during the year ended December 31, 2012. There were no purchased other TDRs that had
been modified during the previous twelve months ended that subsequently defaulted during the years ended
December 31, 2013 and 2012.
F-42
(h) Purchased Impaired Loans
As indicated above, the Company purchased impaired loans from the Cowlitz, Pierce, NCB and Valley
Acquisitions which are accounted for under FASB ASC 310-30.
The following tables reflect the outstanding balance at December 31, 2013 and December 31, 2012 of the
purchased impaired loans by acquisition:
Cowlitz Bank
December 31, 2013 December 31, 2012
Commercial business:
Commercial and industrial .................................................................. $
Owner-occupied commercial real estate ............................................
Non-owner occupied commercial real estate .....................................
Total commercial business ..........................................................
One-to-four family residential .....................................................................
Real estate construction and land development:
One-to-four family residential .............................................................
Five or more family residential and commercial properties................
Total real estate construction and land development..................
Consumer ..................................................................................................
(In thousands)
10,608 $
11,538
10,611
32,757
3,966
1,298
—
1,298
2,022
21,624
17,157
12,908
51,689
4,262
6,122
—
6,122
3,533
Gross purchased impaired covered loans .................................. $
40,043 $
65,606
The total balance of subsequent advances on the purchased impaired covered loans was $2.6 million and $3.8
million as of December 31, 2013 and December 31, 2012, respectively. The Bank has the option to modify certain
purchased covered loans which may terminate the FDIC shared-loss coverage on those modified loans. At both
December 31, 2013 and December 31, 2012, the recorded investment balance of purchased impaired covered loans
which are no longer covered under the FDIC shared-loss agreements was $1.7 million. The Bank continues to report
these loans in the covered portfolio as they are in a pool and they continue to be accounted for under
FASB ASC 310-30. The FDIC indemnification asset has been adjusted to reflect the change in the loan status.
Pierce Commercial Bank
December 31, 2013 December 31, 2012
(In thousands)
Commercial business:
Commercial and industrial .................................................................. $
Owner-occupied commercial real estate ............................................
Non-owner occupied commercial real estate .....................................
Total commercial business ..........................................................
One-to-four family residential .....................................................................
Real estate construction and land development:
One-to-four family residential ...........................................................
Five or more family residential and commercial properties .............
Total real estate construction and land development ..................
Consumer ...................................................................................................
15,684 $
5,067
4,893
25,644
4,055
1,967
469
2,436
1,013
21,953
5,748
7,802
35,503
3,303
3,375
820
4,195
4,393
Gross purchased impaired non-covered loans ........................... $
33,148 $
47,394
F-43
Commercial business:
Commercial and industrial .................................................................
Owner-occupied commercial real estate ...........................................
Non-owner occupied commercial real estate ....................................
$
Total commercial business .........................................................
One-to-four family residential ....................................................................
Real estate construction and land development:
Five or more family residential and commercial properties...............
Total real estate construction and land development.................
Consumer .................................................................................................
NCB
Valley
December 31, 2013 (1)
(In thousands)
$
1,014
—
2,028
3,042
—
608
608
79
1,495
443
1,355
3,293
—
—
—
58
Gross purchased impaired non-covered loans ..........................
$
3,729
$
3,351
(1) The NCB Acquisition was completed on January 9, 2013 and the Valley Acquisition was completed on July 15,
2013.
On the acquisition dates, the amount by which the undiscounted expected cash flows of the purchased impaired
loans exceeded the estimate fair value of the loan is the “accretable yield”. The accretable yield is then measured at
each financial reporting date and represents the difference between the remaining undiscounted expected cash flows
and the current carrying value of the purchased impaired loan.
The following tables summarize the accretable yield on the purchased impaired loans resulting from the Cowlitz,
Pierce, NCB and Valley Acquisitions for the years ended December 31, 2013 and 2012. As the NCB and Valley
Acquisitions were completed in 2013, there are no balances for the years ended December 31, 2012 or 2011.
Year Ended December 31, 2013
Cowlitz
Bank
Pierce
Commercial
Bank
NCB (1)
Valley (2)
Total
(In thousands)
Balance at the beginning of the year .................................... $14,286
(4,210)
(4,902)
4,361
Accretion ........................................................................
Disposal and other .........................................................
Change in accretable yield ............................................
$
7,352
(4,115)
45
3,847
$ — $ — $21,638
(8,612)
(5,220)
9,443
(273)
(258)
964
(14)
(105)
271
Balance at the end of the year .............................................. $ 9,535
$
7,129
$
433 $ 152
$17,249
Year Ended
December 31, 2012
Year Ended
December 31, 2011
Cowlitz
Bank
Pierce
Commercial
Bank
Cowlitz
Bank
Pierce
Commercial
Bank
Balance at the beginning of the year ........................... $
Accretion ...............................................................
Disposals and other ..............................................
Change in accretable yield ...................................
.....................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................
19,912 $
(6,679)
(1,140)
2,193
(In thousands)
14,638 $
(6,238)
(2,798)
1,750
20,082 $
(9,206)
(80)
9,116
10,943
(6,288)
20
9,963
Balance at the end of the year ..................................... $
14,286 $
7,352 $
19,912 $
14,638
F-44
(1) For the NCB Acquisition, the contractual cash flows were $8.5 million and the expected cash flows were $5.6
million, resulting in a non-accretable difference of $2.9 million. As the fair value of these purchased impaired
loans at the January 9, 2013 NCB Acquisition date was $4.9 million, this provides an accretable yield of
$745,000, which the Company included in the change in accretable yield in the quarter of acquisition.
(2) For the Valley Acquisition, the contractual cash flows were $5.1 million and the expected cash flows were $4.4
million, resulting in a non-accretable difference of $692,000. As the fair value of these purchased impaired loans
at the July 15, 2013 Valley Acquisition date was $4.1 million, this provides an accretable yield of $271,000, which
the Company included in the change in accretable yield in the quarter of acquisition.
(i) Related Party Loans
In the ordinary course of business, the Company has granted loans to certain directors, executive officers and
their affiliates (collectively referred to as “related parties”).
Activity in related party loans for the years ended December 31, 2013, 2012 and 2011 was as follows
(in thousands):
Balance outstanding at December 31, 2010......................................................................... $ 10,547
6,427
(6,583)
Principal additions ..........................................................................................................
Principal reductions .......................................................................................................
Balance outstanding at December 31, 2011.........................................................................
Principal additions ..........................................................................................................
10,391
8,906
Principal reductions .......................................................................................................
Balance outstanding at December 31, 2012.........................................................................
Principal additions ..........................................................................................................
Elimination of outstanding loan balance due to change in related party status ............
Principal reductions .......................................................................................................
(7,855)
11,442
—
(3,045)
(923)
Balance outstanding at December 31, 2013......................................................................... $
7,474
The Company had $184,000 and $2.0 million of unfunded commitments to related parties as of December 31,
2013 and 2012, respectively. The Company did not have any borrowings from related parties at December 31, 2013
or 2012.
(j) Mortgage Banking Activities
The Bank historically originated certain single family residential loans to be sold on the secondary market. These
loans were presented as held for sale. The Bank ceased these mortgage banking activities in the second quarter of
2013. Details of certain mortgage banking activities are as follows:
Years Ended or As of December 31,
2013
2012
Loans held for sale at lower of cost or market ..................................
Loans serviced for others ..................................................................
Total loans sold during the year .........................................................
Commitments to sell mortgage loans ................................................
Commitments to fund mortgage loans (at interest rates
approximating market rates):
Fixed rate ...................................................................................
Variable or adjustable rate .........................................................
$
$
(In thousands)
—
$
—
8,460
—
1,676
49
21,187
2,971
—
—
$
5,714
—
There was no servicing fee income from mortgage loans serviced for others for the years ended December 31,
2013, 2012 and 2011.
F-45
(6) Allowance for Loan Losses
The allowance for loan losses is maintained at a level deemed appropriate by management to adequately provide
for known and inherent risks in the loan portfolio. A summary of the changes in the originated loans’ allowance for loan
losses for the years ended December 31, 2013, 2012 and 2011 are as follows:
Years Ended December 31,
2013
2012
2011
(In thousands)
Balance at the beginning of the year ..................................................... $19,125
Charge-offs .....................................................................................
Recoveries of loans previously charged-off ...................................
Provision for loan losses ................................................................
(3,791)
929
890
$ 22,317 $22,062
(5,969)
(5,624)
1,044
1,737
5,180
695
Balance at the end of the year ............................................................... $17,153
$ 19,125 $22,317
A summary of the changes in the purchased covered loans’ allowance for loan losses for the years ended
December 31, 2013, 2012 and 2011 are as follows:
Years Ended December 31,
2013
2012
2011
Balance at the beginning of the year ..................................................... $4,352
Charge-offs .....................................................................................
Provision for loan losses .................................................................
(73)
1,888
(In thousands)
$ 3,963
(57)
446
$ —
(435)
4,398
Balance at the end of the year ............................................................... $6,167
$ 4,352 $3,963
A summary of the changes in the purchased noncovered loans’ allowance for loan losses for the years ended
December 31, 2013, 2012 and 2011 are as follows:
Balance at the beginning of the year ...................................................... $ 5,117
$ 4,635 $ —
Charge-offs ......................................................................................
Provision for loan losses ..................................................................
(507)
894
(393)
875
(217)
4,852
Balance at the end of the year ................................................................ $5,504
$ 5,117 $ 4,635
Years Ended December 31,
2013
2012
2011
(In thousands)
The purchased loans acquired in the Cowlitz, Pierce, NCB and Valley Acquisitions are subject to the Company’s
internal credit review. If and when credit deterioration occurs subsequent to the acquisition dates, a provision for loan
losses will be charged to earnings for the full amount without regard to the FDIC shared-loss agreements for the
covered loan balances. The portion of the estimated loss reimbursable from the FDIC is recorded in noninterest
income and increases the FDIC indemnification asset.
F-46
The following table details activity in the allowance for loan losses disaggregated on the basis of the Company’s
impairment method as of and for the year ended December 31, 2013:
Commercial
and
industrial
Owner-
occupied
commercial
real estate
Non-owner
occupied
commercial
real estate
One-to-four
family
residential
Real estate
construction
and land
development:
five or more
family
residential
and
commercial
properties
Real estate
construction
and land
development:
one-to-four
family
residential
Consumer Unallocated Total
Allowance for loan losses for the
year ended December 31, 2013:
December 31, 2012 ................. $
Charge-offs .............................
Recoveries ..............................
Provisions for / (Reallocation
of) loan losses ....................
9,912 $
(2,826)
248
4,021 $
(247)
560
5,369 $
—
—
1,221 $
(52)
—
3,131 $
(423)
—
2,309 $
(142)
32
1,761 $
(681)
89
870 $ 28,594
(4,371)
—
929
—
6,144
(285)
(43)
(69)
(988)
(1,246)
428
(269) 3,672
December 31, 2013 ................. $
13,478 $
4,049 $
5,326 $
1,100 $
1,720 $
953 $
1,597 $
601 $ 28,824
(In thousands)
Allowance for loan losses as of
December 31, 2013 allocated to:
Originated loans individually
evaluated for impairment .... $
1,891 $
595 $
364 $
— $
211 $
— $
38 $
— $ 3,099
Originated loans collectively
evaluated for impairment ....
6,614
2,039
2,459
564
429
855
493
601 14,054
Purchased other covered
loans individually evaluated
for impairment ....................
Purchased other covered
loans collectively evaluated
for impairment ....................
Purchased other non-covered
loans individually evaluated
for impairment ....................
Purchased other non-covered
loans collectively evaluated
for impairment ....................
Purchased impaired covered
loans collectively evaluated
for impairment ....................
Purchased impaired non-
covered loans collectively
evaluated for impairment ....
629
—
—
18
7
14
31
13
825
—
—
—
113
62
57
6
—
—
—
—
—
—
—
660
—
57
—
109
—
115
—
940
—
82
—
320
1,094
998
2,073
270
789
—
174
— 5,398
2,294
348
359
216
291
98
638
— 4,244
December 31, 2013 ................. $
13,478 $
4,049 $
5,326 $
1,100 $
1,720 $
953 $
1,597 $
601 $ 28,824
F-47
The following table details the balance in the allowance for loan losses disaggregated on the basis of the
Company’s impairment method for the year ended December 31, 2012:
Commercial
and
industrial
Owner-
occupied
commercial
real estate
Non-owner
occupied
commercial
real estate
One-to-four
family
residential
Real estate
construction
and land
development:
five or more
family
residential
and
commercial
properties
Real estate
construction
and land
development:
one-to-four
family
residential
Consumer Unallocated Total
Allowance for loan losses for the
year ended December 31,
2012:
December 31, 2011 ............. $
Charge-offs .........................
Recoveries ..........................
Provision for / (Reallocation
of) loan losses ................
11,805 $
(2,292)
1,560
2,979 $
(1,142)
8
4,394 $
(292)
11
794 $
(391)
—
4,823 $
(835)
125
3,800 $
(445)
—
1,410 $
(677)
33
910 $ 30,915
— (6,074)
— 1,737
(1,161)
2,176
1,256
818
(982)
(1,046)
995
(40) 2,016
December 31, 2012 ............. $
9,912 $
4,021 $
5,369 $
1,221 $
3,131 $
2,309 $
1,761 $
870 $ 28,594
(In thousands)
Allowance for loan losses as of
December 31, 2012 allocated
to:
Originated loans individually
evaluated for
impairment ..................... $
Originated loans collectively
evaluated for
impairment .....................
Purchased other covered
loans individually
evaluated for
impairment .....................
Purchased other covered
loans collectively
evaluated for
impairment .....................
Purchased other non-
covered loans
individually evaluated for
impairment .....................
Purchased other non-
covered loans
collectively evaluated for
impairment .....................
Purchased impaired
covered loans
collectively evaluated for
impairment .....................
Purchased impaired non-
covered loans
collectively evaluated for
impairment .....................
858 $
509 $
1,386 $
46 $
792 $
658 $
110 $
— $ 4,359
5,372
2,054
2,375
591
1,339
1,527
638
870 14,766
4
—
—
44
—
—
33
—
81
38
29
—
23
—
—
4
—
94
10
7
18
61
—
—
124
—
220
30
40
16
5
—
—
14
—
105
1,034
989
1,164
210
639
—
141
— 4,177
2,566
393
410
241
361
124
697
— 4,792
December 31, 2012 ............. $
9,912 $
4,021 $
5,369 $
1,221 $
3,131 $
2,309 $
1,761 $
870 $ 28,594
F-48
The following table details the recorded investment balance of the loan receivables disaggregated on the basis of
the Company’s impairment method as of December 31, 2013:
Commercial
and
industrial
Owner-
occupied
commercial
real estate
Non-owner
occupied
commercial
real estate
One-to-four
family
residential
Real estate
construction
and land
development:
five or more
family
residential
and
commercial
properties
Real estate
construction
and land
development:
one-to-four
family
residential
Consumer
Total
Originated loans individually evaluated for
impairment.................................................... $
Originated loans collectively evaluated for
9,693 $
2,972 $
6,903 $
592 $
4,684 $
2,404 $
138 $
27,386
(In thousands)
impairment....................................................
273,382
208,315
347,548
38,643
13,909
42,780
27,992
952,569
Purchased other covered loans individually
evaluated for impairment ..............................
Purchased other covered loans collectively
evaluated for impairment ..............................
Purchased other non-covered loans individually
evaluated for impairment ..............................
Purchased other non-covered loans collectively
evaluated for impairment ..............................
Purchased impaired covered loans collectively
evaluated for impairment ..............................
Purchased impaired non-covered loans
3,761
—
—
2,249
13,443
2,438
1,297
26
520
35,389
64,877
38,223
450
797
—
79
—
—
—
—
7
4,218
—
1,733
20,660
—
640
2,483
1,099
2,114
10,600
152,381
8,680
10,923
12,187
3,530
1,556
—
2,000
38,876
collectively evaluated for impairment ............
16,779
5,119
6,785
3,768
32
1,357
2,177
36,017
Total gross loans receivable as of
December 31, 2013 ...................................... $
351,230 $
305,675 $
414,604 $
47,859 $
21,280 $
48,655 $
45,287 $ 1,234,590
The following table details the recorded investment balance of the loan receivables disaggregated on the basis of
the Company’s impairment method for the year ended December 31, 2012:
Commercial
and
industrial
Owner-
occupied
commercial
real estate
Non-owner
occupied
commercial
real estate
One-to-four
family
residential
Real estate
construction
and land
development:
five or more
family
residential
and
commercial
properties
Real estate
construction
and land
development:
one-to-four
family
residential
Consumer
Total
Originated loans individually evaluated for
impairment .................................................. $
10,440 $
2,051 $
7,257 $
811 $
3,424 $
3,357 $
157 $ 27,497
(In thousands)
Originated loans collectively evaluated for
impairment ..................................................
Purchased other covered loans individually
evaluated for impairment .............................
Purchased other covered loans collectively
evaluated for impairment .............................
Purchased other non-covered loans
individually evaluated for impairment ...........
Purchased other non-covered loans
collectively evaluated for impairment ...........
Purchased impaired covered loans collectively
evaluated for impairment .............................
Purchased impaired non-covered loans
collectively evaluated for impairment ...........
Total gross loans receivable as of
December 31, 2012 ..................................... $
266,800
186,443
258,578
38,037
21,751
48,718
28,757 849,084
51
—
7,232
18,347
385
139
—
384
973
4,313
7,924
3,456
466
857
61
—
—
—
—
—
—
38
555
—
1,911
28,731
—
125
1,683
—
4,691
20,384
18,498
16,449
12,644
3,704
4,433
—
3,316
59,044
20,065
5,148
6,590
2,979
513
864
5,897
42,056
327,784 $
236,501 $
289,882 $
46,915 $
30,121 $
52,939 $
44,892 $1,029,034
F-49
(7) FDIC Indemnification Asset
Changes in the FDIC indemnification asset during the years ended December 31, 2013, 2012 and 2011 are as
follows:
Years Ended December 31,
2013
2012
2011
Balance at the beginning of year ..................................................... $ 7,100
(2,537)
1,086
(1,267)
Cash payments received or receivable from the FDIC ............
FDIC share of additional estimated losses...............................
Net amortization .......................................................................
(In thousands)
$10,350 $16,071
(3,471)
2,178
(4,428)
(2,217)
843
(1,876)
Balance at the end of year ............................................................... $ 4,382
$ 7,100 $10,350
(8) Other Real Estate Owned
Changes in other real estate owned during the years ended December 31, 2013, 2012 and 2011 are as follows:
Years Ended December 31,
2013
2012
2011
Balance at the beginning of the year ............................................... $ 5,666
2,974
2,279
(6,253)
264
(371)
Additions ...................................................................................
Additions from acquisitions .......................................................
Proceeds from dispositions ......................................................
Gain (loss) on sales, net ...........................................................
Valuation adjustment ................................................................
(In thousands)
$ 4,484 $ 3,030
5,653
7,406
—
—
(5,987)
587
(824)
(3,257)
(71)
(871)
Balance at the end of the year ......................................................... $ 4,559
$ 5,666 $ 4,484
(9) Premises and Equipment
A summary of premises and equipment are follows:
December 31, 2013
December 31, 2012
Land ......................................................................... $
Buildings and building improvements......................
Furniture, fixtures and equipment............................
(In thousands)
$
10,876
33,482
18,054
Total premises and equipment .........................
Less accumulated depreciation ...............................
62,412
28,064
Premises and equipment, net .......................... $
34,348
$
8,201
26,677
16,057
50,935
26,180
24,755
Total depreciation expense on premises and equipment was $2.3 million, $2.1 million and $1.9 million for the
years ended December 31, 2013, 2012 and 2011, respectively.
F-50
(10) 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 purchases of Valley Community Bancshares, Inc. on July 15, 2013, Western Washington Bancorp in 2006 and
North Pacific Bank in 1998. The Company’s goodwill is assigned to the Bank and is evaluated for impairment at the
Bank level (reporting unit).
The Company recorded$16.4 million of goodwill during the year ended December 31, 2013 due to the Valley
Acquisition. There was no goodwill additions recorded during the year ended December 31, 2012.
At December 31, 2013, the Company’s step-one analysis concluded that the reporting unit’s fair value was
greater than its carrying value and therefore no goodwill impairment charges were required for the year ended
December 31, 2013. The Company did not record goodwill impairment charges for the years ended December 31,
2013, 2012 or 2011. Even though there was no goodwill impairment at December 31, 2013, adverse events may
impact the recoverability of goodwill and could result in a future impairment charge which could have a material
impact on the Company’s Consolidated Financial Statements.
b) Other Intangible Assets
The other intangible assets represents the Core Deposit Intangible acquired in business combinations. The useful
life of the CDI related to Valley Community Bancshares, Inc., Northwest Commercial Bank, Pierce Commercial Bank,
Cowlitz Bank, and Western Washington Bancorp acquisitions is ten, five, four, nine, and eight years, respectively.
During the year ended December 31, 2013, the Company recorded additions of intangible assets of $1.1 million
due to the NCB and Valley Acquisitions. There were no intangible asset additions recorded during the year ended
December 31, 2012.
Amortization expense related to the core deposit intangibles was $543,000, $427,000 and $440,000 for the years
ended December 31, 2013, 2012 and 2011.
The estimated aggregated amortization expense related to these intangible assets for future years is as follows:
Years Ending December 31,
(In thousands)
2014 ........................................................................ $
2015 ........................................................................
2016 ........................................................................
2017 ........................................................................
2018 ........................................................................
Thereafter .......................................................................
565
456
156
139
91
208
$
1,615
F-51
(11) Deposits
Deposits consisted of the following:
December 31, 2013
December 31, 2012
Amount
Percent
Amount
Percent
Noninterest demand deposits .......................................... $ 349,902
352,051
NOW accounts .................................................................
232,016
Money market accounts ...................................................
155,790
Savings accounts .............................................................
(Dollars in thousands)
25.0% $ 247,048
303,487
25.2%
157,728
16.6%
120,781
11.1%
Total non-maturity deposits .......................................
Certificate of deposit accounts .........................................
1,089,759
309,430
77.9%
22.1%
829,044
288,927
22.1%
27.2%
14.1%
10.8%
74.2%
25.8%
Total deposits ............................................................ $1,399,189
100.0% $ 1,117,971
100.0%
Accrued interest payable on deposits was $152,000 and $106,000 as of December 31, 2013 and 2012,
respectively and is included in accrued expenses and other liabilities in the Consolidated Statements of Financial
Condition.
Interest expense, by category, is as follows:
Years Ended December 31,
2013
2012
2011
(In thousands)
NOW accounts ....................................................................................... $ 645
386
Money market accounts ........................................................................
Savings accounts ...................................................................................
164
2,478
Certificate of deposit accounts ..............................................................
$ 797 $ 1,215
653
361
4,274
452
204
3,016
$ 3,673
$ 4,469 $ 6,503
Scheduled maturities of certificates of deposit for future years are as follows:
Year Ending December 31,
(In thousands)
2014 ............................................................................................ $
2015 ............................................................................................
2016 ............................................................................................
2017 ............................................................................................
2018 ............................................................................................
Thereafter .......................................................................................
$
222,817
45,943
21,844
11,317
7,509
—
309,430
Certificates of deposit issued in denominations equal to or in excess of $100,000 totaled $171.3 million and
$164.9 million as of December 31, 2013 and 2012, respectively.
F-52
(12) Repurchase Agreements
The Company utilizes repurchase agreements with a one-day maturity as a supplement to funding sources. At
December 31, 2013 and 2012 the Company had securities sold under agreement to repurchase of $29.4 million and
$16.0 million, respectively. The weighted average interest rates on the utilized repurchased agreements was 0.3% as
of December 31, 2013 and 2012. Repurchase agreements are secured by investment securities available for sale.
Upon maturity of the agreements, the pledged investment securities will be returned to the Company.
(13) Other Borrowings
(a) FHLB Advances
The Federal Home Loan Bank of Seattle functions as a member-owned cooperative providing credit for member
financial institutions. Advances are made pursuant to several different programs. Each credit program has its own
interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based
either on a fixed percentage of an institution’s net worth or on the FHLB’s assessment of the institution’s
creditworthiness. At December 31, 2013, the Bank maintained a credit facility with the FHLB of Seattle for $283.6
million. During the years ended December 31, 2013 and 2012 there were no FHLB borrowing transactions completed
and at December 31, 2013 and 2012 there were no FHLB advances outstanding.
Advances from the FHLB are collateralized by a blanket pledge on FHLB stock owned by the Bank, deposits at
the FHLB and all mortgages or deeds of trust securing such properties. In accordance with the pledge agreement, the
Company must maintain unencumbered collateral in an amount equal to varying percentages ranging from 100% to
125% of outstanding advances depending on the type of collateral. At December 31, 2013, the Bank was not required
to maintain collateral in order to meet the collateral requirements of the FHLB.
(b) Federal Funds Purchased
The Bank maintains advance lines to purchase federal funds totaling $50.0 million as of December 31, 2013. The
lines generally mature annually or are reviewed annually. As of December 31, 2013 and 2012, there were no federal
funds purchased.
(c) Credit facilities
The Bank maintains a credit facility with the Federal Reserve Bank of San Francisco for $56.7 million as of
December 31, 2013, of which there were no borrowings outstanding as of December 31, 2013 or 2012. Any advances
on the credit facility would have to be first pledged with the Bank's investment securities or loans.
(14) Income Taxes
Income tax expense is substantially due to Federal income taxes as the provision for the state of Oregon income
taxes is insignificant. Income tax expense for the years ended December 31, 2013, 2012 and 2011 consisted of the
following:
Years Ended December 31,
2013
2012
2011
(In thousands)
Current tax expense .......................................................................... $ 4,344
326
Deferred tax expense (benefit) ..........................................................
(77)
(Decrease) increase in valuation allowance......................................
$ 5,916 $10,098
(7,465)
185
77
—
$ 4,593
$ 6,178 $ 2,633
F-53
A reconciliation of the Company's effective income tax rate with the Federal statutory income tax rate of 35% is
as follows:
Years Ended December 31,
2013
2012
2011
(In thousands)
Income tax expense at Federal statutory rate ...................................... $ 4,959
Tax exempt interest ...............................................................................
Non-deductible acquisition costs ..........................................................
Valuation allowance ..............................................................................
Other, net ..............................................................................................
(858)
469
(77)
100
$ 6,804 $ 3,203
(542)
(649)
—
77
(54)
—
—
(28)
The following table presents major components of the deferred income tax asset (liability) resulting from
differences between financial reporting and tax basis:
$ 4,593
$ 6,178 $ 2,633
Deferred tax assets:
Allowance for loan losses .................................................
Accrued compensation .....................................................
Capital loss carryforward ..................................................
Unrealized losses charged to earnings on other than
temporarily impaired investment securities ...................
Net unrealized losses charged to other comprehensive
income on securities .....................................................
Goodwill and other intangible assets ................................
Market discount on purchased loans ................................
Foregone interest on nonaccrual loans ............................
Net operating loss carryforward acquired from
NCB ...............................................................................
Other .................................................................................
Deferred tax assets before valuation
allowance ...............................................................
Valuation allowance ...................................................
Total deferred tax assets ...........................................
Deferred tax liabilities:
Deferred loan fees ............................................................
Premises and equipment ..................................................
FHLB stock .......................................................................
Net unrealized gains charged to other comprehensive
income on securities .....................................................
Indemnification asset ........................................................
Total deferred tax liabilities ........................................
Deferred income tax asset, net .................................
December 31, 2013
December 31, 2012
(In thousands)
$
$
7,003
821
95
622
626
2,107
6,767
1,026
588
67
19,722
—
19,722
(867)
(1,520)
(1,039)
—
(1,539)
(4,965)
14,757
$
$
9,182
280
246
609
—
2,280
2,982
798
—
505
16,882
(77)
16,805
(720)
(888)
(1,043)
(939)
(2,493)
(6,083)
10,722
The Company has qualified under provisions of the Internal Revenue Code to compute income taxes after
deductions of additions to the bad debt reserves. At December 31, 2013, the Company had a taxable temporary
difference of approximately $2.8 million that arose before 1988 (base-year amount). In accordance with FASB ASC
740, a deferred tax liability of an estimated $980,000 has not been recognized for the temporary difference.
Management does not expect this temporary difference to reverse in the foreseeable future.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that
some portion or all of the deferred tax assets will not be realized. A valuation allowance is required to be recognized
for the portion of the deferred tax asset that will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in which those temporary differences
become deductible. Based upon the level of historical taxable income and projections for future taxable income over
the periods in which the deferred tax assets are deductible, management expects to realize the benefits of these
deductible differences at December 31, 2013.
F-54
The Company has a net operating loss carryforward of $1.7 million as of December 31, 2013 that will expire in
2033. The Company is limited to the amount of the net operating loss carryforward that it can deduct each year. The
Company also has $270,000 of federal capital loss carryforwards as of December 31, 2013 which will expire in 2018.
A tax planning strategy has been developed that will enable the Company to deduct all of the net operating loss and
capital loss carryforwards prior to their respective expirations. Based on these estimates, management has not
recorded a valuation allowance as of December 31, 2013. During the year ended December 31, 2013, management
reversed the valuation allowance that was established in the prior year.
As of December 31, 2013 and December 31, 2012, the Company had an insignificant amount of unrecognized
tax benefits, none of which would materially affect its effective tax rate if recognized. The Company does not
anticipate that the amount of unrecognized tax benefits will significantly increase or decrease in the next 12 months.
The amount of interest and penalties accrued as of December 31, 2013 and 2012 and for the years ended
December 31, 2013, 2012 and 2011 were immaterial.
The Company and its subsidiary file a United States consolidated federal income tax return and an Oregon State
income tax return, and the tax years subject to examination by the Internal Revenue Service are the years ended
December 31, 2013, 2012, 2011 and 2010.
(15) Stock-Based Compensation
Stock options generally vest ratably over three years and expire five years after they become exercisable or vest
ratably over four years and expire ten years from date of grant. Restricted stock awards issued generally have a five-
year cliff vesting or four year ratable vesting schedule. The Company issues new shares to satisfy share option
exercises and restricted stock awards. As of December 31, 2013, 110,436 shares remain available for future
issuances under stock-based compensation plans.
(a) Stock Option Awards
For the years ended December 31, 2013, 2012 and 2011, the Company recognized compensation expense
related to stock options of $71,000, $106,000 and $165,000, respectively, and a related tax benefit of $0, $1,000 and
$6,000, respectively. As of December 31, 2013, the total unrecognized compensation expense related to non-vested
stock options was $76,000 and the related weighted average period over which it is expected to be recognized is
approximately 0.39 years. The intrinsic value and cash proceeds from options exercised during the year ended
December 31, 2013 totaled $54,000 and $200,000, respectively. The intrinsic value and cash proceeds from options
exercised during the year ended December 31, 2012 totaled $31,000 and $129,000, respectively.
F-55
The following tables summarize the stock option activity for the years ended December 31, 2013, 2012 and 2011:
Weighted-
Average
Remaining
Contractual
Term (In years)
Aggregate
Intrinsic
Value (In
thousands)
Outstanding at December 31, 2010 ......................
Granted ..........................................................
Exercised .......................................................
Forfeited or expired ........................................
Outstanding at December 31, 2011 ......................
Granted ..........................................................
Exercised .......................................................
Forfeited or expired ........................................
Outstanding at December 31, 2012 ......................
Granted ..........................................................
Exercised .......................................................
Forfeited or expired........................................
Weighted-
Average
Exercise
Price
$ 18.70
—
11.35
20.15
18.33
—
11.35
21.52
17.48
—
12.10
22.07
Shares
550,524
—
(4,350)
(129,051)
417,123
—
(11,365)
(105,100)
300,658
—
(16,553)
(89,623)
Outstanding at December 31, 2013 ......................
194,482
$ 15.82
3.38
$
553
Vested and expected to vest at December 31,
2013 ...................................................................
194,450
$ 15.82
Exercisable at December 31, 2013 .......................
176,576
$ 15.93
3.38
3.08
$
$
553
511
The Company measures the fair value of each stock option grant at the date of the grant using the Black-
Scholes-Merton option pricing model. The expected term of share options is derived from historical data and
represents the period of time that share options granted are expected to be outstanding. The risk-free interest rate is
based on the U.S. Treasury yield curve in effect at the time of grant for a bond with a maturity equal to the expected
term. Expected volatility is based on historical volatility of Company shares over a period commensurate with the
expected term. Expected dividend yield is based on dividends expected to be paid during the expected term of the
share options. There were no options granted during the years ended December 31, 2013, 2012 or 2011.
(b) Restricted and Unrestricted Stock Awards
For the years ended December 31, 2013, 2012 and 2011, the Company recognized compensation expense
related to restricted and unrestricted stock awards of $1.2 million, $1.1 million and $737,000, respectively, and a
related tax benefit of $428,000, $367,000, and $258,000, respectively. As of December 31, 2013, the total
unrecognized compensation expense related to non-vested restricted and unrestricted stock awards was $1.9 million
and the related weighted average period over which it is expected to be recognized is approximately 2.17 years. The
vesting date fair value of restricted stock awards that vested during the years ended December 31, 2013, 2012 and
2011 was $1.2 million, $842,000 and $396,000, respectively.
F-56
The following tables summarize the restricted and unrestricted stock award activity for the years ended
December 31, 2013, 2012 and 2011:
Nonvested at December 31, 2010......................................
Granted........................................................................
Vested..........................................................................
Forfeited ......................................................................
Nonvested at December 31, 2011 ......................................
Granted........................................................................
Vested..........................................................................
Forfeited ......................................................................
Nonvested at December 31, 2012......................................
Granted........................................................................
Vested..........................................................................
Forfeited ......................................................................
Nonvested at December 31, 2013......................................
Weighted-
Average
Grant
Date Fair
Value
$ 18.29
14.79
20.50
14.47
16.29
14.02
17.41
15.21
14.86
14.31
15.55
14.89
$ 14.29
Shares
118,379
80,723
(29,352)
(4,870)
164,880
91,738
(61,445)
(5,503)
189,670
103,195
(86,819)
(3,107)
202,939
(16) Employee Benefit Plans
(a) Employee Stock Ownership Plan
Effective October 1, 1999 the Company combined three retirement plans, a money purchase pension plan, a
401(k) plan, and an employee stock ownership plan (ESOP) at Heritage Bank, and the 401(k) plan at Central Valley
Bank into one plan called the Heritage Financial Corporation 401(k) Employee Stock Ownership Plan (“KSOP”). In
2010, the Company amended the KSOP to provide certain service credit for vesting and/or contribution purposes to
employees of Cowlitz Bank and Pierce Commercial Bank at the time of each acquisition.
The profit sharing portion of the KSOP is a defined contribution retirement plan. The plan provides a contribution
to all eligible participants upon credit of 1,000 hours of service during the plan year, the attainment of 18 years of age,
and employment on the last day of the year of 2% of the participants’ eligible compensation. The Company can also
provide discretionary profit sharing contributions beyond the required 2% contribution. It is the Company’s policy to
fund plan costs as accrued. Employee vesting in the profit sharing occurs over a period of six years, at which time
they become fully vested. Employer profit sharing contributions were $600,000, $631,000 and $562,000 for the years
ended December 31, 2013, 2012 and 2011, respectively.
The KSOP also includes the Company’s salary savings 401(k) plan for its employees. All persons employed as of
July 1, 1984 automatically participate in the plan. All employees hired after that date who are at least 18 years of age
may participate in the plan the first of the month following thirty days of service. Employees who participate may
contribute a portion of their salary, which is matched by the employer at 50% up to 6% of eligible compensation, up to
certain Internal Revenue Service limits. Employee vesting in employer matching occurs over a period of 6 years for
those contributions made after January 1, 2003. Employer matching contributions for the years ended December 31,
2013, 2012 and 2011 were $497,000, $444,000 and $438,000, respectively.
The third portion of the KSOP is the employee stock ownership plan (ESOP). Heritage Bank established the
ESOP and related trust for eligible employees effective July 1, 1994, which became active upon the former mutual
holding company’s conversion to a stock-based holding company in January 1995. The ESOP provides a contribution
to all eligible participants upon completion of one year of service, the attainment of 18 years of age, and employment
on the last day of the year. Employee vesting occurs over a period of six years. The ESOP is funded by employer
contributions in cash or common stock. During the year ended December 31, 2012, the loan related to the ESOP was
paid in full; therefore, there is no ESOP compensation expense for the year ended December 31, 2013. ESOP
compensation expense was $139,000 and $119,000 for the years ended December 31, 2012 and 2011, respectively.
For the year ended December 31, 2013, the Company had no allocated or committed shares to be released to the
ESOP and has no unearned, restricted shares remaining to be released as of December 31, 2013.
F-57
(b) Employment Agreements
The Company has entered into contracts with certain senior officers that provide benefits under certain
conditions following termination without cause, and/or following a change of control of the Company.
(c) Deferred Compensation Plan
During 2012, the Company adopted a Deferred Compensation Plan, which provides its directors and select
executive officers with the opportunity to defer current compensation. Under the Plan, participants are permitted to
elect to defer compensation and the Company has the discretion to make additional contributions to the Plan on
behalf of any participant based on a number of factors. Compensation expense under the Deferred Compensation
Plan totaled $445,000 and $312,000 for the years ended December 31, 2013 and 2012, respectively. The Company’s
contributions totaled $155,000 and $150,000 for the years ended December 31, 2013 and 2012, respectively.
(17) Stockholders’ Equity
(a) Earnings Per Common Share
The following table illustrates the reconciliation of weighted average shares used for earnings per common share
computations for the years ended December 31, 2013, 2012 and 2011:
Years Ended December 31,
2013
2012
2011
(Dollars in thousands)
Net income:
Net income ................................................................ $
Less: Dividends and undistributed earnings
allocated to participating securities .......................
9,575
$
13,261 $
6,518
(118)
(162)
(67)
Net income allocated to common shareholders ....... $
9,457
$
13,099 $
6,451
Basic:
Weighted average common shares outstanding ...... 15,667,912
(191,677)
Less: Restricted stock awards ..................................
15,262,452
(182,303)
15,601,537
(170,182)
Total basic weighted average common shares
outstanding ............................................................ 15,476,235
15,080,149
15,431,355
Diluted:
Basic weighted average common shares
outstanding ............................................................ 15,476,235
11,480
Incremental shares from stock options .....................
15,080,149
14,640
15,431,355
66,071
Total diluted weighted average common shares
outstanding ............................................................ 15,487,715
15,094,789
15,497,426
Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. For
the years ended December 31, 2013, 2012 and 2011, anti-dilutive shares outstanding related to options to acquire
common stock totaled 163,863, 249,215 and 488,423, respectively, as the assumed proceeds from exercise price, tax
benefits and future compensation was in excess of the market value.
F-58
(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
sources of income. The following table summarizes the dividend activity for the years ended December 31, 2013 and
2012.
Declared
February 1, 2012
April 26, 2012
June 26, 2012
July 25, 2012
October 30, 2012
November 30, 2012
January 30, 2013
April 24, 2013
July 23, 2013
October 23, 2013
Cash
Dividend per
Share
Record Date
Paid Date
$0.06
$0.08
$0.20
$0.08
$0.08
$0.30
$0.08
$0.08
$0.18
$0.08
February 24, 2012
May 24, 2012
July 24, 2012
August 24, 2012
February 10, 2012
May 10, 2012
July 10, 2012
August 14, 2012
November 9, 2012 November 21, 2012
November 26, 2012 December 6, 2012
February 22, 2013
May 24, 2013
August 15, 2013
February 8, 2013
May 10, 2013
August 6, 2013
November 5, 2013 November 15, 2013
The FDIC and the Washington DFI have the authority under their supervisory powers to prohibit the payment of
dividends by Heritage Bank to the Company. Additionally, current guidance from the Federal Reserve Board 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 its subsidiary
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 Board and the FDIC.
(c) Stock Repurchase Program
The Company has had various stock repurchase programs since March 1999. On August 30, 2012, the Board of
Directors approved the Company’s tenth stock repurchase plan, authorizing the repurchase of up to 5% of the
Company’s outstanding shares of common stock, or approximately 757,000 shares. On August 30, 2011, the Board of
Directors approved the Company's ninth stock repurchase plan, authorizing the repurchase of up to 5% of the
Company's outstanding share of common stock, or approximately 782,000 shares over a period of twelve months.
The following table provides total repurchased shares and average share prices under the applicable Plans and
years:
Years Ended December 31,
2013
2012
Plan Total
Ninth Plan
Repurchased shares ...................................................
Stock repurchase average share price........................
—
$0
389,627
$13.45
590,832
$12.83
Tenth Plan
Repurchased shares ...................................................
Stock repurchase average share price........................
544,000
$15.88
52,900
$13.88
596,900
$15.70
During the years ended December 31, 2013 and 2012, the Company repurchased 13,138 and 3,419 shares at an
average price of $14.29 and $14.08 to pay withholding taxes on restricted stock that vested during the years ended
December 31, 2013 and 2012, respectively.
F-59
(d) Preferred Stock and Warrant
On November 21, 2008, the Company completed a sale to the U.S. Department of the Treasury (“Treasury”) of
24,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“preferred shares”), for
an aggregate purchase price of $24.0 million in cash, with a related warrant to purchase 276,074 shares of the
Company’s common stock. On December 22, 2010, the Company redeemed the 24,000 preferred shares. The
Company paid the Treasury a total of $24.1 million, consisting of $24.0 million of principal and $123,000 of accrued
and unpaid dividends.
Under the terms of the warrant, and because the Company’s September 2009 common stock issuance was a
“qualified equity offering” resulting in aggregate gross proceeds of at least $24.0 million, the number of shares of the
Company’s common stock underlying the warrant was reduced by 50% to 138,037 shares. On August 17, 2011, the
Company repurchased the warrant from the Treasury for $450,000. The warrant repurchase, together with the
Company’s earlier redemption of the entire amount of the preferred shares issued to the Treasury, represents full
repayment of all TARP obligations and cancellation of all equity interests in the Company held by the Treasury.
(e) Common Stock
The acquisition of Valley Community Bancshares, Inc. was effective on July 15, 2013. In conjunction with this
acquisition was the issuance of 1.53 million shares of the Company’s common stock at a fair value of $24.2 million.
(18) Accumulated Other Comprehensive (Loss) Income
The changes in accumulated other comprehensive (loss) income (“AOCI”) by component, during the years ended
December 31, 2013 and 2012 are as follows:
Year Ended December 31, 2013
Accretion
of other-
than-
temporary
impairment
on held to
maturity
securities
(1)
Changes in
fair value of
available
for sale
securities
(1)
Total
Balance of AOCI at the beginning of the year ................................................. $
Other comprehensive (loss) income before reclassification.....................
Amounts reclassified from AOCI ..............................................................
Net current period other comprehensive (loss) income....................
(In thousands)
$
2,042
(2,965)
—
(2,965)
(298) $
59
—
59
1,744
(2,906)
—
(2,906)
Balance of AOCI at the end of the year ........................................................... $
(923)
$
(239) $ (1,162)
(1) All amounts are net of tax.
F-60
Year Ended December 31, 2012
Changes in
fair value
of
available
for
sale
securities
(1)
Accretion
of other-
than-
temporary
impairment
on held to
maturity
securities
(1)
Other-than-
temporary
impairments
on
securities
held to
maturity (1)
Total
Balance of AOCI at the beginning of the year ....................................... $
Other comprehensive (loss) income before reclassification...........
Amounts reclassified from AOCI ....................................................
2,105 $
(63)
—
(In thousands)
(369) $
105
—
— $ 1,736
(34)
8
—
—
Net current period other comprehensive (loss) income ..........
(63)
105
(34)
8
Balance of AOCI at the end of the year ................................................. $
2,042 $
(264) $
(34) $ 1,744
(1) All amounts are net of tax.
(19) Regulatory Capital Requirements
The Company is a bank holding company under the supervision of the Federal Reserve Bank of San Francisco.
Bank holding companies are subject to capital adequacy requirements of the Federal Reserve Board under the Bank
Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve Board. Heritage Bank is a
federally insured institution and thereby is subject to the capital requirements established by the FDIC. The Federal
Reserve Board capital requirements generally parallel the FDIC requirements. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if
undertaken, could have a direct material effect on the Company’s consolidated financial statements and operations.
Management believes the Company and the Bank meet all capital adequacy requirements to which they are subject.
On June 19, 2013, the Company merged its two subsidiary banks, Heritage Bank and Central Valley Bank, with
Central Valley Bank being merged into Heritage Bank. Therefore, the tables below do not show the capital ratios for
Central Valley Bank at December 31, 2013.
F-61
Pursuant to minimum capital requirements of the FDIC, Heritage Bank and Central Valley Bank were required to
maintain a leverage ratio (Tier 1 capital to average assets ratio) of 4.0% and risk-based capital ratios of Tier 1 capital
and total capital (to total risk-weighted assets) of 4.0% and 8.0%, respectively. As of December 31, 2013 and
December 31, 2012, the most recent regulatory notifications categorized Heritage Bank and Central Valley Bank as
well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since
that notification that management believes have changed the Banks’ categories.
Minimum
Requirements
$
%
Well-
Capitalized
Requirements
Actual
$
%
$
%
(Dollars in thousands)
As of December 31, 2013:
The Company consolidated
Tier 1 leverage capital to average
assets .................................................
Tier 1 capital to risk-weighted assets .....
Total capital to risk-weighted assets ......
$ 65,847
47,853
95,706
4.0%
4.0
8.0
N/A
N/A
N/A
Heritage Bank
Tier 1 leverage capital to average
assets .................................................
Tier 1 capital to risk-weighted assets .....
Total capital to risk-weighted assets ......
65,831
47,807
95,613
4.0
4.0
8.0
82,288
71,710
119,517
As of December 31, 2012:
The Company consolidated
Tier 1 leverage capital to average
assets .................................................
Tier 1 capital to risk-weighted assets .....
Total capital to risk-weighted assets ......
$ 53,756
39,232
78,464
4.0%
4.0
8.0
Heritage Bank
Tier 1 leverage capital to average
assets .................................................
Tier 1 capital to risk-weighted assets .....
Total capital to risk-weighted assets ......
Central Valley Bank
Tier 1 leverage capital to average
assets .................................................
Tier 1 capital to risk-weighted assets .....
Total capital to risk-weighted assets ......
47,112
34,121
68,241
6,632
5,081
10,162
4.0
4.0
8.0
4.0
4.0
8.0
N/A
N/A
N/A
58,890
51,181
85,302
8,289
7,622
12,703
N/A
N/A
N/A
5.0
6.0
10.0
N/A
N/A
N/A
5.0
6.0
10.0
5.0
6.0
10.0
$185,951 11.3 %
185,951
201,076
15.5
16.8
182,543 11.1
15.3
182,543
16.5
197,656
$183,099 13.6 %
183,099
195,561
18.7
19.9
149,613 12.7
17.5
149,613
18.8
160,457
16,953 10.2
13.4
16,953
14.6
18,562
In July 2013, the Federal banking regulators approved a final rule to implement the revised capital adequacy
standards of the Basel Committee on Banking Supervision, commonly called Basel III, and to address relevant
provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). The final rule
strengthens the definition of regulatory capital, increases risk-based capital requirements, makes selected changes to
the calculation of risk-weighted assets, and adjusts the prompt corrective action thresholds. Community banking
organizations, such as the Company and the Bank, become subject to the new rule on January 1, 2015 and certain
provisions of the new rule will be phased in over the period of 2015 through 2019. The final rule:
• Permits banking organizations that had less than $15 billion in total consolidated assets as of December 31,
2009, or were mutual holding companies as of May 19, 2010, to include in Tier 1 capital trust preferred
securities and cumulative perpetual preferred stock that were issued and included in Tier 1 capital prior to
May 19, 2010, subject to a limit of 25% of Tier 1 capital elements, excluding any non-qualifying capital
instruments and after all regulatory capital deductions and adjustments have been applied to Tier 1 capital.
• Establishes new qualifying criteria for regulatory capital, including new limitations on the inclusion of deferred
tax assets and mortgage servicing rights.
F-62
• Requires a minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5%.
•
Increases the minimum Tier 1 capital to risk-weighted assets ratio requirement from 4% to 6%.
• Retains the minimum total capital to risk-weighted assets ratio requirement of 8%.
• Establishes a minimum leverage ratio requirement of 4%.
• Retains the existing regulatory capital framework for 1-4 family residential mortgage exposures.
• Permits banking organizations that are not subject to the advanced approaches rule, such as the Company
and the Bank, to retain, through a one-time election, the existing treatment for most accumulated other
comprehensive income, such that unrealized gains and losses on securities available for sale will not affect
regulatory capital amounts and ratios.
•
Implements a new capital conservation buffer requirement for a banking organization to maintain a common
equity capital ratio more than 2.5% above the minimum common equity Tier 1 capital, Tier 1 capital and total
risk-based capital ratios in order to avoid limitations on capital distributions, including dividend payments,
and certain discretionary bonus payments. The capital conservation buffer requirement will be phased in
beginning on January 1, 2016 at 0.625% and will be fully phased in at 2.50% by January 1, 2019. A banking
organization with a buffer of less than the required amount would be subject to increasingly stringent
limitations on such distributions and payments as the buffer approaches zero. The new rule also generally
prohibits a banking organization from making such distributions or payments during any quarter if its eligible
retained income is negative and its capital conservation buffer ratio was 2.5% or less at the end of the
previous quarter. The eligible retained income of a banking organization is defined as its net income for the
four calendar quarters preceding the current calendar quarter, based on the organization’s quarterly
regulatory reports, net of any distributions and associated tax effects not already reflected in net income.
•
Increases capital requirements for past-due loans, high volatility commercial real estate exposures, and
certain short-term commitments and securitization exposures.
• Expands the recognition of collateral and guarantors in determining risk-weighted assets.
• Removes references to credit ratings consistent with the Dodd-Frank Act and establishes due diligence
requirements for securitization exposures.
The Company’s management is currently evaluating the provisions of the final rule and their expected impact on
the Company.
(20) Commitments and Contingencies
(a) Lease Commitments
The Bank leases premises and equipment under operating leases. Rental expense of leased premises and
equipment was $2.3 million, $1.9 million, and $1.7 million for the years ended December 31, 2013, 2012 and 2011,
respectively, which is included in occupancy and equipment expense.
The estimated future minimum annual rental commitments under noncancelable leases having an original or
remaining term of more than one year are as follows:
Years Ending December 31,
(In thousands)
2014 ...........................................................
2015 ...........................................................
2016 ...........................................................
2017 ...........................................................
2018 ...........................................................
Thereafter ..........................................................
$
$
1,755
1,768
1,590
1,384
1,138
3,951
11,586
F-63
Certain leases contain renewal options from two to ten years and escalation clauses based on increases in
property taxes and other costs.
(b) Commitments to Extend Credit
In the ordinary course of business, the Company may enter into various types of transactions that include
commitments to extend credit that are not included in the Consolidated Financial Statements. The Company applies
the same credit standards to these commitments as it uses in all its lending activities and have included these
commitments in its lending risk evaluations. The Company’s exposure to credit loss under commitments to extend
credit is represented by the amount of these commitments.
The following table presents outstanding commitments to extend credit, including letters of credit, at the dates
indicated:
December 31, 2013
December 31, 2012
(In thousands)
Commercial business:
Commercial and industrial .................................................... $
Owner-occupied commercial real estate ..............................
Non-owner occupied commercial real estate .......................
Total commercial business ............................................
One-to-four family residential .......................................................
Real estate construction and land development:
One-to-four family residential ...............................................
Five or more family residential and commercial
properties ..............................................................................
Total real estate construction and land
development ..................................................................
Consumer ....................................................................................
$
169,079
2,812
2,405
174,296
45
12,236
20,720
32,956
27,480
126,162
2,151
7,006
135,319
—
4,662
26,301
30,963
34,525
Total outstanding commitments ............................................ $
234,777
$
200,807
(c) Regulatory and Legal Proceedings
The Company is involved in numerous business transactions, which, in some cases, depend on regulatory
determination as to compliance with rules and regulations. Also, the Company has certain litigation and negotiations in
progress. All such matters are attributable to activities arising from normal operations, except the proposed merger as
mentioned below. In the opinion of management, after review with legal counsel, the eventual outcome of the
aforementioned matters, including the proposed merger, is unlikely to have a materially adverse effect on the
Company’s Consolidated Financial Statements or its financial position.
On October 23, 2013, the Company announced the signing of a merger agreement with Washington Banking
with Washington Banking merging into Heritage. Washington Banking, its directors and Heritage are named as
defendants in two lawsuits pending in the Superior Court for the State of Washington in King County, Washington,
which have been consolidated under the caption In Re Washington Banking Company Shareholder Litigation, Lead
Case No. 13-2-38689-5 SEA. The consolidated litigation generally alleges that Washington Banking’s directors
breached their fiduciary duties to Washington Banking and its shareholders by agreeing to the proposed merger at an
unfair price and without an adequate sales process, because they have interests in the merger different from
shareholders and by agreeing to deal protection provisions in the merger agreement that are alleged to prevent bids
by third parties. The consolidated litigation also alleges that the disclosures in connection with the merger are
misleading in various respects. Heritage is alleged to have aided and abetted the directors’ alleged breaches of their
fiduciary duties. The consolidated litigation seeks, among other things, an order enjoining the defendants from
consummating the proposed merger, as well as attorneys’ and experts’ fees and certain other damages.
F-64
Heritage believes that the aiding and abetting claim against it lacks merit. Washington Banking and its directors
and Heritage separately filed motions to dismiss the claims against them.
(21) Fair Value Measurements
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the
principal or most advantageous market for the asset or liability in an orderly transaction between market participants
on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1: Valuations for assets and liabilities traded in active exchange markets, or interest in open-end mutual
funds that allow the Company to sell its ownership interest back to the fund at net asset value on a daily basis.
Valuations are obtained from readily available pricing sources for market transactions involving identical assets,
liabilities, or funds.
Level 2: Valuations for assets and liabilities traded in less active dealer, or broker markets, such as quoted prices
for similar assets or liabilities, quoted prices in markets that are not active or valuations using methodologies with
observable inputs.
Level 3: Valuations for assets and liabilities that are derived from other valuation methodologies, such as option
pricing models, discounted cash flow models and similar techniques using unobservable inputs, and not based
on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions
and projections in determining the fair value assigned to such assets or liabilities.
(a) Recurring and Nonrecurring Basis
The Company used the following methods and significant assumptions to estimate fair value of certain assets on
a recurring and nonrecurring basis:
Investment Securities Available for Sale and Held to Maturity:
The fair value of all investment securities are based upon the assumptions market participants would use in
pricing the security. If available, 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). Level 2 includes U.S. Treasury, U.S. government and agency debt securities, municipal
securities, corporate securities and mortgage-backed securities and collateralized mortgage obligations-residential.
For investment securities where quoted prices or market prices of similar securities are not available, fair values are
calculated by using observable and unobservable inputs such as discounted cash flows or other market indicators
(Level 3). Security valuations are obtained from third party pricing services for comparable assets or liabilities.
Impaired Loans:
At the time a loan is considered impaired, its impairment is measured based on the present value of expected
future cash flows discounted at the loan’s effective interest rate, a loan’s observable market prices, or fair market
value of the collateral if the loan is collateral-dependent. Impaired loans for which impairment is measured using the
discounted cash flow approach are not considered to be measured at fair value because the loan’s effective interest
rate is not a fair value input, and for the purposes of fair value disclosures, the fair value of these loans are measured
commensurate with non-impaired loans. Generally, the Company utilizes the fair market value of the collateral, which
is commonly based on recent real estate appraisals, to measure impairment. 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 the independent appraisers to adjust for differences
between the comparable sales and income data available. Such adjustments are usually significant and typically
result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using
an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based
on management’s historical knowledge, changes in market conditions from the time of the valuation, and
management’s expertise and knowledge of the client and client’s business (Level 3). Impaired loans are evaluated on
a quarterly basis for additional impairment and adjusted accordingly.
F-65
Other Real Estate Owned:
Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when
acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value
less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. 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 the independent appraisers to adjust for
differences between the comparable sales and income data available. Such adjustments are usually significant and
typically result in Level 3 classification of the inputs for determining fair value.
Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified
general appraisers for commercial properties or certified residential appraisers for residential properties whose
qualifications and licenses have been reviewed and verified by the Company. Once received, the Company reviews
the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with
independent data sources such as recent market data or industry-wide statistics. On a quarterly basis, the Company
compares the actual selling price of collateral that has been liquidated to the most recent appraised value to
determine what additional adjustment should be made to the appraisal value to arrive at fair value.
The following table summarizes the balances of assets measured at fair value on a recurring basis as of
December 31, 2013 and December 31, 2012.
Investment securities available for sale:
U.S. Treasury and U.S. Government-
sponsored agencies .......................................
Municipal securities ...........................................
Mortgage backed securities and collateralized
mortgage obligations—residential:
U.S Government-sponsored
December 31, 2013
Total
Level 1
Level 2
Level 3
(In thousands)
$ 6,039
49,060
$ —
—
$ 6,039
49,060
$ —
—
agencies .................................................
108,035
—
108,035
—
Total .....................................................
$163,134
$ —
$163,134
$
—
December 31, 2012
Total
Level 1
Level 2
Level 3
(In thousands)
Investment securities available for sale:
U.S. Treasury and U.S. Government-
sponsored agencies .......................................
Municipal securities ...........................................
Mortgage backed securities and collateralized
mortgage obligations—residential:
$ 11,035
47,360
U.S Government-sponsored agencies .......
85,898
$ —
—
—
$ 11,035
47,360
85,898
$ —
—
—
Total .....................................................
$144,293
$ —
$ 144,293
$ —
There were no transfers between Level 1 and Level 2 during the years ended December 31, 2013 or 2012.
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.
F-66
The tables below represent assets measured at fair value on a nonrecurring basis at December 31, 2013 and
December 31, 2012 and the net losses (gains) recorded in earnings during the years ended December 31, 2013 and
2012.
Fair Value at December 31, 2013
Basis (1)
Total
Level 1
Level 2
Level 3
(In thousands)
Net Losses
(Gains)
Recorded in
Earnings During
the Year Ended
December 31,
2013
Impaired originated loans:
Commercial business:
Commercial and industrial ..................... $ 4,835 $ 2,944
Owner-occupied commercial real
$ — $ — $ 2,944 $
1,904
1,880
1,285
—
—
1,285
estate .................................................
Non-owner occupied commercial real
estate .................................................
4,123
3,759
—
—
3,759
Total commercial business ............. 10,838
340
One-to-four family residential .......................
Real estate construction and land
7,988
340
development:
One-to-four family residential ................
Five or more family residential and
1,585
1,374
commercial properties .......................
2,404
2,404
Total real estate construction and
land development .......................
Consumer .....................................................
3,989
38
3,778
—
Total impaired originated loans ...... 15,205
12,106
Purchased other impaired loans:
Commercial business:
Commercial and industrial .....................
Non-owner occupied commercial real
estate .................................................
Total commercial business .............
One-to-four family residential .......................
Consumer .....................................................
4,721
3,267
520
5,241
450
647
520
3,787
419
532
Total purchased other impaired
loans ...........................................
6,338
4,738
Investment securities held to maturity:
Mortgage back securities and collateralized
mortgage obligations—residential:
Private residential collateralized
mortgage obligations .........................
Other real estate owned:
Commercial properties ..................................
19
19
1,720
1,222
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
— 7,988
340
—
— 1,374
—
2,404
—
—
3,778
—
— 12,106
— 3,267
—
520
— 3,787
419
—
532
—
19
—
— 1,222
Total ................................................ $23,282 $ 18,085
$ — $
19
$ 18,066 $
—
4,738
1,526
194
(1,022 )
1,076
(32)
(276)
(357 )
(633 )
38
449
1,444
(18 )
1,426
(13)
113
38
348
2,361
(1) Basis represents the unpaid principal balance of impaired originated and purchased other impaired loans,
amortized cost of investment securities held to maturity, and carrying value at ownership date of other real estate
owned.
F-67
Fair Value at December 31, 2012
Basis (1)
Total
Level 1
Level 2
Level 3
(In thousands)
Net Losses
(Gains)
Recorded in
Earnings During
the Year Ended
December 31,
2012
Impaired originated loans:
Commercial business:
Commercial and industrial ....................... $ 6,137 $ 5,279 $ — $
Owner-occupied commercial real
estate ...................................................
1,418
909
—
— $ 5,279 $
(138)
—
909
Non-owner occupied commercial real
estate ...................................................
Total commercial business .......................
One-to-four family residential ..........................
Real estate construction and land
development:
One-to-four family residential ......................
Five or more family residential and
commercial properties ..........................
4,226
2,840
—
—
2,840
11,781
811
9,028
764
2,720
1,929
—
—
—
—
—
9,028
764
—
1,929
3,357
2,699
—
—
2,699
Total real estate construction and land
development .........................................
Consumer ........................................................
6,077
109
4,628
—
Total impaired originated loans .........
18,778
14,420
Purchased other impaired loans:
Commercial business:
Commercial and industrial .......................
Owner-occupied commercial real
estate ...................................................
Non-owner occupied commercial real
436
139
422
132
estate ...................................................
973
955
Total commercial business ...............
One-to-four family residential ..........................
Consumer ........................................................
1,548
527
163
1,509
422
6
—
—
—
—
—
—
—
—
—
—
—
4,628
—
— 14,420
1,102
—
422
—
132
—
—
—
—
955
1,509
422
6
Total purchased other impaired
loans .............................................
Investment securities held to maturity:
Mortgage back securities and collateralized
mortgage obligations — residential:
Private residential collateralized
2,238
1,937
—
—
1,937
mortgage obligations ............................
117
113
—
113
—
Other real estate owned:
Agricultural properties ..............................
Commercial properties .............................
Total other real estate owned ...........
602
2,540
3,142
450
1,941
2,391
—
—
—
—
—
450
1,941
—
2,391
438
622
922
30
(182)
223
41
109
14
7
18
39
105
152
296
78
152
499
651
Total ........................................... $ 24,275 $18,861 $
— $
113 $ 18,748 $
2,127
(1) Basis represents the unpaid principal balance of impaired originated and purchased other impaired loans,
amortized cost of investment securities held to maturity, and carrying value at ownership date of other real estate
owned.
F-68
The following table presents quantitative information about Level 3 fair value measurements for financial
instruments measured at fair value on a non-recurring basis at December 31, 2013 and December 31, 2012.
Impaired originated loans ....................
Purchased other impaired loans ..........
Other real estate owned ......................
Impaired originated loans .....................
Purchased other impaired loans .........
Other real estate owned .....................
Fair Value
Valuation
Technique(s)
December 31, 2013
Unobservable Input(s)
(Dollars in thousands)
Adjustment for differences
Range of Inputs;
Weighted
Average
12,106 Market approach
between the comparable sales
(27.8%) - 19.1%; (7.6%)
4,738 Market approach
between the comparable sales
(50.0%) - 15.0%; (26.2%)
Adjustment for differences
1,222 Market approach
between the comparable sales
(60.1)% - 13.6%; (35.2%)
Adjustment for differences
Fair Value
Valuation
Technique(s)
December 31, 2012
Unobservable Input(s)
(Dollars in thousands)
Adjustment for differences
Range of Inputs;
Weighted
Average
14,420 Market approach
between the comparable sales
(35.1)% - 22.0%; (2.0%)
1,937 Market approach
Adjustment for differences
between the comparable sales
Adjustment for differences
(5.0%) - 0.0%; (2.5%)
2,391 Market approach
between the comparable sales
(47.7%) - 5.0%; (27.6%)
$
$
$
$
$
$
(b) Fair Value of Financial Instruments
Because broadly traded markets do not exist for most of the Company’s financial instruments, the fair value
calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are
subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications;
therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and
may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses
in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates
of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value
calculations presented herein do not represent, and should not be construed to represent, the underlying value of the
Company.
F-69
The tables below present the carrying value amount of the Company’s financial instruments and their
corresponding estimated fair values at the dates indicated.
Carrying Value
Fair Value
Level 1
Level 2
Level 3
December 31, 2013
Fair Value Measurements Using:
Financial Assets:
Cash and cash equivalents .................. $ 130,400
Other interest earning deposits ............
15,662
Investment securities available
for sale ..............................................
163,134
Investment securities held to
maturity .............................................
36,154
FHLB stock ...........................................
5,741
Loans receivable, net of allowance ...... 1,203,096
Accrued interest receivable ..................
5,462
Financial Liabilities:
Deposits:
(In thousands)
$
130,400 $
15,747
130,400
—
$
— $
15,747
163,134
36,340
N/A
1,218,192
5,462
—
—
N/A
—
26
163,134
36,340
—
—
910
—
—
1,218,192
4,526
—
—
—
Noninterest deposits, NOW
accounts, money market
accounts and savings
accounts .................................... $ 1,089,759 $ 1,089,759 $ 1,089,759 $
309,430
Certificate of deposit accounts ......
311,065
—
— $
311,065
Total deposits ......................... $ 1,399,189
$ 1,400,824 $ 1,089,759
$
311,065 $
Securities sold under agreement to
repurchase ........................................ $
Accrued interest payable ......................
29,420
152
$
29,420 $
152
29,420 $
17
— $
135
Carrying Value
Fair Value
Level 1
Level 2
Level 3
December 31, 2012
Fair Value Measurements Using:
Financial Assets:
Cash and cash equivalents .................. $ 104,268
2,818
Other interest earning deposits ............
Investment securities available for
sale ...................................................
144,293
$
104,268
2,818
$
104,268
$
— $
—
2,818
144,293
—
144,293
(In thousands)
—
—
—
—
—
—
—
—
Investment securities held to
maturity .............................................
FHLB stock ...........................................
Loans held for sale ...............................
Loans receivable, net of allowance ......
Accrued interest receivable ..................
Financial Liabilities:
Deposits:
10,099
5,495
1,676
998,344
4,821
11,010
N/A
1,676
1,012,880
4,821
—
N/A
—
—
6
11,010
—
—
—
717
—
—
1,676
1,012,880
4,098
Noninterest deposits, NOW
accounts, money market
accounts and savings
accounts .................................... $ 829,044
288,927
Certificate of deposit accounts ......
$ 829,044 $
290,484
829,044
$
— $
—
290,484
Total deposits ......................... $ 1,117,971
$ 1,119,528
$
829,044
$ 290,484 $
Securities sold under agreement to
repurchase ........................................ $
Accrued interest payable ...................... $
16,021
106
$
$
16,021 $
$
106
16,021
19
$
$
— $
87 $
—
—
—
—
—
F-70
The methods and assumptions, not previously presented, used to estimate fair value are described as follows:
Cash and Cash Equivalents:
The fair value of financial instruments that are short-term or reprice frequently and that have little or no risk are
considered to have a fair value equal to carrying value (Level 1).
Other Interest Earning Deposits:
These deposits with other banks have maturities greater than three months. The fair value is calculated based
upon market prices for similar deposits (Level 2).
FHLB Stock:
FHLB of Seattle stock is not publicly traded, as such, it is not practicable to determine the fair value of FHLB
stock due to restrictions placed on its transferability.
Loans Receivable and Loans Held for Sale:
Except for impaired loans discussed previously, fair value is based on discounted cash flows using current market
rates applied to the estimated life (Level 3). While these methodologies are permitted under U.S. GAAP, they are
not based on the exit price concept of the fair value required under ASC 820-10, Fair Value Measurements and
Disclosures, and generally produces a higher value.
Accrued Interest Receivable/Payable:
The fair value of accrued interest receivable/payable balances are determined using inputs and fair value
measurements commensurate with the asset from which the accrued interest is generated. The carrying amounts
of accrued interest approximate fair value (Level 1, Level 2, and Level 3).
Deposits:
For deposits with no contractual maturity, the fair value is assumed to equal the carrying value (Level 1). The fair
value of fixed maturity deposits is based on discounted cash flows using the difference between the deposit rate
and the rates offered by the Company for deposits of similar remaining maturities (Level 2).
Securities Sold Under Agreement to Repurchase:
Securities sold under agreement to repurchase are short-term in nature, repricing on a daily basis. Fair value
financial instruments that are short-term or reprice frequently and that have little or no risk are considered to have
a fair value equal to carrying value (Level 1).
Off-Balance Sheet Financial Instruments:
The majority of our commitments to extend credit, standby letters of credit and commitments to sell mortgage
loans carry current market interest rates if converted to loans. As such, no premium or discount was ascribed to
these commitments (Level 1). They are excluded from the preceding tables.
(22) Proposed Merger
On October 23, 2013, the Company, along with the Bank, and Washington Banking Company and its wholly
owned subsidiary bank, Whidbey Island Bank jointly announced the signing of a merger agreement under which
Heritage and Washington Banking will enter into a strategic merger with Washington Banking merging into Heritage.
Immediately following the merger, Whidbey will merge into the Bank. Washington Banking branches will adopt the
Heritage Bank name in all markets, with the exception of six branches in Whidbey Island markets which will continue
to operate using the Whidbey Island Bank name. The corporate headquarters of the combined company will be in
Olympia, Washington.
Under the terms of the merger agreement, Washington Banking shareholders will receive 0.89000 shares of
Heritage common stock and $2.75 in cash for each share of Washington Banking common stock. Based on the
closing price of Heritage common stock of $16.72 on December 20, 2013, the consideration value for Washington
Banking was approximately $276.8 million in aggregate. Upon consummation, the shareholders of Washington
Banking will own approximately 46% of the combined company and the shareholders of Heritage will own
approximately 54%. As of September 30, 2013, Washington Banking had approximately $1.6 billion in total assets.
F-71
The merger agreement has been unanimously approved by the boards of directors of Heritage and Washington
Banking. The merger is subject to regulatory approvals, approval by Heritage and Washington Banking shareholders,
and certain other customary closing conditions. As of date of this Form 10-K, the Company has received approval for
the bank merger from the FDIC and the DFI and a waiver from the FRB. There can be no assurance that the
regulatory approvals received will not contain a condition or requirement that results in a failure to satisfy the
conditions to closing set forth in the merger agreement. The merger is expected to close in the first half of 2014. The
transaction is intended to qualify as a tax-free reorganization for U.S. federal income tax purposes and Washington
Banking shareholders are not expected to recognize any taxable gain or loss in connection with the share exchange
to the extent of the stock consideration received.
For further information, reference is made to the Form 8-K filed by the Company with the SEC on October 24,
2013 and the Form S-4/A filed by the Company with the SEC on February 27, 2014.
(23) Heritage Financial Corporation (Parent Company Only)
Following is the condensed financial statements of the Parent Company.
HERITAGE FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
Condensed Statements of Financial Condition
December 31, 2013
December 31, 2012
(In thousands)
ASSETS
Cash and interest earning deposits..................... $
Investment in subsidiary banks ...........................
Other assets ........................................................
$
LIABILITIES AND STOCKHOLDERS’ EQUITY
Other liabilities ..................................................... $
Total stockholders’ equity ....................................
$
2,645
212,354
1,041
216,040
278
215,762
216,040
$
$
$
$
16,251
182,404
668
199,323
385
198,938
199,323
HERITAGE FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
Condensed Statements of Income
Years Ended December 31,
2013
2012
2011
(In thousands)
$
22
—
44 $
8
95
20
26,000
(13,001 )
13,021
1,718
2,905
4,623
8,398
(1,177)
9,575
$
14,100
6,000
962
15,114
—
2,766
2,766
12,348
(913)
13,261 $
2,169
8,284
—
2,501
2,501
5,783
(735)
6,518
Interest income:
Interest earning deposits ........................................... $
ESOP loan ..........................................................
Other income:
Dividends from subsidiary banks .......................
Equity in undistributed income of subsidiary
banks ..............................................................
Total income ................................................
Noninterest expense:
Professional services .................................................
Other expense ...........................................................
Total noninterest expense ...........................
Income before income taxes.......................
Benefit for income taxes ............................................
Net income ......................................................... $
F-72
HERITAGE FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
Condensed Statements of Cash Flows
Years Ended December 31,
2013
2012
2011
(In thousands)
9,575
$
13,261
$
6,518
13,001
(962)
(2,169 )
13
1,223
71
(489)
23,394
—
(21,666)
(21,666)
(6,672)
176
(13)
(8,825)
—
(15,334)
(13,606)
16,251
2,645
$
93
1,185
106
7
13,690
161
—
161
(12,155)
129
(93)
(6,023)
—
(18,142)
(4,291)
20,542
16,251
$
4
855
165
(250)
5,123
136
—
136
(5,910)
50
(4 )
(2,342)
(450)
(8,656)
(3,397)
23,939
20,542
Cash flows from operating activities:
Net income......................................................................................... $
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in excess distributed (undistributed) income of
subsidiary bank .......................................................................
Tax provision realized from stock options exercised, share-
based payment and dividends on unallocated ESOP
shares .....................................................................................
Recognition of compensation related to ESOP shares and
share based payment .............................................................
Stock option compensation expense .........................................
Net change in other assets and liabilities...................................
Net cash provided by operating activities ...........................
Cash flows from investing activities:
ESOP loan principal repayments.......................................................
Investment in subsidiary ....................................................................
Net cash (used in) provided by investing activities .............
Cash flows from financing activities:
Common stock cash dividends paid ..................................................
Proceeds from exercise of stock options ...........................................
Tax provision realized from stock options exercised, share-based
payment and dividends on unallocated ESOP shares ..................
Repurchase of common stock ...........................................................
Repurchase of common stock warrant ..............................................
Net cash used in financing activities ...................................
Net decrease in cash and cash equivalents .......................
Cash and cash equivalents at beginning of year......................................
Cash and cash equivalents at end of year ............................................... $
F-73
(24) Selected Quarterly Financial Data (Unaudited)
Results of operations on a quarterly basis were as follows:
Year Ended December 31, 2013
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
(Dollars in thousands, except per share amounts)
Interest income ......................................................... $
Interest expense .......................................................
Net interest income ............................................
Provision for loan losses ..........................................
Net interest income after provision for loan
losses ............................................................
Noninterest income ..................................................
Noninterest expense ................................................
Income before provision for income taxes ........
Income tax expense .................................................
Net income ........................................................ $
Basic earnings per common share ........................... $
Diluted earnings per common share ........................
Cash dividends declared on common stock ............ $
17,484
946
16,538
858
15,680
2,282
13,719
4,243
1,358
2,885
0.19
0.19
0.08
$
$
$
$
16,859
919
15,940
1,308
14,632
2,357
13,007
3,982
1,292
2,690
0.18
0.18
0.08
$
18,533 $
952
17,581
1,078
16,503
2,582
14,285
4,800
1,510
$
$
$
3,290 $
0.20 $
0.20
0.18 $
18,552
907
17,645
428
17,217
2,430
18,504
1,143
433
710
0.04
0.04
0.08
Year Ended December 31, 2012
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
Interest income ......................................................... $
Interest expense .......................................................
(Dollars in thousands, except per share amounts)
17,989
1,295
17,031 $
1,076
17,389
1,179
$
$
16,700
984
Net interest income ...........................................
Provision for loan losses ..........................................
16,694
(109)
Net interest income after provision for loan
losses ............................................................
Noninterest income ..................................................
Noninterest expense ................................................
Income before provision for income taxes ........
Income tax expense .................................................
Net income ........................................................ $
Basic earnings per common share ........................... $
Diluted earnings per common share ........................
Cash dividends declared on common stock ............ $
16,803
1,908
12,598
6,113
1,943
4,170
0.27
0.27
0.06
$
$
$
16,210
619
15,591
2,064
12,870
4,785
1,591
3,194
0.21
0.21
0.28
15,955
807
15,716
699
15,148
1,527
12,503
15,017
1,773
12,421
4,172
1,309
2,863 $
0.19 $
0.19
0.08 $
$
$
$
4,369
1,335
3,034
0.20
0.20
0.38
F-74
Board oF directorS
anthony B. pickering
Chairman of the Board, former Owner of
max dale’s restaurant and Stanwood Grill
Brian S. charneski
vice Chairman of the Board,
president, l&e Bottling Company
rhoda l. altom
president and managing member, milestone
properties and milestone managers
david H. Brown
retired CeO of valley Community Bancshares, inc.
gary B. christensen
president, Chief executive Officer and Chairman
of powell-Christensen, inc.; Chief executive
Officer and Chairman, midvalley Chrysler, Jeep,
dodge inc.
John a. clees
Attorney, Worth law Group
mark d. crawford
vice president of Smokey point Concrete/Skagit
ready mix
Kimberly t. ellwanger
retired Senior director of Corporate Affairs and
Associate General Counsel, microsoft Corporation
deborah J. gavin
retired vice president of finance and Controller of
the Boeing Company
Jay t. lien
Owner/president, Saratoga passage llC
Jeffrey S. lyon, ccim, Sior
Chairman and Chief executive Officer,
Kidder mathews
gragg e. miller
principal managing Broker of
Coldwell Banker Bain
robert t. Severns
retired president, Chicago title Company,
island division
Brian l. Vance
president and Chief executive Officer,
heritage financial Corporation
ann Watson
Chief financial Officer, moss Adams, llp
Heritage Financial
corporation
Brian l. Vance
president and Chief executive Officer
Jeffrey J. deuel
executive vice president
edward eng
executive vice president and
Chief Administrative Officer
donald J. Hinson
executive vice president,
Chief financial Officer
Bryan mcdonald
executive vice president and
Chief lending Officer
david a. Spurling
executive vice president and
Chief Credit Officer
cindy m. Huntley
Senior vice president,
retail Banking division
Kaylene m. lahn
Senior vice president,
Corporate Secretary
Heritage BanK
oFFicerS
Brian l. Vance
Chief executive Officer
Jeffrey J. deuel
president, Chief Operating Officer
edward eng
executive vice president and
Chief Administrative Officer
donald J. Hinson
executive vice president,
Chief financial Officer
Bryan mcdonald
executive vice president and
Chief lending Officer
gregory d. patjens
executive vice president,
Commercial Group manager
david a. Spurling
executive vice president,
Chief Credit Officer
Brett l. Bryant
Senior vice president,
market executive
lynn garrison
Senior vice president,
human resources director
cindy m. Huntley
Senior vice president,
retail Banking division
darin Johnson
Senior vice president, Controller
Kaylene m. lahn
Senior vice president,
Corporate Secretary
Sabrina c. robison
Senior vice president,
human resources manager
Joe Saletto
Senior vice president, it/iS director
lisa a. Welander
Senior vice president,
director of Bank Operations
SHareHolder inFormation
tranSFer agent
the annual meeting will be held
July 24, 2014, at 10:30 a.m. at the doubletree
by hilton, 415 Capitol Way n, Olympia, WA.
All shareholders are invited to attend.
Computershare
250 royall Street
Canton, mA 02021
phone: 800.962.4284
Corporate Website:
www.computershare.com
Heritage Bank
Olympia Main Office
201 5th ave. SW
Olympia, Wa 98501
Allenmore
1722 S Union ave.
tacoma, Wa 98405
Anacortes
2202 Commercial ave.
anacortes, Wa 98221
Auburn North
1001 D St. ne
auburn, Wa 98002
Auburn South
4220 a St. Se, Suite 109
auburn, Wa 98002
Bakerview Road–Bellingham
2504 e Bakerview rd.
Bellingham, Wa 98226
Bellevue
520 112th ave. ne, Suite 160
Bellevue, Wa 98004
Bellingham
265 York St.
Bellingham, Wa 98225
Bothell
20611 Bothell-everett Hwy.
Bothell, Wa 98012
Burlington
1800 S Burlington Blvd.
Burlington, Wa 98233
Camano Island
165 e Mcelroy Dr.
Camano island, Wa 98282
Canyon Road
12803 Canyon rd. e
Puyallup, Wa 98373
Downtown Puyallup
209 S Meridian
Puyallup, Wa 98371
Downtown Tacoma
1119 Pacific ave.
tacoma, Wa 98402
Everett
5615 evergreen Way
everett, Wa 98203
Fairhaven–Bellingham
1318 12th St.
Bellingham, Wa 98225
Federal Way
32303 Pacific Hwy. S
Federal Way, Wa 98003
Friday Harbor
535 Market St.
Friday Harbor, Wa 98250
Northwest Avenue–Bellingham
920 W Bakerview rd.
Bellingham, Wa 98226
Woodinville
13930 ne Mill Place, Suite 112
Woodinville, Wa 98072
Gig Harbor
5119 Olympic Dr. nW
gig Harbor, Wa 98335
Indian Summer
5800 rainier Lp. Se
Lacey, Wa 98513
Issaquah
1250 nW Mall St.
issaquah, Wa 98027
Kelso
1000 S 13th St.
kelso, Wa 98626
Kent
415 W James St.
kent, Wa 98032
Lacey
4400 Pacific ave. Se
Lacey, Wa 98503
Lake Stevens
629 Sr 9 ne
Lake Stevens, Wa 98258
Lakewood
10318 gravelly Lake Dr. SW
Lakewood, Wa 98499
Longview
927 Commerce ave.
Longview, Wa 98632
Lynnwood
19510 58th ave. W
Lynnwood, Wa 98087
Lynnwood Financial Center
14807 Hwy. 99
Lynnwood, Wa 98087
Marysville
1031 State ave.
Marysville, Wa 98270
Mill Creek
1504 132nd St. Se
Mill Creek, Wa 98012
Mount Vernon
1700 Urban ave.
Mount Vernon, Wa 98273
Mukilteo
11832 Mukilteo Speedway
Mukilteo, Wa 98275
North Seattle
20333 Ballinger Way ne
Seattle, Wa 98155
Portland
1001 SW 5th ave.
Portland, Or 97204
Puyallup East Main
1307 east Main ave.
Puyallup, Wa 98372
Puyallup South Hill
4627 S Meridian
Puyallup, Wa 98373
Richmond Beach–Shoreline
18840 8th ave. nW
Shoreline, Wa 98177
Seattle
1505 Westlake ave. n, Suite 125
Seattle, Wa 98109
Seattle Hill–Everett
5006 132nd St. Se, Bldg. B
everett, Wa 98208
Sedro–Woolley
339 Ferry St.
Sedro-Woolley, Wa 98284
Shelton
301 e Wallace kneeland Blvd.,
Suite 115
Shelton, Wa 98584
Smokey Point–Arlington
4220 172nd St. ne
arlington, Wa 98223
Spanaway
15211 Pacific ave. S
tacoma, Wa 98444
Stanwood
26317 72nd ave. nW
Stanwood, Wa 98292
Sumner
1005 Wood ave.
Sumner, Wa 98390
Tumwater
850 trosper rd. SW
tumwater, Wa 98512
Vancouver
700 Washington St., Suite 106
Vancouver, Wa 98660
Vancouver East
16400 Se 18th St.
Vancouver, Wa 98683
West Olympia
900 Cooper Point rd. SW
Olympia, Wa 98502
56th & South Tacoma Way
5448 South tacoma Way
tacoma, Wa 98409
80th & Pacific
8002 Pacific ave.
tacoma, Wa 98408
88th & South Tacoma Way
8801 South tacoma Way
Lakewood, Wa 98499
CentraL VaLLeY Bank
a DiViSiOn OF Heritage Bank
Downtown Yakima
301 W Yakima ave.
Yakima, Wa 98907
Ellensburg
100 n Main St.
ellensburg, Wa 98926
Nob Hill
3919 W nob Hill Blvd.
Yakima, Wa 98902
Toppenish
537 West 2nd ave.
toppenish, Wa 98948
Union Gap
2205 S First St.
Yakima, Wa 98903
Wapato
507 West 1st St.
Wapato, Wa 98951
WHiDBeY iSLanD Bank
a DiViSiOn OF Heritage Bank
Clinton
8786 Sr 525
Clinton, Wa 98236
Coupeville
401 n Main
Coupeville, Wa 98239
Freeland
5590 S Harbor ave.
Freeland, Wa 98249
Langley
105 1st St., Suite 101
Langley, Wa 98260
Midway–Oak Harbor
675 ne Midway Blvd.
Oak Harbor, Wa 98277
Oak Harbor
450 SW Bayshore Dr.
Oak Harbor, Wa 98277
Heritage Financial corporation
201 5th Avenue SW
OlympiA, WA 98501
360.943.1500 | 800.455.6126
nASdAq: hfWA | www.HF -wA.com