2019
ANNUAL
REPORT
March 19, 2020
Dear Fellow Shareholders:
2019 was a year of leadership transition for Heritage. After 25 years with the bank, including the
previous 13 as CEO, Mr. Vance retired on July 1, 2019. At that time, Mr. Deuel was appointed
President and CEO while Mr. Vance assumed the Executive Chairman position. As a result of
advanced planning and focus, the leadership change proved seamless.
Heritage continued to make positive progress in 2019, even as the industry was challenged by
the interest rate environment, regulatory demands and technology advancements. Our progress
was demonstrated by a diluted earnings per share increase of $0.34 from the prior year-end,
or $1.83 for the year ended December 31, 2019. Additionally, while our stock closed at $28.30
on December 31, 2019, resulting in a three-year total shareholder return of 18%, we declared
dividends of $0.84 in 2019, representing an increase of 17% from the $0.72 declared in 2018. This
was followed in first quarter 2020 by a regular dividend of $0.20 per common share, an increase of
5% from the prior quarter dividend of $0.19.
We remained focused on our growth strategies with several key initiatives. These included an
emphasis on driving new loan mix and core deposit growth, evolving our online and mobile
technology, improving the management of data and systems and a continued focus on enhancing
the operating leverage of the company, all while maintaining excellent credit quality and solid
balance sheet management.
Everyone at Heritage recognizes that our services and capital play a crucial role in the vibrant
economy by providing fuel for prosperity and positively impacting our communities, customers
and shareholders. That spirit is proven with our commitment to fulfill our mission of being the
leading commercial community bank in the Pacific Northwest by continuously improving customer
satisfaction, employee empowerment, community investment and shareholder value.
Our board, our leadership team and our employees continue to demonstrate a collaborative
corporate culture, defined by our traditions, our combined heritage, our focus on integrity and
continual improvement and, ultimately, by our desire to serve our customers and communities in
the pursuit of positive outcomes.
We thank you for your investment and confidence in Heritage. We are dedicated to growing
the company in an environment that requires quick response and adaptation, while remaining
diligently focused on executing on our long-term strategies.
Sincerely,
Brian L. Vance
Executive Chairman
Jeffrey J. Deuel
President & Chief Executive Officer
Brian L. Vance
Jeffrey J. Deuel
2019
FORM 10–K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019 or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 000-29480
HERITAGE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Washington
(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
Trading Symbol
HFWA
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
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes
No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes
No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was
required to submit such files). Yes
No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting
company, or an emerging growth company. See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company,"
and "emerging growth company" in Rule 12b-2 of the Exchange Act
Large accelerated filer
Non-accelerated filer
Accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying
with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
No
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2019, based on
the closing price of its common stock on such date, on the NASDAQ Global Select Market, of $29.54 per share, and 36,332,780 shares
held by non-affiliates was $1,073,270,321. The registrant had 36,483,089 shares of common stock outstanding as of February 18, 2020.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 2020 Annual Meeting of Shareholders are incorporated by reference into Part III
of this Annual Report on Form 10-K where indicated. The 2020 Proxy Statement will be filed with the U.S. Securities and Exchange
Commission within 120 days after the end of the fiscal year to which this report relates.
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
FORM 10-K
December 31, 2019
TABLE OF CONTENTS
GLOSSARY OF ACRONYMS, ABBREVIATIONS AND TERMS
FORWARD LOOKING STATEMENTS
PART I
ITEM 1.
BUSINESS
ITEM 1A. RISK FACTORS
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2.
PROPERTIES
ITEM 3.
LEGAL PROCEEDINGS
ITEM 4. MINE SAFETY DISCLOSURES
PART II
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
ITEM 6.
SELECTED FINANCIAL DATA
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
CRITICAL ACCOUNTING POLICIES
CONSOLIDATED FINANCIAL CONDITION OVERVIEW
INVESTMENT ACTIVITIES OVERVIEW
LENDING ACTIVITIES OVERVIEW
DEPOSITS AND OTHER BORROWINGS OVERVIEW
STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL REQUIREMENTS OVERVIEW
AVERAGE BALANCES, YIELDS AND RATES PAID FOR THE YEARS ENDED DECEMBER 31,
2019, 2018 AND 2017
EARNINGS SUMMARY
NET INTEREST INCOME OVERVIEW
PROVISION FOR LOAN LOSSES OVERVIEW
NONINTEREST INCOME OVERVIEW
NONINTEREST EXPENSE OVERVIEW
INCOME TAX EXPENSE OVERVIEW
RECONCILIATIONS OF NON-GAAP MEASURES
LIQUIDITY AND CAPITAL RESOURCES
ASSET AND LIABILITY MANAGEMENT
IMPACT OF INFLATION AND CHNAGING PRICES
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION—DECEMBER 31, 2019 AND
DECEMBER 31, 2018
CONSOLIDATED STATEMENTS OF INCOME—FOR THE YEARS ENDED DECEMBER 31, 2019,
2018 AND 2017
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME—FOR THE YEARS ENDED
DECEMBER 31, 2019, 2018 AND 2017
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY—FOR THE YEARS ENDED
DECEMBER 31, 2019, 2018 AND 2017
2
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CONSOLIDATED STATEMENTS OF CASH FLOWS—FOR THE YEARS ENDED DECEMBER 31,
2019, 2018 AND 2017
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1.
DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, SIGNIFICANT ACCOUNTING
POLICIES AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
NOTE 2. BUSINESS COMBINATIONS
NOTE 3.
INVESTMENT SECURITIES
NOTE 4.
LOANS RECEIVABLE
NOTE 5. ALLOWANCE FOR LOAN LOSSES
NOTE 6. OTHER REAL ESTATE OWNED
NOTE 7. PREMISE AND EQUIPMENT
NOTE 8. GOODWILL AND OTHER INTANGIBLE ASSETS
NOTE 9. DEPOSITS
NOTE 10. JUNIOR SUBORDINATED DEBENTURES
NOTE 11. SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE
NOTE 12. OTHER BORROWINGS
NOTE 13. LEASES
NOTE 14. EMPLOYEE BENEFITS
NOTE 15. COMMITMENTS AND CONTINGENCIES
NOTE 16. DERIVATIVE FINANCIAL INSTRUMENTS
NOTE 17. STOCKHOLDERS’ EQUITY
NOTE 18. ACCUMULATED OTHER COMPREHENSIVE LOSS
NOTE 19. FAIR VALUE MEASUREMENTS
NOTE 20. STOCK-BASED COMPENSATION
NOTE 21. CASH REQUIREMENT
NOTE 22.
INCOME TAXES
NOTE 23. REGULATORY CAPITAL REQUIREMENTS
NOTE 24. HERITAGE FINANCIAL CORPORATION (PARENT COMPANY ONLY)
NOTE 25. SELECTED QUARTERLY FINANCIAL DATA
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9B. OTHER INFORMATION
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
ITEM 16. FORM 10-K SUMMARY
SIGNATURES
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GLOSSARY OF ACRONYMS, ABBREVIATIONS, AND TERMS
The acronyms, abbreviations, and terms listed below are used in various sections of this Annual Report on
Form 10-K. As used throughout this report, the terms “we”, “our”, or “us” refer to Heritage Financial Corporation and
its consolidated subsidiaries, unless the context otherwise requires.
ALL
Form 10-K
AOCI
ASC
ASU
Bank
Basel III
BOLI
CDI
CECL
CEO
CFO
CET1
Company
DFI
Allowance for Loan Losses
Company's Annual Report on Form 10-K
Accumulated other comprehensive income (loss), net
Accounting Standards Codification
Accounting Standards Update
Heritage Bank
A comprehensive capital framework and rules for U.S. banking organizations
approved by the Federal Reserve Board and the FDIC in 2013
Bank owned life insurance
Core Deposit Intangible
Current Expected Credit Loss Model
Chief Executive Officer
Chief Financial Officer
Common equity tier 1
Heritage Financial Corporation
Division of Banks of the Washington State Department of Financial Institutions
Dodd Frank Act
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
Economic Growth Act
Economic Growth, Regulatory Relief and Consumer Protection Act
Equity Plan
Exchange Act
FASB
FDIC
Heritage Financial Corporation 2014 Omnibus Equity Plan
Securities Exchange Act of 1934, as amended
Financial Accounting Standards Board
Federal Deposit Insurance Corporation
Federal Reserve
Board of Governors of the Federal Reserve System
Federal Reserve Bank
Federal Reserve Bank of San Francisco
FHLB
GAAP
Heritage
LIBOR
LIHTC
NMTC
OAEM
OCC
PCI
Plan
Premier Merger
PRSU
Puget Sound Merger
Federal Home Loan Bank of Des Moines
U.S. Generally Accepted Accounting Principles
Heritage Financial Corporation
London Interbank Offering Rate
Low-Income Housing Tax Credit partnerships
New Market Tax Credits
Other Assets Especially Mentioned
Office of the Comptroller of the Currency
Purchased Credit Impaired; loans purchased with evidence of credit
deterioration since origination for which it is probable that not all contractually
required payments will be collected; accounted for under FASB ASC 310-30
Heritage Financial Corporation 401(k) Profit Sharing Plan and Trust
Merger with Premier Commercial Bancorp & Premier Community Bank
completed July 2, 2018
Performance-based stock-settled restricted stock unit awards
Merger with Puget Sound Bancorp, Inc. & Puget Sound Bank completed
January 16, 2018
Premier and Puget Mergers
Premier Merger and Puget Sound Mergers, collectively
Proxy Statement
Definitive proxy statement for the annual meeting of shareholders to be held on
May 4, 2020
4
Related Party
Certain directors, executive officers and their affiliates
ROU
RSU
SBA
SEC
SOFR
Right-of-Use
Restricted stock unit awards
Small Business Administration
Securities and Exchange Commission
Secured Overnight Financing Rate
Sarbanes-Oxley Act
Sarbanes-Oxley Act of 2002
Tax Act
USDA
TDR
Comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs
Act enacted on December 22, 2017
United States Department of Agriculture
Troubled Debt Restructured
Washington Banking Merger
Merger with Washington Banking Company & Whidbey Island Bank completed
on May 1, 2014
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
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 but not limited to:
•
the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-
offs and changes in our allowance for loan losses and provision for loan losses that may be effected by
deterioration in the housing and commercial real estate markets, which may lead to increased losses and
nonperforming assets in our loan portfolio, and may result in our allowance for loan losses no longer 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 bank regulators, including the possibility that any such regulatory authority
may, among other things, initiate an enforcement action against the Company or our bank subsidiary which
could require us to increase our allowance for loan losses, write-down assets, change our regulatory capital
position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements
on us, any of which could affect our ability to continue our growth through mergers, acquisitions or similar
transactions and adversely affect our liquidity and earnings;
legislative or regulatory changes that adversely affect our business
implementing regulations, changes in regulatory policies and principles, or the interpretation of regulatory
capital or other rules;
our ability to control operating costs and expenses;
increases in premiums for deposit insurance;
the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect
and result in significant declines in valuation;
difficulties in reducing risk associated with the loans on our Consolidated Statements of Financial Condition;
staffing fluctuations in response to product demand or the implementation of corporate strategies that affect
our workforce and potential associated charges;
disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information
technology systems or on the third-party vendors who perform several of our critical processing functions;
our ability to retain key members of our senior management team;
costs and effects of litigation, including settlements and judgments;
our ability to implement our growth strategies;
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
5
•
•
•
•
•
•
•
•
our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel
we may acquire into our operations and our ability to realize related revenue synergies and cost savings within
expected time frames or at all, and any goodwill charges related thereto and costs or difficulties relating to
integration matters, including but not limited to customer and employee retention, which might be greater than
expected;
increased competitive pressures among financial service companies;
changes in consumer spending, borrowing and savings habits;
the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
adverse changes in the securities markets;
inability of key third-party providers to perform their obligations to us;
changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies
or the FASB, including additional guidance and interpretation on accounting issues and details of the
implementation of new accounting methods including the adoption of CECL on January 1, 2020 as required
by the FASB ASU 2016-13; and
other economic, competitive, governmental, regulatory, and technological factors affecting our operations,
pricing, products and services and the other risks detailed from time to time in our filings with the SEC including
in this Form 10-K.
Some of these and other factors are discussed in this Form 10-K under the caption Item 1A. Risk Factors and
elsewhere in this Form 10-K.
The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover,
you should treat these statements as speaking only as of the date they are made and based only on information then
actually known to the Company. The Company does not undertake and specifically disclaims any obligation to revise
any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after
the date of such statements. These risks could cause our actual results for future periods to differ materially from those
expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company's operating
results and stock price performance.
ITEM 1.
BUSINESS
General
PART I
Heritage Financial Corporation is a bank holding company that was incorporated in the State of Washington
in August 1997. We are primarily engaged in the business of planning, directing, and coordinating the business activities
of our wholly owned subsidiary, Heritage Bank. The deposits of the Bank are insured by the FDIC.
Heritage Bank is headquartered in Olympia, Washington and conducts business from its 62 branch offices
located primarily along the I-5 corridor in the western Washington and the greater Portland, Oregon area. We additionally
have offices located in central Washington, primarily in Yakima County.
Our business consists primarily of commercial lending and deposit relationships with small and medium sized
businesses and their owners in our market areas and attracting deposits from the general public. We also make real
estate construction and land development loans and consumer loans. The Bank also originates for sale or investment
purposes one-to-four family residential loans on residential properties located primarily in our market.
Business Strategy
Our business strategy is to be a commercial community bank, seeking deposits from our communities and
making loans to customers with local ties to our markets. We believe we have an innovative team providing financial
services and focusing on the success of our customers. We are committed to being the leading commercial community
bank in the Pacific Northwest by continuously improving customer satisfaction, employee empowerment, community
investment and shareholder value. Our commitment defines our relationships, sets expectations for our actions and
directs decision-making in these four fundamental areas. We will seek to achieve our business goals through the
following strategies:
Expand geographically as opportunities present themselves. We are committed to continuing the controlled
expansion of our franchise through strategic acquisitions designed to increase our market share and enhance franchise
value. We believe that consolidation across the community bank landscape will continue to take place and further
believe that, with our capital and liquidity positions, our approach to credit management, and our extensive acquisition
experience, we are well-positioned to take advantage of acquisitions or other business opportunities in our market
areas. In markets where we wish to enter or expand our business, we will also consider opening de novo branches.
6
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 has moderate risk while
at the same time allowing us to achieve our lending objectives. We will continue to focus on loan types and markets
that we know well and where we have a historical record of success. We focus on loan relationships that are well-
diversified in both size and industry types. With respect to commercial business lending, which is our predominant
lending activity, we view ourselves as cash-flow lenders obtaining additional support from realistic collateral values,
personal guarantees and other secondary sources of repayment. We have a problem loan resolution process that is
focused on quick detection and implementing feasible solutions. We seek to maintain strong internal controls and
subject our loans to periodic and independently managed internal loan reviews.
Maintain a Strong Balance Sheet. In addition to our focus on underwriting, we believe that the strength of
our balance sheet provides us with the flexibility to manage through a variety of scenarios including additional growth-
related activities. Our liquidity position was also strong, with $228.6 million in cash and cash equivalents as of
December 31, 2019. As of December 31, 2019, the regulatory capital ratios of our subsidiary bank were well in excess
of the levels required for “well-capitalized” status, and our consolidated common equity tier 1 capital to risk-weighted
assets, leverage capital, Tier 1 risk-based capital, and total risk-based capital ratios were 11.5%, 10.6%, 12.0%, and
12.8%, 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, 2019, our non-maturity deposits
were 88.6% of our total deposits. Our technology-based products, including online personal financial management,
business cash management and business remote deposit products enable us to compete effectively with banks of all
sizes. Our retail and commercial management teams are well-seasoned and have strong ties to the communities we
serve with a strong focus on relationship building and customer service.
Emphasize business relationships with a focus on commercial lending. We will continue to market primarily
commercial business loans and the deposit balances that accompany these relationships. Our seasoned lending staff
has extensive knowledge and can add value through a focused advisory role that we believe strengthens our customer
relationships and develops loyalty. We currently have and will seek to maintain a diversified portfolio of lending
relationships without significant concentrations in any industry.
Recruit and retain highly competent personnel to execute our strategies. Our compensation and staff
development programs are aligned with our strategies to grow our loans and core deposits (which we define to include
all deposits except certificates of deposit) 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.
History
The Bank was established in 1927 as a federally-charted mutual savings bank. In 1992, the Bank converted
to a state-charted mutual savings bank under the name Heritage Savings Bank. Through the mutual holding company
reorganization of the Bank and the subsequent conversion of the mutual holding company, the Bank became a stock
savings bank and a wholly-owned subsidiary of the Company effective August 1997. Effective September 1, 2004,
Heritage Savings Bank switched its charter from a state-chartered savings bank to a state-chartered commercial bank
and changed its legal name from Heritage Savings Bank to Heritage Bank.
The Company acquired North Pacific Bancorporation in June 1998 and Washington Independent Bancshares
and its wholly-owned subsidiary, Central Valley Bank, in March 1999. In June 2006, the Company completed the
acquisition of Western Washington Bancorp and its wholly owned subsidiary, Washington State Bank, N.A., at which
time Washington State Bank, N.A. was merged into Heritage Bank.
Effective July 30, 2010, Heritage Bank entered into a definitive agreement with the FDIC, pursuant to which
Heritage Bank acquired certain assets and assumed certain liabilities of Cowlitz Bank, a Washington state-chartered
7
commercial bank headquartered in Longview, Washington. The acquisition included nine branches of Cowlitz Bank,
including its division Bay Bank, which opened as branches of Heritage Bank on August 2, 2010. The acquisition also
included the Trust Services Division of Cowlitz Bank.
Effective November 5, 2010, Heritage Bank entered into a definitive agreement with the FDIC, pursuant to
which Heritage Bank acquired certain assets and assumed certain liabilities of Pierce Commercial Bank, a Washington
state-chartered commercial bank headquartered in Tacoma, Washington. The acquisition included one branch, which
opened as a branch of Heritage Bank on November 8, 2010.
On September 14, 2012, the Company announced that it had entered into a definitive agreement along with
Heritage Bank, to acquire Northwest Commercial Bank, a full-service commercial bank headquartered in Lakewood,
Washington that operated two branch locations in Washington State. The acquisition was completed on January 9,
2013, at which time Northwest Commercial Bank was merged with and into Heritage Bank.
On March 11, 2013, the Company entered into a definitive agreement to acquire Valley Community Bancshares,
Inc. and its wholly-owned subsidiary, Valley Bank, both headquartered in Puyallup, Washington, and its eight branches.
The acquisition was completed on July 15, 2013.
On April 8, 2013, the Company announced its intent to merge two of its wholly-owned bank subsidiaries,
Central Valley Bank and Heritage Bank, with Central Valley Bank merging into Heritage Bank. The common control
merger was completed on June 19, 2013. Central Valley Bank operated as a division of Heritage Bank until September
2018 at which time the five Central Valley Bank branches were renamed to Heritage Bank branches.
On October 23, 2013, the Company, the Bank, Washington Banking Company and its wholly-owned subsidiary
bank, Whidbey Island Bank, jointly announced the signing of a definitive merger agreement pursuant to which Heritage
and Washington Banking Company entered into a strategic merger with Washington Banking Company merging into
Heritage. Washington Banking Company branches adopted the Heritage Bank name in all markets, with the exception
of six branches in Whidbey Island markets which continue to operate using the Whidbey Island Bank name, as a
division of Heritage Bank. The Washington Banking Merger was completed on May 1, 2014.
On July 26, 2017, the Company announced the execution of a definitive agreement to purchase Puget Sound
Bancorp, Inc., the holding company of Puget Sound Bank, a one-branch business bank headquartered in Bellevue,
Washington. The Puget Sound Merger was completed on January 16, 2018.
On March 8, 2018, the Company announced the signing of a definitive agreement to purchase Premier
Commercial Bancorp, the holding company for Premier Community Bank, both of Hillsboro, Oregon, and its six
branches. The Premier Merger was completed on July 2, 2018.
For additional information regarding the Puget Sound Merger and Premier Merger see Note (2) Business
Combinations of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And
Supplementary Data.
Retail Banking
We offer a full range of products and services to customers for personal and business banking needs designed
to attract both short-term and long-term deposits. Deposits are our primary source of funds. Our personal and business
banking customers have the option of selecting from a variety of accounts. The major categories of deposit accounts
that we offer are described below. These accounts, with the exception of noninterest demand accounts, generally earn
interest at rates established by management based on competitive market factors and management’s desire to increase
or decrease certain types or maturities of deposits.
Noninterest Demand Deposits. Deposits are noninterest bearing and may be charged service fees based
on activity and balances.
Interest Bearing Demand Deposits. Deposits are interest bearing and may be charged service fees based
on activity and balances. Interest bearing demand deposits pay interest, but require a higher minimum balance
to avoid service charges.
Money Market Accounts. Deposits pay an interest rate that is tiered depending on the balance maintained
in the account. Minimum opening balances vary.
Savings Accounts. Deposits are interest bearing and allow for unlimited deposits and withdrawals, provided
that a minimum balance is maintained.
Certificate of Deposit Accounts. Deposits require a minimum deposit of $2,500 and have maturities ranging
from three months to five years. Jumbo certificate of deposit accounts are offered in amounts of $100,000 or
more for terms of seven days to one year.
8
Our personal checking accounts feature an array of benefits and options, including online banking, online
statements, mobile banking with mobile deposit, VISA debit cards and access to more than 32,000 surcharge free
Automated Teller Machines through the MoneyPass network.
We also offer trust services through trust powers in the states of Washington and Oregon, and a Wealth
Management department that provides objective advice from trusted advisers.
Lending Activities
Our lending activities are conducted through Heritage Bank. While our focus is on commercial business lending,
we also originate consumer loans, real estate construction and land development loans and one-to-four family
residential loans. Our loans are originated under policies that are reviewed and approved annually by our Board of
Directors. In addition, we have established internal lending guidelines that are updated as needed. These policies and
guidelines address underwriting standards, structure and rate considerations, and compliance with laws, regulations
and internal lending limits. We conduct post-approval reviews on selected loans and routinely perform internal loan
reviews of our loan portfolio to confirm credit quality, proper documentation and compliance with laws and regulations.
Loan repayments are considered one of the primary sources of funding for the Bank.
The Company has also acquired loans through mergers and acquisitions, which are designated as "purchased"
loans.
Commercial Business Lending
We offer different types of commercial business loans, including lines of credit, term equipment financing and
term owner-occupied and non-owner occupied commercial real estate loans. We also originate loans that are
guaranteed by the U.S. SBA, for which Heritage Bank is a “preferred lender”, and the Federal Agricultural Mortgage
Corporation. Before extending credit to a business, we review and analyze the borrower’s management ability, financial
history, including cash flow of the borrower and all guarantors, and the liquidation value of the collateral. Emphasis is
placed on having a comprehensive understanding of the borrower’s global cash flow and performing necessary financial
due diligence.
At December 31, 2019 we had $2.95 billion, or 78.3%, of our loans receivable, net in commercial business
loans with an average outstanding loan balance of approximately $495,000 at December 31, 2019, excluding loans
with no outstanding balance.
We originate commercial real estate loans within our primary market areas with a preference for loans secured
by owner-occupied properties. Our underwriting standards require that non-owner occupied and owner-occupied
commercial real estate loans not exceed 75% and 80%, respectively, of the lower of appraised value at origination or
cost of the underlying collateral. Cash flow debt coverage requirements range from 1.15 times to 1.25 times, depending
on the type of property. We also stress test debt coverage 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 and
any tenants, the quality and value of the collateral, and the management of the property securing the loan. We also
generally obtain personal guarantees from the owners of the collateral after a thorough review of personal financial
statements. In addition, we review a sample of 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 also Item 1A. Risk Factors—Our loan portfolio is concentrated in loans with a higher risk of loss.
The Bank also enters into non-hedging interest rate swap contracts with its commercial customers, as
necessary, to accommodate the business needs of borrowers. For additional information, see Note (16) Derivative
Financial Instruments of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And
Supplementary Data.
One-to-Four Family Residential Loans, Originations and Sales
At December 31, 2019, one-to-four family residential loans totaled $132.1 million, or 3.5%, of our loans
receivable, net. 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.
9
As part of our asset/liability management strategy, we typically sell a portion of our one-to-four family residential
loans in the secondary market with no recourse and servicing released. One-to-four family residential loans intended
for sale are classified as loans held for sale at the loan origination date. See Item 7. Management’s Discussion And
Analysis Of Financial Condition And Results Of Operations—Asset and Liability Management. We did not service any
of these sold loans during the years ended December 31, 2019, 2018 or 2017.
Real Estate Construction and Land Development
At December 31, 2019, we had $276.7 million, or 7.3%, of our loans receivable, net, of real estate construction
and land development loans. 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 and management by a separate group of bankers that specialize in this property type. Speculative
construction loans are short term in nature and have a variable rate of interest. We require builders to have tangible
equity in each construction project and have prompt and thorough documentation of all draw requests, and we inspect
the project prior to paying any draw requests.
See also Item 1A. Risk Factors—Our loan portfolio is concentrated in loans with a higher risk of loss.
Consumer
At December 31, 2019, we had $406.6 million, or 10.8%, of our loans receivable, net, of consumer loans. We
purchase indirect consumer loans. These loans are for new and used automobile and recreational vehicles that are
originated indirectly by selected dealers located in our market areas. We have limited our indirect loans purchased
primarily to dealerships that are established and well-known in their market areas and to applicants that are not classified
as sub-prime. We also originate consumer loans and lines of credit that are both secured and unsecured. The majority
of our consumer loans are for relatively small amounts disbursed among many individual borrowers.
Liquidity
Our primary sources of funds are deposits and loan repayments. Scheduled loan repayments are a relatively
stable source of funds, while deposits and unscheduled loan prepayments, which are influenced significantly by general
interest rate levels, interest rates available on other investments, competition, economic conditions and other factors,
may not be stable. Customer deposits remain an important source of funding, but these balances have been influenced
in the past by adverse market conditions in the industry and may be affected by future developments such as interest
rate fluctuations and new competitive pressures. In addition to customer deposits, management may utilize brokered
deposits on an as-needed basis and securities sold under agreement to repurchase. At December 31, 2019, we had
brokered deposits of $2.5 million and securities sold under agreement to repurchase of $20.2 million which were
secured by investment securities available for sale.
As secondary sources of funding, we might utilize other borrowings on a short-term basis to compensate for
reductions in other sources of funds (such as deposit inflows at less than projected levels). Borrowings may also be
used on a longer-term basis to support expanded lending activities and match the maturity of repricing intervals of
assets. Other borrowings include advances from the FHLB and other credit facilities.
Federal Home Loan Bank:
The Bank is a member of the FHLB which is one of 11 regional Federal Home Loan Banks that administer the
home financing credit function of savings institutions. Each Federal Home Loan Bank serves as a reserve or central
bank for its member financial institutions within its assigned region. It is funded primarily from proceeds derived from
the sale of consolidated obligations of the Federal Home Loan Bank system. It makes loans or advances to members
in accordance with policies and procedures, established by the Board of Directors of the Federal Home Loan Bank,
which are subject to the oversight of the Federal Housing Finance Agency. We rely upon advances from the FHLB as
a secondary source of liquidity to supplement our supply of lendable funds and meet deposit withdrawal requirements.
Advances are made pursuant to several different programs. Each credit program has its own interest rate and range
of maturities. Depending on the program, limitations on the amount of advances are based on a percentage of an
institution’s assets or on the Federal Home Loan Bank’s assessment of the institution’s creditworthiness. Under its
current credit policies, the Federal Home Loan Bank limits advances to 45% of the Bank's assets.
Advances from the FHLB are typically secured by our first lien one-to-four family residential loans, commercial
real estate loans and stock issued by the FHLB, which is owned by us. At December 31, 2019, the Bank maintained
a credit facility with the FHLB in the amount of $945.2 million, of which there were no advances outstanding.
10
For membership purposes, the Bank is required to maintain an investment in the stock of the FHLB in an
amount equal to 0.12% of the Bank's assets as calculated on an annual basis. In addition to the FHLB stock required
for membership, the Bank must purchase activity stock equal to 4.0% of all outstanding borrowing balances. The
activity stock is automatically redeemed in amounts equal to the FHLB advance balances as they are repaid. At
December 31, 2019 the Bank had an investment in stock issued by the FHLB carried at a cost basis (par value) of
$6.4 million, which entirely represented its membership stock. The Bank was not required to have any activity stock
because it did not have any outstanding FHLB advance balance at December 31, 2019.
Other borrowings:
In addition to liquidity provided by the FHLB, the Bank maintained an uncommitted credit facility with the
Federal Reserve Bank of $73.1 million, of which there were no advances or borrowings outstanding as of December 31,
2019. The Bank also maintains advance lines with Wells Fargo Bank, US Bank, The Independent Bankers Bank,
Pacific Coast Bankers’ Bank, and JP Morgan Chase to purchase federal funds of up to $140.0 million, of which there
were no advances or borrowings outstanding as of December 31, 2019.
Supervision and Regulation
We are subject to extensive legislation, regulation, and supervision under federal law and the law of Washington
State, which are primarily intended to protect depositors and the FDIC, and not shareholders. The laws and regulations
affecting banks and bank holding companies have changed significantly particularly in connection with the enactment
of the Dodd-Frank Act. Among other changes, the Dodd-Frank Act established the Consumer Financial Protection
Bureau as an independent bureau of the Federal Reserve. The Consumer Financial Protection Bureau assumed
responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations
and has authority to impose new requirements. See “—Other Regulatory Developments—The Dodd-Frank Act” herein
for a discussion of this legislation.
Any change in applicable laws, regulations, or regulatory policies may have a material effect on our business,
operations, and prospects. We cannot predict the nature or the extent of the effects on our business and earnings that
any fiscal or monetary policies or new Federal or State legislation may have in the future.
The following is a summary discussion of certain laws and regulations applicable to Heritage and Heritage
Bank which is qualified in its entirety by reference to the actual laws and regulations.
Heritage
As a bank holding company registered with the Federal Reserve, we are subject to comprehensive regulation
and supervision by the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations
of the Federal Reserve. This regulation and supervision is generally intended to ensure that we limit our activities to
those allowed by law and that we operate in a safe and sound manner without endangering the financial health of
Heritage Bank. We are required to file annual and periodic reports with the Federal Reserve and provide additional
information as the Federal Reserve may require. The Federal Reserve may examine us, and any of our subsidiaries,
and assess us for the cost of such examination.
The Federal Reserve has extensive enforcement authority over bank holding companies, including, among
other things, the ability to assess civil money penalties, to issue cease and desist or removal orders, or require that a
holding company divest subsidiaries (including its bank subsidiary). In general, enforcement actions may be initiated
for violations of laws and regulations and unsafe or unsound practices. The Company is also required to file certain
reports with, and otherwise comply with, the rules and regulations of the SEC. The Federal Reserve may also order
termination of non-banking activities by non-banking subsidiaries of bank holding companies, or divestiture of ownership
and control of a non-banking subsidiary by a bank holding company. Some violations may also result in criminal
penalties.
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.
In addition, the Dodd Frank Act and Federal Reserve policy provides that a bank holding company shall be required
to serve as a source of financial strength for its subsidiary bank. A bank holding company’s failure to meet its obligation
to serve as a source of strength by providing financial assistance to a subsidiary bank in financial distress is generally
considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve’s
regulations or both.
Under the prompt corrective action provisions of the Federal Deposit Insurance Act, a bank holding company
with an undercapitalized subsidiary bank must guarantee, within limitations, the capital restoration plan that is required
to be implemented for its undercapitalized subsidiary bank. If an undercapitalized subsidiary bank fails to file an
acceptable capital restoration plan or fails to implement an accepted plan, the Federal Reserve may, among other
11
restrictions, prohibit the bank holding company or its undercapitalized subsidiary bank from paying any dividend or
making any other form of capital distribution without the prior approval of the Federal Reserve. Federal Reserve policy
also provides that a bank holding company may pay cash dividends only to the extent that the company’s net income
for the past year is sufficient to cover both the cash dividend and a rate of earnings retention that is consistent with
the company’s capital needs, asset quality and overall financial condition. A bank holding company or bank that does
not meet the capital conservation buffer requirement is subject to restrictions on the payment of dividends. See “—
Capital Adequacy” below. In addition, under Washington corporate law, a company generally may not pay dividends
if, after that payment, the company would not be able to pay its liabilities as they become due in the usual course of
business or its total assets would be less than its total liabilities.
We, and any subsidiaries which we may control, are considered “affiliates” of the Bank 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 minimum capital ratios. For additional
information, see “—Capital Adequacy” below.
Heritage Bank
Heritage Bank is a Washington state-chartered commercial bank, the deposits of which are insured by the
FDIC. Heritage Bank is subject to regulation by the FDIC and the DFI.
Applicable Federal and State statutes and regulations which govern a bank’s operations relate to minimum
capital requirements, required reserves against deposits, investments, loans, legal lending limits, mergers and
consolidation, borrowings, issuance of securities, payment of dividends, establishment of branches, and other aspects
of its operations, among other things. The DFI 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 DFI and is subject to periodic examinations
and evaluations by these 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 at least every 12 months.
Dividends paid by the Bank provide substantially all of our cash flow. The FDIC and the DFI also have the
general authority to restrict capital distributions by the Bank, including dividends paid by the Bank to Heritage. Such
restrictions are generally tied to the Bank’s capital levels after giving effect to such distributions. For additional
information regarding the restrictions on the payment of dividends, see ”—Capital Adequacy" below and Note (17)
Stockholders' Equity herein.
Capital Adequacy
The Federal Reserve and FDIC have issued substantially similar risk-based and leverage capital regulations
applicable to bank holding companies and banks, respectively. In addition, these regulatory agencies may from time
to time require that a bank holding company or bank maintain capital above the minimum levels, based on its financial
condition or actual or anticipated growth. These regulations implement the regulatory capital reforms required by the
Dodd-Frank Act and the Basel III requirements.
Under these capital regulations, the minimum capital ratios are: (1) a CET1 capital ratio of 4.5% of risk-weighted
assets; (2) a leverage ratio (the ratio of Tier 1 capital to average total adjusted assets) of 4.0%; (3) a Tier 1 capital ratio
of 6.0% of risk-weighted assets; and (4) a total capital ratio of 8.0% of risk-weighted assets. CET1 generally consists
of common stock; retained earnings; accumulated other comprehensive income (loss), net unless an institution elects
to exclude accumulated other comprehensive income (loss), net from regulatory capital; and certain minority interests;
all subject to applicable regulatory adjustments and deductions. Tier 1 capital generally consists of CET1 and
noncumulative perpetual preferred stock. Tier 2 capital generally consists of other preferred stock and subordinated
debt meeting certain conditions plus an amount of the allowance for loan and lease losses up to 1.25% of assets. Total
capital is the sum of Tier 1 and Tier 2 capital.
In addition to the minimum CET1, Tier 1, leverage ratio and total capital ratios, the Company and the Bank
must maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% above the required
minimum risk-based capital levels in order to avoid limitations on paying dividends, repurchasing shares, and paying
discretionary bonuses. To be considered "well capitalized," a bank holding company must have, on a consolidated
basis, a Tier 1 risk-based capital ratio of 6.0% or greater and a total risk-based capital ratio of 10.0% or greater and
must not be subject to an individual order, directive or agreement under which the Federal Reserve requires it to
maintain a specific capital level. To be considered “well capitalized,” a depository institution must have a a CET1 capital
12
ratio of at least 6.5%, a leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 8%, a total risk-based
capital ratio of at least 10% and not be subject to an individualized order, directive or agreement under which its primary
federal banking regulator requires it to maintain a specific capital level. The FDIC has not imposed such a requirement
on Heritage Bank. As of December 31, 2019, the Company and the Bank met all minimum requirements and the most
recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt
corrective action.
For a complete description of the Company’s and the Bank's required and actual capital levels as of
December 31, 2019, see Note (23) Regulatory Capital Requirements of the Notes to Consolidated Financial Statements
included in Item 8. Financial Statements And Supplementary Data. Also, see Other Regulatory Developments below
for additional information related to CECL and the Community Bank Leverage Ratio which may impact our capital
levels and requirements in the future.
Prompt Corrective Action
Federal statutes establish a supervisory framework for FDIC-insured institutions based on five capital
categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized. An institution’s category depends upon where its capital levels are in relation to relevant capital
measures. The well capitalized category is described above. An institution that is not well capitalized is subject to
certain restrictions on brokered deposits, including restrictions on the rates it can offer on its deposits. To be considered
adequately capitalized, an institution must have the minimum capital ratios described above. Any institution which is
neither well capitalized nor adequately capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls
and restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by
Heritage Bank to comply with applicable capital requirements would result in progressively more severe restrictions
on its activities and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to
ensure the maintenance of required capital levels and, ultimately, the appointment of the FDIC as receiver or
conservator. Banking regulators will take prompt corrective action with respect to depository institutions that do not
meet minimum capital requirements. Additionally, approval of any regulatory application filed for their review may be
dependent on compliance with capital requirements.
As of December 31, 2019, the Bank met the requirements to be classified as “well capitalized.” See Note (23)
Regulatory Capital Requirements of the Notes to Consolidated Financial Statements included in Item 8. Financial
Statements And Supplementary Data.
Classification of Loans
Federal regulations require the Bank to periodically evaluate the risks inherent in its loan portfolio. In addition,
the DFI and the FDIC have the authority to identify adversely classified loans and, if appropriate, require them to be
reclassified. There are three types of classified loans: Substandard, Doubtful, and Loss. Substandard loans have one
or more defined weaknesses and are characterized by the distinct possibility that the institution will sustain some loss
if the deficiencies are not corrected. Doubtful loans have the weaknesses of Substandard loans, with additional
characteristics that the weaknesses make collection or liquidation in full on the basis of currently existing facts,
conditions, and values questionable. There is a high probability of some loss in loans classified as Doubtful. A loan
classified as Loss is considered uncollectible and of such little value that continuance as a loan of the institution is not
warranted. If a loan or a portion of the loan is classified as Loss, the institution must charge-off this amount.
Deposit Insurance and Other FDIC Programs
The deposits of the Bank are insured up to $250,000 per separately insured category by the Deposit Insurance
Fund, which is administered by the FDIC. The FDIC is an independent federal agency that insures the deposits, up
to applicable limits, of depository institutions. As insurer of the Bank's deposits, the FDIC has supervisory and
enforcement authority over 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 FDIC-insured institution from
engaging in any activity determined by regulation or order to pose a serious risk to the institution and the Deposit
Insurance Fund. The FDIC also has the authority to initiate enforcement actions and may terminate the deposit insurance
if it determines that an institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
The Dodd-Frank Act broadened the base for FDIC insurance assessments. Assessments are now based on
the average consolidated total assets less tangible equity capital of a financial institution. In addition, the Dodd-Frank
Act set the minimum designated reserve ratio of the Deposit Insurance Fund at 1.35%, required the FDIC to set a
target for the ratio each year, and eliminated the requirement that the FDIC pay dividends to insured depository
13
institutions when the ratio exceeds certain thresholds. The FDIC set the target ratio at 2.0% and adopted a plan to
achieve that target ratio. Currently, total base assessment rates range from 1.5 to 40 basis points on an annualized
basis, subject to certain adjustments. Under current regulations, the ranges of assessment rates are scheduled to
decrease as the ratio increases in increments above 2.0%. No institution may pay a dividend if it is in default on its
federal deposit insurance assessment.
The FDIC announced that the Deposit Insurance Fund ratio surpassed 1.35% as of September 30, 2018 which
triggered two changes under the regulations: surcharges on large banks (total consolidated assets of $10 billion or
more) ended and small banks (total consolidated assets of less than $10 billion, which includes the Bank) were awarded
assessment credits for the portion of their assessments that contributed to the growth in the Reserve Ratio from 1.15%
to 1.35% to be applied when the reserve ratio is at least 1.35%. The Bank was awarded $1.2 million in small bank
assessment credits of which $726,000 was applied against quarterly FDIC assessments during the year ended
December 31, 2019. The remaining balance of small bank assessment credits is available to the Bank for future FDIC
assessments for any quarter that the reserve ratio is above 1.35%.
Other Regulatory Developments
The following summarizes some of the significant federal legislation affecting banking in recent years.
The Dodd-Frank Act.
The Dodd-Frank-Act imposes restrictions and an expanded framework of regulatory
oversight for financial institutions, including depository institutions and implements new capital regulations that we are
subject to and that are discussed above under “—Capital Adequacy.”
The federal banking and securities regulators have issued final rules to implement Section 619 of the Dodd-
Frank Act, commonly known as the “Volcker Rule.” Generally, subject to a transition period and certain exceptions,
the Volcker Rule restricts insured depository institutions and their affiliated companies from engaging in short-term
proprietary trading of certain securities, investing in funds with collateral comprised of any loans that are not registered
with the SEC and from engaging in hedging activities that do not hedge a specific identified risk. In accordance with
the transition period, the Volcker Rule prohibitions and restrictions apply to banking entities, including the Company
and the Bank, unless an exception applies. We are continuously reviewing our investment portfolio to determine if
changes to our investment strategies may be required in order to comply with the various provisions of the Volcker
Rule.
In addition, among other changes, the Dodd-Frank Act requires public companies, like us, to (i) provide their
shareholders with a non-binding vote (a) at least once every three years on the compensation paid to executive officers
and (b) at least once every six years on whether they should have a “say on pay” vote every one, two or three years;
(ii) have a separate, non-binding shareholder vote regarding golden parachutes for named executive officers when a
shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the
parachute payments; (iii) provide disclosure in annual proxy materials concerning the relationship between the executive
compensation paid and the financial performance of the issuer; and (iv) amend Item 402 of Regulation S-K to require
companies to disclose the ratio of the CEO's annual total compensation to the median annual total compensation of
all other employees.
Economic Growth Act.
In May 2018 the Economic Growth Act was enacted to modify or remove certain
financial reform rules and regulations, including some of those implemented under the Dodd-Frank Act. While the
Economic Growth Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain
aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and for large
banks with assets of more than $50 billion.
The Economic Growth Act, among other matters, expands the definition of qualified mortgages which may be
held by a financial institution and simplifies the regulatory capital rules for financial institutions and their holding
companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish
a Community Bank Leverage Ratio. In addition, the Economic Growth Act includes regulatory relief for community
banks regarding regulatory examination cycles, call reports, the Volcker Rule (proprietary trading prohibitions),
mortgage disclosures and risk weights for certain high-risk commercial real estate loans.
The FDIC introduced the final rule applicable to the Community Bank Leverage Ratio during 2019. The new
ratio is an optional framework that is designed to reduce regulatory burden by removing the requirements for calculating
and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework
starting in the first quarter of 2020. Qualifying community banking organizations that elect to use the Community Bank
Leverage Ratio framework and that maintain a leverage ratio of greater than nine percent are considered to have
satisfied the risk-based and leverage capital requirements in the agencies’ generally applicable capital rule. Additionally,
such insured depository institutions are considered to have met the well-capitalized ratio requirements for purposes
of section 38 of the Federal Deposit Insurance Act. The leverage ratio required for purposes of the new framework is
14
calculated as tier 1 capital divided by average total consolidated assets, consistent with how banking organizations
calculate their leverage ratio under the current rules.
It is difficult at this time to predict when or how any new standards under the Economic Growth Act will ultimately
be applied to us or what specific impact the Act and the yet-to-be-written implementing rules and regulations will have
on community banks.
Current Expected Credit Losses Model. The FASB has adopted a new accounting standard for GAAP that
was effective for us on January 1, 2020. This standard, referred to as CECL, requires FDIC-insured institutions and
their holding companies (banking organizations) to recognize credit losses expected over the life of certain financial
assets. CECL covers a broader range of assets than the current method of recognizing credit losses and generally
results in earlier recognition of credit losses. Upon adoption of CECL, a banking organization must record a one-time
adjustment to its credit loss allowances as of the beginning of the fiscal year of adoption equal to the difference, if any,
between the amount of credit loss allowances under the current methodology and the amount required under CECL.
For a banking organization, implementation of CECL is generally likely to reduce retained earnings, and to affect other
items, in a manner that reduces its regulatory capital.
The federal banking regulators (the Federal Reserve, the OCC and the FDIC) have adopted a rule that gives
a banking organization the option to phase in over a three-year period the day-one adverse effects of CECL on its
regulatory capital.
Sarbanes-Oxley Act. As a public company that files periodic reports with the SEC, under the Exchange
Act, Heritage is subject to the Sarbanes-Oxley Act, which addresses, among other issues, corporate governance,
auditing and accounting, executive compensation and enhanced and timely disclosure of corporate information.
The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state
regulatory systems, such as the 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.
Website Access to Company Reports
We post publicly available reports required to be filed with the SEC on our website, www.hf-wa.com, as soon
as reasonably practicable after filing such reports. The required reports are available free of charge through our website.
Code of Ethics
We have adopted a Code of Ethics that applies to our principal officers. We have posted the text of our Code
of Ethics at www.hf-wa.com in the section titled Overview: Governance Documents. Any waivers of the code of ethics
will be publicly disclosed to shareholders.
Competition
We compete for loans and deposits with other commercial banks, credit unions, mortgage bankers, and other
providers of financial services, including finance companies, online-only banks, mutual funds, insurance companies,
and more recently with financial technology (or "FinTech") companies that rely on technology to provide financial
services. Many of our competitors have substantially greater resources than we do. Particularly in times of high or
rising interest rates, we also face significant competition for investors’ funds from short-term money market securities
and other corporate and government securities.
We compete for loans principally through the range and quality of the services we provide, interest rates and
loan fees, and the locations 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 884 full-time equivalent employees at December 31, 2019. 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.
15
Executive Officers
The following table sets forth certain information with respect to the executive officers of the Company at
December 31, 2019.
Name
Brian L. Vance
Jeffrey J. Deuel
Donald J. Hinson
David A. Spurling
Bryan McDonald
Cindy Huntley
Age as of
December 31,
2019
Position
Has Served the
Company or
Heritage Bank
Since
65 Executive Chair of the Board
61 Chief Executive Officer of Heritage
58 Executive Vice President and Chief
Financial Officer of Heritage and
Heritage Bank
66 Executive Vice President and Chief
Credit Officer of Heritage and
Heritage Bank
48 Executive Vice President and Chief
Operating Officer of Heritage and
Heritage Bank
56 Executive Vice President and Chief
Banking Officer of Heritage Bank
1996
2010
2005
2001
2014
1988
The business experience of each executive officer is set forth below.
Mr. Vance was appointed the Executive Chair of the Board in June 2019. He served as the Chief Executive
Officer of Heritage Financial Corporation from June 2018 to June of 2019. In 2006, Mr. Vance was appointed President
and Chief Executive Officer of Heritage and Heritage Bank, and Vice Chairman and Chief Executive Officer of Central
Valley Bank. 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.
Mr. Deuel is the Chief Executive Officer of Heritage Bank and Heritage Financial Corporation. Mr. Deuel was
promoted to President and Chief Executive Officer of Heritage Bank and President of Heritage Financial Corporation
effective July 2018 and then promoted to Chief Executive Officer of Heritage Financial Corporation effective July 2019.
Mr. Deuel was promoted to President and Chief Operating Officer of Heritage Bank and Executive Vice President of
Heritage Financial Corporation 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 previously held the position of Executive Vice President Commercial Operations with JPMorgan Chase,
formerly Washington Mutual. Prior to joining Washington Mutual Mr. Deuel was based in Philadelphia where he worked
for Bank United, First Union Bank, CoreStates Bank, and First Pennsylvania Bank. During his career Mr. Deuel held
a variety of leadership positions in commercial banking including lending, credit administration, portfolio management,
retail, corporate strategies, and support services. He earned his Bachelor’s degree at Gettysburg College.
Mr. Hinson was promoted to Executive Vice President and Chief Financial Officer in September 2012. From
2007 to 2012, he was Senior Vice President and Chief Financial Officer. Mr. Hinson joined the Company in 2005 as
Vice President and Controller. Prior to that, he served in the banking audit practice of local and national accounting
firms of Knight, Vale and Gregory and RSM McGladrey from 1994 to 2005. Mr. Hinson holds a Bachelor's degrees in
Accounting from Central Washington University and in Psychology from Western Washington University and is a
licensed Certified Public Accountant.
David A. Spurling became Executive Vice President and Chief Credit Officer of Heritage and 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.
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Bryan McDonald was appointed Executive Vice President and Chief Operating Officer of Heritage Bank in
July of 2018. Mr. McDonald became Executive Vice President and Chief Lending Officer of Heritage Bank upon
completion of the Washington Banking Merger effective on May 1, 2014. Mr. McDonald had previously served as
President and Chief Executive Officer of Whidbey Island Bank since January 1, 2012. Mr. McDonald joined Whidbey
Island Bank in 2006 as Commercial Banking Manager and he served as Senior Vice President and Chief Operating
Officer of Whidbey Island Bank from April 1, 2010 until his promotion to Executive Vice President on August 26, 2010.
Mr. McDonald has been serving in the banking industry since 1994, including regional commercial lending management
roles with Washington Mutual and Peoples Bank. Mr. McDonald holds a Bachelor's and Master’s Degree in Business
Administration from Washington State University.
Cindy Huntley was appointed Executive Vice President and Chief Banking Officer in September of 2019. Cindy
has been with Heritage Bank since 1988 and previously served as a Senior Vice President in 2004 and Director of
Retail Banking in 2006. She holds a Bachelor's Degree in Management from the University of Northern Colorado and
graduated from the Pacific Coast Banking School.
ITEM 1A.
RISK FACTORS
We assume and manage a certain degree of risk in order to conduct our business strategy. The following
provides a discussion of 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 and operational risks
that could adversely affect us.
We are pursuing a strategy of supplementing organic growth by acquiring other financial institutions or their
businesses that we believe will help us fulfill our strategic objectives and enhance our earnings. There are risks
associated with this strategy, however, including the following:
•
•
•
•
•
•
•
•
•
we may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks,
businesses, assets and liabilities we acquire. If these issues or liabilities exceed our estimates, our
results of operations and financial condition may be materially negatively affected;
higher than expected deposit attrition;
potential diversion of our management's time and attention;
prices at which acquisitions are made can fluctuate with market conditions. We have experienced
times during which acquisitions could not be made in specific markets at prices we considered
acceptable and expect that we may continue to experience this condition in the future;
the acquisition of other entities generally requires integration of systems, procedures and personnel
of the acquired entity into our company to make the transaction economically successful. This
integration process is complicated and time consuming and can also be disruptive to the customers
of the acquired business. If the integration process is not conducted successfully and with minimal
effect on the acquired business and its customers, we may not realize the anticipated economic benefits
of an acquisition within the expected time frame, and we may lose customers or employees of the
acquired business. We may also experience greater than anticipated customer losses even if the
integration process is successful.
to finance an acquisition, we may borrow funds, thereby increasing our leverage and diminishing our
liquidity, or raise additional capital, which could dilute the interests of our existing shareholders;
from 2006 through 2019, we completed eight acquisitions or mergers, including one acquisition in
2006, two acquisitions during 2010, two acquisitions during 2013, one merger in 2014 and two
acquisitions in 2018 that enhanced our rate of growth. We may not be able to continue to sustain our
past rate of growth or to grow at all in the future;
we expect our net income will increase following our acquisitions; however, we also expect our general
and administrative expenses and consequently our efficiency ratios 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
to the extent our costs of an acquisition exceed the fair value of the net assets acquired, the acquisition
will generate goodwill. As discussed below under “-If the goodwill we have recorded in connection
17
with acquisitions becomes impaired, our earnings and capital could be reduced,” we are required to
assess our goodwill for impairment at least annually, and any goodwill impairment charge could have
a material adverse effect on our results of operations and financial condition.
Our business strategy includes significant growth plans, and our financial condition and results of operations
could be negatively affected if we are not successful in executing this strategy or if we fail to grow or manage
our growth effectively.
We intend to pursue a growth strategy for our business. We regularly evaluate potential acquisitions and
expansion opportunities. If appropriate opportunities present themselves, we expect to engage in selected acquisitions
of financial institutions in the future, including branch acquisitions, or other business growth initiatives or undertakings.
There can be no assurance that we will successfully identify appropriate opportunities, that we will be able to negotiate
or finance such activities or that such activities, if undertaken, will be successful.
Our growth initiatives may require us to recruit experienced personnel to assist in such initiatives, which will
increase our compensation costs. In addition, the failure to identify and retain such personnel would place significant
limitations on our ability to successfully execute our growth strategy. To the extent we expand our lending beyond our
current market areas, we also could incur additional risk related to those new market areas. We may not be able to
expand our market presence in our existing market areas or successfully enter new markets.
If we do not successfully execute our acquisition growth plan, it could adversely affect our business, financial
condition, results of operations, reputation and growth prospects. In addition, if we were to conclude that the value of
an acquired business had decreased and that the related goodwill had been impaired, that conclusion would result in
an impairment of goodwill charge to us, which would adversely affect our results of operations. While we believe we
have the executive management resources and internal systems in place to successfully manage our future growth,
there can be no assurance that suitable growth opportunities will be available or that we will successfully manage our
growth. See below “-If the goodwill we have recorded in connection with acquisitions becomes impaired, our earnings
and capital could be reduced” and see above “-Our strategy of pursuing acquisitions and de novo branching exposes
us to financial and operational risks that could adversely affect us” for additional risks related to our acquisition strategy.
The required accounting treatment of purchased loans we acquire through acquisitions could result in higher
net interest margins and interest income in current periods and lower net interest margins and interest income
in future periods.
We are required to record purchased loans acquired through acquisitions at fair value, which may differ from
the outstanding balance of such loans. Estimating the fair value of such loans requires management to make estimates
based on available information and facts and circumstances on the acquisition date. The difference between the fair
value and the outstanding balance of such loans is accreted into net interest income. Thus, our net interest margins
may initially increase due to accretion. The yields on our loans could decline as our acquired loan portfolio pays down
or matures, and we expect downward pressure on our interest income to the extent that the runoff on our acquired
loan portfolio is not replaced with comparable high-yielding loans. This could result in higher net interest margins and
interest income in current periods and lower net interest rate margins and lower interest income in future periods.
New or changing tax, accounting, and regulatory rules and interpretations could significantly impact strategic
initiatives, results of operations, cash flows, and financial condition.
The financial services industry is extensively regulated. Federal and state banking regulations are designed
primarily to protect the deposit insurance funds and consumers, not to benefit our stockholders. These regulations,
along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards,
policies, and interpretations control the methods by which financial institutions conduct business, implement strategic
initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards,
policies, and interpretations are constantly evolving and may change significantly over time. Any new regulations or
legislation, change in existing regulation or oversight, whether a change in regulatory policy or a change in a regulator's
interpretation of a law or regulation, could have a material impact on our operations, increase our costs of regulatory
compliance and of doing business and adversely affect our profitability. Regulatory authorities also have extensive
discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on
the operation of an institution, the classification of assets by the institution and adequacy of an institution's allowance
for loan losses. These bank regulators also have the ability to impose conditions in the approval of merger and acquisition
transactions.
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,
18
which may be unpredictable, and the collateral securing these loans may fluctuate in value. We offer different types
of commercial business loans to a variety of businesses with a focus on real estate related industries and businesses
in agricultural, healthcare, legal and other professions. The types of commercial business loans offered are lines of
credit, term equipment financing and term real estate loans. We also originate loans that are guaranteed by the SBA,
and we are a “preferred lender” of the SBA. Commercial business lending involves risks that are different from those
associated with real estate lending. Our commercial business loans are primarily made based on our assessment of
the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The borrower's
cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Although these commercial
business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the
liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable
may be uncollectible and inventories may be obsolete or of limited use, among other things. Accordingly, the repayment
of commercial business loans depends primarily on the cash flow and creditworthiness of the borrower and secondarily
on the underlying collateral provided by the borrower. In addition, as part of our commercial business lending activities,
we originate agricultural loans. Agricultural lending involves a greater degree of risk. Payments on agricultural loans
are typically dependent on the profitable operation or management of the related farm property. The success of the
farm may be affected by many factors outside the control of the borrower, including adverse weather conditions that
prevent the planting of a crop or limit crop yields (such as hail, drought and floods), loss of livestock due to disease
or other factors, declines in market prices for agricultural products (both domestically and internationally), changes in
the economy (such as tariffs) and the impact of government regulations (including changes in price supports, subsidies
and environmental regulations). In addition, many farms are dependent on a limited number of key individuals whose
injury or death may significantly affect the successful operation of the farm. If the cash flow from a farming operation
is diminished, the borrower’s ability to repay the loan may be impaired.
Consequently, agricultural loans may involve a greater degree of risk than other types of loans, particularly in
the case of loans that are unsecured or secured by rapidly depreciating assets such as farm equipment (some of which
is highly specialized with a limited or no market for resale), or assets such as livestock or crops. In such cases, any
repossessed collateral for a defaulted agricultural operating loan may not provide an adequate source of repayment
of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation or because the
assessed value of the collateral exceeds the eventual realization value.
At December 31, 2019, our commercial business loans totaled $2.95 billion, or approximately 78.3% of our
total loan portfolio. Approximately $44.3 million, or 1.5%, of our commercial business loans were nonperforming at
December 31, 2019. The majority of the nonperforming commercial business loans were commercial and industrial
loans of which nonperforming agricultural lending was $25.9 million, or 58.1% of nonperforming loans. Our agricultural
lending totaled $99.6 million, or 2.6% of our total loan portfolio and 3.4% of our commercial business loans at
December 31, 2019.
Our non-owner occupied commercial real estate loans, which include 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 one-to-four family residential real estate because the collateral securing these loans typically cannot
be sold as easily as one-to-four family residential real estate. In addition, many of our commercial and five or more
family residential real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such
balloon payments may require the borrower to either sell or refinance the underlying property in order to make the
payment, which may increase the risk of default or non-payment. If we foreclose on a commercial and five or more
family residential real estate loan, our holding period for the collateral typically is longer than for one-to-four family
residential loans because there are fewer potential purchasers of the collateral. Additionally, commercial and five or
more family residential real estate loans generally have relatively large balances to single borrowers or related groups
of borrowers. Accordingly, if we make any errors in judgment regarding the collectability of our commercial and five or
more family residential real estate loans, any resulting charge-offs may be larger on a per loan basis than those incurred
with our residential or consumer loan portfolios.
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As of December 31, 2019, our non-owner occupied commercial real estate loans totaled $1.29 billion, or 34.3%
of our total loan portfolio. Approximately $6.1 million, or 0.5%, of our non-owner occupied commercial real estate loans
were nonperforming at December 31, 2019.
Our real estate construction and land development loans are based upon estimates of costs and the related
value associated with the completed project. These estimates may be inaccurate. Construction lending involves
additional risks when compared with permanent residential lending because funds are advanced upon the collateral
for the project based on an estimate of costs that will produce a future value at completion. Because of the uncertainties
inherent in estimating construction costs, as well as the market value of the complete project and the effects of
governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to
complete a project and the completed project loan-to-value ratio. Changes in demand for new housing and higher than
anticipated building costs may cause actual results to vary significantly from those estimated. For these reasons, this
type of lending also typically involves higher loan principal amounts and may be concentrated with a small number of
builders. A downturn in housing, or the real estate market, could increase delinquencies, defaults and foreclosures,
and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. Some of the
builders we deal with have more than one loan outstanding with us. Consequently, an adverse development with
respect to one loan or one credit relationship can expose us to a significantly greater risk of loss. In addition, during
the term of some of our construction loans, no payment from the borrower is required since the accumulated interest
is added to the principal of the loan through an interest reserve. As a result, these loans often involve the disbursement
of funds with repayment substantially dependent on the success of the ultimate project and the ability of the borrower
to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor
to repay principal and interest. If our appraisal of the value of a completed project proves to be overstated, we may
have inadequate security for the repayment of the loan upon completion of construction of the project and may incur
a loss. Because construction loans require active monitoring of the building process, including cost comparisons and
on-site inspections, these loans are more difficult and more costly to monitor. Increases in market rates of interest may
have a more pronounced effect on construction loans by rapidly increasing the end-purchaser's borrowing costs,
thereby possibly reducing the homeowner's ability to finance the home upon completion or the overall demand for the
project. Properties under construction are often difficult to sell and typically must be completed in order to be successfully
sold which also complicates the process of working out problem construction loans. This may require us to advance
additional funds and/or contract with another builder to complete construction and assume the market risk of selling
the project at a future market price, which may or may not enable us to fully recover unpaid loan funds and associated
construction and liquidation costs. Furthermore, in the case of speculative construction loans, there is the added risk
associated with identifying an end-purchaser for the finished project. Land development loans also pose additional
risk because of the lack of income being produced by the property and potential illiquid nature of the collateral. These
risks can be significantly impacted by supply and demand conditions.
As of December 31, 2019, our real estate construction and land development loans totaled $276.7 million, or
7.3% of our total loan portfolio. Of these loans, $104.9 million, or 2.8% of our total loan portfolio, were one-to-four
family residential construction related and $171.8 million, or 4.5% of our total loan portfolio, were five or more family
residential and commercial property construction related. None of our total construction and land development loans
were nonperforming at December 31, 2019.
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:
•
•
•
•
•
the cash flow of the borrower, guarantors and/or the project being financed;
the changes and uncertainties as to the future value of the collateral, in the case of a collateralized
loan;
the character and creditworthiness of a particular borrower or guarantor;
changes in economic and industry conditions; and
the duration of the loan.
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses
charged against earnings, which we believe is appropriate to absorb probable incurred losses in our loan portfolio.
The amount of this allowance is determined by our management through a periodic comprehensive review and
consideration of several factors, including, but not limited to:
•
•
our general reserve, based on our historical default and loss experience;
our specific reserve, based on our evaluation of impaired loans and their underlying collateral or
discounted cash flows; and
20
•
current macroeconomic factors and regulatory requirements.
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. If our estimates are incorrect, the allowance for loan losses may not be sufficient to cover
losses inherent in our loan portfolio, resulting in the need for increases in our allowance for loan losses through the
provision for losses on loans which is charged against income. Management also recognizes that significant new
growth in loan portfolios, new loan products and the refinancing of existing loans can result in portfolios comprised of
unseasoned loans that may not perform in a historical or projected manner and will increase the risk that our allowance
may be insufficient to absorb losses without significant additional provisions.
Deterioration in economic conditions affecting borrowers, new information regarding existing loans,
identification of additional problem loans and other factors, both within and outside of our control, may require an
increase in the allowance for loan losses. If current conditions in the housing and real estate markets weaken, we
expect we will experience increased delinquencies and credit losses. In addition, bank regulatory agencies periodically
review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition
of further loan charge-offs, based on their judgments about information available to them at the time of their examination.
In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to
increase the allowance for loan losses.
The FASB has adopted a new accounting standard referred to as CECL which will require financial institutions
to determine periodic estimates of lifetime expected credit losses on loans and recognize the expected credit losses
as allowances for credit losses. This will change the current method of providing allowances for credit losses that are
probable, which may require us to increase our allowance for loan losses, and may greatly increase the types of data
we would need to collect and review to determine the appropriate level of the allowance for credit losses. This accounting
pronouncement was adopted by us effective for our fiscal year beginning January 1, 2020. Please see Note (1)
Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting
Pronouncements in Item 8. Financial Statements And Supplementary Data for an evaluation of the impact the CECL
accounting model will have on our accounting. The federal banking regulators, including the Federal Reserve and the
FDIC, have adopted a rule that gives a banking organization the option to phase in over a three year period the day
one adverse effects of CECL on its regulatory capital. Any increases in the allowance for loan losses due to the one-
time cumulative-effect adjustment will result in a decrease in capital and may have a material adverse effect on our
financial condition and results of operations.
If our allowance for loan losses is not sufficient to cover actual loan losses our earnings could decrease.
For the year ended December 31, 2019 we recorded a provision for loan losses of $4.3 million compared to
$5.1 million for the year ended December 31, 2018. We recorded net charge-offs of loans of $3.2 million for the year
ended December 31, 2019 compared to $2.2 million for the year ended December 31, 2018. At December 31, 2019
our total nonperforming loans were $44.5 million, or 1.18% of loans receivable, net, compared to $13.7 million or 0.37%
of loans receivable, net, at December 31, 2018. Generally, our nonperforming loans reflect operating difficulties of
individual borrowers, which may be the result of current economic conditions. If economic conditions deteriorate, we
expect that we could experience significantly higher delinquencies and loan charge-offs. As a result, we may be required
to make further increases in our provision for loan losses in the future, which could adversely affect our financial
condition and results of operations, perhaps materially.
General economic conditions tend to impact loan segments at varying degrees. At December 31, 2019, our
commercial and industrial loan portfolio had the greatest percentage of nonaccrual loans of 75.3% as the borrowers
are primarily business owners whose business results are influenced by economic conditions as well as impact of the
types of collateral generally securing these loans. Our owner-occupied commercial real estate loans and non-owner
occupied commercial real estate loans portfolio, which contained 10.6% and 13.6%, respectively, of our nonaccrual
loans at December 31, 2019, generally have a large percentage of nonperforming loans because of the same reasons
as the commercial and industrial loan portfolio noted above.
The current economic condition in the market areas we serve may adversely impact our earnings and could
increase the credit risk associated with our loan portfolio.
Substantially all of our loans are to businesses and individuals in the states of Washington and Oregon. A
decline in the economies of our primary market areas of the Pacific Northwest in which we operate could have a
material adverse effect on our business, financial condition, results of operations and prospects. Weakness in the
global economy has adversely affected many businesses operating in our markets that are dependent upon international
trade and it is not known how the recent changes in tariffs being imposed on international trade may also affect these
businesses.
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While real estate values and unemployment rates have improved, a deterioration in economic conditions in
our market areas of the Pacific Northwest 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 allowance for loan losses;
the sale of foreclosed assets may be slow;
our provision for loan losses may increase;
demand for our products and services may decline, possibly resulting in a decrease in our total loans;
collateral for loans made may decline further in value, exposing us to increased risk of loss on existing
loans;
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments
to us; and
the amount of our deposits may decrease and the composition of our deposits may be adversely
affected.
A decline in local economic conditions may have a greater effect on our earnings and capital than on the
earnings and capital of larger financial institutions whose real estate loans are geographically diverse. Many of the
loans in our portfolio are secured by real estate. Deterioration in the real estate markets where collateral for a mortgage
loan is located could negatively affect the borrower’s ability to repay the loan and the value of the collateral securing
the loan. Real estate values are affected by various other factors, including changes in general or regional economic
conditions, governmental rules or policies and natural disasters such as earthquakes and flooding. If we are required
to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and
profitability could be adversely affected.
Adverse changes in the regional and general economy could reduce our growth rate, impair our ability to
collect loans and generally have a negative effect on our financial condition and results of operations.
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 GAAP, our goodwill is evaluated for impairment
on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists. The
evaluation is based on a variety of factors, including the quoted price of our common stock, market prices of common
stock of other banking organizations, common stock trading multiples, discounted cash flows, and data from comparable
acquisitions. At December 31, 2019, we had goodwill with a carrying amount of $240.9 million.
Declines in our stock price or a prolonged weakness in the operating environment of the financial services
industry may result in a future impairment charge. Any such impairment charge could have a material adverse effect
on our operating results and financial condition.
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.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding
liabilities. Changes in monetary policy, including changes in interest rates, could influence not only the interest we
receive on loans and investments and the amount of interest we pay on deposits and borrowings, but these changes
could also affect (i) our ability to originate and/or sell loans and obtain deposits, (ii) the fair value of our financial assets
and liabilities, which could negatively impact shareholders’ equity, and our ability to realize gains from the sale of such
assets, (iii) our ability to obtain and retain deposits in competition with other available investment alternatives, (iv) the
ability of our borrowers to repay adjustable or variable rate loans, and (v) the average duration of our investment
securities portfolio and other interest-earning assets. If the interest rates paid on deposits and other borrowings increase
at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore
earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans
and other investments fall more quickly than the interest rates paid on deposits and other borrowings. In a changing
interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate
risk effectively, our business, financial condition and results of operations could be materially affected.
22
Interest rates are highly sensitive to many factors that are beyond our control, including general economic
conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. In
an attempt to help the overall economy, the Federal Reserve kept interest rates low through its targeted Fed Funds
rate for a number of years; however, the Federal Reserve steadily increased the targeted Fed Funds rate in 2018 and
2017. Beginning in August 2019 the Federal Reserve has reduced the targeted Fed Funds rate 25 basis points three
times to a range of 1.50% to 1.75% at December 31, 2019 in response to some recent weakness in economic data
and indicated possible further decreases, subject to economic conditions. If the Federal Reserve increases the targeted
federal funds rates, overall interest rates will likely rise, which may negatively impact both the housing market by
reducing refinancing activity and new home purchases, and the U.S. economy. In addition, deflationary pressures,
while possibly lowering our operational costs, could have a significant negative effect on our borrowers, especially our
business borrowers, and the values of collateral securing loans which could negatively affect our financial performance.
A sustained increase in market interest rates could adversely affect our earnings. As is the case with many
banks and saving institutions, our emphasis on increasing the development of core deposits--those deposits bearing
no or a relatively low rate of interest with no state maturity date--has resulted in our interest-bearing liabilities having
a shorter duration than our assets. We would incur a higher cost of funds to retain these deposits in a rising interest
rate environment. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest
rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely
affected.
Changes in interest rates also affect the value of our interest-earning assets and in particular our securities
portfolio. Generally, the fair value of fixed-rate securities fluctuates inversely with changes in interest rates. Unrealized
gains and losses on securities available for sale are reported as a separate component of equity, net of tax. Decreases
in the fair value of securities available for sale resulting from increases in interest rates could have an adverse effect
on stockholders’ equity.
Although management believes it has implemented effective asset and liability management strategies to
reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected or
prolonged change in market interest rates could have a material adverse effect on our financial condition and results
of operations. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture
the impact of actual interest rate changes on our balance sheet.
Uncertainty relating to the LIBOR calculation process and potential phasing out of LIBOR may adversely affect
our results of operations.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates
LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR
to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current
basis cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will
continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR
may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may
become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value
of LIBOR-based securities and variable rate loans, subordinated debentures, or other securities or financial
arrangements, given LIBOR's role in determining market interest rates globally. The Federal Reserve, in conjunction
with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions,
selected a new index (the Secured Overnight Financing Rate or "SOFR") to replace LIBOR. SOFR is calculated as a
volume-weighted median of transaction level data from the Bank of New York Mellon, Global Collateral Finance Repo
and bilateral Treasury repo transactions cleared through the Fixed Income Clearing Corporation. SOFR is observed
and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated
forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that
SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit
risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with
the funding costs of financial institutions. Whether or not SOFR attains market traction as a LIBOR replacement tool
remains in question, although some transactions using SOFR have been completed in 2019, and the future of LIBOR
remains uncertain at this time. Uncertainty as to the nature of alternative reference rates and as to potential changes
or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and to a lesser
extent securities in our portfolio, and may impact the availability and cost of hedging instruments and borrowings,
including the rates we pay on our subordinated debentures and trust preferred securities. If LIBOR rates are no longer
available, and we are required to implement substitute indices for the calculation of interest rates under our loan
agreements with our borrowers or our existing borrowings, we may incur significant expenses in effecting the transition,
23
and may be subject to disputes or litigation with customers and creditors over the appropriateness or comparability to
LIBOR of the substitute indices, which could have an adverse effect on our results of operations.
Our securities portfolio may be negatively impacted by fluctuations in market value and interest rates.
Our securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated
other comprehensive income (loss), net and/or earnings. Fluctuations in market value may be caused by changes in
market interest rates, rating agency actions in respect of the securities, defaults by the issuer or with respect to the
underlying securities, lower market prices for securities and limited investor demand. Our securities portfolio is evaluated
for other-than-temporary impairment. If this evaluation shows impairment to the actual or projected cash flows
associated with one or more securities, a potential loss to earnings may occur. Changes in interest rates can also have
an adverse effect on our financial condition, as our available-for-sale securities are reported at their estimated fair
value, and therefore are impacted by fluctuations in interest rates. We increase or decrease our shareholders' equity
by the amount of change in the estimated fair value of the available-for-sale securities, net of taxes. There can be no
assurance that the declines in market value will not result in other-than-temporary impairments of these assets, which
would lead to accounting charges that could have a material adverse effect on our net income and capital levels.
Decreased volumes and lower gains on sales of mortgage loans sold could adversely impact our noninterest
income.
We originate and sell one-to-four family residential loans. Our mortgage banking income is a significant portion
of our noninterest income. We generate gains on the sale of one-to-four family residential loans pursuant to programs
currently offered by the Federal Home Loan Mortgage Corporation and other secondary market purchasers. Any future
changes in their purchase programs, our eligibility to participate in such programs, the criteria for loans to be accepted
or laws that significantly affect the activity of such entities could, in turn, materially adversely affect our results of
operations. Further, in a rising or higher interest rate environment, our originations of mortgage loans may decrease,
resulting in fewer loans that are available to be sold to investors. This would result in a decrease in mortgage banking
revenues and a corresponding decrease in noninterest income. In addition, our results of operations are affected by
the amount of noninterest expense associated with mortgage banking activities, such as salaries and employee benefits,
occupancy, equipment and data processing expense and other operating costs. During periods of reduced loan demand,
our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate
with the decline in loan originations.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, growth and
prospects.
Liquidity is essential to our business. We rely on a number of different sources in order to meet our potential
liquidity demands. We require sufficient liquidity to meet customer loan requests, customer deposit maturities and
withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal
operating conditions and other unpredictable circumstances, including events causing industry or general financial
market stress. A tightening of the credit markets and the inability to obtain adequate funding may negatively affect our
liquidity, asset growth and, consequently, our earnings capability and capital levels. In addition to any deposit growth,
and the sale of loans or investment securities, maturity of investment securities and loan payments, we rely from time
to time on advances from the FHLB, and certain other wholesale funding sources to meet liquidity demands. Our
liquidity position could be significantly constrained if we were unable to access funds from the FHLB or other wholesale
funding sources. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level
of our business activity as a result of a downturn in the markets in which our loans are concentrated, negative operating
results, or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not
specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects
for the financial services industry or deterioration in credit markets. Any decline in available funding in amounts adequate
to finance our activities or on terms which are acceptable could adversely impact our ability to originate loans, invest
in securities, meet our expenses, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal
demands, any of which could, in turn, have a material adverse effect on our business, financial condition and results
of operations.
Additionally, collateralized public funds are bank deposits of state and local municipalities. These deposits
are required to be secured by certain investment grade securities to ensure repayment, which on the one hand tends
to reduce our contingent liquidity risk by making these funds somewhat less credit sensitive, but on the other hand
reduces standby liquidity by restricting the potential liquidity of the pledged collateral. Although these funds historically
have been a relatively stable source of funds for us, availability depends on the individual municipality's fiscal policies
and cash flow needs.
24
Our growth or future losses may require us to raise additional capital in the future, but that capital may not
be available when it is needed or the cost of that capital may be very high; further, the resulting dilution of
our equity may adversely affect the market price of our common stock.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support
our operations. At some point, we may need to raise additional capital to support our growth or replenish future losses.
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are
outside our control, and on our financial condition and performance. If we are able to raise capital it may not be on
terms that are acceptable to us. Accordingly, we cannot make assurances that we will be able to raise additional capital
if needed on terms that are acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to
further expand our operations through internal growth and acquisitions could be materially impaired and our financial
condition and liquidity could be materially and adversely affected.
In addition, any additional capital we obtain may result in the dilution of the interests of existing holders of our
common stock. Further, if we are unable to raise additional capital when required by our bank regulators, we may be
subject to adverse regulatory action.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in
fines or sanctions and limit our ability to get regulatory approval of acquisitions.
The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial
institutions from being used for money laundering and terrorist activities. If such activities are detected, financial
institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes
Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying
the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result
in fines or sanctions and limit our ability to get regulatory approval of acquisitions. Recently several banking institutions
have received large fines for non-compliance with these laws and regulations. While we have developed policies and
procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these
policies and procedures will be effective in preventing violations of these laws and regulations.
Failure to maintain and implement adequate programs to combat money laundering and terrorist financing
could also have serious reputational consequences for us. Any of these results could have a material adverse effect
on our business, financial condition, results of operations and growth prospects.
We rely on other companies to provide key components of our business infrastructure.
We rely on numerous external vendors to provide us with products and services necessary to maintain our
day-to-day operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance
with the contracted arrangements under service level agreements. The failure of an external vendor to perform in
accordance with the contracted arrangements under service level agreements because of changes in the vendor's
organizational structure, financial condition, support for existing products and services or strategic focus or for any
other reason, could be disruptive to our operations, which in turn could have a material negative impact on our financial
condition and results of operations. We also could be adversely affected to the extent a service agreement is not
renewed by the third party vendor or is renewed on terms less favorable to us. Additionally, the bank regulatory agencies
expect financial institutions to be responsible for all aspects of our vendors’ performance, including aspects which they
delegate to third parties. Disruptions or failures in the physical infrastructure or operating systems that support our
business and customers, or cyber-attacks or security breaches of the networks, systems or devices that our customers
use to access our products and services could result in client attrition, regulatory fines, penalties or intervention,
reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which
could materially adversely affect our results of operations or financial condition.
We are subject to certain risks in connection with our use of technology.
Our security measures may not be sufficient to mitigate the risk of a cyber-attack. Communications and
information systems are essential to the conduct of our business, as we use such systems to manage our customer
relationships, our general ledger and virtually all other aspects of our business. Our operations rely on the secure
processing, storage, and transmission of confidential and other information in our computer systems and networks.
Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our
computer systems, software, and networks may be vulnerable to breaches, fraudulent or unauthorized access, denial
or degradation of service attacks, misuse, computer viruses, malware or other malicious code and cyber-attacks that
could have a security impact. If one or more of these events occur, this could jeopardize our or our customers' confidential
and other information processed and stored in, and transmitted through, our computer systems and networks, or
otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties.
We may be required to expend significant additional resources to modify our protective measures or to investigate
25
and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are
either not insured against or not fully covered through any insurance maintained by us. We could also suffer significant
reputational damage.
Security breaches in our internet banking activities could further expose us to possible liability and damage
our reputation. Increases in criminal activity levels and sophistication, advances in computer capabilities, new
discoveries, and vulnerabilities in third party technologies (including browsers and operating systems) or other
developments could result in a compromise or breach of the technology, processes and controls that we use to prevent
fraudulent transactions and to protect data about us, our clients and underlying transactions. Any compromise of our
security could deter customers from using our internet banking services that involve the transmission of confidential
information. We rely on standard internet security systems to provide the security and authentication necessary to
effect secure transmission of data. Although we have developed and continue to invest in systems and processes that
are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, these
precautions may not protect our systems from compromises or breaches of our security measures. and could result
in losses to us or our customers, our loss of business and/or customers, damage to our reputation the incurrence of
additional expenses, disruption to our business, our inability to grow our online services or other businesses, additional
regulatory scrutiny or penalties, or our exposure to civil litigation and possible financial liability, any of which could have
a material adverse effect on our business, financial condition and results of operations.
Our security measures may not protect us from system failures or interruptions. While we have established
policies and procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance
that such events will not occur or that they will be adequately addressed if they do. In addition, we outsource certain
aspects of our data processing and other operational functions to certain third-party providers. While the Company
selects third-party vendors carefully, it does not control their actions. If our third-party providers encounter difficulties,
including those resulting from breakdowns or other disruptions in communication services provided by a vendor, failure
of a vendor to handle current or higher transaction volumes, cyber-attacks and security breaches or if we otherwise
have difficulty in communicating with them, our ability to adequately process and account for transactions could be
affected, and our ability to deliver products and services to our customers and otherwise conduct business operations
could be adversely impacted. Replacing these third-party vendors could also entail significant delay and expense.
Threats to information security also exist in the processing of customer information through various other vendors and
their personnel.
We cannot assure you that such breaches, failures or interruptions will not occur or, if they do occur, that they
will be adequately addressed by us or the third parties on which we rely. We may not be insured against all types of
losses as a result of third party failures and insurance coverage may be inadequate to cover all losses resulting from
breaches, system failures or other disruptions. If any of our third-party service providers experience financial, operational
or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to
identify alternative sources of such services, and we cannot assure you that we could negotiate terms that are as
favorable to us or could obtain services with similar functionality as found in our existing systems without the need to
expend substantial resources, if at all. Further, the occurrence of any systems failure or interruption could damage our
reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny, or could
expose us to legal liability. Any of these occurrences could have a material adverse effect on our financial condition
and results of operations.
The board of directors oversees the risk management process, including the risk of cybersecurity, and engages
with management on cybersecurity issues.
If our enterprise risk management framework is not effective at mitigating risk and loss to us, we could suffer
unexpected losses and our results of operations could be materially adversely affected.
Our enterprise risk management framework seeks to achieve an appropriate balance between risk and return,
which is critical to optimizing stockholder value. We have established processes and procedures intended to identify,
measure, monitor, report, analyze and control the types of risk to which we are subject. These risks include liquidity
risk, credit risk, market risk, interest rate risk, operational risk, legal and compliance risk, and reputational risk, among
others. We also maintain a compliance program to identify, measure, assess, and report on our adherence to applicable
laws, policies and procedures. While we assess and improve these programs on an ongoing basis, there can be no
assurance that our risk management or compliance programs, along with other related controls, will effectively mitigate
all risk and limit losses in our business. However, as with any risk management framework, there are inherent limitations
to our risk management strategies as there may exist, or develop in the future, risks that we have not appropriately
anticipated or identified. If our risk management framework proves ineffective, we could suffer unexpected losses and
our business, financial condition and results of operations could be materially adversely affected.
26
We are subject to certain risks in connection with our data management or aggregation.
We are reliant on our ability to manage data and our ability to aggregate data in an accurate and timely manner
to ensure effective risk reporting and management. Our ability to manage data and aggregate data may be limited by
the effectiveness of our policies, programs, processes and practices that govern how data is acquired, validated,
stored, protected and processed. While we continuously update our policies, programs, processes and practices, many
of our data management and aggregation processes are manual and subject to human error or system failure. Failure
to manage data effectively and to aggregate data in an accurate and timely manner may limit our ability to manage
current and emerging risks, as well as to manage changing business needs.
We rely on dividends from Heritage Bank for substantially all of our revenue at the holding company level.
We are an entity separate and distinct from our subsidiary, Heritage Bank, and derive substantially all of our
revenue at the holding company level in the form of dividends from that subsidiary. Accordingly, we are, and will be,
dependent upon dividends from the Bank to pay the principal of and interest on our indebtedness, to satisfy our other
cash needs and to pay dividends on our common stock. The Bank's ability to pay dividends is subject to its ability to
earn net income and to meet certain regulatory requirements. In the event the Bank is unable to pay dividends to us,
we may not be able to pay dividends on our common stock. Also, our right to participate in a distribution of assets upon
a subsidiary's liquidation or reorganization is subject to the prior claims of the subsidiary's creditors.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
As a bank, we are susceptible to fraudulent activity that may be committed against us or our customers which
may result in financial losses or increased costs to us or our customers, disclosure or misuse of our information or our
customer’s information, misappropriation of assets, privacy breaches against our customers, litigation or damage to
our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud,
phishing, social engineering and other dishonest acts. Nationally, reported incidents of fraud and other financial crimes
have increased. We have also experienced losses due to apparent fraud and other financial crimes, although such
losses have been relatively insignificant to date. While we have policies and procedures designed to prevent such
losses, there can be no assurance that such losses will not occur.
Managing reputational risk is important to attracting and maintaining customers, investors and employees.
Threats to our reputation can come from many sources, including adverse sentiment about financial institutions
generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality,
compliance deficiencies and questionable or fraudulent activities of our customers. We have policies and procedures
in place to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully
effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the
loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental
regulation.
We are dependent on key personnel and the loss of one or more of those key personnel may materially and
adversely affect our prospects.
Competition for qualified employees and personnel in the banking industry is intense and there are a limited
number of qualified persons with knowledge of, and experience in, the community banking industry where we conduct
our business. The process of recruiting personnel with the combination of skills and attributes required to carry out
our strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified
management, loan origination, finance, administrative, marketing and technical personnel and upon the continued
contributions of our management and personnel. In particular, our success has been and continues to be highly
dependent upon the abilities of key executives, including our Chief Executive Officer, Jeffrey J. Deuel, and certain
other employees. The loss of key personnel could adversely affect our ability to successfully conduct our business.
Our ability to sustain or improve upon existing performance is dependent upon our ability to respond to
technological change, and we may have fewer resources than some of our competitors to continue to invest
in technological improvements.
The financial services industry is experiencing rapid technological changes with frequent introductions of new
technology-driven products and services. Effective use of technology increases efficiency and enables financial
institutions to better serve customers and to reduce costs. Many of our competitors have substantially greater resources
to invest in technological improvements than we do. Our future success will depend, to some degree, upon our ability
to address the needs of our customers by using technology to provide products and services that will satisfy customer
demands for convenience, as well as create additional efficiencies in our operations. We may not be able to effectively
implement new technology-driven products or services or be successful in marketing these products and services.
Additionally, the implementation of technological changes and upgrades to maintain current systems and integrate
27
new ones may cause services interruptions, transaction processing errors and system conversion delays and may
cause us to fail to comply with applicable laws. There can be no assurance that we will be able to successfully manage
the risks associated with increased dependency on technology.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
The Company has no unresolved staff comments from the SEC as it relates to the Company's financial
information as reported in the 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, Washington. In addition, the Company's branch network at December 31, 2019 was
comprised of 62 branches located throughout Washington and Oregon. In the opinion of management, all properties
are adequately covered by insurance, are in a good state of repair and are adequate to meet our present and immediately
foreseeable needs. We will, however, continue to monitor customer growth and expand our branching network, if
necessary, to serve our customers' needs.
For additional information concerning our premises and equipment and lease obligations, see Note (7)
Premises and Equipment and Note (15) Commitments and Contingencies of the Notes to Consolidated Financial
Statements included in Item 8. Financial Statements And Supplementary Data.
ITEM 3.
LEGAL PROCEEDINGS
We, and our Bank, are not a party to any material pending legal proceedings other than ordinary routine
litigation incidental to the business of the Bank.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable
28
PART II
ITEM 5.
AND ISSUER PURCHASES OF EQUITY SECURITIES
MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
Our common stock is traded on the NASDAQ Global Select Market under the symbol HFWA. At December 31,
2019, we had approximately 1,348 shareholders of record (not including the number of persons or entities holding
stock in nominee or street name through various brokerage firms) and 36,618,729 outstanding shares of common
stock.
Stock Repurchases
The Company has had various stock repurchase programs since March 1999. On October 23, 2014, the
Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares,
or approximately 1,513,000 shares, under the eleventh stock repurchase plan. At December 31, 2019, there were
approximately 639,922 shares remaining to be purchased under the eleventh stock repurchase plan. The number,
timing and price of shares repurchased will depend on business and market conditions, and other factors, including
opportunities to deploy the Company's capital.
Since the inception of the eleventh plan, the Company has repurchased 872,678 shares at an average share
price of $20.03. During the year ended December 31, 2019, the Company repurchased 292,712 shares with an average
share price of $26.50. No shares were repurchased under this plan during the years ended December 31, 2018 and
2017.
In addition to the stock repurchases under a plan, the Company repurchases shares to pay withholding taxes
on the vesting of restricted stock awards and units. The following table provides total repurchased shares for the
periods indicated:
Year Ended December 31,
2019
2018
2017
Repurchased shares to pay withholding taxes (1)
Stock repurchase to pay withholding taxes average share price
28,479
53,256
$
30.83 $
31.99 $
29,429
25.01
(1) During the year ended December 31, 2018, the Company repurchased 26,741 shares related to the withholding
taxes due on the accelerated vesting of the restricted stock units of Puget Sound which were converted to Heritage
common stock shares with a share price of $31.80 under the terms of the Puget Sound Merger.
The following table sets forth information about the Company’s purchases of its outstanding common stock
during the quarter ended December 31, 2019.
Period
October 1, 2019—
October 31, 2019
November 1, 2019—
November 30, 2019
December 1, 2019—
December 31, 2019
Total
Total Number of
Shares
Purchased (1)
Average Price
Paid Per Share (1)
— $
—
45
45 $
—
—
27.09
27.09
Cumulative
Total Number of
Shares
Purchased as
Part of Publicly
Announced Plans
or Programs
Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs
8,186,101
8,186,101
8,186,101
639,922
639,922
639,922
(1) Of the common shares repurchased by the Company between October 1, 2019 and December 31, 2019, all of the
shares represented the cancellation of stock to pay withholding taxes on vested restricted stock awards or units.
29
Stock Performance Graph
The following graph depicts total return to shareholders during the five-year period beginning December 31,
2014 and ending December 31, 2019. Total return includes appreciation or depreciation in market value of the
Company’s common stock as well as actual cash and stock dividends paid to common shareholders. The graph
additionally shows the five-year comparison of the total return to shareholders of the Company’s common stock as
compared to the NASDAQ Composite Index and the SNL U.S. Bank NASDAQ Index. The NASDAQ Composite Index
is a comparative broad market index comprised of all domestic and international common stocks listed on the Nasdaq
Stock Market. The SNL U.S. Bank NASDAQ Index is a comparative peer index comprised of banks and related holding
companies listed on the NASDAQ Stock Market. The graph assumes that the value of the investment in Heritage’s
common stock and each of the three indices was $100 on December 31, 2014, and that all dividends were reinvested.
.
Index
Heritage Financial Corporation
NASDAQ Composite Index
SNL U.S. Bank NASDAQ Index
2014
2015
2016
2017
2018
2019
Years Ended December 31,
$ 100.00 $ 110.63 $ 157.42 $ 192.51 $ 189.92 $ 186.11
200.49
150.96
146.67
106.96
100.00
116.45
100.00
107.95
149.68
157.58
132.82
166.75
*Information for the graph was provided by S&P Global Market Intelligence.
ITEM 6.
SELECTED FINANCIAL DATA
The following tables set forth certain information concerning our consolidated financial position and results of
operations at and for the dates indicated and have been derived from our audited Consolidated Financial Statements.
The information below is qualified in its entirety by the detailed information included elsewhere herein and should be
read along with Item 7. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations and
Item 8. Financial Statements And Supplementary Data.
30
Matters affecting comparability in the five-year summary detailed below include the Premier and Puget Mergers
completed in 2018 as discussed below.
Operations Data:
Interest income
Interest expense
Net interest income
Provision for loan losses
Noninterest income
Noninterest expense
Income tax expense (1)
Net income
Earnings per common share
Basic
Diluted
Dividend payout ratio to common
shareholders (2)
Performance Ratios:
Net interest spread (3)
Net interest margin (4)
Efficiency ratio (5)
Noninterest expense to average assets
Return on average assets
Return on average common equity
Year Ended December 31,
2019
2018
2017
2016
2015
(Dollars in thousands, except per share amounts)
$ 217,850
$ 199,406
$ 147,709
$ 138,512
$ 135,739
18,168
199,682
4,311
32,462
146,788
13,488
67,557
12,413
186,993
5,129
31,618
8,346
6,006
6,120
139,363
132,506
129,619
4,220
35,579
4,931
31,619
4,372
32,268
149,187
110,575
106,473
106,208
11,238
53,057
18,356
41,791
13,803
38,918
13,818
37,489
$
$
1.84
1.83
$
1.49
1.49
$
1.39
1.39
$
1.30
1.30
1.25
1.25
45.9%
48.3%
43.9%
55.4%
42.4%
4.03%
4.15%
3.83%
3.89%
4.04%
4.22
63.23
2.71
1.25
8.56
4.29
68.24
3.00
1.07
7.72
3.93
63.21
2.78
1.05
8.36
3.96
64.87
2.84
1.04
8.01
4.11
65.61
3.01
1.06
8.08
(1) The Tax Act decreased the federal corporate income tax rate from 35% to 21% beginning January 1, 2018 and impacted
the comparability of our results. The results for the year ended December 31, 2017 included a $2.6 million increase to
the income tax expense as a result of the revaluation of our deferred tax assets and liabilities to account for the tax rate
change.
(2) Dividend payout ratio is declared dividends per common share divided by diluted earnings per common share.
(3) Net interest spread is the difference between the average yield on interest earning assets and the average cost of
interest bearing liabilities.
(4) Net interest margin is net interest income divided by average interest earning assets.
(5) The efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.
31
Balance Sheet Data:
Total assets
Total loans receivable, net
Investment securities
Goodwill and other intangible assets
Deposits
Federal Home Loan Bank advances
Junior subordinated debentures
Securities sold under agreement to
repurchase
Stockholders’ equity
Financial Measures:
Book value per common share
Stockholders' equity to assets ratio
Net loans to deposits (1)
Capital Ratios:
Total risk-based capital ratio
Tier 1 risk-based capital ratio
Leverage ratio
Common equity Tier 1 capital to risk-
weighted assets
Asset Quality Ratios:
Nonperforming loans to loans
receivable, net
Allowance for loan losses to loans
receivable, net
Allowance for loan losses to
nonperforming loans
Nonperforming assets to total assets
Net charge-off on loans to average
loans receivable, net
Other Data:
Number of banking offices
Number of full-time equivalent
employees
Deposits per branch
Assets per full-time equivalent
December 31,
2019
2018
2017
2016
2015
(Dollars in thousands)
$5,552,970
$5,316,927
$4,113,270
$3,878,981
$3,650,792
3,731,708
3,619,118
2,816,985
2,609,666
2,372,296
952,312
257,552
976,095
261,553
810,530
125,117
794,645
126,403
811,869
127,818
4,582,676
4,432,402
3,393,060
3,229,648
3,108,287
—
—
20,595
20,302
20,169
809,311
31,487
760,723
92,500
20,009
31,821
508,305
79,600
19,717
22,104
481,763
—
19,424
23,214
469,970
$
22.10
$
20.63
$
16.98
$
16.08
$
15.68
14.6%
82.2%
14.3%
82.4%
12.4%
84.0%
12.4%
81.8%
12.9%
77.3%
12.8%
12.9%
12.8%
13.0%
13.7%
12.0
10.6
11.5
12.1
10.5
11.7
11.8
10.2
11.3
12.0
10.3
11.4
12.7
10.4
12.0
1.18%
0.37%
0.38%
0.41%
0.40%
0.96
81.22
0.82
0.09
0.96
1.13
1.18
1.24
255.73
0.30
299.79
0.26
284.93
0.30
307.67
0.32
0.06
0.12
0.14
0.10
62
64
59
63
67
884
73,914
6,282
859
69,256
6,190
735
57,509
5,596
760
51,264
5,104
717
46,392
5,092
(1) Loans receivable, net of deferred costs divided by deposits.
During the period from December 31, 2015 through December 31, 2019 total assets increased $1.90 billion,
or 52.1%, to $5.55 billion as of December 31, 2019 from $3.65 billion at December 31, 2015. The total loans receivable,
net of allowance for loan losses increased $1.36 billion, or 57.3%, to $3.73 billion as of December 31, 2019 from $2.37
billion at December 31, 2015. Loan increases during the four-year period were attributable primarily to the Premier
and Puget Mergers with a combined fair value of loans acquired of $718.6 million as of the merger dates. The remaining
increase in loans of $640.8 million, or 6.2% annualized growth, was due to organic growth.
Deposits increased $1.47 billion, or 47.4%, to $4.58 billion at December 31, 2019 from $3.11 billion at
December 31, 2015. Deposit increases during the four-year period were attributable primarily to the Premier and Puget
Mergers with a combined fair value of deposits acquired of $824.6 million as of the merger dates. From December 31,
32
2015 to December 31, 2019, non-maturity or core deposits (which we define to include all deposits except certificates
of deposit), including acquired deposits, increased $1.37 billion, or 51.0%, to $4.06 billion at December 31, 2019. The
percentage of certificate of deposit accounts to total deposits decreased to 11.4% at December 31, 2019 from 13.5%
at December 31, 2015.
Stockholders’ equity increased by $339.3 million, or 72.2%, to $809.3 million at December 31, 2019 from
$470.0 million at December 31, 2015 due primarily to a combination of earnings and issuances of common stock for
the Premier and Puget Mergers, partially offset by repurchases of common stock and declarations of cash dividends.
Our net income increased $30.1 million, or 80.2%, to $67.6 million for the year ended December 31, 2019 from $37.5
million for the year ended December 31, 2015 as a result of growth in the Company due primarily to the Premier and
Puget Mergers. Net interest income increased $70.1 million, or 54.1%, to $199.7 million for the year ended
December 31, 2019 from $129.6 million during the year ended December 31, 2015. The increase in net interest income
was primarily a result of an increase in interest income of $82.1 million, or 60.5%, to $217.9 million for the year ended
December 31, 2019 from $135.7 million for the year ended December 31, 2015.The increase in net income was partially
offset by an increase in noninterest expense of $40.6 million, or 38.2%, to $146.8 million for the year ended
December 31, 2019 from $106.2 million for the year ended December 31, 2015 as a result of the growth of the Company
primarily through the Premier and Puget Mergers.
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion is intended to assist in understanding the financial condition and results of operations
of the Company for the year ended December 31, 2019. The information contained in this section should be read with
the December 31, 2019 audited Consolidated Financial Statements and Notes thereto included in Item 8. Financial
Statements And Supplementary Data of this Form 10-K.
This section of this Form 10-K generally discusses 2019 and 2018 items and year-to-year comparisons between
2019 and 2018. Discussions of 2017 items and year-to-year comparisons between 2018 and 2017 that are not included
in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” in Part II, Item 7 of the Company’s Form 10-K for the fiscal year ended December 31, 2018.
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 credit impaired loans, business combinations, other-than-temporary
impairments in the fair value of investments and consideration of potential impairment of goodwill.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged against earnings.
The balance of the allowance for loan losses is maintained at the amount management believes will be appropriate
to absorb probable incurred credit losses in the loan portfolio at the balance sheet date. The allowance for loan losses
is determined by applying estimated loss factors to the credit exposure from outstanding loans.
We assess the estimated credit losses inherent in our loan portfolio by considering a number of elements
including:
•
•
historical loss experience in the loan portfolio;
impact of environmental factors, including:
levels of and trends in delinquencies, classified and impaired loans;
levels of and trends in charge-offs and recoveries;
trends in volume and terms of loans;
effects of changes in risk selection and underwriting standards, and other changes in lending
policies, procedures and practices;
experience, ability, and depth of lending management and other relevant staff;
national and local economic trends and conditions;
other external factors such as competition, legal and regulatory;
33
effects of changes in credit concentrations; and
other factors.
We calculate an appropriate allowance for loan losses for the loans in our loan portfolio by applying historical
loss factors for homogeneous classes of the portfolio, adjusted for changes to the above-noted environmental factors.
We may record a specific allowance for impaired loans, including loans on nonaccrual status and TDR loans, after a
careful analysis of each loan’s credit and collateral factors. Our analysis of an appropriate allowance for loan losses
combines the provisions made for our non-impaired loans and the specific provisions made for each impaired loan.
While we believe we use the best information available to determine the allowance for loan losses, our results
of operations could be significantly affected if circumstances differ substantially from the assumptions used in
determining the allowance. A decline in national and local economic conditions, or other factors, could result in a
material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and
results of operations. In addition, the determination of the amount of the allowance for loan losses is subject to review
by bank regulators, as part of their routine examination process, which may result in the establishment of additional
allowance for loan losses based upon their judgment of information available to them at the time of their examination.
For additional information regarding the allowance for loan losses, its relation to the provision for loan losses,
its risk related to asset quality and lending activity, see “—Results of Operations for the Years Ended December 31,
2019 and 2018—Provision for Loan Losses” and “—Consolidated Financial Condition —Allowance for Loan Losses”
below, Item 1A. Risk Factors—Our allowance for loan losses may prove to be insufficient to absorb losses in our loan
portfolio as well as Note (5) Allowance for Loan Losses of the Notes to Consolidated Financial Statements included
in Item 8. Financial Statements And Supplementary Data.
Estimated Expected Cash Flows related to PCI Loans
Loans purchased in an acquisition with evidence of credit deterioration since origination for which it is probable
that all contractually required payments will not be collected are accounted for under FASB ASC 310-30, Loans and
Debt Securities Acquired with Deteriorated Credit Quality. In situations where such PCI loans have similar risk
characteristics, loans may be aggregated into pools to estimate cash flows. A pool is accounted for as a single asset
with a single interest rate, cumulative loss rate and cash flow expectation.
The cash flows expected over the life of the PCI loan or pool are estimated using an external cash flow model
that projects cash flows and calculates the carrying values, book yields, effective interest income and impairment, if
any, based on loan or pool level events. Assumptions as to default rates, loss severity and prepayment speeds are
utilized to calculate the expected cash flows.
Expected cash flows at the acquisition date in excess of the fair value of loans are considered to be accretable
yield, which is recognized as interest income over the life of the loan or pool using a level yield method if the timing
and amounts of the future cash flows of the loan or pool are reasonably estimable. Subsequent to the acquisition date,
cash flows expected over the life of the PCI loan or pool are estimated quarterly using an external cash flow model
that projects cash flows and calculates the carrying values of the loans or pools, book yields, effective interest income
and impairment, if any, based on loan or pool level events. Any increases in cash flow over those expected at the prior
quarter are recorded as interest income prospectively. Any subsequent decreases in cash flow over those expected
at the prior quarter are recognized by recording an allowance for loan losses. Any disposals of loans in pools, including
sales of loans, payments in full or foreclosures result in the removal of the loan from the loan pool at the carrying
amount and recognition of income if the proceeds from such activity is in excess of the carrying amount removed from
the pool.
Other-Than-Temporary Impairments in the Fair Value of Investments
Unrealized losses on investment securities available for sale are evaluated at least quarterly to determine
whether declines in value should be considered “other than temporary” and therefore be subject to immediate loss
recognition in income. Although these evaluations involve significant judgment, an unrealized loss in the fair value of
a debt security is generally deemed to be temporary when the fair value of the security is below the carrying value
primarily due to changes in interest rates, there has not been significant deterioration in the financial condition of the
issuer, and it is not more likely than not that the Company will be required to sell the security before the anticipated
recovery of its remaining carrying value. Other factors that may be considered in determining whether a decline in the
value of an investment security is “other than temporary” include ratings by recognized rating agencies; actions of
commercial banks or other lenders relative to the continued extension of credit facilities to the issuer of the security;
the financial condition, capital strength and near-term prospects of the issuer and recommendations of investment
34
advisors or market analysts. Therefore, deterioration of market conditions could result in impairment losses recognized
within the investment portfolio.
Goodwill
The Company’s goodwill is assigned to Heritage Bank and is evaluated for impairment at the Heritage Bank
level (reporting unit). Goodwill is reviewed for impairment annually and between annual tests if an event occurs or
circumstances change that might indicate the Company’s recorded value is more than its implied value. Such indicators
may include, among others: a significant adverse change in legal factors or in the general business climate; significant
decline in the Company’s stock price and market capitalization; unanticipated competition; and an adverse action or
assessment by a regulator. Any adverse changes in these factors could have a significant impact on the recoverability
of goodwill and could have a material impact on the Company’s Consolidated Financial Statements.
The goodwill impairment test involves a two-step process. The first test for goodwill impairment is done by
comparing the reporting unit’s aggregate fair value to its carrying value. Absent other indicators of impairment, if the
aggregate fair value exceeds the carrying value, goodwill is not considered impaired and no additional analysis is
necessary. If the carrying value of the reporting unit were to exceed the aggregate fair value, a second test would be
performed to measure the amount of impairment loss, if any. Alternatively, the testing for impairment may begin with
an assessment of qualitative factors to determine whether the existence of events or circumstances leads to a
determination that the fair value of goodwill is less than carrying value. The qualitative assessment includes adverse
events or circumstances identified that could negatively affect the reporting unit's fair value as well as positive and
mitigating events. To measure any impairment loss, the implied fair value would be determined in the same manner
as if the reporting unit were being acquired in a business combination. If the implied fair value of goodwill is less than
the recorded goodwill an impairment charge would be recorded for the difference.
For the year ended December 31, 2019, the Company completed step one of the two-step process of the
goodwill impairment test. Based on the results of the test, the Company concluded that the reporting unit’s fair value
was greater than its carrying value and there was no impairment of goodwill.
For additional information regarding goodwill, see Note (8) Goodwill and Other Intangible Assets of the Notes
to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
Financial Overview
Heritage Financial Corporation is a bank holding company which primarily engages in the business activities
of our wholly-owned financial institution subsidiary, Heritage Bank. We provide financial services to our local
communities with an ongoing strategic focus on our commercial banking relationships, market expansion and asset
quality.
35
Consolidated Financial Condition
The Company’s total assets increased $236.0 million, or 4.4%, to $5.55 billion at December 31, 2019 from
$5.32 billion at December 31, 2018. The increase was primarily due to a $112.6 million, or 3.1%, increase in loans
receivable, net. Total assets also increased due to a $65.6 million, or 66.6%, increase in prepaid expenses and other
assets due primarily to an increase in capital contributions in the Company's investment in LIHTC partnerships totaling
$46.7 million during 2019 and the recognition of $29.8 million in operating lease ROU assets from the adoption of ASU
2016-02, Leases. The Company's investment in LIHTC partnerships increased $41.8 million inclusive of amortization,
or 82.0%, to $92.7 million at December 31, 2019 from $50.9 million at December 31, 2018. As of December 31, 2019,
the Company’s lease ROU assets totaled $23.0 million. Additionally, cash and cash equivalents increased $66.7 million,
or 41.2% to $228.6 million at December 31, 2019 from $161.9 million at December 31, 2018 due to an inflow of deposits
at year-end 2019. The asset balances at December 31, 2019 and 2018 and the changes in those balances are included
in the following table:
December 31,
2019
December 31,
2018
Change 2019
vs. 2018
(Dollars in thousands)
Percent
Change 2019
vs. 2018
Cash and cash equivalents
$
228,568 $
161,910 $
66,658
Investment securities available for sale, at fair value
Loans held for sale
Total loans receivable, net
Other real estate owned
Premises and equipment, net
Federal Home Loan Bank stock, at cost
Bank owned life insurance
Accrued interest receivable
Prepaid expenses and other assets
Other intangible assets, net
Goodwill
Total assets
Investment Activities Overview
952,312
5,533
976,095
1,555
3,731,708
3,619,118
841
87,888
6,377
103,616
14,446
164,129
16,613
240,939
1,983
81,100
6,076
93,612
15,403
98,522
20,614
240,939
(23,783)
3,978
112,590
(1,142)
6,788
301
10,004
(957)
65,607
(4,001)
—
$ 5,552,970 $ 5,316,927 $
236,043
41.2%
(2.4)
255.8
3.1
(57.6)
8.4
5.0%
10.7
(6.2)
66.6
(19.4)
—
4.4%
Our investment policy is established by the Board of Directors and monitored by the Risk 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 is not permitted under the policy.
36
U.S. Treasury and U.S.
Government-sponsored
agencies
Municipal securities
Mortgage-backed securities
and collateralized mortgage
obligations(1):
Residential
Commercial
Collateralized loan
obligations
Investment securities available for sale decreased $23.8 million, or 2.4%, to $952.3 million at December 31,
2019 from $976.1 million at December 31, 2018. The decrease was due primarily to maturities, calls and payments
of investment securities of $242.3 million and sales of investment securities of $44.0 million, offset partially by purchases
of investment securities of $242.8 million and an increase in the fair value of investment securities available for sale,
net of $22.6 million during the year ended December 31, 2019. The following table provides information regarding our
investment securities available for sale at the dates indicated:
December 31, 2019
December 31, 2018
December 31, 2017
Fair Value
% of
Total
Investments
Fair Value
% of
Total
Investments
Fair Value
% of
Total
Investments
(Dollars in thousands)
$ 105,223
133,014
11.0% $ 101,603
158,864
14.0
10.4% $
16.3
13,442
250,015
1.7%
30.8
339,608
327,095
—
35.7
34.4
—
331,602
333,761
—
34.0
34.2
—
280,211
217,079
4,580
24,194
Corporate obligations
Other securities(2)(3)
Total
(1) Issued and guaranteed by U.S. Government-sponsored agencies.
(2) Primarily asset-backed securities issued and guaranteed by U.S. Government-sponsored agencies.
(3) As a result of the adoption of FASB ASU 2016-01 on January 1, 2018, equity investments of $146,000 as of
24,702
100.0% $ 976,095
23,178
$ 952,312
100.0% $ 810,530
28,433
16,770
25,563
2.6
2.5
2.5
2.4
34.5
26.8
0.6
2.1
3.5
100.0%
December 31, 2017 are no longer classified as investment securities available for sale and their presentation is not
comparable to the presentation as of December 31, 2019 and 2018.
37
U.S. Treasury and
U.S.
Government-
sponsored
agencies
Municipal
securities
Mortgage-backed
securities and
collateralized
mortgage
obligations(1):
Residential
The following table provides information regarding our investment securities available for sale, by contractual
maturity, at December 31, 2019.
One Year or Less
Over One to Five
Years
Over Five to Ten
Years
Over Ten Years
Total
Fair
Value
Yield(2)
Fair
Value
Yield(2)
Fair
Value
Yield(2)
Fair
Value
Yield(2)
Fair
Value
Yield(2)
(Dollars in thousands)
$
4,431
2.73% $ 26,739
2.45% $ 44,827
2.94% $ 29,226
2.61% $105,223
2.72%
8,459
3.33
18,588
3.24
34,509
3.31
71,458
3.36
133,014
3.33
Commercial
5,000
2.48
—
—
21,260
86,951
2.76
2.53
62,942
156,372
2.39
2.70
255,406
78,772
2.56
2.76
Corporate
obligations
Other securities(3)
998
—
3.65
—
23,196
2.97
—
—
—
—
—
—
—
—
23,178
2.93
$ 18,888
Total
2.99% $176,734
(1) Issued and guaranteed by U.S. Government-sponsored agencies.
(2) Taxable equivalent weighted average yield.
(3) Primarily asset-backed securities issued and guaranteed by U.S. Government-sponsored agencies.
2.74% $458,040
2.68% $298,650
2.74% $952,312
—
339,608
327,095
24,194
23,178
2.54
2.67
3.00
2.93
2.55%
Lending Activities Overview
The Bank is a full service commercial bank, which originates a wide variety of loans with a focus on commercial
business loans. Total loans receivable, net of allowance for loan losses, increased $112.6 million, or 3.1%, to $3.73
billion at December 31, 2019 from $3.62 billion at December 31, 2018 due primarily to increases in total real estate
construction and land development loans of $61.2 million, or 28.4%, to $276.7 million during the year ended December
31, 2019 and in one-to-four family residential loans of $30.3 million, or 29.8%, to $132.1 million during the year ended
December 31, 2019.
38
The following table provides information about our loan portfolio by type of loan at the dates indicated. These
balances are prior to deduction for the allowance for loan losses.
2019
2018
December 31,
2017
2016
2015
Balance
% of
(2)
Total
Balance
% of
Total(2)
Balance
% of
Total(2)
Balance
% of
(2)
Total
Balance
% of
Total(2)
(Dollars 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
(1)
residential
Real estate
$ 851,834
22.6% $ 853,606
23.4% $ 645,396
22.7% $ 637,773
24.2% $ 596,726
24.8%
806,609
21.4
779,814
21.3
622,150
21.8
558,035
21.1
572,609
23.8
1,291,592
34.3
1,304,463
35.7
986,594
34.6
880,880
33.4
753,986
31.4
2,950,035
78.3
2,937,883
80.4
2,254,140
79.1
2,076,688
78.7
1,923,321
80.0
132,088
3.5
101,763
2.8
86,997
3.1
77,391
2.9
72,548
3.0
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 loans
receivable
Net deferred loan
costs
Loans receivable,
net
104,910
2.8
102,730
2.8
51,985
1.8
50,414
1.9
51,752
2.2
171,777
4.5
112,730
3.1
97,499
3.4
108,764
4.1
55,325
2.3
276,687
406,628
7.3
10.8
215,460
395,545
5.9
10.8
149,484
355,091
5.2
12.5
159,178
325,140
6.0
12.3
107,077
298,167
4.5
12.4
3,765,438
99.9
3,650,651
99.9
2,845,712
99.9
2,638,397
99.9
2,401,113
99.9
2,441
0.1
3,509
0.1
3,359
0.1
2,352
0.1
929
0.1
$3,767,879
100.0% $3,654,160
100.0% $2,849,071
100.0% $2,640,749
100.0% $2,402,042
100.0%
(1) Excludes loans held for sale of $5.5 million, $1.6 million, $2.3 million, $11.7 million, and $7.7 million as of
December 31, 2019, 2018, 2017, 2016 and 2015, respectively.
(2) Percent of total loans receivable, net.
39
The following table presents at December 31, 2019 (i) the aggregate contractual maturities of loans in the
named categories of our loan portfolio and (ii) the aggregate amounts of fixed rate and variable or adjustable rate
loans in the named categories.
Commercial business
One-to-four family residential
Real estate construction and land development
Consumer
Gross loans receivable
Fixed rate loans
Variable or adjustable rate loans (1)
Total
One Year or
Less
Over One to
Five Years
Over Five
Years
Total
Maturing
(In thousands)
$
339,218 $
680,888 $
1,929,929 $
2,950,035
226
99,877
17,022
1,748
37,537
128,083
130,114
139,273
261,523
132,088
276,687
406,628
456,343 $
848,256 $
2,460,839 $
3,765,438
85,968 $
583,184 $
914,728 $
1,583,880
370,375
265,072
456,343 $
848,256 $
1,546,111
2,460,839 $
2,181,558
3,765,438
$
$
$
(1) Includes certain commercial loans in which the Bank entered into non-hedge interest rate swap contracts with the
borrower and a third party. Under these derivative contract arrangements, the Bank effectively earns a variable rate of
interest based on one-month LIBOR plus various margins while the customer pays a fixed rate of interest. At December 31,
2019, the Bank had 60 separate interest rate swap contracts with borrowers with notional value of $221.4 million compared
to 48 separate interest rate swap contracts with borrowers with notional value of $171.8 million at December 31, 2018.
These loans primarily have a maturity of over five years.
40
Nonperforming Assets and Credit Quality Metrics
The following table provides information about our nonaccrual loans, other real estate owned and performing
TDR loans for the indicated dates.
Nonaccrual loans:
Commercial business
One-to-four family residential
Real estate construction and land
development
Consumer
Total nonaccrual loans(1)
Other real estate owned
December 31,
2019
2018
2017
2016
2015
(Dollars in thousands)
$ 44,331
$ 12,564
$
9,098
$
8,580
$
7,122
19
—
186
71
899
169
44,536
841
13,703
1,983
81
94
1,247
277
10,703
—
2,008
227
10,909
754
38
2,414
94
9,668
2,019
Total nonperforming assets
$ 45,377
$ 15,686
$ 10,703
$ 11,663
$ 11,687
Allowance for loan losses
$ 36,171
$ 35,042
$ 32,086
$ 31,083
$ 29,746
Allowance for loan losses to loans
receivable, net
Allowance for loan losses to nonaccrual
loans
Nonperforming loans to loans receivable,
net
Nonperforming assets to total assets
Performing TDR loans:
Commercial business
One-to-four family residential
Real estate construction and land
development
Consumer
0.96%
0.96%
1.13%
1.18%
1.24%
81.22
255.73
299.79
284.93
307.67
1.18
0.82
0.37
0.30
0.38
0.26
0.41
0.30
0.40
0.32
$ 13,663
$ 22,170
$ 25,729
$ 19,837
$ 17,345
198
237
368
208
—
358
218
645
165
227
2,141
83
236
3,014
100
Total performing TDR loans
$ 14,466
$ 22,736
$ 26,757
$ 22,288
$ 20,695
Accruing loans past due 90 days or more
$
— $
— $
— $
— $
Potential problem loans
87,825
101,349
83,543
87,762
—
110,357
(1) At December 31, 2019, 2018, 2017, 2016 and 2015, $26.3 million, $6.9 million, $5.2 million, $6.9 million and $6.3 million
of nonaccrual loans were considered TDR loans, respectively.
Nonaccrual Loans. Nonaccrual loans increased $30.8 million to $44.5 million, or 1.18% of loans receivable,
net, at December 31, 2019 from $13.7 million, or 0.37% of loans receivable, net, at December 31, 2018. The increase
was primarily related to the addition of eight commercial lending relationships totaling $35.7 million which showed
increased signs of cash flow deterioration, including four agricultural business relationships of $28.6 million, of which
a $5.6 million loan was previously classified as a performing TDR loan.
41
The following table reflects the changes in nonaccrual loans during the years ended December 31, 2019 and
2018:
Nonaccrual loans
Balance, beginning of period
Addition of previously classified pass graded loans
Addition of previously classified potential problem loans
Addition of previously classified performing TDR loans
Addition of acquired loans
Charge-offs
Net principal payments
Balance, end of period
Year Ended December 31,
2019
2018
(In thousands)
$
13,703 $
4,621
23,041
11,737
—
(1,948)
(6,618)
$
44,536 $
10,703
5,469
5,319
786
130
(1,027)
(7,677)
13,703
At December 31, 2019, nonaccrual loans of $4.4 million had related allowance for loan losses of $763,000
and nonaccrual loans of $40.1 million had no related allowance for loan losses as the collateral value or the discounted
cash flows was greater than the outstanding loan balance. At December 31, 2018 nonaccrual loans of $9.5 million had
related allowance for loan losses of $1.9 million and nonaccrual loans of $4.2 million had no allowance for loan losses.
At December 31, 2019, nonperforming TDR loans, included in the nonaccrual loan table above, were $26.3
million and had a related allowance for loan losses of $218,000. At December 31, 2018, nonperforming TDR loans
were $6.9 million and had a related allowance for loan losses of $658,000.
The ratio of allowance for loan losses to nonperforming loans decreased to 81.22% at December 31, 2019
compared to 255.73% at December 31, 2018 due primarily to an increase in well-collateralized nonaccrual loans that
had no related allowance for loan losses which increased the balance of nonaccrual loans at end of period without a
proportional increase in related allowance for loan losses.
Nonperforming Assets. Nonperforming assets consist of nonaccrual loans and other real estate owned.
Nonperforming assets increased $29.7 million to $45.4 million, or 0.82% of total assets, at December 31, 2019 from
$15.7 million, or 0.30% of total assets, at December 31, 2018 due primarily to the increase in nonaccrual loans discussed
above. The increase in nonperforming assets was offset partially by a decrease in other real estate owned of $1.1
million, or 57.59%, to $841,000 at December 31, 2019 from $2.0 million at December 31, 2018 due to the sale of three
other real estate owned properties during the year ended December 31, 2019.
Troubled Debt Restructured Loans. TDR loans are considered impaired and are separately measured for
impairment whether on accrual or nonaccrual status. Performing TDR loans are not considered nonperforming assets
as they continue to accrue interest despite being considered impaired due to the restructured status. Our performing
TDR loans decreased $8.3 million, or 36.4%, to $14.5 million at December 31, 2019 from $22.7 million at December 31,
2018. The decrease was due primarily to net principal payments and transfers to nonaccrual status, including the
transfer of one agricultural business relationship of $5.6 million previously discussed. The decrease was partially offset
by the addition of TDR loans as a result of extending maturities on five commercial lending relationships totaling $12.3
million, including $5.1 million related to agricultural borrowers and $4.2 million due to a modification of payment terms
on one commercial lending relationship, which showed signs of cash flow deterioration.
42
The following table reflects the changes in performing TDR loans during the years ended December 31, 2019
and 2018:
Performing TDR loans
Balance, beginning of period
Addition of previously classified pass graded loans
Addition of previously classified potential problem loans
Transfers of loans to nonaccrual status
Charge-offs
Net principal payments
Balance, end of period
Year Ended December 31,
2019
2018
(In thousands)
$
22,736 $
6,848
9,417
(11,737)
(220)
(12,578)
$
14,466 $
26,757
2,165
9,651
(786)
—
(15,051)
22,736
The related allowance for loan losses on performing TDR loans was $1.3 million as of December 31, 2019
and $2.3 million as of December 31, 2018.
Potential Problem Loans. Potential problem loans decreased $13.5 million, or 13.3%, to $87.8 million at
December 31, 2019 from $101.3 million at December 31, 2018. The decrease was primarily attributed to net principal
payments, including loans paid in full of $20.3 million and the significant pay down of four commercial lines of credit
totaling $6.3 million. Potential problem loans also decreased as a result of transfers of loans to nonaccrual and TDR
status, including $11.3 million related to a $20.0 million agricultural business relationship transferred to nonaccrual
status, and upgrades of $17.2 million of loans as a result of active management of potential problem loans. Offsetting
these decreases in potential problem loans was the addition of previously classified pass graded loans of $69.7 million.
The risk rating downgrade of these relationships will enhance the Company's monitoring of these credits. The following
table reflects the changes in potential problem loans during the years ended December 31, 2019 and 2018:
Potential problem loans
Balance, beginning of period
Addition of previously classified pass graded loans
Acquired in Premier and Puget Mergers
Net principal payments
Upgrades to pass graded loan status
Transfers of loan to nonaccrual and troubled debt restructured status
Charge-offs
Balance, end of period
Year Ended December 31,
2019
2018
(In thousands)
$
101,349 $
69,745
—
(33,117)
(17,184)
(32,458)
(510)
83,543
59,238
18,869
(28,184)
(16,746)
(14,970)
(401)
$
87,825 $
101,349
43
Analysis of Allowance for Loan Losses
The following table provides information regarding changes in our allowance for loan losses at and for the
indicated years:
Allowance for loan losses at
beginning of the year
Provision for loan losses
Charge-offs:
Commercial business
One-to-four family residential
Real estate construction and
land development
Consumer
Total charge-offs
Recoveries:
Commercial business
One-to-four family residential
Real estate construction and
land development
Consumer
Total recoveries
Net charge-offs
Allowance for loan losses at end
of the year
Gross loans receivable at end of
the year (1)
Average total loans receivable,
net during the year (1)(2)
Net charge-offs on loans to
average loans receivable
At or For the Years Ended December 31,
2019
2018
2017
2016
2015
(Dollars in thousands)
$
35,042
$
32,086
$
31,083
$
29,746
$
27,729
4,311
5,129
4,220
4,931
4,372
(2,692)
(60)
(133)
(2,104)
(4,989)
657
—
637
513
(1,400)
(45)
—
(2,160)
(3,605)
908
—
11
513
(2,438)
(30)
(556)
(1,814)
(4,838)
947
2
202
470
1,807
(3,182)
1,432
(2,173)
1,621
(3,217)
(4,153)
—
(154)
(1,778)
(6,085)
1,844
2
83
562
2,491
(3,594)
(1,676)
—
(106)
(1,700)
(3,482)
476
13
100
538
1,127
(2,355)
$
36,171
$
35,042
$
32,086
$
31,083
$
29,746
$ 3,765,438
$ 3,650,651
$ 2,845,712
$ 2,638,397
$ 2,401,113
3,668,665
3,414,424
2,703,934
2,489,730
2,316,175
0.09%
0.06%
0.12%
0.14%
0.10%
(1) Excludes loans held for sale.
(2) The average loan balances presented in the table are net of net deferred costs and allowances for loan losses.
Nonaccrual loans have been included in the table as loans carrying a zero yield.
44
The following table shows the allocation of the allowance for loan losses at the indicated dates. The allocation
is based upon an evaluation of defined loan problems, historical loan loss ratios, and industry-wide and other factors
that affect loan losses in the categories shown below:
December 31,
2019
2018
2017
2016
2015
Allowance
for Loan
Losses
% of
Total (1)
Allowance
for Loan
Losses
% of
Total (1)
Allowance
for Loan
Losses
% of
Total (1)
(Dollars in thousands)
Allowance
for Loan
Losses
% of
Total (1)
Allowance
for Loan
Losses
% of
Total (1)
$ 23,933
78.3% $ 23,711
80.5% $ 21,999
79.1% $ 22,382
78.8% $ 22,064
80.1%
1,458
3.5
1,203
2.8
1,056
3.1
1,015
2.9
1,157
3.0
3,060
6,821
899
7.4
10.8
—
2,194
6,581
1,353
5.9
10.8
—
2,052
6,081
898
5.3
12.5
—
2,156
5,024
506
6.0
12.3
—
1,871
4,309
345
4.5
12.4
—
$ 36,171
100.0% $ 35,042
100.0% $ 32,086
100.0% $ 31,083
100.0% $ 29,746
100.0%
Commercial
business
One-to-four
family
residential
Real estate
construction
Consumer
Unallocated
Total
allowance
for loan
losses
(1) Represents the percent of loans receivable by loan category to total gross loans receivable.
The allowance for loan losses increased $1.1 million, or 3.2%, to $36.2 million at December 31, 2019 from
$35.0 million at December 31, 2018. The increase was the result of provision for loan losses of $4.3 million offset
partially by net charge-offs of $3.2 million recorded during the year ended December 31, 2019. The allowance for loan
losses to loans receivable, net, was 0.96% at both December 31, 2019 and 2018. The remaining net discount on
purchased loans was $8.4 million at December 31, 2019 compared to $11.8 million at December 31, 2018.
The Company recorded charge-offs of $5.0 million during the year ended December 31, 2019 due primarily
to commercial and industrial loan charge-offs of $2.7 million, including $1.7 million related to agricultural business
relationships, and secondarily due to a large volume of small charge-offs on consumer loans. The Company recorded
recoveries of $1.8 million during the year ended December 31, 2019, primarily due to a recovery of a residential
construction loan of $602,000 as a result of a bankruptcy resolution and small recoveries on a large volume of small
dollar consumer loans of $513,000.
As of December 31, 2019, the Bank identified $42.5 million of nonperforming loans, excluding PCI loans, $14.2
million of performing TDR loans, excluding PCI loans, and other loans with a specific valuation allowance of $807,000
for a total of $57.5 million of impaired loans. Of these impaired loans, $39.7 million had no allowances for loan losses
as their estimated collateral value or discounted expected cash flow is equal to or exceeds their carrying costs. The
remaining $17.8 million of impaired loans had related allowances for loan losses totaling $2.1 million. As of
December 31, 2018, the Bank identified $13.7 million of nonperforming loans, excluding PCI loans, and $22.7 million
of performing TDR loans, excluding PCI loans, for a total of $36.4 million of impaired loans. Of these impaired loans,
$7.6 million had no allowances for loan losses as their estimated collateral value or discounted expected cash flow is
equal to or exceeds their carrying costs. The remaining $28.8 million of impaired loans had related allowances for loan
losses totaling $4.2 million.
45
The following table outlines the allowance for loan losses and related outstanding loan balances on loans at
December 31, 2019 and 2018:
General Valuation Allowance:
Allowance for loan losses
Gross loans, excluding PCI and impaired loans
Percentage
PCI Allowance:
Allowance for loan losses
Gross PCI loans
Percentage
Specific Valuation Allowance:
Allowance for loan losses
Gross impaired loans
Percentage
Total Allowance for Loan Losses:
Allowance for loan losses
Gross loans receivable
Percentage
December 31, 2019
December 31, 2018
(Dollars in thousands)
31,759
$
3,689,834
0.86%
27,854
3,589,305
0.78%
2,269
$
18,113
12.53%
2,143
$
57,491
3.73%
3,018
24,907
12.12%
4,170
36,439
11.44%
36,171
$
3,765,438
0.96%
35,042
3,650,651
0.96%
$
$
$
$
Based on the Bank's established comprehensive methodology, management deemed the allowance for loan
losses of $36.2 million at December 31, 2019 (0.96% of loans receivable, net and 81.22% of nonperforming loans)
appropriate to provide for probable incurred credit losses based on an evaluation of known and inherent risks in the
loan portfolio at that date. This compares to an allowance for loan losses at December 31, 2018 of $35.0 million (0.96%
of loans receivable, net and 255.73% of nonperforming loans).
While we believe we use the best information available to determine the allowance for loan losses, our results
of operations could be significantly affected if circumstances differ substantially from the assumptions used in
determining the allowance. A decline in national and local economic conditions, or other factors, could result in a
material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and
results of operations. In addition, the 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 an additional
allowance for loan losses based upon their judgment of information available to them at the time of their examination.
Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance
that the existing allowance for loan losses is appropriate or that increased provisions will not be necessary should
there be deterioration in the quality of the loans. Any material increase in the allowance for loan losses would adversely
affect the Company’s financial condition and results of operations.
Deposits and Other Borrowings Overview
Total deposits increased $150.3 million, or 3.4%, to $4.58 billion at December 31, 2019 from $4.43 billion at
December 31, 2018 due primarily to an increase in noninterest bearing demand deposits of $84.2 million, or 6.2%, to
$1.45 billion at December 31, 2019 from $1.36 billion at December 31, 2018 and an increase in certificates of deposit
accounts of $57.7 million, or 12.4%, to $524.6 million at December 31, 2019 from $466.9 million at December 31,
2018. Brokered certificates of deposit decreased $25.6 million, or 91.1%, to $2.5 million at December 31, 2019 from
$28.1 million at December 31, 2018. Non-maturity deposits as a percentage of total deposits decreased to 88.6% at
December 31, 2019 from 89.5% at December 31, 2018 and the percentage of certificates of deposit to total deposits
increased to 11.4% at December 31, 2019 from 10.5% at December 31, 2018 due to customer demand of higher-
paying certificates of deposit during the year ended December 31, 2019.
46
The following table provides the balances outstanding for each major category of deposits at the dates indicated:
December 31, 2019
December 31, 2018
December 31, 2017
Amount
Percent of
Total
Amount
Percent of
Total
Amount
Percent of
Total
(Dollars in thousands)
Noninterest demand deposits
$1,446,502
31.6% $1,362,268
30.7% $ 944,791
27.8%
Interest bearing demand
deposits
Money market accounts
Savings accounts
Total non-maturity deposits
Certificate of deposit accounts
Total deposits
1,348,817
753,684
509,095
4,058,098
524,578
$4,582,676
29.4
16.4
11.2
88.6
11.4
1,317,513
765,316
520,413
3,965,510
466,892
29.7
17.3
11.8
89.5
10.5
1,051,752
499,618
498,501
2,994,662
398,398
31.1
14.7
14.7
88.3
11.7
100.0% $4,432,402
100.0% $3,393,060
100.0%
The following table provides the average balances outstanding and the weighted average interest rates for
each major category of deposits for the years indicated:
Year Ended December 31,
2019
2018
2017
Average
Balance
Average
Yield/Rate
Average
Balance
Average
Yield/Rate
Average
Balance
Average
Yield/Rate
(Dollars in thousands)
$ 2,052,573
506,073
512,732
0.33% $ 1,916,319
0.23% $ 1,498,619
0.52
1.37
513,680
463,124
0.40
0.85
499,435
378,044
3,071,378
0.53
2,893,123
0.36
2,376,098
1,389,721
$ 4,461,099
—
1,240,621
—
902,716
0.37% $ 4,133,744
0.25% $ 3,278,814
0.17%
0.26
0.59
0.25
—
0.18%
Interest bearing demand
deposits and money
market accounts
Savings accounts
Certificate of deposit
accounts
Total interest bearing
deposits
Noninterest demand
deposits
Total deposits
The following table shows the amount and maturity of certificate of deposit accounts of $100,000 or more:
Remaining maturity:
Three months or less
Over three months through six months
Over six months through twelve months
Over twelve months
Total
December 31, 2019
(In thousands)
$
$
70,819
89,280
148,811
48,751
357,661
Borrowings may be used on a short-term basis to compensate for reductions in other sources of funds (such
as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support
expanded lending activities and match the maturity of repricing intervals of interest earning assets. The Bank also
utilizes securities sold under agreement to repurchase as a supplement to its funding sources. Our securities sold
under agreement to repurchase are secured by available for sale investment securities. At December 31, 2019, the
Bank had securities sold under agreement to repurchase of $20.2 million, a decrease of $11.3 million, or 35.9%, from
$31.5 million at December 31, 2018. The decrease was the result of customer activity during the period.
The Company also has junior subordinated debentures with a par value of $25.0 million which pay quarterly
interest based on three-month LIBOR plus 1.56%. The debentures mature in 2037. The balance of the junior
47
subordinated debentures was $20.6 million at December 31, 2019, which reflects the fair value of the junior subordinated
debentures established during the Washington Banking Merger, adjusted for the accretion of discount from purchase
accounting fair value adjustment.
At December 31, 2019, the Bank maintained credit facilities with the FHLB for $945.2 million and credit facilities
with the Federal Reserve Bank for $73.1 million. The Company had no FHLB advances outstanding at both the years
ended December 31, 2019 and 2018. The average cost of the FHLB advances during the years ended December 31,
2019 and 2018 was 2.56% and 1.98%, respectively. The Bank also maintains lines of credit with five correspondent
banks to purchase federal funds totaling $140.0 million as of December 31, 2019. There were no federal funds
purchased as of December 31, 2019 or December 31, 2018.
Off-Balance Sheet Arrangements
In the ordinary course of business, we enter into various types of transactions that include commitments to
extend credit that are not included in our Consolidated Financial Statements. We apply the same credit standards to
these commitments as we use in all our lending activities and have included these commitments in our lending risk
evaluations. Our exposure to credit loss under commitments to extend credit is represented by the amount of these
commitments. The Company had off-balance sheet loan commitments, including letters of credit, aggregating $1.21
billion at December 31, 2019, an increase of $222.3 million, or 22.5%, from $990.0 million at December 31, 2018. For
additional information, see Note (15) Commitments and Contingencies included in Item 8. Financial Statements And
Supplementary Data.
Stockholders' Equity and Regulatory Capital Requirements Overview
Stockholders’ equity at December 31, 2019 was $809.3 million compared to $760.7 million at December 31,
2018. The changes to stockholders' equity during the years ended December 31, 2019 and 2018 are as follows:
Balance, beginning of period
Effects of implementation of accounting change related to operating leases
Common stock issued in the Premier and Puget Mergers
Net income
Dividends declared
Common stock repurchased
Other comprehensive income (loss), net
Other
Balance, end of period
Year Ended December 31,
2019
2018
(In thousands)
$
760,723 $
508,305
(399)
—
67,557
(31,056)
(8,636)
17,833
3,289
—
230,043
53,057
(25,791)
(1,704)
(6,064)
2,877
$
809,311 $
760,723
The Company has historically paid cash dividends to its common shareholders. Payments of future cash
dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including
our business, operating results and financial condition, capital requirements, current and anticipated cash needs, plans
for expansion, any legal or contractual limitation on our ability to pay dividends and other relevant factors. Dividends
on common stock from the Company depend substantially upon receipt of dividends from the Bank, which is the
Company’s predominant source of income. On January 22, 2020, the Company’s Board of Directors declared a regular
quarterly dividend of $0.20 per common share payable on February 20, 2020 to shareholders of record on February 6,
2020.
Dividends paid per common share
Dividend payout ratio (1)
Year Ended December 31,
2019
2018
2017
$
0.84
$
0.72
$
45.9%
48.3%
0.61
43.9%
(1) Dividend payout ratio is declared dividends per common share divided by diluted earnings per common share.
48
The Company is a bank holding company under the supervision of the Federal Reserve Bank. Bank holding
companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company
Act of 1956, as amended, and the regulations of the Federal Reserve. The Bank is a federally insured institution and
thereby is subject to the capital requirements established by the FDIC. The Federal Reserve capital requirements
generally parallel the FDIC requirements. Failure to meet minimum capital requirements can initiate certain mandatory,
and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on
the Company’s consolidated financial statements and operations. Management believes as of December 31, 2019,
the Company and the Bank met all capital adequacy requirements to which they are subject. For additional information
regarding the Company’s and the Bank’s regulatory capital requirements, see “Supervision and Regulation-Capital
Adequacy” in Item 1. Business and Note (23) Regulatory Capital Requirements included in Item 8. Financial Statements
And Supplementary Data.
Average Balances, Yields and Rates Paid for the Years Ended December 31, 2019, 2018 and 2017
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 interest expense, which consists of interest paid on deposits
and borrowed funds. Like most financial institutions, our interest income and interest expense 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:
Year Ended December 31,
2019
Interest
Earned/
Paid
Average
Balance
Average
Yield/
Rate
Average
Balance
2018
Interest
Earned/
Paid
Average
Yield/
Rate
Average
Balance
2017
Interest
Earned/
Paid
Average
Yield/
Rate
(Dollars in thousands)
Interest Earning Assets:
Total loans receivable, net (1) (2) $ 3,668,665
Taxable securities
827,822
Nontaxable securities (2)
135,245
Other interest earning assets
98,153
$ 189,515
5.17% $ 3,414,424
$ 175,466
5.14% $ 2,703,934
$ 129,213
4.78%
23,045
3,396
1,894
2.78
2.51
1.93
677,893
190,209
76,117
17,602
4,649
1,689
2.60
2.44
2.22
570,969
226,934
45,949
12,688
5,269
539
2.22
2.32
1.17
Total interest earning assets
4,729,885
217,850
4.61% 4,358,643
199,406
4.57% 3,547,786
147,709
4.16%
Noninterest earning assets
Total assets
681,193
$ 5,411,078
615,372
$ 4,974,015
433,566
$ 3,981,352
Interest Bearing Liabilities:
Certificate of deposits
Savings accounts
Interest bearing demand and
money market accounts
Total interest bearing
deposits
Junior subordinated
debentures
Securities sold under
agreement to repurchase
FHLB advances and other
borrowings
$ 512,732
$
7,021
1.37% $ 463,124
$
3,959
0.85% $ 378,044
$
2,244
0.59%
506,073
2,633
0.52
513,680
2,056
0.40
499,435
1,311
0.26
2,052,573
6,695
0.33
1,916,319
4,382
0.23
1,498,619
2,494
0.17
3,071,378
16,349
0.53
2,893,123
10,397
0.36
2,376,098
6,049
0.25
20,438
1,339
6.55
20,145
1,263
6.27
19,860
1,014
5.11
28,457
175
0.61
31,426
82
0.26
25,434
57
0.22
Total interest bearing liabilities
3,132,172
18,168
0.58% 2,978,608
12,413
0.42% 2,527,040
11,899
305
2.56
33,914
671
1.98
105,648
1,226
8,346
1.16
0.33%
Demand and other noninterest
bearing deposits
1,389,721
Other noninterest bearing
liabilities
Stockholders’ equity
99,683
789,502
Total liabilities and stock-
holders’ equity
$ 5,411,078
Net interest income
Net interest spread
Net interest margin
Average interest earning
1,240,621
67,692
687,094
902,716
51,820
499,776
$ 199,682
$ 186,993
$ 139,363
$ 4,974,015
$ 3,981,352
4.03%
4.22%
4.15%
4.29%
3.83%
3.93%
assets to average interest
bearing liabilities
140.39%
(1) The average loan balances presented in the table are net of net deferred costs and allowances for loan losses. Nonaccrual
146.33%
151.01%
loans have been included in the table as loans carrying a zero yield.
(2) Yields on tax-exempt securities and loans have not been stated on a tax-equivalent basis.
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,
2019 Compared to 2018
Increase (Decrease) Due to
2018 Compared to 2017
Increase (Decrease) Due to
Volume
Rate
Total
Volume
Rate
Total
(Dollars in thousands)
$
$
$
Interest Earning Assets:
Total loans receivable, net (1)
Taxable securities
Nontaxable securities
Other interest earning assets
Total interest income
Interest Bearing Liabilities:
Certificate of deposit accounts
Savings accounts
Interest bearing demand and
money market accounts
Total interest bearing deposits
Junior subordinated debentures
Securities sold under
agreement to repurchase
FHLB advances and other
borrowings
Total interest expense
$
13,134
$
915
$
14,049
$
36,512
$
9,741
$
4,174
(1,380)
425
1,269
127
(220)
5,443
(1,253)
205
2,776
(898)
651
2,138
278
452
16,353
$
2,091
$
18,444
$
39,041
$
12,609
$
680
$
(40)
444
1,084
19
(18)
(564)
521
$
2,382
$
3,062
$
727
$
617
1,869
4,868
57
111
198
577
2,313
5,952
76
93
57
955
1,739
18
16
(366)
(1,419)
$
988
688
933
2,609
231
9
864
5,234
$
5,755
$
354
$
3,713
$
46,253
4,914
(620)
1,103
51,650
1,715
745
1,888
4,348
249
25
(555)
4,067
Net Interest Income
47,583
(1) The average loan balances utilized in the table are net of net deferred costs and allowances for loan losses. Nonaccrual
(3,143) $
38,687
15,832
12,689
8,896
$
$
$
$
$
loans carry a zero yield.
Earnings Summary
Results of Operations for the Years Ended December 31, 2019 and 2018
Net income was $67.6 million, or $1.83 per diluted common share, for the year ended December 31, 2019
compared to $53.1 million, or $1.49 per diluted common share, for the year ended December 31, 2018. Net income
increased $14.5 million, or 27.3%, for the year ended December 31, 2019 compared to the year ended December 31,
2018 primarily due to an increase in net interest income of $12.7 million, or 6.8%, and a decrease in noninterest
expense of $2.4 million, or 1.6%. The increase in net interest income and the decrease in noninterest expense during
the year ended December 31, 2019 compared to the year ended December 31, 2018 were primarily the result of the
full year impact of the Premier Merger and a significant reduction in acquisition-related expenses related to the Premier
and Puget Mergers.
The net interest margin decreased seven basis points to 4.22% for the year ended December 31, 2019
compared to 4.29% for the year ended December 31, 2018. The decrease in net interest margin was primarily due to
increases in the cost of total interest bearing liabilities and a change in the mix of interest earning assets to lower
yielding assets as a percentage of total assets, offset partially by an increase in the average loan balance.
The Company’s efficiency ratio was 63.23% for the year ended December 31, 2019 compared to 68.24% for
the year ended December 31, 2018. The improvement in the efficiency ratio for the year ended December 31, 2019
compared to the year ended December 31, 2018 was primarily attributable to lower acquisition-related expenses
included in noninterest expense as a result of the Premier and Puget Mergers completed during the year ended
December 31, 2018.
Net Interest Income Overview
One of the Company's key sources of earnings is net interest income. There are several factors that affect net
interest income including, but not limited to, the volume, pricing, mix and maturity of interest earning assets and interest
51
bearing liabilities; the volume of noninterest bearing deposits and other liabilities and stockholders' equity; the volume
of noninterest earning assets; market interest rate fluctuations; and asset quality. Net interest income increased $12.7
million, or 6.8%, to $199.7 million for the year ended December 31, 2019 compared to $187.0 million for the year
ended December 31, 2018. The increase in net interest income was primarily due to an increase in average interest
earning assets, which increased substantially as a result of the full year impact of the Premier Merger, offset partially
by an increase in the average cost of total interest bearing liabilities which outpaced the increase in the average yield
on total interest earning assets as a result of higher interest rates during the year ended December 31, 2019 compared
to the year ended December 31, 2018. The effect of changes in the targeted Fed Funds rate on the cost of interest
bearing liabilities typically lags the effect on the yield earned on interest earning assets because rates on many deposit
accounts are decision-based, are not tied to a specific market-based index, and are based on competition for deposits,
while most interest earning assets adjust earlier because they are tied to a specific market-based index.
Interest Income
Total interest income increased $18.4 million, or 9.2%, to $217.9 million for the year ended December 31,
2019 compared to $199.4 million for the year ended December 31, 2018. The balance of average interest earning
assets increased $371.2 million, or 8.5%, to $4.73 billion for the year ended December 31, 2019 from $4.36 billion for
the year ended December 31, 2018 and the yield on total interest earning assets increased four basis points to 4.61%
for the year ended December 31, 2019 compared to 4.57% for the year ended December 31, 2018. The increase in
the interest income was due primarily to interest income from interest and fees on loans and secondarily due to interest
income on investment securities.
Interest income from interest and fees on loans increased $14.0 million, or 8.0%, to $189.5 million for the year
ended December 31, 2019 from $175.5 million for the year ended December, 31, 2018 due primarily to increases in
average loans receivable, net and secondarily to increases in loan yield. Average total loans receivable, net increased
$254.2 million, or 7.4%, to $3.67 billion for the year ended December 31, 2019 compared to $3.41 billion for the year
ended December 31, 2018 primarily as a result of the full year impact of the Premier Merger. Loan yields increased
three basis points to 5.17% for the year ended December 31, 2019 from 5.14% for the year ended December 31, 2018
due to a combination of higher contractual loan rates as a result of the interest rate environment during 2019. Market
interest rates were higher for a longer period of time during the year ended December 31, 2019 compared to 2018 as
the interest rates on adjustable rate instruments decreased reflecting three separate 25 basis point reductions in the
targeted Fed Funds rate during the second half of 2019 compared to four separate 25 basis point increases in the
targeted Fed Funds rate during the year ended December 31, 2018. The increase in interest income from loans was
partially offset by a four basis point decrease in loans yield as a result of the impact of nonaccrual loan activity.
Incremental accretion income was $4.9 million and $8.0 million for the years ended December 31, 2019 and
2018, respectively. The impact on loan yield from incremental accretion on purchased loans was 0.13% and 0.23%
for the years ended December 31, 2019 and 2018. The decrease in the incremental accretion and its impact on yield
was primarily due to the decrease in accretion of the loans acquired in the Premier and Puget Mergers. The incremental
accretion and the impact to loan yield will change during any quarter based on the volume of prepayments, but is
expected to decrease over time as the balance of the purchased loans continues to decrease.
52
The following table presents a reconciliation of the loan yield calculated in accordance with GAAP to the loan
yield excluding the effect of the incremental accretion on purchased loans for the year ended December 31, 2019 and
2018:
Yield non-GAAP reconciliations: (2)
Loan yield (GAAP)
Impact on loan yield from incremental accretion on purchased loans (1)
Loan yield, excluding incremental accretion on purchased loans (non-
GAAP) (1) (2)
Year Ended December 31,
2019
2018
(Dollars in thousands)
5.17 %
(0.13)%
5.14 %
(0.23)%
5.04 %
4.91 %
Incremental accretion on purchased loans (1)
$
4,876
$
7,964
(1) As of the date of completion of each merger and acquisition transaction, purchased loans were recorded at their estimated
fair value, including our estimate of future expected cash flows until the ultimate resolution of these credits. The difference
between the contractual loan balance and the fair value represents the purchased discount. The purchased discount is
accreted into income over the estimated remaining life of the loan or pool of loans, based upon results of the quarterly
cash flow re-estimation. The incremental accretion income represents the amount of income recorded on the purchased
loans in excess of the contractual stated interest rate in the individual loan notes.
(2) For additional information, see "Non-GAAP Financial Information."
Interest income on investment securities increased $4.1 million, or 18.8%, to $26.4 million during the year
ended December 31, 2019 compared to $22.3 million for the year ended December 31, 2018. The increase in interest
income on investment securities was the result of a combination of increases in both the average balance and investment
yields for investment securities for the year ended December 31, 2019 compared to the prior year. The average balance
of investment securities increased $95.0 million, or 10.9%, to $963.1 million during the year ended December 31, 2019
from $868.1 million during the year ended December 31, 2018. Yields on taxable securities increased 18 basis points
to 2.78% for the year ended December 31, 2019 compared to 2.60% for the year ended December 31, 2018. Yields
on nontaxable securities increased seven basis points to 2.51% for the year ended December 31, 2019 from 2.44%
for the prior year. The Company continued to reduce the balance of its tax exempt securities during the year ended
December 31, 2019 compared to the year ended December 31, 2018 as holding tax exempt securities was not as
beneficial given the decrease in the federal corporate income tax rate as a result of the Tax Act commencing in 2018.
The Company has actively managed its investment securities portfolio to improve performance in the fluctuating rate
environment.
Income on other interest earning assets increased $205,000, or 12.1%, to $1.9 million during the year ended
December 31, 2019 compared to $1.7 million during the prior year due to an increase in the average balance, offset
partially by a decrease in the yield. Average other interest earning assets increased $22.1 million, or 29.0%, to $98.2
million for the year ended December 31, 2019 compared to $76.1 million for the year ended December 31, 2018. The
increase was primarily the result of an increase in interest earning deposits compared to the average during the year
ended December 31, 2018, as the Bank experienced an increase in interest bearing deposits due to organic growth.
The yield on other interest earning assets decreased 29 basis points to 1.93% during the year ended December 31,
2019 compared to 2.22% during the year ended December 31, 2018, reflecting a decrease in market rates during the
periods in which the Bank held the highest amounts of its interest earning deposits.
Interest Expense
Total interest expense increased $5.8 million, or 46.4%, to $18.2 million for the year ended December 31,
2019 compared to $12.4 million for the prior year due primarily to an increase in the cost of funds. The cost of total
interest bearing liabilities increased 16 basis points to 0.58% for the year ended December 31, 2019 from 0.42% for
the year ended December 31, 2018 primarily as a result of the full year impact in 2019 of steadily rising interest rates
throughout 2018, and the lag in the decrease in costs when market rates decreased in the second half of 2019. The
increase in interest expense was secondarily due to an increase in the total average interest bearing liabilities of $153.6
million, or 5.2%, to $3.13 billion for the year ended December 31, 2019 from $2.98 billion for the year ended December
31, 2018, primarily as a result of the full year impact from liabilities assumed in the Premier Merger.
Interest expense on certificates of deposits increased $3.1 million, or 77.34%, to $7.0 million for the year ended
December 31, 2019 from $4.0 million for the year ended December 31, 2018 due primarily to an increase in the cost
53
of certificates of deposit of 52 basis points to 1.37% for the year ended December 31, 2019 from 0.85% in the prior
year as a result of competitive pressure.
The Company was able to reduce the impact of the increase in the cost of interest bearing deposits by increasing
the average balance of noninterest bearing deposits. The average balance of noninterest bearing deposits increased
by $149.1 million, or 12.0%, during the year ended December 31, 2019 to $1.39 billion from $1.24 billion for the year
ended December 31, 2018. The total cost of deposit accounts increased 12 basis points to 0.37% for the year ended
December 31, 2019 compared to 0.25% for the year ended December 31, 2018.
Interest expense on FHLB advances and other borrowings decreased $366,000, or 54.5%, to $305,000 for
the year ended December 31, 2019 from $671,000 for the year ended December 31, 2018 due to a decrease in the
average balance, partially offset by an increase in the cost. The average balance for FHLB advances and other
borrowings decreased $22.0 million to $11.9 million for the year ended December 31, 2019 from $33.9 million for 2018.
The average rate of the FHLB advances and other borrowings increased 58 basis points to 2.56% for the year ended
December 31, 2019 compared to 1.98% for 2018 as a result of the increase in market rates during the months in which
the Bank had outstanding balances.
The cost of the junior subordinated debentures, including the effects of accretion of the discount established
as of the date of the merger with Washington Banking Company, increased 28 basis points to 6.55% for the year ended
December 31, 2019 compared to 6.27% for 2018. The increase on the cost of debentures was due primarily to an
increase in the average three-month LIBOR rate, the index rate upon which these instruments are based.
Net Interest Margin
Net interest margin for the year ended December 31, 2019 decreased seven basis points to 4.22% from 4.29%
for the prior year primarily due to the above mentioned changes in asset mix, yield, and costs of funds. The net interest
spread for the year ended December 31, 2019 decreased 12 basis points to 4.03% from 4.15% for the year ended
December 31, 2018 primarily due to the increase in the cost of funds.
Net interest margin is impacted by the incremental accretion on purchased loans. The following table presents
a reconciliation of the net interest margin calculated in accordance with GAAP to the net interest margin excluding the
effect of the incremental accretion on purchased loans for the year ended December 31, 2019 and 2018:
Net interest margin (GAAP)
Impact on net interest margin from incremental accretion on purchased
loans(1)
Year Ended December 31,
2019
2018
4.22 %
4.29 %
(0.10)%
(0.18)%
Net interest margin, excluding incremental accretion on purchased loans
(non-GAAP)(1)(2)
4.11 %
(1) As of the date of completion of each merger and acquisition transaction, purchased loans were recorded at their estimated
fair value, including our estimate of future expected cash flows until the ultimate resolution of these credits. The difference
between the contractual loan balance and the fair value represents the purchased discount. The purchased discount is
accreted into income over the estimated remaining life of the loan or pool of loans, based upon results of the quarterly
cash flow re-estimation. The incremental accretion income represents the amount of income recorded on the purchased
loans in excess of the contractual stated interest rate in the individual loan notes.
(2) For additional information, see "Non-GAAP Financial Information."
4.12 %
Provision for Loan Losses Overview
The Bank has established a comprehensive methodology for determining its allowance for loan losses. The
allowance for loan losses is increased by provisions for loan losses charged to expense, and is reduced by loans
charged-off, net of loan recoveries or a recovery of previous provision. The amount of the provision expense recognized
during the years ended December 31, 2019 and 2018 was calculated in accordance with the Bank's methodology. For
additional information, see “—Critical Accounting Policies” above.
The provision for loan losses is dependent on the Bank’s ability to manage asset quality and control the level
of net charge-offs through prudent underwriting standards. In addition, a decline in general economic conditions could
increase future provisions for loan losses and have a material effect on the Company’s net income.
The provision for loan losses decreased $818,000, or 15.9% to $4.3 million for the year ended December 31,
2019 from $5.1 million for the year ended December 31, 2018. The decrease in the provision for loan losses for the
54
year ended December 31, 2019 from the prior year was primarily due to a decrease in specific reserves on loans that
are individually evaluated for impairment of $2.0 million to $2.1 million at December 31, 2019 from $4.2 million at
December 31, 2018, offset partially by an increase in net charge offs of $1.0 million. The Bank recorded net charge
offs of $3.2 million during the year ended December 31, 2019 compared to $2.2 million during the year ended December
31, 2018. Based on a thorough review of the loan portfolio, the Bank determined that the provision for loan losses for
the year ended December 31, 2019 was appropriate as it was calculated in accordance with the Bank's methodology
for determining the allowance for loan losses.
Noninterest Income Overview
Total noninterest income increased $844,000, or 2.7%, to $32.5 million for the year ended December 31, 2019
compared to $31.6 million for the same period in 2018. The following table presents the change in the key components
of noninterest income for the periods noted:
Year Ended December 31,
2019
2018
Change
(Dollars in thousands)
Percentage
Change
Service charges and other fees
$
Gain on sale of investment securities, net
Gain on sale of loans, net
Interest rate swap fees
Other income
18,712 $
330
2,424
1,232
9,764
18,914 $
137
2,759
564
9,244
Total noninterest income
$
32,462 $
31,618 $
(202)
193
(335)
668
520
844
(1.1)%
140.9
(12.1)
118.4
5.6
2.7 %
Interest rate swap fees increased $668,000, or 118.4%, to $1.2 million for the year ended December 31, 2019
compared to $564,000 for the year ended December 31, 2018 as a result of an increase in interest rate swap
transactions.
Other income increased $520,000, or 5.6%, to $9.8 million for the year ended December 31, 2019 compared
to $9.2 million for the year ended December 31, 2018, due primarily to an increase in income from BOLI investments
of $407,000 an increase in mortgage service rights income of $367,000, and an increase in fees earned from Wealth
Management and Trust Services of $421,000. The increase in other income was offset partially by a decrease in gain
on sale of assets of $554,000 to $246,000 during the year ended December 31, 2019 compared to gain of $800,000
for the prior year.
The increase in noninterest income was offset partially by a decrease in gain on sale of loans, net of $335,000,
or 12.1%, to $2.4 million for the year ended December 31, 2019 compared to $2.8 million for the year ended December
31, 2018 due primarily to a decrease in the gain on sale of mortgage loans. Proceeds from sale of mortgage loans
held for sale decreased $8.8 million, or 11.2%, to $70.4 million for the year ended December 31, 2019 from $79.2
million for the prior year. The decrease in originations during 2019 was primarily due to a decision to retain more
mortgage loans in the portfolio based on risk and rate assessments. The detail of gain on sale of loans, net is included
in the following schedule:
Year Ended December 31,
2019
2018
Change
(Dollars in thousands)
Percentage
Change
Gain on sale of mortgage loans, net
Gain on sale of guaranteed portion of SBA loans, net
Gain on sale of loans, net
$
$
2,159 $
265
2,424 $
2,403 $
356
2,759 $
(244)
(91)
(335)
(10.2)%
(25.6)
(12.1)%
55
Noninterest Expense Overview
Noninterest expense decreased $2.4 million, or 1.6%, to $146.8 million during the year ended December 31,
2019 compared to $149.2 million for the year ended December 31, 2018. The following table presents changes in the
key components of noninterest expense for the periods noted:
Year Ended December 31,
2019
2018
Change
Percentage
Change
Compensation and employee benefits
$
Occupancy and equipment
Data processing
Marketing
Professional services
State/municipal business and use tax
Federal deposit insurance premium
Other real estate owned, net
Amortization of intangible assets
Other expense
87,568 $
21,690
8,976
3,481
5,192
3,754
725
352
4,001
11,049
(Dollars in thousands)
86,830 $
19,779
9,888
3,228
9,670
3,002
1,480
106
3,819
11,385
Total noninterest expense
$
146,788 $
149,187 $
738
1,911
(912)
253
(4,478)
752
(755)
246
182
(336)
(2,399)
0.8 %
9.7
(9.2)
7.8
(46.3)
25.0
(51.0)
232.1
4.8
(3.0)
(1.6)%
The Company incurred significant acquisition-related expenses as a result of the Premier and Puget Mergers.
The following table presents these expenses by key component for the periods noted:
Compensation and employee benefits
Occupancy and equipment
Data processing
Marketing
Professional services
Other expense
Total merger related expenses
Year Ended December 31,
2019
2018
(In thousands)
76 $
—
55
—
1
—
5,455
45
1,365
24
3,046
456
132 $
10,391
$
$
Compensation and employee benefits increased $738,000, or 0.8%, to $87.6 million during the year ended
December 31, 2019 from $86.8 million during the year ended December 31, 2018. Excluding the acquisition-related
expenses, compensation and benefit expense increased $6.2 million primarily as a result of additional employees,
mostly due to the full year impact of the Premier Merger, expansion of the commercial banking team in Portland,
Oregon, and standard increases in salary rates. Average full time equivalent employees increased to 881 for the year
ended December 31, 2019 compared to 840 for the prior year.
Occupancy and equipment increased $1.9 million, or 9.7%, to $21.7 million during the year ended December
31, 2019 from $19.8 million during the year ended December 31, 2018 due substantially to investments in technology,
including the full year impact of retained service contracts acquired in the Premier Merger. Additionally, lease and rent
expense increased due to the full year impact of five leases acquired in the Premier Merger, leased space expansion
in the Portland branch, standard increases in common area maintenance charges and the impact of implementing
ASU 2016-02, Leases, on January 1, 2019.
Data processing decreased $912,000, or 9.2%, to $9.0 million during the year ended December 31, 2019 from
$9.9 million during the year ended December 31, 2018 primarily due to acquisition-related costs for core system
conversions incurred during 2018, offset partially by costs related to strategic technology initiatives.
Professional services decreased $4.5 million, or 46.3%, to $5.2 million during the year ended December 31,
2019 from $9.7 million during the year ended December 31, 2018 primarily due to a decrease in professional services
56
acquisition costs of $3.0 million and the buy-out of a third party contract in the amount of $1.7 million during the year
ended December 31, 2018. The third party assisted the Company in its deposit product realignment and was
compensated based on success factors over three years subsequent to implementation. The Company assessed the
contract and determined that it was advantageous to buy-out the contract prior to the system conversions relating to
the Premier and Puget Mergers.
State/municipal business and use tax increased $752,000, or 25.0%, to $3.8 million during the year ended
December 31, 2019 from $3.0 million during the comparable period in 2018 due primarily to an assessment in the
amount of $537,000 from a Washington State Department of Revenue Business and Occupation audit and an increase
in taxable revenue subject to Washington business and occupation tax during the year ended December 31, 2019.
Federal deposit insurance premium decreased $755,000, or 51.0%, to $725,000 during the year ended
December 31, 2019 from $1.5 million during the comparable period in 2018 due primarily to the recognition of small
bank credits awarded by the FDIC of $726,000 during the year ended December 31, 2019. The Bank has $518,000
in small bank credits on future assessments remaining as of December 31, 2019, which may be recognized in future
periods when allowed for by the FDIC upon insurance fund levels being met.
The ratio of noninterest expense to average total assets was 2.71% for the year ended December 31, 2019
compared to 3.00% for the year ended December 31, 2018. The decrease was primarily a result of a decrease in
acquisition-related costs and an increase in average assets during the year ended December 31, 2019.
Income Tax Expense Overview
Income tax expense increased $2.3 million, or 20.0%, to $13.5 million for the year ended December 31, 2019
from $11.2 million for the year ended December 31, 2018. The effective tax rate was 16.6% for the year ended December
31, 2019 compared to 17.5% for the prior year. The decrease in the effective tax rate was primarily due to a change
in the estimated current tax benefits from certain LIHTC during the year ended December 31, 2018.
Reconciliations of Non-GAAP Measures
This report contains certain financial information determined by methods other than in accordance with
accounting principles generally accepted in the United States of America. These measures include net interest income,
interest and fees on loans, and loan yield and net interest margin excluding the effect of the incremental accretion on
purchased loans acquired through mergers. Our management uses these non-GAAP measures, together with the
related GAAP measures, in its analysis of our performance and in making business decisions. Management also uses
these measures for peer comparisons. Management believes that presenting loan yield and net interest margin
excluding the effect of the acquisition accounting discount accretion on loans acquired through mergers is useful in
assessing the impact of acquisition accounting on loan yield and net interest margin, as the effect of loan discount
accretion is expected to decrease as the acquired loans mature or roll off our balance sheet. These disclosures should
not be viewed as substitutes for the results determined to be in accordance with GAAP, nor are they necessarily
comparable to non-GAAP performance measures that may be presented by other companies.
57
Reconciliations of the GAAP and non-GAAP financial measures on net interest income, interest and fees on loans,
loan yield and net interest margin are presented below for the periods indicated:
Net interest income and interest and fees on loans:
Net interest income (GAAP)
Incremental accretion on purchased loans
Adjusted net interest income (non-GAAP)
Average total interest earning assets, net
Net interest margin, annualized (GAAP)
Net interest margin, excluding incremental accretion on purchased loans,
annualized (non-GAAP)
Interest and fees on loans (GAAP)
Incremental accretion on purchased loans
Adjusted interest and fees on loans (non-GAAP)
Average total loans receivable, net
Loan yield, annualized (GAAP)
Loan yield, excluding incremental accretion on purchased loans, annualized (non-
GAAP)
Year Ended December 31,
2019
2018
(Dollars in thousands)
$
$
199,682
(4,876)
194,806
$
$
186,993
(7,964)
179,029
$ 4,729,885
$ 4,358,643
4.22%
4.12%
4.29%
4.11%
$
$
189,515
(4,876)
184,639
$
$
175,466
(7,964)
167,502
$ 3,668,665
$ 3,414,424
5.17%
5.04%
5.14%
4.91%
Liquidity and Capital Resources
Our primary sources of funds are customer and local government deposits, loan principal and interest
payments, loan sales, and interest earned on and proceeds from sales and maturities of investment securities. These
funds, together with retained earnings, equity and other borrowed funds, are used to make loans, acquire investment
securities and other assets, and fund continuing operations. While maturities and scheduled amortization of loans are
a predictable source of funds, deposit flows and loan prepayments are greatly influenced by the level of interest rates,
economic conditions, and competition.
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 investments to meet short-term liquidity needs. At December 31, 2019, cash and cash equivalents
totaled $228.6 million, or 4.1%, of total assets. Investment securities available for sale totaled $952.3 million at
December 31, 2019, of which $232.9 million were pledged to secure public deposits, borrowing arrangements or
securities sold under agreement to repurchase. Management considers unpledged investment securities available for
sale to be a viable source of liquidity. The fair value of investment securities available for sale that were not pledged
to secure public deposits, borrowing arrangements or securities sold under agreement to repurchase totaled $719.4
million, or 13.0% of total assets, at December 31, 2019. The fair value of investment securities available for sale with
maturities of one year or less amounted to $18.9 million, or 0.34% of total assets. At December 31, 2019, the Bank
maintained credit facilities with the FHLB for $945.2 million, of which there were no borrowings outstanding as of
December 31, 2019, and credit facilities with the Federal Reserve Bank for $73.1 million, of which there were no
borrowings outstanding as of December 31, 2019. The Bank also maintains advance lines with Wells Fargo Bank, US
Bank, The Independent Bankers Bank, Pacific Coast Bankers’ Bank, and JP Morgan Chase to purchase federal funds
totaling $140.0 million as of December 31, 2019. As of December 31, 2019, there were no overnight federal funds
purchased.
Our strategy has been to acquire core 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.
58
Contractual Obligations
The following table provides the amounts due under specified contractual obligations for the periods indicated
as of December 31, 2019:
One Year or
Less
One to
Three Years
December 31, 2019
Over Three
to Five
Years
Over Five
Years
(In thousands)
Other (1)
Total
$
440,996 $
55,537 $
28,019 $
26 $ 4,058,098 $ 4,582,676
—
—
4,842
—
—
6,837
—
—
5,977
—
20,169
20,169
25,000
10,046
—
—
25,000
27,702
$
445,838 $
62,374 $
33,996 $
35,072 $ 4,078,267 $ 4,655,547
Contractual payments
by period:
Deposits
Securities sold under
agreement to
repurchase
Junior subordinated
debentures
Operating leases
Total contractual
obligations
(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 and 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
certain commercial business loans and real estate construction and land development loans at variable interest rates
repricing for terms generally one year or less; and offering noninterest bearing demand deposit accounts to businesses
and individuals. The longer-term objective is to increase the proportion of noninterest bearing demand deposits ad
low-rate interest bearing demand deposits, money market accounts, and savings deposits relative to certificate of
deposit accounts to reduce our overall cost of funds.
A number of measures are used to monitor and manage interest rate risk, including income simulations, interest
sensitivity (gap) analysis and economic value of equity sensitivity. An income simulation model is the primary tool used
to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Key
assumptions in the model include prepayment speeds on loans and investment securities, decay rates on non-maturity
deposits, and pricing on investment securities, loans, deposits and borrowings. In order to measure the interest rate
risk sensitivity as of December 31, 2019, this simulation model uses a “no growth” assumption and assumes an
instantaneous and sustained uniform change in market interest rates at all maturities. These assumptions are inherently
uncertain and, as a result, the net interest income projections should be viewed as an estimate of the net interest
income sensitivity at the time of the analysis. Actual results will differ from simulated results due to timing, magnitude
and frequency of interest rate changes and changes in market conditions and management strategies, among other
factors.
Based on the results of the simulation model as of December 31, 2019, we would expect increases in net
interest income of $8.1 million and $15.6 million in year one and year two, respectively, if interest rates increased from
current rates by 100 basis points. We would expect an increase in net interest income of $15.9 million and $29.8 million
in year one and year two, respectively, if interest rates increased from current rates by 200 basis points. If interest
rates decreased by 100 basis points, we would expect decreases of $7.4 million and $15.2 million in year one and
year two, respectively.
Our asset and liability management strategies have resulted in a negative less than 3 month “gap” of 32.7%
as of December 31, 2019. This “gap” measures the difference between the dollar amount of our interest earning assets
and interest bearing liabilities that mature or reprice within the designated period (three months or less) as a percentage
of total interest earning assets, based on certain estimates and assumptions as discussed below. We believe that the
implementation of our operating strategies has reduced the potential effects of changes in market interest rates on
59
our results of operations. The negative gap for the less than three month period indicates that decreases in market
interest rates may favorably affect our results over that period.
The following table provides the estimated maturity or repricing and the resulting interest rate sensitivity gap
of our interest earning assets and interest bearing liabilities at December 31, 2019. 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, 2019
Estimated Maturity or Repricing Within
Three Months
or Less
Over Three
Months to 12
Months
Over One to
Five Years
Over Five to
15
Years
Over
15 Years
Total
(Dollars in thousands)
$
864,330
$
237,156
$ 1,649,599
$
900,830
$
113,523
$ 3,765,438
167,920
133,529
70,675
—
229,669
270,282
213,766
—
—
—
952,312
133,529
$ 1,165,779
$
307,831
$ 1,879,268
$ 1,171,112
$
327,289
$ 4,851,279
24.0 %
6.4 %
38.7%
24.1%
6.8%
100.0%
$ 2,709,400
$
342,419
$
84,329
$
26
$
— $ 3,136,174
20,595
20,169
—
—
—
—
—
—
—
—
20,595
20,169
$ 2,750,164
$
342,419
$
84,329
$
26
$
— $ 3,176,938
56.7 %
7.1 %
1.7%
—%
—%
65.5%
Interest Earnings Assets:
Loans receivable (1)
Investment securities
Interest earning deposits
Total interest earning
assets
Percentage of interest
earning assets
Interest Bearing
Liabilities:
Total interest bearing
deposits (2)
Junior subordinated
debentures
Securities sold under
agreement to repurchase
Total interest bearing
liabilities
Interest bearing liabilities,
as a percentage of total
interest earning assets
Interest rate sensitivity gap
$(1,584,385)
$
(34,588)
$ 1,794,939
$ 1,171,086
$
327,289
$ 1,674,341
Interest rate sensitivity gap,
as a percentage of total
interest earning assets
Cumulative interest rate
sensitivity gap
(32.7)%
(0.7)%
37.0%
24.1%
6.7%
34.5%
$(1,584,385)
$(1,618,973)
$
175,966
$ 1,347,052
$ 1,674,341
Cumulative interest rate
sensitivity gap, as a
percentage of total
interest earning assets
(32.7)%
(1) Excludes net deferred loan costs and allowance for loan losses.
(2) Adjustable-rate liabilities are included in the period in which interest rates are next scheduled to adjust rather than in
the period they are due to mature. Although noninterest demand deposits, interest bearing demand deposits, money
market accounts, and saving 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.
(33.4)%
27.8%
34.5%
3.6%
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
60
the interest rates of those assets both on a short-term basis and over the lives of such assets. Further, if a change in
market interest rates occurs, prepayment and early withdrawal levels could deviate significantly from those assumed
in calculating the tables. Finally, the ability of many borrowers to service their adjustable rate debt may decrease if
market interest rates increase substantially.
The table below provides information about our financial instruments that are sensitive to changes in interest
rates as of December 31, 2019. 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 estimated repricing date or maturity date, whichever occurs sooner.
By Expected Maturity Date
Year Ended December 31, 2019
Three
Months or
Less
Over Three
Months to
12 Months
Over One
Year to
Five Years
Over Five
Years to 15
Years
Over
15 Years
Total
Fair Value
(Dollars in thousands)
Investment Securities
Amounts maturing:
Fixed rate
Weighted average
interest rate
Adjustable rate
Weighted average
interest rate
$ 52,071
$ 48,536
$ 205,301
$ 267,985
$ 213,765
$ 787,658
2.80%
2.94%
2.84%
2.83%
2.58%
2.77%
$
5,074
$
— $ 10,132
$
57,949
$ 91,499
$ 164,654
2.93%
—%
3.04%
2.34%
2.64%
2.57%
Total
$ 57,145
$ 48,536
$ 215,433
$ 325,934
$ 305,264
$ 952,312
$
952,312
Loans (1)
Amounts maturing:
Fixed rate
Weighted average
interest rate
Adjustable rate
Weighted average
interest rate
$ 27,767
$ 58,201
$ 583,183
$ 801,206
$ 113,523
$ 1,583,880
5.28%
4.75%
4.66%
4.51%
4.40%
4.58%
$ 143,765
$ 226,609
$ 265,072
$1,311,245
$ 234,867
$ 2,181,558
6.08%
5.79%
5.13%
4.60%
4.73%
4.90%
Total
$ 171,532
$ 284,810
$ 848,255
$2,112,451
$ 348,390
$ 3,765,438
$ 3,791,557
Certificate of Deposit
Accounts
Amounts maturing:
Fixed rate
Weighted average
interest rate
Junior Subordinated
Debentures
Amounts maturing:
Adjustable rate
Weighted average
interest rate (2)
$ 98,790
$ 342,206
$ 83,556
$
26
$
— $ 524,578
$
529,679
1.23%
1.75%
1.50%
0.77%
—%
1.61%
$
— $
— $
— $
— $ 20,595
$
20,595
$
20,000
—%
—%
—%
—%
6.55%
6.55%
(1) Excludes net deferred loan costs and allowance for loan losses.
(2) The contractual interest rate of the junior subordinated debentures was 3.47% at December 31, 2019. The weighted
average interest rate includes the effects of the discount accretion for the Washington Banking Merger purchase
accounting adjustment.
61
Impact of Inflation and Changing Prices
Inflation affects our operations by increasing operating costs and indirectly by affecting the operations and
cash flow of our customers. Unlike most industrial companies, virtually all the assets and liabilities of a financial
institution are monetary in nature. As a result, changes in interest rates generally have a more significant impact on a
financial institution’s performance than the effects of general levels of inflation. Although interest rates do not necessarily
move in the same direction or the same extent as the prices of goods and services, increases in inflation generally
have resulted in increased interest rates.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to interest rate risk through our lending and deposit gathering activities. For a discussion of
how this exposure is managed and the nature of changes in our interest rate risk profile during the past year, see
Item 7. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations.
Neither we, nor the Bank, maintain a trading account for any class of financial instrument, nor do we, or the
Bank, engage in hedging activities or purchase high risk derivative instruments. Moreover, neither we, nor the Bank,
are subject to foreign currency exchange rate risk or commodity price risk.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
Stockholders and the Board of Directors of Heritage Financial Corporation
Olympia, Washington
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated statements of financial condition of Heritage Financial Corporation
and subsidiaries (the "Company") as of December 31, 2019 and 2018, the related consolidated statements of income,
comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended
December 31, 2019, and the related notes (collectively referred to as the "financial statements"). We also have audited
the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in the
2013 Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position
of the Company as of December 31, 2019 and 2018, and the results of their operations and their cash flows for each
of the years in the three-year period ended December 31, 2019 in conformity with accounting principles generally
accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal
Control - Integrated Framework issued by COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control
over financial reporting, and for their assessment of the effectiveness of internal control over financial reporting, included
in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express
an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial
reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight
Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with
the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission
and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial statements are free of material
misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was
maintained in all material respects.
62
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of
the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such
procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial
statements. Our audits also included evaluating the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control
over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the
risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audits also included performing such other procedures as we considered
necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal control over financial reporting includes those policies
and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may
deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements
that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or
disclosures that are material to the consolidated financial statements and (2) involved especially challenging, subjective,
or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the
financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a
separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Loan Losses - Environmental Loss Factors
As described in Note 1, “Description of Business, Basis of Presentation, Significant Accounting Policies and Recently
Issued Accounting Pronouncements” and Note 5, “Allowance for Loan Losses” to the consolidated financial statements,
the Company’s consolidated allowance for loan losses balance was $36,171,000 at December 31, 2019 which consists
of three components: allowance allocations calculated in accordance with FASB ASC 310, $2,143,000 and allowance
allocations calculated in accordance with FASB ASC 450, $31,759,000; and Purchase Credit Impaired loans in
accordance with FASB ASC 310-30 was $2,269,000. The allowance for loan losses is the estimated amount considered
necessary to cover probable incurred credit losses inherent in the loan portfolio at the balance sheet date. The allowance
for loan losses evaluation is inherently subjective, as it utilizes estimates which require a high degree of judgment
relating to general economic conditions and other qualitative risk factors both internal and external to the Company.
Changes in these assumptions could have a material effect on the Company’s financial results.
The Company’s allowance allocations calculated in accordance with FASB ASC 450 include reserve factors for both
historical loss factors and environmental loss factors. The historical loss factors and environmental loss factors are
combined and multiplied against the unguaranteed outstanding principal balances of loans in pools of similar loans
with similar characteristics. The reserve factor for environmental losses involves an evaluation of factors including:
levels of and trends in delinquencies, classified, and impaired loans; levels of and trends in charge-offs and recoveries;
trends in volume and terms of loans; changes in risk selection and underwriting standards, and other changes in
lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant
staff; national and local economic trends and conditions; other external factors, such as competition, legal, and
regulatory; credit concentrations; and other factors. Each factor is determined to be on a scale of risk. The results are
63
then utilized in a matrix to determine an appropriate environmental loss factor for each class of loan. The evaluation
of these factors contributes significantly to the allowance allocations calculated in accordance with FASB ASC 450
component of the estimate of the allowance for loan losses. We identified auditing the estimate of the aggregate effect
of the environmental loss factors as a critical audit matter as it involved especially subjective auditor judgment. Auditing
management’s determination of environmental loss factors involved especially subjective auditor judgment because
management’s estimate relies on an inherently subjective analysis to determine the quantitative impact the factors
have on the allowance. Management’s analysis of these factors requires significant judgment.
The primary procedures we performed to address this critical audit matter included:
Testing the effectiveness of controls over the evaluation of the factors used to estimate the environmental loss factors,
including management’s controls addressing:
The completeness and accuracy of data inputs used as the basis for the adjustments relating to
•
environmental loss factors.
•
data used in the determination of environmental loss factors and the resulting allocation to the allowance.
Management’s judgments and estimates related to the qualitative and quantitative assessment of the
Substantively testing management’s process, including evaluating their judgments and assumptions, for developing
the environmental loss factors which included:
Evaluation of the completeness and accuracy of the data used as a basis for the adjustments relating
•
to qualitative general reserve factors.
•
Evaluation of the reasonableness of management’s judgments related to the qualitative and
quantitative assessment of the data used in the determination of environmental loss factors and the resulting
allocation to the allowance.
•
•
Verifying the mathematical accuracy of the environmental loss factor calculation.
Analytically evaluating the general allocation component year over year.
/s/ Crowe LLP
We have served as the Company's auditor since 2012.
Sacramento, California
February 28, 2020
64
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except shares)
December 31, 2019 December 31, 2018
$
95,039 $
ASSETS
Cash on hand and in banks
Interest earning deposits
Cash and cash equivalents
Investment securities available for sale, at fair value
Loans held for sale
Loans receivable, net
Allowance for loan losses
Total loans receivable, net
Other real estate owned
Premises and equipment, net
Federal Home Loan Bank stock, at cost
Bank owned life insurance
Accrued interest receivable
Prepaid expenses and other assets
Other intangible assets, net
Goodwill
Total assets
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Junior subordinated debentures
Securities sold under agreement to repurchase
Accrued expenses and other liabilities
Total liabilities
Stockholders’ equity:
Preferred stock, no par value, 2,500,000 shares authorized; no
shares issued and outstanding at December 31, 2019 and 2018
Common stock, no par value, 50,000,000 shares authorized;
36,618,729 and 36,874,055 shares issued and outstanding at
December 31, 2019 and 2018, respectively
Retained earnings
Accumulated other comprehensive income (loss), net
Total stockholders’ equity
$
$
133,529
228,568
952,312
5,533
3,767,879
(36,171)
3,731,708
841
87,888
6,377
103,616
14,446
164,129
16,613
240,939
5,552,970 $
92,704
69,206
161,910
976,095
1,555
3,654,160
(35,042)
3,619,118
1,983
81,100
6,076
93,612
15,403
98,522
20,614
240,939
5,316,927
4,582,676 $
4,432,402
20,595
20,169
120,219
4,743,659
20,302
31,487
72,013
4,556,204
—
—
586,459
212,474
10,378
809,311
591,806
176,372
(7,455)
760,723
5,316,927
Total liabilities and stockholders’ equity
$
5,552,970 $
See accompanying Notes to Consolidated Financial Statements.
65
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
INTEREST INCOME:
Interest and fees on loans
Taxable interest on investment securities
Nontaxable interest on investment securities
Interest on other interest earning assets
Total interest income
INTEREST EXPENSE:
Deposits
Junior subordinated debentures
Other borrowings
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
NONINTEREST INCOME:
Service charges and other fees
Gain on sale of investment securities, net
Gain on sale of loans, net
Interest rate swap fees
Other income
Total noninterest income
NONINTEREST EXPENSE:
Compensation and employee benefits
Occupancy and equipment
Data processing
Marketing
Professional services
State/municipal business and use taxes
Federal deposit insurance premium
Other real estate owned, net
Amortization of intangible assets
Other expense
Total noninterest expense
Income before income taxes
Income tax expense
Net income
Basic earnings per common share
Diluted earnings per common share
Dividends declared per common share
Year Ended December 31,
2019
2018
2017
$
189,515
$
175,466
$
129,213
23,045
3,396
1,894
17,602
4,649
1,689
12,688
5,269
539
217,850
199,406
147,709
16,349
1,339
480
18,168
199,682
4,311
195,371
10,397
1,263
753
12,413
186,993
5,129
181,864
6,049
1,014
1,283
8,346
139,363
4,220
135,143
18,712
18,914
18,004
330
2,424
1,232
9,764
137
2,759
564
9,244
6
7,696
1,045
8,828
32,462
31,618
35,579
87,568
21,690
8,976
3,481
5,192
3,754
725
352
4,001
11,049
146,788
81,045
13,488
67,557
1.84
1.83
0.84
$
$
$
$
86,830
19,779
9,888
3,228
9,670
3,002
1,480
106
3,819
11,385
149,187
64,295
11,238
53,057
1.49
1.49
0.72
$
$
$
$
64,268
15,396
8,176
2,943
4,777
2,461
1,435
(70)
1,286
9,903
110,575
60,147
18,356
41,791
1.39
1.39
0.61
$
$
$
$
See accompanying Notes to Consolidated Financial Statements.
66
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Net income
Change in fair value of investment securities available for sale, net of
tax of $4,834, $(1,591) and $826, respectively
Reclassification adjustment for net gain from sale of investment
securities available for sale included in income, net of tax of
$(69), $(29) and $(2), respectively
Other comprehensive income (loss)
Comprehensive income
Year Ended
December 31,
2019
2018
2017
$
67,557 $
53,057 $
41,791
18,094
(5,956)
1,530
(261)
17,833
(108)
(6,064)
(4)
1,526
$
85,390 $
46,993 $
43,317
See accompanying Notes to Consolidated Financial Statements.
67
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except per share amounts)
Year Ended December 31, 2019
Number of
common
shares
Common
stock
Retained
earnings
Accumulated
other
comprehensive
(loss)
income, net
Total
stockholders’
equity
36,874
$
591,806
$
176,372
$
(7,455) $
760,723
—
62
4
—
(321)
—
—
—
—
—
58
3,231
(8,636)
—
—
—
(399)
—
—
—
—
67,557
—
—
—
—
—
—
(399)
—
58
3,231
(8,636)
67,557
—
17,833
17,833
(31,056)
—
(31,056)
Balance at December 31, 2018
Effects of implementation of
accounting change related to
operating leases
Restricted stock units vested, net of
forfeitures of restricted stock
awards
Exercise of stock options
Stock-based compensation expense
Common stock repurchased
Net income
Other comprehensive income, net of
tax
Cash dividends declared on common
stock ($0.84 per share)
Balance at December 31, 2019
36,619
$
586,459
$
212,474
$
10,378
$
809,311
Balance at December 31, 2017
Effects of implementation of
accounting change related to
equity investments, net
Restricted stock units vested, net of
forfeitures of restricted stock
awards
Exercise of stock options
Stock-based compensation expense
Common stock repurchased
Net income
Other comprehensive loss, net of tax
Common stock issued in business
combination
Cash dividends declared on common
stock ($0.72 per share)
Year Ended December 31, 2018
Number of
common
shares
Common
stock
Retained
earnings
Accumulated
other
comprehensive
loss, net
Total
stockholders’
equity
29,928
$
360,590
$
149,013
$
(1,298) $
508,305
—
29
10
—
(53)
—
—
—
—
133
2,744
(1,704)
—
—
6,960
230,043
93
—
—
—
—
53,057
—
—
—
—
(25,791)
(93)
—
—
—
—
—
(6,064)
—
—
—
—
133
2,744
(1,704)
53,057
(6,064)
230,043
(25,791)
Balance at December 31, 2018
36,874
$
591,806
$
176,372
$
(7,455) $
760,723
68
Year Ended December 31, 2017
Number of
common
shares
Common
stock
Retained
earnings
Accumulated
other
comprehensive
(loss)
income, net
Total
stockholders’
equity
29,955
$
359,060
$
125,309
$
(2,606) $
481,763
—
(10)
13
—
(30)
—
—
—
—
218
(218)
—
—
—
—
41,791
—
—
—
—
—
—
—
164
2,103
(737)
41,791
—
1,526
1,526
(18,305)
—
(18,305)
—
164
2,103
(737)
—
—
—
Balance at December 31, 2016
Effects of implementation of
accounting change related to Tax
Act
Restricted stock units vested, net of
forfeitures of restricted stock
awards
Exercise of stock options
Stock-based compensation expense
Common stock repurchased
Net income
Other comprehensive income, net of
tax
Cash dividends declared on common
stock ($0.61 per share)
Balance at December 31, 2017
29,928
$
360,590
$
149,013
$
(1,298) $
508,305
See accompanying Notes to Consolidated Financial Statements.
69
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation of premises and equipment, amortization of securities
available for sale, and amortization of discount of junior
subordinated debentures
Changes in net deferred loan costs, net of amortization
Provision for loan losses
Net change in accrued interest receivable, prepaid expenses and
other assets, and accrued expenses and other liabilities
Stock based compensation expense
Amortization of intangible assets
Origination of mortgage loans held for sale
Proceeds from sale of mortgage loans held for sale
Earnings on bank owned life insurance
Valuation adjustment on other real estate owned
Loss (gain) on sale of other real estate owned, net
Gain on sale of loans, net
Gain on sale of investment securities, net
Gain on sale of assets held for sale
Impairment of assets held for sale
Impairment for right of use asset
(Gain) loss on sale of premises and equipment, net
Year Ended
December 31,
2019
2018
2017
$
67,557
$
53,057
$
41,791
8,169
1,068
4,311
5,748
3,231
4,001
(72,216)
70,397
(2,151)
51
227
(2,424)
(330)
(169)
102
117
(75)
9,808
(150)
5,129
10,195
2,744
3,819
(76,101)
79,237
(1,753)
49
—
(2,759)
(137)
(798)
75
—
32
10,704
(1,007)
4,220
11,634
2,103
1,286
(108,696)
121,482
(1,424)
—
(144)
(7,696)
(6)
(747)
—
—
13
Net cash provided by operating activities
87,614
82,447
73,513
Cash flows from investing activities:
Loans originated, net of principal payments
(121,266)
(98,563)
(235,154)
Maturities, calls and payments of investment securities available
for sale
Purchase of investment securities available for sale
Proceeds from sales of investment securities available for sale
Purchase of premises and equipment
Proceeds from sales of other loans
Proceeds from sales of other real estate owned
Proceeds from sales of assets held for sale
Proceeds from redemption of Federal Home Loan Bank stock
Purchases of Federal Home Loan Bank stock
Proceeds from sales of premises and equipment
Purchase of bank owned life insurance
Proceeds from bank owned life insurance death benefit
Capital contributions to low-income housing tax credit partnerships
and new market tax credit partnerships, net
Net cash received from acquisitions
Net cash used in investing activities
242,348
(242,776)
43,962
(13,041)
3,562
864
1,664
18,032
(18,333)
96
(8,053)
—
(27,485)
—
(120,426)
92,563
(342,141)
156,014
(23,265)
9,993
198
1,908
26,538
(22,524)
28
(54)
—
(8,303)
105,974
(101,634)
98,894
(149,914)
31,028
(3,063)
28,874
930
1,849
30,018
(30,801)
—
(4,394)
1,101
(10,762)
—
(241,394)
70
Cash flows from financing activities:
Net increase in deposits
Federal Home Loan Bank advances
Repayment of Federal Home Loan Bank advances
Common stock cash dividends paid
Net (decrease) increase in securities sold under agreement to
repurchase
Proceeds from exercise of stock options
Repurchase of common stock
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental disclosures of cash flow information:
Cash paid for interest
Cash paid for income taxes, net of refunds
Supplemental non-cash disclosures of cash flow information:
Transfers of loans receivable to other real estate owned
Transfers of properties held for sale recorded in premises and
equipment, net to prepaid expenses and other assets
Investment in low income housing tax credit partnership and
related funding commitment
Transfer of bank owned life insurance to prepaid expenses and
other assets
Business Combinations:
Year Ended
December 31,
2019
2018
2017
150,274
445,800
(445,800)
(30,908)
(11,318)
58
(8,636)
99,470
66,658
214,740
554,950
(663,450)
(25,791)
(796)
133
(1,704)
78,082
58,895
161,910
103,015
228,568
$
161,910
$
163,412
763,350
(750,450)
(18,305)
9,717
164
(737)
167,151
(730)
103,745
103,015
17,867
$
12,385
$
7,528
5,634
8,399
2,045
— $
434
$
32
1,533
1,836
2,687
$
$
$
46,677
209
—
421
Common stock issued for business combinations
$
— $
230,043
$
Assets acquired (liabilities assumed) in acquisitions:
Investment securities available for sale
Loans receivable
Other real estate owned
Premises and equipment
Federal Home Loan Bank stock
Accrued interest receivable
Bank owned life insurance
Prepaid expenses and other assets
Other intangible assets
Goodwill
Deposits
Federal Home Loan Bank advances
Securities sold under agreement to repurchase
Accrued expenses and other liabilities
—
—
—
—
—
—
—
—
—
—
—
—
—
—
84,846
718,620
1,796
3,785
1,743
2,454
17,116
2,957
18,345
121,910
(824,602)
(16,000)
(462)
(8,439)
See accompanying Notes to Consolidated Financial Statements.
71
33,171
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2019, 2018 and 2017
(1)
Description of Business, Basis of Presentation, Significant Accounting Policies and Recently
Issued Accounting Pronouncements
(a) Description of Business
Heritage Financial Corporation is a bank holding company that was incorporated in the State of Washington
in August 1997. The Company is primarily engaged in the business of planning, directing and coordinating the business
activities of its wholly-owned subsidiary, Heritage Bank. The Bank is a Washington-chartered commercial bank and
its deposits are insured by the FDIC. The Bank is headquartered in Olympia, Washington and conducts business from
its 62 branch offices as of December 31, 2019 located throughout Washington State and the greater Portland, Oregon
area. The Bank’s business consists primarily of commercial lending and deposit relationships with small businesses
and their owners in its market areas and attracting deposits from the general public. The Bank also makes real estate
construction and land development loans, consumer loans and originates first mortgage loans on residential properties
primarily located in its market areas.
Effective January 16, 2018, the Company completed the Puget Sound Merger and on July 2, 2018, the Company
completed the Premier Merger. See Note (2) Business Combinations for additional information on the Premier and
Puget Mergers.
(b) Basis of Presentation
The accompanying audited Consolidated Financial Statements have been prepared in accordance with GAAP
for annual financial information and pursuant to the rules and regulations of the SEC. In preparing the audited
Consolidated Financial Statements, management is required to make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues, expenses and related disclosures. Management believes that the
judgments, estimates, and assumptions used in the preparation of the consolidated financial statements are appropriate
based on the facts and circumstances at the time. Actual results, however, could differ significantly from those estimates.
The accompanying Consolidated Financial Statements include the accounts of the Company and its wholly
owned subsidiary, the Bank. All significant intercompany balances and transactions among the Company and the Bank
have been eliminated in consolidation.
Certain prior year amounts in the Consolidated Statements of Income have been reclassified to conform to
the current year’s presentation. Reclassifications had no effect on the prior years' net income or stockholders’ equity.
(c) Significant Accounting Policies
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and due from banks and interest-bearing balances due from
the Federal Reserve Bank. Cash equivalents have a maturity of 90 days or less at the time of purchase.
Investment Securities
The Company identifies investments as 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. As of
December 31, 2019 and December 31, 2018 the Bank does not hold any securities classified as held to maturity. See
Note (3) Investment Securities for additional information.
Securities available for sale are carried at fair value. Interest income includes amortization of purchase
premiums or accretion of purchase discounts using the interest method. Unrealized gains and losses on securities
available for sale are generally excluded from earnings and are reported in other comprehensive income (loss), net.
Realized gains and losses on sale of investment securities are computed on the specific identification method. Transfers
of securities between the available for sale and held to maturity categories, if executed, are accounted for at fair value.
Management evaluates securities for other-than-temporary impairment 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
72
a) the fair value of the security is below the carrying value primarily due to changes in interest rates; b) there has not
been significant deterioration in the financial condition of the issuer; and, c) it is not more likely than not that the
Company will be required to, nor does it have the intent 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)
other-than-temporary impairment related to credit loss, which must be recognized in the income statement and 2)
other-than-temporary impairment related to other factors, which is recognized in other comprehensive income (loss).
The credit loss is defined as the difference between the present value of the cash flows expected to be collected and
the amortized cost basis. For debt securities with other-than-temporary impairment, the previous amortized cost basis
less the other-than-temporary impairment recognized in earnings shall be the new amortized cost basis of the security.
In subsequent periods, the Company accretes into interest income the difference between the new amortized cost
basis and cash flows expected to be collected prospectively over the life of the debt security. Continued deterioration
of market conditions could result in additional impairment losses recognized within the investment portfolio.
Other factors that may be considered in determining whether a decline in the value of a debt 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.
Loans Held for Sale
Mortgage loans held for sale are carried at the lower of amortized cost or fair value. Any loan that management
does not have the intent and ability to hold for the foreseeable future or until maturity or payoff is classified as held for
sale at the time of origination, purchase or securitization, or when such decision is made. Unrealized losses on loans
held for sale are recorded as a valuation allowance and included in other expense on the Consolidated Statements
of Income.
Loans Receivable and Loan Commitments
Loans receivable include loans originated and indirect loans purchased by the Bank as well as loans acquired
in business combinations. 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.
Loans purchased with evidence of credit deterioration since origination for which it is probable that all
contractually required payments will not be collected are accounted for under FASB ASC 310-30, Loans and Debt
Securities Acquired with Deteriorated Credit Quality. These loans are identified as PCI loans. In situations where such
loans have similar risk characteristics, loans may be aggregated into pools to estimate cash flows. A pool is accounted
for as a single asset with a single interest rate, cumulative loss rate and cash flow expectation. Expected cash flows
at the acquisition date in excess of the fair value of loan or pool are considered to be accretable yield, which is recognized
as interest income over the life of the loan or pool using a level yield method if the timing and amount of the future
cash flows of the loan or pool is reasonably estimable.
The cash flows expected over the life of the PCI loan or pool are estimated quarterly using an external cash
flow model that projects cash flows and calculates the carrying values of the loans or pools, book yields, effective
interest income and impairment, if any, based on loan or pool level events. Assumptions as to default rates, loss severity
and prepayment speeds are utilized to calculate the expected cash flows. To the extent actual or projected cash flows
are less than previously estimated, additional provisions for loan losses on the purchased loan portfolios will be
recognized immediately into earnings. To the extent actual or projected cash flows are more than previously estimated,
the increase in cash flows is recognized immediately as a recapture of provision for loan losses up to the amount of
any provision previously recognized for that loan or pool, if any, then prospectively recognized in interest income as
a yield adjustment. Any disposals of a loan in a pool, including sale of a loan, payment in full or foreclosure results in
the removal of the loan from the loan pool at the carrying amount.
Loans accounted for under FASB ASC 310-30 are generally considered accruing and performing loans or
pools as the assets accrete interest income over the estimated life of the asset when cash flows are reasonably
estimable. Accordingly, PCI loans that are contractually past due are generally considered to be accruing and performing
loans if a fair value discount exists. If the timing and amount of cash flows of PCI loans not accounted for in a pool are
not reasonably estimable, the loans may be classified as nonaccrual loans and interest income may be recognized
on a cash basis or all cash payments may be accounted for as a reduction of the principal amount outstanding. PCI
pools that include loans with contractually past due balances are generally considered to be accruing and performing.
Loans purchased that are not accounted for under FASB ASC 310-30 are accounted for under FASB ASC
310-20, Receivables—Nonrefundable fees and Other Costs. These loans are identified as non-PCI loans, and are
initially recorded at their fair value, which is estimated using an external cash flow model and assumptions similar to
73
the FASB ASC 310-30 loans. The difference between the estimated fair value and the unpaid principal balance at
acquisition date is recognized as interest income over the life of the loan using an effective interest method for non-
revolving credits or a straight-line method, which approximates the effective interest method, for revolving credits. Any
unrecognized discount for a loan that is subsequently repaid in full will be recognized immediately into income.
Loans are generally recorded at the unpaid principal balance, net of premiums, unearned discounts and net
deferred loan origination fees and costs. The premiums and unearned discounts may include values determined in
purchase accounting. Interest on loans is calculated using the simple interest method based on the daily balance of
the principal amount outstanding and is credited to income as earned. Loans are considered past due or delinquent
when principal or interest payments are past due 30 days or more.
The Company's policies for determining past due or delinquency status, placing loans on nonaccrual status,
recording payments received on nonaccrual loans, resuming accrual of interest, and charging off uncollectible loans
generally do not differ by loan segments or classes. Any differences are denoted in the applicable sections below.
Delinquent Loans:
Commercial loans are serviced by the relationship manger assigned to the account. System-generated
delinquency reports are provided to all relationship managers monthly and relationship managers take follow-up action
as needed, including contacting the borrower or transferring seriously delinquent loans to the Bank’s Special Assets
Department for collection. Consumer loans are monitored by the Bank’s Consumer Collections Department, with initial
delinquency notices sent after 15 days, with follow up notices at 30 and 45 days. The Consumer Collections Department
attempts to make direct contact with the borrower to establish a plan to bring the loan current. Consumer loans that
become 90 days delinquent are charged off.
Nonaccrual and Charged-off Loans:
Loans for which the accrual of interest has been discontinued are designated as nonaccrual loans. Delinquent
loans may remain on accrual status between 30 days and 89 days past due. The accrual of interest is generally
discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection.
Loans are placed on nonaccrual at an earlier date if collection of the contractual principal or interest is doubtful. All
interest accrued, but not collected, on loans deemed nonaccrual during the period is reversed against interest income
in that period. The interest payments received on nonaccrual loans are generally accounted for on the cost-recovery
method whereby the interest payment is applied to the principal balances. Loans may be returned to accrual status
when improvements in credit quality eliminate the doubt as to the full collectability of both interest and principal and a
period of sustained performance has occurred. Substantially all loans that are nonaccrual are also considered impaired.
Income recognition on impaired loans conforms to that used on nonaccrual loans.
Loans are generally 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.
Impaired Loans:
The Bank routinely tests its classified loans for potential impairment. Classified loans that may be impaired
are identified using the Bank's normal loan review procedures, which include post-approval reviews, quarterly reviews
by credit administration of criticized loan reports, scheduled internal reviews, underwriting during extensions and
renewals, and the analysis of information routinely received on a borrower’s financial performance. A loan is considered
impaired when, based on current information and events, it is probable the Bank will be unable to collect the scheduled
payments of principal or interest when due according to the original contractual terms of the loan agreement. Purchased
loans classified as PCI cannot be classified as impaired loans. Factors considered by management in determining
impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest
payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not
classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-
by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrowers, including
length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amounts of the shortfall in
relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows
discounted at the loan’s effective interest rate or, as a practical expedient, the loan’s observable market price or the
fair value of the collateral (less cost to sell) if the loan is collateral dependent. Income recognition on impaired loans
conforms to that used on nonaccrual loans.
Subsequent to an initial measure of impairment and based on new information received, if there is a significant
change in the amount or timing of a loan’s expected future cash flows or a change in the value of collateral or market
74
price of a loan, the impairment is recalculated. However, the net carrying value of a loan never exceeds the recorded
investment in the loan.
Troubled Debt Restructures:
A 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 its 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.
The Company has implemented more stringent definitions of concessions and impairment measures for PCI
loans which are not in pools as these loans have known credit deteriorations and are generally accreting income at a
lower discounted rate as compared to the contractual note rate based on the guidance of FASB ASC 310-30.
Modifications of PCI loans which are not in pools are considered TDRs if they result in a decrease in expected cash
flows when compared to the pre-modification expected cash flows, without any other changes to the agreement to
consider.
A loan that has been placed on nonaccrual status that is subsequently restructured will usually remain on
nonaccrual status until the borrower is able to demonstrate repayment performance in compliance with the restructured
terms for a sustained period, typically for six months. A restructured loan may return to accrual status sooner based
on other significant events or mitigating circumstances. A loan that has not been placed on nonaccrual status may be
restructured and such loan may remain on accrual status after such restructuring. In these circumstances, the borrower
has made payments before the restructuring and is expected to continue to perform after the restructuring. Generally,
this type of restructuring involves a reduction in the loan interest rate and/or a change to interest-only payments for a
period of time. The restructured loan is considered impaired despite the accrual status and a specific valuation
allowance, if any, is calculated in the manner described in the Impaired Loans section above.
A TDR is considered defaulted if, during the 12-month period after the restructure, the loan has not performed
in accordance to the restructured terms. Defaults generally include loans whose payments are 90 days or more past
due and loans whose revised maturity date passed and no further modifications will be granted for that borrower.
Once a loan is classified as a TDR Loan, it continues to be reported as such until it is paid off or charged-off.
Unfunded Loan Commitments:
Unfunded loan commitments are generally related to the unused portion of the total commitment of a loan or
providing credit facilities to clients of the Bank and are not actively traded financial instruments. These unfunded
commitments are disclosed as financial instruments with off-balance sheet risk in Note (15) Commitments and
Contingencies and Note (19) Fair Value Measurements in the Notes to Consolidated Financial Statements.
Loan Fees and Costs
Direct loan origination fees and costs on originated loans and premiums or discounts on acquired loans are
deferred and subsequently amortized or accreted as a yield adjustment over the expected life of the loan utilizing the
interest method. The objective of the interest method is to calculate periodic interest income at a constant effective
yield. When a loan is paid off prior to maturity, the remaining direct loan origination fees and costs on originated loans
and premiums or discounts on acquired loans are immediately recognized into interest income. In the event loans are
sold, the unamortized net deferred loan origination fees or costs are recognized as a component of the gain or loss
on the sale of loans. The interest method is used for all loans except revolving loans, for which the straight-line method
is used. Fees related to lending activities, other than the origination or purchase of loans, are recognized as noninterest
income during the period the related services are performed.
75
Allowance for Loan Losses
Allowance for Loan Losses:
The ALL 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 loans. Loan
losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.
Subsequent recoveries, if any, are credited to the allowance. The ALL on loans designated as non-PCI loans is similar
to the methodology described below except that for non-PCI loans, the remaining unaccreted discounts resulting from
the fair value adjustments recorded at the time the loans were purchased are additionally factored into the allowance
methodology. The ALL on PCI loans is described in the “Allowance for Loan Losses on Purchased Credit Impaired
Loans” section below.
The allowance, in the judgment of management, is necessary to reserve for estimated loan losses from risks
inherent in the loan portfolio. The Company’s ALL methodology includes allowance allocations calculated in accordance
with FASB ASC 310, Receivables and allowance allocations calculated in accordance with FASB ASC 450,
Contingencies. Accordingly, the methodology is based on historical loss experience by type of credit, specific
homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The
Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for
credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and
trends related to nonaccrual loans, past due loans, classified loans and net charge-offs or recoveries, among other
factors. The provision for loan losses also reflects all actions taken on all loans for a particular period. Therefore, the
amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly
identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any
necessary increases or decreases in specific valuation allowances for impaired loans or loan pools.
The level of the allowance reflects management’s continuing evaluation of known and inherent risks in the
loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available
for any credit that, in management’s judgment, could be charged off.
Loans which management determines are impaired are individually evaluated for impairment, and specific
valuation allowances are recorded, if any, on these loans based on the methodology previously described. Loans that
are determined not to meet management's definition of impaired are collectively evaluated for impairment based on
(i) historical loss factors determined in accordance with FASB ASC 450 based on historical loan loss experience for
similar loans with similar characteristics and trends; and (ii) environmental loss factors that reflect the impact of current
conditions, as determined in accordance with FASB ASC 450 based on general economic conditions and other
qualitative risk factors both internal and external to the Company. The historical loss factors and environmental loss
factors are combined and multiplied against the unguaranteed outstanding principal balances of loans in pools of
similar loans with similar characteristics.
The Company evaluates specific loans for credit quality indicators and performs regular analysis and evaluation
of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other
things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and
industry in which the borrower operates. This analysis is performed at the loan officer level for all loans. When a loan
is performing, but has an assigned risk grade other than pass, the loan officer analyzes the loan to determine an
appropriate monitoring and collection strategy. When a loan is nonperforming or has been classified as a nonaccrual
loan, a member from the portfolio risk department will analyze the loan to determine if it is impaired. If the loan is
considered impaired, the portfolio risk 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 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 trends in delinquencies, classified and impaired loans; (ii) levels of and trends in charge-
offs and recoveries; (iii) trends in volume and terms of loans (iv) effects of changes in risk selection and underwriting
standards, and other changes in lending policies, procedures, and practices; (v) experience, ability, and depth of
lending management and other relevant staff; (vi) national and local economic trends and conditions; (vii) other external
factors such as competition, legal, and regulatory; (viii) effects of changes in credit concentrations, and (ix) other
factors. Management evaluates the degree of risk that each one of these components has on the quality of the loan
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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.
The ALL 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 of the above considerations.
Allowance for Loan Losses on Purchased Credit Impaired Loans:
The PCI loans acquired in the Company's mergers and acquisitions are subject to the Company’s internal and
external credit review. Under the accounting guidance of FASB ASC 310-30, the ALL on PCI loans is measured at
each financial reporting period, or measurement date, based on expected cash flows. If and when credit deterioration,
or decreases in expected cash flows previously estimated, occurs subsequent to the acquisition date, a provision for
loan losses will be charged to earnings as of the measurement date.
Allowance for Losses on Unfunded Commitments:
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 disbursed
amounts recognized in the Consolidated Statements of Financial Condition. 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 ALL, 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 $306,000 as of
December 31, 2019 and 2018, respectively. This allowance is reported within accrued expenses and other liabilities
on the Company's Consolidated Statements of Financial Condition.
Mortgage Banking Operations
The Bank originates and sells certain one-to-four family residential loans on a servicing-released basis. The
Bank recognizes a gain or loss to the extent that the sale proceeds of the loan sold differs from the net book value at
the time of sale. Income from one-to-four family residential loans brokered to other lenders is recognized into income
on date of loan closing.
Commitments to sell one-to-four family residential loans are made primarily during the period between the
taking of the loan application and the closing of the loan. The timing of making these sale commitments is dependent
upon the timing of the borrower’s election to lock-in the mortgage interest rate and fees prior to loan closing. Most of
these sale commitments are made on a best-efforts basis whereby the Bank is only obligated to sell the loan if the
loan is approved and closed by the Bank. Commitments to fund one-to-four family residential loans (interest rate locks)
to be sold into the secondary market and forward commitments for the future delivery of these loans are accounted
for as free standing derivatives. Fair values of these mortgage derivatives are estimated based on changes in mortgage
interest rates between the date the interest on the loan was locked and the balance sheet date. The Company enters
into forward commitments for the future delivery of one-to-four family residential loans when interest rate locks are
entered into, in order to hedge the interest rate risk resulting from its commitments to fund the loans. Changes in the
fair values of these derivatives are included in other income. The fair value of these derivative instruments was not
significant at December 31, 2019 and 2018.
Commercial Loan Sales, Servicing, and Commercial Servicing Asset
The Company, on a limited basis, sells the guaranteed portion of SBA and USDA loans, with servicing retained,
for cash proceeds, and records a related servicing asset. The Company does not sell loans with servicing retained
unless it retains a participating interest. The servicing asset is recorded at fair value upon sale, and the fair value is
estimated by discounting estimated net future cash flows from servicing using discount rates that approximate current
market rates and using estimated prepayment rates. Subsequent to initial recognition, all classes of servicing rights
are carried at the lower of amortized cost or fair value, and are amortized in proportion to, and over the period of, the
estimated net servicing income. The servicing asset is reported within prepaid expenses and other assets on the
Company's Consolidated Statements of Financial Condition.
For purposes of evaluating and measuring impairment, the fair value of servicing rights is measured using a
discounted estimated net future cash flow model as described above at least annually. Any impairment is measured
as the amount by which the carrying value of servicing rights exceeds its fair value. Impairment is determined by
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stratifying rights into groupings based on predominant risk characteristics including investor type, loan type, and
maturity. Impairment is recognized through a valuation allowance for an individual strata, to the extent that fair value
is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer
exists for a particular strata, a reduction of the allowance may be recorded as an increase to income. Changes in
valuation allowances are reported within other income on the Consolidated Statements of Income. The fair values of
servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayments
speeds and default rates and losses.
Servicing fee income, which is reported as other income on the Consolidated Statements of Income, is recorded
for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal and
are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing
fee income. Late fees and ancillary fees related to loan servicing were not material for the years ended December 31,
2019, 2018, and 2017.
A premium over the adjusted carrying value is received upon the sale of the guaranteed portion of a SBA or
USDA loan. The Bank's investment in a SBA or USDA loan is allocated among the sold and retained portions of the
loan based on the relative fair value of each portion at the time of loan origination, adjusted for payments and other
activities. Because the portion retained does not carry a SBA or USDA guarantee, part of the gain recognized on the
sold portion of the loan is deferred and amortized as a yield enhancement on the retained portion in order to obtain a
market equivalent yield. The balance of the deferred gain was immaterial at December 31, 2019, 2018 and 2017.
Other Real Estate Owned
Other real estate acquired by the Company in partial or full satisfaction of a loan obligation is classified as
held for sale. When acquired, the property 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.
Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal
title is obtained upon completion of foreclosure, or when the borrower conveys all interest in the properly to satisfy the
loan through completion of a deed in lieu of foreclosure or through a similar legal agreement.
After acquisition, all costs incurred in maintaining the property are expensed except for costs relating to the
development and improvement of the property which are capitalized to the extent of the property’s net realizable value.
If the estimated realizable value of the other real estate owned property declines after the acquisition date, the valuation
adjustment is charged to other real estate owned expense, net on the Consolidated Statements of Income.
Premises and Equipment
Premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the lease
period, whichever is shorter. The estimated useful lives used to compute depreciation and amortization for buildings
and building improvements 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.
Bank Owned Life Insurance
The Company's BOLI policies insure the lives of certain current or former Bank officers, and name the Bank
as beneficiary. Noninterest income is generated tax-free (subject to certain limitations) from the increase in the policies'
underlying investments made by the insurance company. The Bank utilizes BOLI to partially offset costs associated
with employee compensation and benefit programs with the earnings on the BOLI. The Company records BOLI at the
amount that can be realized under the insurance contract at the statement of financial condition date, which is the
cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
Other Intangible Assets
The other intangible assets represents the 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 annually, or more frequently if an indication of impairment exists.
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Goodwill
The Company’s goodwill represents the excess of the purchase price over the fair value of net assets acquired
in certain mergers and acquisitions. Goodwill is assigned to Heritage Bank and is evaluated for impairment at the Bank
level (reporting unit) on an annual basis, or more frequently if an indication of impairment exists between the annual
tests. Factors to consider may include, among others: a significant change in legal factors or in the general business
climate; significant change in the Company’s stock price and market capitalization; unanticipated competition; and an
action or assessment by a regulator.
For the goodwill impairment assessment, the Company has the option, prior to the two-step process, to first
assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that
it is more-likely-than-not that the fair value of a reporting unit is less than its carrying value. The Company opted to
bypass the qualitative assessment for its 2019 and 2018 annual goodwill impairment testing and proceed directly to
the two-step goodwill impairment test.
The goodwill impairment two-step process requires the Company to make assumptions and judgments
regarding fair value. The first step of the goodwill impairment test is performed by comparing the reporting unit’s
aggregate fair value to its carrying value. Absent other indicators of impairment, if the aggregate fair value exceeds
the carrying value, goodwill is not considered impaired and no additional analysis is necessary. If the carrying value
of the reporting unit were to exceed the aggregate fair value, a second step would be performed to measure the amount
of impairment loss, if any. To measure any impairment loss the implied fair value would be determined in the same
manner as if the reporting unit were being acquired in a business combination. If the implied fair value of goodwill is
less than the recorded goodwill, an impairment charge would be recorded for the difference.
For additional information relating to goodwill, see Note (8) Goodwill and Other Intangible Assets.
Income Taxes
The Company and the Bank file a United States consolidated federal income tax return and an Oregon State
income tax return. Income tax expense is the total of the current year income tax due or refundable and the change
in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the consolidated financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates
applicable to taxable income in the periods in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period
that includes the enactment date. A valuation allowance, if needed, reduces deferred tax assets to the amounts expected
to be realized.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained
in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount
of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more
likely than not” test, no tax benefit is recorded.
The Company’s policy is to recognize interest and penalties on unrecognized tax benefits in “income taxes”
in the Consolidated Statements of Income as the amounts are generally insignificant each year.
Operating leases
During the normal course of business, the Company enters into agreements, and at inception it determines if
a particular agreement is a lease. The Company's noncancelable operating lease agreements relate to certain banking
offices, back-office operational facilities, office equipment, and sublease agreements. The agreements are recorded
as ROU assets and liabilities within prepaid expenses and other assets and accrued expenses and other liabilities,
respectively, in the Condensed Consolidated Statements of Financial Condition. Operating lease ROU assets and
lease liabilities are recognized at the commencement date based on the present value of lease payments over the
lease term, and represent the right to use an underlying asset for the lease term and the obligation to make lease
payments arising from the lease. As the Company's leases do not provide an implicit rate, the Company uses its
incremental borrowing rate based on the information available at the commencement date in determining the present
value of lease payments. The operating lease ROU asset also includes any lease pre-payments made and excludes
lease incentives. The Company's lease terms may include options to extend or terminate the lease when it is reasonably
certain that the Company will exercise that option. Lease expense for lease payments is recognized on a straight-line
basis over the lease term.
The Company elected an exclusion policy for ROU assets and liabilities for operating leases with a term of
twelve months or less and a capitalization threshold policy for total contractual lease payments of $25,000 or more.
The Company does not account for any leases at a portfolio level.
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Stock-Based Compensation
The Company maintains a number of stock-based incentive programs, which are discussed in more detail in
Note (20) Stock-Based Compensation. Compensation cost is recognized for stock options, restricted stock awards
and restricted stock units issued to employees and directors based on the fair value of these awards at the date of
grant. Compensation cost is generally recognized over the requisite service period, generally defined as the vesting
period, on a straight-line basis. Compensation cost for restricted stock units with market-based vesting is recognized
over the service period to the extent the restricted stock units are expected to vest. Forfeitures are recognized as they
occur.
The market price of the Company’s common stock at the date of grant is used to determine the fair value of
the restricted stock awards and restricted stock units. The fair value of stock options granted is estimated based on
the date of grant using the Black-Scholes-Merton option pricing model. Certain restricted stock unit grants are subject
to performance-based vesting as well as other approved vesting conditions and cliff-vest based on those conditions,
and the fair value is estimated using a Monte Carlo simulation pricing model. The assumptions used in the Black-
Scholes-Merton option pricing model and the Monte Carlo simulation pricing model include the expected term based
on the valuation date and the remaining contractual term of the award; the risk-free interest rate based on the U.S.
Treasury curve at the valuation date of the award; the expected dividend yield based on expected dividends being
payable to the holders; and the expected stock price volatility over the expected term based on the historical volatility
over the equivalent historical term.
Low Income Housing Tax Credit Investments
The Company has two equity investments in LIHTC partnerships, which are indirect federal subsidies that
finance low-income housing projects. As a limited liability investor in these partnerships, the Company receives tax
benefits in the form of tax deductions from partnership operating losses and federal income tax credits. The federal
income tax credits are earned over a 10-year period as a result of the investment properties meeting certain criteria
and are subject to recapture for noncompliance with such criteria over a 15-year period. The Company accounts for
the LIHTCs under the proportional amortization method and amortizes the initial cost of the investment in proportion
to the tax credits and other tax benefits received and recognizes the net investment performance on the Company's
Consolidated Statements of Income as a component of income tax expense. The Company reported the carrying value
of the equity investments in the unconsolidated LIHTCs as prepaid expenses and other assets on the Company’s
Statements of Financial Condition.
The maximum exposure to loss in the LIHTCs is the amount of equity invested and credit extended by the
Company. Loans to these entities are underwritten in substantially the same manner as are other loans and are
generally secured. The Company has evaluated the variable interests held by the Company in each LIHTC investment
and determined that the Company does not have controlling financial interests in such investments, and is not the
primary beneficiary.
New Market Tax Credit Investments
The Company has a total of $25.0 million of qualified equity investments into three certified development
entities which are eligible to receive NMTC. The NMTC program provides federal tax incentives to investors to make
investments in distressed communities and promotes economic improvements through the development of successful
businesses in these communities. The NMTC is available to investors over a seven-year period and is subject to
recapture if certain events occur during such period. The Company is required to fund 85 percent of a tranche by a
predetermined deadline to claim the entire tax credit. The Company funded its tranche before the deadline.
The Company accounts for its NMTC on the equity method and reports the investment balance as prepaid
expenses and other assets on the Company’s Consolidated Statements of Financial Condition and the investment
income in other income on the Company's Consolidated Statements of Income.
Deferred Compensation Plans
The Company has a Deferred Compensation Plan and has entered into arrangements with certain executive
officers. Under the Deferred Compensation Plan, participants are permitted to elect to defer compensation and the
Company has the discretion to make additional contributions to the Deferred Compensation Plan on behalf of any
participant based on a number of factors. Such discretionary contributions are generally approved by the Compensation
Committee of the Company's Board of Directors. The notional account balances of participants under the Deferred
Compensation Plan earn interest on an annual basis. The applicable interest rate is the Moody’s Seasoned Aaa
Corporate Bond Yield as of January 1 of each year. Generally, a participant’s account is payable upon the earliest of
the participant’s separation from service with the Company, the participant’s death or disability, or a specified date that
is elected by the participant in accordance with applicable rules of the Internal Revenue Code.
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Additionally, in conjunction with the Premier Merger, the Company assumed a Salary Continuation Plan. The
Salary Continuation Plan is an unfunded non-qualified deferred compensation plan for select former Premier
Commercial executive officers, some of which are current Heritage officers. Under the Salary Continuation Plan, the
Company will pay each participant, or their beneficiary, specified amounts over specified periods beginning with the
individual's termination of service due to retirement subject to early termination provisions.
The Company’s obligation to make payments under the Deferred Compensation Plan and the Salary
Continuation Plan is a general obligation of the Company and is to be paid from the Company’s general assets. As
such, participants are general unsecured creditors of the Company with respect to their participation under both plans.
The Company records a liability within accrued expenses and other liabilities on the Consolidated Statements of
Financial Condition and records compensation expense in a systematic and rational manner. Since the amounts earned
under the Deferred Compensation Plan are generally based on the Company’s annual performance, the Company
records deferred compensation expense each year for an amount calculated based on that year’s financial performance.
Earnings per Share
The two-class method is used in the calculation of basic and diluted earnings per common share. Basic earnings
per common share is net income allocated to common shareholders divided by the weighted average number of
common shares outstanding during the period. All outstanding unvested share-based payment awards that contain
rights to nonforfeitable dividends are considered participating securities for this calculation. Dividends and undistributed
earnings allocated to participating securities are excluded from net income allocated to common shareholders and
participating securities are excluded from weighted average common shares outstanding. Diluted earnings per common
share is calculated using the treasury stock method and includes the dilutive effect of additional potential common
shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and stock
dividends through the date of issuance of the financial statements.
Derivative Financial Instruments
The commitments to originate mortgage loans held for sale and the related forward delivery contracts are
considered derivatives. The Company also utilizes interest rate swap derivative contracts to facilitate the needs of its
commercial customers whereby it enters into an interest rate swap with a customer while at the same time entering
into an offsetting interest rate swap with another financial institution. In connection with each swap transaction, the
Company agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest
from the customer on a similar notional amount at a fixed interest rate. At the same time, the Company agrees to pay
another financial institution the same fixed interest rate on the same notional amount and receive the same variable
interest rate on the same notional amount. The transaction allows the Company’s customer to effectively convert a
variable rate loan to a fixed rate and the Company recognizes immediate income based upon the difference in the bid/
ask spread of the underlying transactions with its customers and the third party. Because the Company acts as an
intermediary for its customer, changes in the fair value of the underlying derivative contracts for the most part offset
each other and do not significantly impact the Company’s results of operations. These interest rate swaps are not
designated as hedging instruments.
Fee income related to these transaction is recorded in interest rate swap fees on the Consolidated Statements
of Income. The fair value of derivative positions outstanding is included in prepaid expenses and other assets and
accrued expenses and other liabilities in the Company's Consolidated Statements of Financial Condition and included
in the net change in accrued interest receivable, prepaid expenses and other assets, and accrued expenses and other
liabilities in the Consolidated Statements of Cash Flows. The gains and losses due to changes in fair value and all
cash flows are included in other noninterest income in the Company's Consolidated Statements of Income, but net to
zero for the years ended December 31, 2019 and 2018 based on the identical back-to-back interest rate swaps.
Advertising Expenses
Advertising costs are expensed as incurred. Costs related to production of advertising are considered incurred
when the advertising is first used.
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.
Revenue from Contracts with Customers
The Company's revenues are primarily composed of interest income on financial instruments, such as loans
and investment securities, which are excluded from the scope of ASC 606. Descriptions of the Company's revenue-
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generating activities that are within the scope ASC 606, which are presented in Service Charges and Other Fees and
Other Income on the Company’s Consolidated Statement of Income, are as follows:
• Service Charges on Deposit Accounts: The Company earns fees from its deposit customers from a variety of
deposit products and services. Non-transaction based fees such as account maintenance fees and monthly
statement fees are considered to be provided to the customer under a day-to-day contract with ongoing
renewals. Revenues for these non-transaction fees are earned over the course of a month, representing the
period over which the Company satisfies the performance obligation. Transaction-based fees such as non-
sufficient fund charges, stop payment charges and wire fees are recognized at the time the transaction is
executed as the contract duration does not extend beyond the service performed.
• Wealth Management and Trust Services: The Company earns fees from contracts with customers for fiduciary
and brokerage activities. Revenues are generally recognized on a monthly basis and are generally based on
a percentage of the customer’s assets under management or based on investment or insurance solutions that
are implemented for the customer.
• Merchant Processing Services and Debit and Credit Card Fees: The Company earns fees from cardholder
transactions conducted through third party payment network providers which consist of (i) interchange fees
earned from the payment network as a debit card issuer, (ii) referral fee income, and (iii) ongoing merchant
fees earned for referring customers to the payment processing provider. These fees are recognized when the
transaction occurs, but may settle on a daily or monthly basis.
(d) Recently Issued Accounting Pronouncements
FASB ASU 2014-09, Revenue from Contracts with Customers, (as amended by FASB ASU 2015-14; FASB
ASU 2016-08; FASB ASU 2016-10 and FASB ASU 2016-12), was issued in May 2014. Under this Accounting Standard
Update ("ASU" or "Update"), the Financial Accounting Standards Board ("FASB") created a new Topic 606 which is in
response to a joint initiative of FASB and the International Accounting Standards Board to clarify the principles for
recognizing revenue and to develop a common revenue standard for U.S. GAAP and international financial reporting
standards that would:
• Remove inconsistencies and weaknesses in revenue requirements.
• Provide a more robust framework for addressing revenue issues.
•
Improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital
markets.
• Provide more useful information to users of financial statements through improved disclosure requirements.
• Simplify the preparation of financial statements by reducing the number of requirements to which an entity
must refer.
The Company adopted the revenue recognition guidance, as amended, on January 1, 2018 using the modified
retrospective approach. A significant amount of the Company’s revenues are derived from interest income on financial
assets, which are excluded from the scope of the amended guidance. With respect to noninterest income and related
disclosures, the Company has identified and evaluated the revenue streams and underlying revenue contracts within
the scope of the guidance. The Company did not identify any significant changes in the timing of revenue recognition
when considering the amended accounting guidance. The adoption of the Update did not have a material impact on
the Company's Consolidated Financial Statements, but the adoption did change certain disclosure requirements as
described in Significant Accounting Policies above.
FASB ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic
825-10), was issued in January 2016, to enhance the reporting model for financial instruments to provide users of
financial statements with more decision-useful information. This Update contained several provisions, including but
not limited to (1) requiring equity investments, with certain exceptions, to be measured at fair value with changes in
fair value recognized in net income; (2) simplifying the impairment assessment of equity investments without readily
determinable fair values by requiring a qualitative assessment to identify impairment; (3) eliminating the requirement
to disclose the method(s) and significant assumptions used to estimate fair value; and (4) requiring separate
presentation of financial assets and liabilities by measurement category and form of financial asset on the balance
sheet or the accompanying notes to the financial statements. The Update also changed certain financial statement
disclosure requirements, including requiring disclosures of the fair value of financial instruments be made on the basis
of exit price. The Company adopted this Update effective January 1, 2018 using the cumulative catch-up transition
method. This change resulted in a cumulative adjustment of $93,000 from accumulated other comprehensive loss,
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net to retained earnings for the unrealized gain related to the Company's equity security. The Company's processes
and procedures utilized to estimate the fair value of loans receivable and certificate of deposit accounts for disclosure
requirements were additionally changed due to adoption of this Update. Previously, the Company valued these items
using an entry price notion. This ASU emphasized that these instruments be measured using the exit price notion;
accordingly, the Company refined its calculation as part of adopting this Update. Prior period information has not been
updated to conform with the new guidance. See the Consolidated Statements of Stockholders' Equity and Note (19)
Fair Value Measurements.
FASB ASU 2016-02, Leases (Topic 842), as amended by ASU 2017-13, 2018-01, 2018-10, 2018-11 and ASU
2018-11 and ASU 2019-01, was originally issued in February 2016, to increase transparency and comparability of
leases among organizations and to disclose key information about leasing arrangements. The ASU sets out the
principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. The
ASU requires lessees to apply a dual approach, classifying leases as either a finance or operating lease. This
classification will determine whether the lease expense is recognized based on an effective interest method or on a
straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability
for all leases with a term greater than 12 months regardless of their classification. All cash payments will be classified
within operating activities in the statement of cash flows. In transition, lessees and lessors are required to recognize
and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The
ASU is effective for public entities for fiscal years beginning after December 15, 2018, including interim periods within
those fiscal years. During 2018, management developed its methodology to estimate the right-of use assets and lease
liabilities and selected a vendor to assist with implementation and calculation of the impact under the modified
retrospective approach. The Company adopted the ASU on January 1, 2019 and elected an exclusion accounting
policy for lease assets and lease liabilities for leases with a term of twelve months or less. The adoption of this ASU
resulted in the recognition of operating lease assets and liabilities of approximately $29.3 million and $30.2 million,
respectively, in prepaid expenses and other assets and accrued expenses and other liabilities in the Condensed
Consolidated Statements of Financial Condition. This change also resulted in a cumulative-effect adjustment to
beginning retained earnings of $399,000, net of tax, under the modified retrospective approach.
FASB ASU 2016-13, Financial Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on
Financial Instruments, as amended by ASU 2018-19, ASU 2019-04, ASU 2019-05, and ASU 2019-11 was originally
issued in June 2016. Commonly referred to as CECL, this ASU requires financial assets measured at amortized cost
basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account
that is deducted from the amortized cost basis of the financial asset to present the net carrying value at the amount
expected to be collected on the financial asset. The measurement of expected credit losses is based on relevant
information about past events including historical experience, current conditions and reasonable and supportable
forecasts that affect the collectibility of the reported amount. The amendment affects loans, debt securities, trade
receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables and any other
financial asset not excluded from the scope that have the contractual right to receive cash. The ASU replaces the
incurred loss impairment methodology, which generally only considered past events and current conditions, with a
methodology that reflects the expected credit losses and required consideration of a broader range of reasonable and
supportable information to estimate all expected credit losses. The ASU additionally addresses purchased assets and
introduces the purchased financial asset with a more-than-insignificant amount of credit deterioration since origination
("PCD"). The accounting for these PCD assets is similar to the existing accounting guidance of FASB ASC
310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, for PCI assets, except the subsequent
improvements in estimated cash flows will be immediately recognized into income, similar to the immediate recognition
of subsequent deteriorations in cash flows. Current guidance only allows for the prospective recognition of these cash
flow improvements. Because the terminology has been changed to a "more-than-insignificant" amount of credit
deterioration, the presumption is that more assets might qualify for this accounting under the ASU than those under
current guidance. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2019,
including interim periods within those fiscal years with early adoption permitted for fiscal years after December 15,
2018. An entity will apply the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of
the first reporting period in which the guidance is adopted. A prospective transition approach is required for debt
securities. An entity that has previously applied the guidance of FASB ASC 310-30 will prospectively apply the guidance
in this ASU for PCD assets. A prospective transition approach should be used for PCD assets where upon adoption,
the amortized cost basis should be adjusted to reflect the addition of the allowance for credit losses.
The Company is in the process of implementing a CECL allowance model which calculates reserves over the
life of the loan and is largely driven by portfolio characteristics, economic outlook, and other key methodology
assumptions versus the current accounting practice that utilizes the incurred loss model. Those assumptions are based
upon the open pool, historical loss framework. The Company will utilize a single economic forecast over a reasonable
83
and supportable forecast period, with a straight-line reversion to historical losses. The Company’s cross functional
team will periodically refine the model as needed. The Company expects an increase of allowance for credit losses
of 10%-30%, including the impact of the allowance for unfunded commitments. This change will decrease the opening
stockholders' equity balance as of January 1, 2020. A majority of the increase is the result of the life of loan estimate.
The Company anticipates increases in the allowance for credit losses on longer dated loans and decreases in the
shorter dated loans. The above range is disclosed due to the fact that the Company is still in the process of finalizing
the CECL allowance model, including the review of assumptions related to qualitative adjustments, probable troubled
debt restructurings, and economic forecasts; finalizing the execution of internal controls; and evaluating the impact to
our financial statement disclosures.
The Company does not expect a material allowance for credit losses to be recorded on its available-for-sale
debt securities under the newly codified available-for-sale debt security impairment model, as the majority of these
securities are government agency-backed securities for which the risk of loss is minimal.
FASB ASU 2017-04, Goodwill (Topic 350), was issued in January 2017 and eliminates Step 2 from the goodwill
impairment test. The ASU is effective for annual periods or any interim goodwill impairment tests beginning after
December 15, 2019 using a prospective transition method and early adoption is permitted. The Company does not
expect the ASU will have a material impact on its Consolidated Financial Statements.
FASB ASU 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value
Measurement, was issued in August 2018 and modifies the disclosure requirements on fair value measurements in
Topic 820. The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those
fiscal years, beginning after December 15, 2019. The Company does not expect the ASU will have a material impact
on its Consolidated Financial Statements.
(2)
Business Combinations
There were no acquisitions or mergers completed during the years ended December 31, 2019 and 2017.
During the year ended December 31, 2018, the Company completed the acquisitions of Puget Sound Bancorp and
Premier Commercial Bancorp.
Puget Sound Merger:
On July 26, 2017, the Company, along with the Bank, and Puget Sound Bancorp, Inc. and its wholly-owned
subsidiary bank, Puget Sound Bank, jointly announced the signing of a definitive agreement. The Puget Sound Merger
was effective on January 16, 2018. As of the acquisition date, Puget Sound merged into Heritage and Puget Sound
Bank merged into Heritage Bank. The Puget Sound Merger resulted in $68.5 million of goodwill.
Pursuant to the terms of the Puget Sound Merger, all outstanding Puget Sound restricted stock awards became
immediately vested on the acquisition date of the Puget Sound Merger. Puget Sound shareholders received 1.1688
shares of Heritage common stock per share of Puget Sound stock. Heritage issued an aggregate of 4,112,258 shares
of its common stock based on the January 12, 2018 closing price of Heritage Common stock of $31.80 for total fair
value of common shares issued of $130.8 million and paid cash of $3,000 for fractional shares in the transaction for
total consideration paid of $130.8 million. Total consideration includes $851,000, representing 26,741 shares which
were forfeited by the Puget Sound shareholders to pay applicable taxes.
The Company incurred acquisition-related costs of $75,000, $5.4 million and $810,000 for the years ended
December 31, 2019, 2018 and 2017 respectively, for the Puget Sound Merger.
Premier Merger:
On March 24, 2018, the Company, along with the Bank, and Premier Commercial Bancorp and its wholly-
owned subsidiary bank, Premier Community Bank, jointly announced the signing of a definitive agreement. The Premier
Merger was effective on July 2, 2018. As of the acquisition date, Premier Commercial Bancorp merged into Heritage
and Premier Community Bank merged into Heritage Bank.
Pursuant to the terms of the Premier Merger, Premier Commercial shareholders received 0.4863 shares of
Heritage common stock in exchange for each share of Premier Commercial common stock based on the closing date
price per share of Heritage common stock on June 29, 2018 of $34.85. Heritage issued an aggregate of 2,848,579
shares of its common stock and paid cash of $2,000 for fractional shares in the transaction for total consideration paid
of $99.3 million.
84
The Company incurred acquisition-related costs of $57,000, and $4.9 million, for the years ended December 31,
2019 and 2018 for the Premier Merger, respectively. There were no incurred acquisition-related costs for the year
ended December 31, 2017 for the Premier Merger.
Business Combination Accounting:
The Premier Merger and Puget Sound Merger resulted in $53.4 million and $68.5 million, respectively, of
goodwill. This goodwill is not deductible for tax purposes.
The primary reason for the Premier and Puget Mergers was to create depth in the Company's geographic
footprint consistent with its ongoing growth strategy, focused heavily on metro markets, and to achieve operational
scale and realize efficiencies of a larger combined organization. The mergers constitute business acquisitions as
defined by FASB ASC 805, Business Combinations. FASB ASC 805 establishes principles and requirements for how
the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired and
the liabilities assumed. Heritage was considered the acquirer in these transactions. Accordingly, the preliminary
estimates of fair values of Premier Commercial and Puget Sound assets, including the identifiable intangible assets,
and the assumed liabilities, were measured and recorded as of the respective acquisition dates. Fair values on the
acquisition dates are preliminary and represent management’s best estimates based on available information and
facts and circumstances in existence on the acquisition date. Fair values are subject to refinement for up to one year
after the closing date of the acquisitions as additional information regarding the closing date fair values becomes
available. The Company finalized the purchase price allocation for both mergers as of December 31, 2018.
The fair value estimates of the assets acquired and liabilities assumed in the Premier and Puget Mergers were
as follows:
Premier Merger
Puget Sound Merger
(In thousands)
Assets
Cash and cash equivalents
Interest earning deposits
Investment securities available for sale
Loans receivable (1)
Other real estate owned
Premises and equipment, net
Federal Home Loan Bank stock, at cost
Bank owned life insurance
Accrued interest receivable
Prepaid expenses and other assets
Other intangible assets
Total assets acquired
Liabilities
Deposits
Federal Home Loan Bank advances
Securities sold under agreement to repurchase
Accrued expenses and other liabilities
Total liabilities acquired
Fair value of net assets acquired
$
22,534 $
3,309
4,493
330,158
1,796
3,053
1,120
10,852
1,006
1,603
7,075
386,999 $
25,889
54,247
80,353
388,462
—
732
623
6,264
1,448
1,354
11,270
570,642
318,717 $
505,885
16,000
462
5,935
341,114 $
—
—
2,504
508,389
45,885 $
62,253
$
$
$
$
(1) The outstanding loan balance acquired in the Premier Merger and Puget Sound Merger was $335.4 million and $392.7
million, respectively, at the acquisition date.
85
A summary of the net assets purchased and the estimated fair value adjustments and resulting goodwill
recognized from the Premier and Puget Sound Mergers are presented in the following tables. Goodwill represents the
excess of the consideration transferred over the estimated fair value of the net assets acquired and liabilities assumed.
Consideration transferred
Cost basis of net assets on merger date
Fair value adjustments:
Investment securities
Total loans receivable, net
Other real estate owned
Premises and equipment
Other intangible assets
Prepaid expenses and other assets
Deposits
Accrued expenses and other liabilities
Fair value of net assets on merger date
Goodwill recognized from the mergers
Premier Merger
Puget Sound Merger
(In thousands)
99,275 $
130,773
40,629 $
54,405
(135)
(111)
(1,017)
1,312
7,075
(1,912)
(310)
354
(348)
1,400
—
(121)
9,207
(2,282)
(62)
54
45,885 $
62,253
53,390 $
68,520
$
$
$
$
The following table presents certain pro forma information, for illustrative purposes only, for the years ended
December 31, 2018 and 2017 as if the Premier and Puget Mergers had occurred on January 1, 2017. The estimated
pro forma information combines the historical results of Premier Commercial and Puget Sound with the Company's
consolidated historical results and includes certain adjustments reflecting the estimated impact of certain fair value
adjustments for the respective periods. The pro forma information is not indicative of what would have occurred had
the Premier and Puget Mergers occurred on January 1, 2017. In particular, the pro forma information does not consider
any changes to the provision for loan losses resulting from recorded loans at fair value. Additionally, Heritage expects
to achieve further operating savings and other business synergies, including interest income growth, as a result of the
Premier and Puget Mergers which are not reflected in the pro forma amounts in the following table. As a result, actual
amounts will differ from the pro forma information presented.
Net interest income
Net income
Basic earnings per common share
Dilutive Earnings per common share
Pro Forma for the Year Ended
December 31,
2018
2017
(Dollars in thousands, except per
share amounts)
$
$
$
194,989 $
174,190
69,515
41,551
1.88 $
1.87 $
1.12
1.12
The Company believes that the historical Premier Commercial and Puget Sound operating results, individually
or collectively, are not considered of enough significance to be meaningful to the Company’s results of operations.
(3)
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.
86
Available for sale investment securities
(a) Securities by Type and Maturity
The following tables present the amortized cost, gross unrealized gains, gross unrealized losses and fair
values of investment securities available for sale at the dates indicated:
U.S. Treasury and U.S. Government-sponsored
agencies
Municipal securities
Mortgage-backed securities and collateralized
mortgage obligations (1):
Residential
Commercial
Corporate obligations
Other asset-backed securities (1)
Amortized
Cost
December 31, 2019
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(In thousands)
Fair
Value
$
104,709 $
598 $
128,183
4,933
(84) $
(102)
105,223
133,014
336,929
322,169
23,893
23,277
3,184
5,575
316
54
(505)
(649)
(15)
(153)
339,608
327,095
24,194
23,178
Total
939,160 $
(1) Issued and guaranteed by U.S. Government-sponsored agencies.
$
14,660 $
(1,508) $
952,312
Amortized
Cost
December 31, 2018
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(In thousands)
Fair
Value
U.S. Treasury and U.S. Government-sponsored
agencies
Municipal securities
$
101,595 $
155 $
158,461
1,209
(147) $
(806)
101,603
158,864
Mortgage-backed securities and collateralized
mortgage obligations (1):
Residential
Commercial
Corporate obligations
Other asset-backed securities (1)
337,295
338,250
25,662
24,278
Total
985,541 $
(1) Issued and guaranteed by U.S. Government-sponsored agencies.
$
426
1,035
36
424
(6,119)
(5,524)
(135)
—
331,602
333,761
25,563
24,702
3,285 $
(12,731) $
976,095
There were no securities classified as trading or held to maturity at December 31, 2019 or December 31, 2018.
The amortized cost and fair value of investment securities available for sale at December 31, 2019, 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.
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Total
87
Amortized
Cost
Fair Value
(In thousands)
18,745 $
$
174,623
293,616
452,176
$
939,160 $
18,888
176,734
298,650
458,040
952,312
(b) Unrealized Losses and Other-Than-Temporary Impairments
The following tables show the gross unrealized losses and fair value of the Company's investment securities
available for sale that are not deemed to be other-than-temporarily impaired, aggregated by investment category and
length of time that the individual securities have been in continuous unrealized loss positions as of December 31, 2019
and December 31, 2018:
December 31, 2019
Less than 12 Months
12 Months or Longer
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
(In thousands)
$
45,999 $
(84) $
13,761
(102)
— $
—
— $
45,999 $
—
13,761
(84)
(102)
14,272
56,263
998
14,383
$ 145,676 $
(66)
(177)
(2)
(127)
60,232
43,623
1,987
1,609
(439)
(472)
(13)
(26)
74,504
99,886
2,985
15,992
(505)
(649)
(15)
(153)
(950) $ 253,127 $
(1,508)
Total
(1) Issued and guaranteed by U.S. Government-sponsored agencies.
(558) $ 107,451 $
December 31, 2018
Less than 12 Months
12 Months or Longer
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
(In thousands)
$
46,992 $
(58) $
7,350 $
(89) $
54,342 $
31,157
(159)
38,792
(647)
69,949
(147)
(806)
U.S. Treasury and U.S.
Government-sponsored
agencies
Municipal securities
Mortgage-backed securities and
collateralized mortgage
obligations (1):
Residential
Commercial
Corporate obligations
Other asset-backed securities (1)
U.S. Treasury and U.S.
Government-sponsored
agencies
Municipal securities
Mortgage-backed securities and
collateralized mortgage
obligations (1):
Residential
Commercial
Corporate obligations
66,620
43,531
13,736
$ 202,036 $
(247)
(272)
(87)
193,726
190,585
1,951
(5,872)
(5,252)
(48)
260,346
234,116
15,687
(6,119)
(5,524)
(135)
(823) $ 432,404 $ (11,908) $ 634,440 $ (12,731)
Total
(1) Issued and guaranteed by U.S. Government-sponsored agencies.
The Company has evaluated these investment securities available for sale as of December 31, 2019 and
December 31, 2018 and has determined that the decline in their value is not other-than-temporary. The unrealized
losses are primarily due to increases in market interest rates since purchase of the securities. The fair value of these
securities is expected to recover as the securities approach their maturity date. None of the underlying issuers of the
municipal securities and corporate obligations had credit ratings that were below investment grade levels at
December 31, 2019 or December 31, 2018. The Company has the ability and intent to hold the investments until
recovery of the securities' amortized cost which may be the maturity date of the securities.
88
For the years ended December 31, 2019, 2018 and 2017 there were no other-than-temporary charges recorded
to net income.
(c) Realized Gains and Losses
The following table presents the gross realized gains and losses on the sale of securities available for sale for the
years ended December 31, 2019, 2018 and 2017:
Gross realized gains
Gross realized losses
Net realized gains
(d) Pledged Securities
Year ended December 31,
2019
2018
2017
(In thousands)
$
$
558 $
(228)
330 $
273 $
(136)
137 $
193
(187)
6
The following table summarizes the amortized cost and fair value of investment securities available for sale that are
pledged as collateral for the following obligations at December 31, 2019 and December 31, 2018:
December 31, 2019
Fair
Value
Amortized
Cost
December 31, 2018
Fair
Value
Amortized
Cost
(In thousands)
$
$
187,700 $
190,773 $
199,026 $
196,786
22,156
19,333
22,294
19,850
48,173
20,778
47,407
20,482
229,189 $
232,917 $
267,977 $
264,675
Washington and Oregon state public deposits
Securities sold under agreement to repurchase
Other securities pledged
Total
(4)
Loans Receivable
The Company originates loans in the ordinary course of business and has also acquired loans through mergers
and acquisitions. Disclosures related to the Company's recorded investment in loans receivable generally exclude
accrued interest receivable and net deferred fees or costs as they were deemed insignificant.
(a) Loan Origination/Risk Management
The Company categorizes loans in one of the four segments of the total loan portfolio: commercial business,
one-to-four family residential, real estate construction and land development and consumer. Within these segments
are classes of loans for which management monitors and assesses credit risk in the loan portfolios. 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 criticized 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.
89
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 business portfolio segment: commercial and
industrial, owner-occupied commercial real estate and non-owner occupied commercial real estate. The owner and
non-owner occupied commercial real estate classes are both considered commercial real estate loans. As the
commercial and industrial loans carry different risk characteristics than the commercial real estate loans, they are
discussed separately below.
Commercial and industrial. Commercial and industrial loans are primarily made based on the identified cash
flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers,
however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and
industrial loans are secured by the assets being financed or other business assets such as accounts receivable or
inventory and may include a personal guarantee; however, some short-term loans may be made on an unsecured
basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans
may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Commercial
and industrial loans carry more risk than other loans because the borrowers’ cash flow is less predictable, and in the
event of a default, the amount of loss is potentially greater and more difficult to quantify because the value of the
collateral securing these loans may fluctuate, may be uncollectible, or may be obsolete or of limited use, among other
things.
Commercial real estate. The Company originates commercial real estate loans primarily within its primary
market areas. These loans are subject to underwriting standards and processes similar to commercial and industrial
loans in that these loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate
properties. Commercial real estate lending typically involves higher loan principal amounts and payments on loans,
and repayment is dependent on successful operation and management of the properties. The value of the real estate
securing these loans can be adversely affected by conditions in the real estate market or the economy. There is little
difference in risk between owner-occupied commercial real estate loans and non-owner occupied commercial real
estate loans.
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. The Company generally sells its single-
family loans in the secondary market and retains a smaller portion in 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 regard to the total funds required to
complete a project and the related loan-to-value ratio may vary from actual results. As a result, construction loans often
involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project
and the ability of the borrower to sell or lease the property or refinance the indebtedness. If the Company’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
dependent upon successful completion of the construction project, interest rate changes, government regulation of
real property, general economic conditions and the availability of long-term financing.
90
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.
The Company also purchases indirect consumer loans. These loans are for new and used automobile and
recreational vehicles that are originated indirectly by selected dealers located in the Company's market areas. The
Company has limited its purchase of indirect loans primarily to dealerships that are established and well-known in their
market areas and to applicants that are not classified as sub-prime.
Loans receivable at December 31, 2019 and December 31, 2018 consisted of the following portfolio segments
and classes:
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 loans receivable
Net deferred loan costs
Loans receivable, net
Allowance for loan losses
December 31, 2019
December 31, 2018
(In thousands)
$
851,834 $
806,609
1,291,592
2,950,035
132,088
104,910
171,777
276,687
406,628
3,765,438
2,441
3,767,879
(36,171)
853,606
779,814
1,304,463
2,937,883
101,763
102,730
112,730
215,460
395,545
3,650,651
3,509
3,654,160
(35,042)
Total loans receivable, net
$
3,731,708 $
3,619,118
(b) Concentrations of Credit
Most of the Company’s lending activity occurs within its primary market areas which are concentrated along
the I-5 corridor from Whatcom County to Clark County in Washington State and Multnomah County and Washington
County in Oregon, as well as other contiguous markets. The majority of the Company’s loan portfolio consists of (in
order of balances at December 31, 2019) non-owner occupied commercial real estate, commercial and industrial and
owner-occupied commercial real estate. As of December 31, 2019 and December 31, 2018, there were no
concentrations of loans related to any single industry in excess of 10% of the Company’s total loans.
(c) Credit Quality Indicators
As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks
certain credit quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified loans,
(iii) net charge-offs, (iv) nonperforming loans and (v) the general economic conditions of the United States of America,
and specifically the states of Washington and Oregon. The Company utilizes a risk grading matrix to assign a risk
grade to each of its loans. Loans are graded on a scale of 1 to 10. A description of the general characteristics of the
risk grades is as follows:
•
Grades 1 to 5: These grades are considered “pass grade” and include loans with negligible to above
average but acceptable risk. These borrowers generally have strong to acceptable capital levels and
91
•
•
•
•
•
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 financial information and/or collateral may be
appropriate. Loans with this grade show no immediate loss exposure.
Grade 6: This grade includes "Watch" loans and is considered a “pass grade”. The grade is intended
to be utilized on a temporary basis for pass grade borrowers where a potentially significant risk-
modifying action is anticipated in the near term.
Grade 7: This grade includes "Special Mention" loans, and is intended to highlight loans with elevated
risks in accordance with regulatory guidelines. This grade is synonymous with the regulatory term
"OAEM". 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 8: This grade includes “Substandard” loans in accordance with regulatory guidelines, which
the Company has determined have a high credit risk. These loans also have well-defined weaknesses
which make payment default or principal exposure likely, 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 9: 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 or have been partially charged off for the amount considered uncollectible.
Grade 10: 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.
Numerical loan grades for loans are established at the origination of the loan. Changes to loan grades are
considered at the time new information about the performance of a loan becomes available, including the receipt of
updated financial information from the borrower, results of annual term loan reviews performed by the Bank’s credit
department and scheduled loan reviews performed by the Bank’s internal Loan Review department. For consumer
loans, the Bank follows the FDIC’s Uniform Retail Credit Classification and Account Management Policy for subsequent
classification in the event of payment delinquencies or default. Typically, an individual loan grade will not be changed
from the prior period unless there is a specific indication of credit deterioration or improvement. Credit deterioration is
evidenced by delinquency, direct communications with the borrower, or other borrower information that becomes known
to management. Credit improvements are evidenced by known facts regarding the borrower or the collateral property.
The loan grades relate to the likelihood of losses in that the higher the grade, the greater the loss potential.
Loans with a pass grade may have some estimated inherent losses, but to a lesser extent than the other loan grades.
The 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 Special Mention 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 outstanding principal balances are generally charged off to the
realizable value.
92
The following tables present the balance of the loans receivable by credit quality indicator as of December 31,
2019 and December 31, 2018:
Pass
Special
Mention
December 31, 2019
Substandard
(In thousands)
Doubtful/
Loss
Total
Commercial business:
Commercial and industrial
$
771,155 $
16,339 $
64,340 $
— $
851,834
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 loans receivable
766,717
24,682
15,210
1,277,305
2,815,177
131,245
5,676
46,697
—
102,587
1,516
171,095
682
273,682
2,198
402,492
$ 3,622,596 $
—
48,895 $
8,611
88,161
843
807
—
807
3,612
93,423 $
524 $ 3,765,438
Pass
Special
Mention
December 31, 2018
Substandard
(In thousands)
Doubtful/
Loss
Total
Commercial business:
Commercial and industrial
$
788,395 $
16,168 $
49,043 $
— $
853,606
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:
741,227
27,724
10,863
1,283,077
2,812,699
100,401
9,438
53,330
—
One-to-four family residential
Five or more family residential
and commercial properties
Total real estate construction
and land development
101,519
112,678
214,197
258
52
310
Consumer
Gross loans receivable
390,808
$ 3,518,105 $
—
53,640 $
11,948
71,854
1,362
953
—
953
4,213
78,382 $
524 $ 3,650,651
Potential problem loans are loans classified as Special Mention or worse that are currently accruing interest,
are not considered a TDR loan and are not considered impaired, but which management is closely monitoring because
the financial information of the borrower causes concern as to their ability to meet their loan repayment terms. Potential
problem loans may include PCI loans as these loans continue to accrete loan discounts established at acquisition
based on the guidance of FASB ASC 310-30. Potential problem loans as of December 31, 2019 and December 31,
2018 were $87.8 million and $101.3 million, respectively.
93
—
—
—
—
—
—
—
524
806,609
1,291,592
2,950,035
132,088
104,910
171,777
276,687
406,628
—
—
—
—
—
—
—
524
779,814
1,304,463
2,937,883
101,763
102,730
112,730
215,460
395,545
(d) Nonaccrual Loans
Nonaccrual loans, segregated by segments and classes of loans, were as follows as of December 31, 2019
and December 31, 2018:
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
Total real estate construction and land development
Consumer
Nonaccrual loans
December 31, 2019
December 31, 2018
(In thousands)
$
33,547 $
4,715
6,069
44,331
19
—
—
186
6,639
4,212
1,713
12,564
71
899
899
169
$
44,536 $
13,703
PCI loans are not included in the nonaccrual loan table above because these loans are accounted for under
FASB ASC 310-30, which provides that accretable yield is calculated based on a loan's expected cash flow even if
the loan or pool is not performing under its contractual terms, except for certain non-pooled PCI loans which are no
longer accreting loan discounts established at acquisition.
(e) Past due loans
The Company performs an aging analysis of past due loans using policies consistent with regulatory reporting
requirements with categories of 30-89 days past due and 90 or more days past due. PCI loans are included in the past
due loans table below solely to reconcile to total gross loans receivable.
94
The balances of past due loans, segregated by segments and classes of loans, as of December 31, 2019 and
December 31, 2018 were as follows:
30-89
Days
90 Days
or Greater
Total Past
Due
Current
Total
PCI Loans
Gross Loan
Receivable
December 31, 2019
(In thousands)
$
10,476
$
6,774
$
17,250
$ 832,217
$ 849,467
$
2,367
$ 851,834
607
806
1,413
800,282
801,695
4,914
806,609
554
1,843
2,397
1,283,704
1,286,101
5,491
1,291,592
11,637
797
9,423
—
21,060
2,916,203
2,937,263
12,772
2,950,035
797
127,712
128,509
3,579
132,088
1,516
—
1,516
2,020
—
—
—
—
—
1,516
103,394
104,910
—
104,910
—
171,777
171,777
—
171,777
1,516
2,020
275,171
402,846
276,687
404,866
—
1,762
276,687
406,628
$
15,970
$
9,423
$
25,393
$ 3,721,932
$ 3,747,325
$
18,113
$ 3,765,438
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
95
30-89
Days
90 Days
or Greater
Total Past
Due
Current
Total
PCI Loans
Gross Loan
Receivable
December 31, 2018
(In thousands)
$
2,711
$
2,281
$
4,992
$ 845,181
$ 850,173
$
3,433
$ 853,606
513
408
921
771,678
772,599
7,215
779,814
3,412
1,103
4,515
1,292,889
1,297,404
7,059
1,304,463
6,636
227
—
665
3,792
10,428
2,909,748
2,920,176
17,707
2,937,883
—
—
227
98,221
98,448
3,315
101,763
—
234
899
101,451
102,350
380
102,730
—
—
—
112,687
112,687
43
112,730
665
2,559
234
—
899
2,559
214,138
389,524
215,037
392,083
423
3,462
215,460
395,545
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
$
10,087
$
4,026
$
14,113
$ 3,611,631
$ 3,625,744
$
24,907
$ 3,650,651
There were no loans 90 days or more past due that were still accruing interest as of December 31, 2019 or
December 31, 2018, excluding PCI loans.
(f) Impaired loans
Impaired loans include nonaccrual loans, performing TDR loans, and other loans with a specific valuation
allowance, excluding PCI loans. The balances of impaired loans as of December 31, 2019 and December 31, 2018
are set forth in the following tables:
96
December 31, 2019
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
$
30,187 $
13,631 $
43,818 $
45,585 $
1,372
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
Total real estate
construction and land
development
Consumer
Total
3,922
2,414
6,336
6,764
5,314
39,423
—
1,016
17,061
216
6,330
56,484
216
6,458
58,807
223
237
237
—
$
39,660 $
—
—
554
17,831 $
237
237
554
237
237
570
57,491 $
59,837 $
2,143
December 31, 2018
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
$
2,523 $
20,119 $
22,642 $
24,176 $
2,607
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
Total real estate
construction and land
development
Consumer
Total
816
3,352
6,691
—
899
899
—
$
7,590 $
5,000
5,816
6,150
2,924
28,043
279
6,276
34,734
279
6,414
36,740
293
1,662
1,662
538
899
899
527
36,439 $
39,233 $
4,170
426
146
1,944
56
—
—
143
1,142
206
3,955
76
—
—
139
—
—
527
28,849 $
97
The average recorded investment of impaired loans for the year ended December 31, 2019, 2018 and 2017
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
Year Ended December 31,
2019
2018
2017
(In thousands)
$
31,906 $
16,773 $
6,009
7,752
45,667
243
682
—
682
574
11,312
9,465
37,550
290
1,091
129
1,220
428
11,310
5,401
12,162
28,873
309
2,315
903
3,218
351
$
47,166 $
39,488 $
32,751
For the years ended December 31, 2019, 2018 and 2017, no interest income was recognized subsequent to
a loan’s classification as nonaccrual. For the years ended December 31, 2019, 2018 and 2017, the Bank recorded
$1.2 million, $1.4 million and $1.2 million, respectively, of interest income related to performing TDR loans.
(g) Troubled Debt Restructured Loans
The majority of the Bank’s TDR loans are a result of granting extensions of maturity on troubled credits which
have already been adversely classified. The Bank grants such extensions to reassess the borrower’s financial status
and to develop a plan for repayment. The second most prevalent concessions are certain modifications with extensions
that also include interest rate reductions. Certain TDR loans were additionally re-amortized over a longer period of
time. These modifications would all be considered a concession for a borrower that could not obtain similar financing
terms from another source other than from the Bank.
The financial effects of each modification will vary based on the specific restructure. The Bank’s TDR loans
are primarily fully amortizing term loans. If the interest rate is not adjusted and the modified terms are consistent with
other similar credits being offered, the Bank may not experience any loss associated with the restructure. If, however,
the restructure involves forbearance agreements or interest rate modifications, the Bank may not collect all the principal
and interest based on the original contractual terms. The Bank estimates the necessary allowance for loan losses on
TDR loans using the same guidance as used for other impaired loans.
The recorded investment balance and related allowance for loan losses of performing and nonaccrual TDR
loans as of December 31, 2019 and December 31, 2018 were as follows:
December 31, 2019
December 31, 2018
Performing
TDR loans
Nonaccrual
TDR loans
Performing
TDR loans
Nonaccrual
TDRs loans
TDR loans
$
14,466 $
(In thousands)
26,343 $
22,736 $
Allowance for loan losses on TDR loans
1,300
218
2,257
6,943
658
The unfunded commitment to borrowers related to TDR loans was $736,000 and $943,000 at December 31,
2019 and December 31, 2018, respectively.
98
Loans that were modified as TDR loans during the years ended December 31, 2019, 2018 and 2017 are set
forth in the following table:
Year Ended December 31,
2019
2018
2017
Number of
Contracts (1)
Recorded
Investment (1)(2)
Number of
Contracts (1)
Recorded
Investment (1)(2)
Number of
Contracts (1)
Recorded
Investment (1)(2)
(Dollars in thousands)
44
$
31,129
31
$
16,129
19
$
7,212
4
4
52
1
1
12
1,695
2,208
35,032
237
237
153
4
3
38
2
2
13
2,521
2,944
21,594
665
665
236
3
4
26
2
2
8
1,366
9,574
18,152
938
938
110
Commercial business:
Commercial and industrial
Owner-occupied commercial real
estate
Non-owner occupied commercial
real estate
Total commercial business
Real estate construction and land
development:
One-to-four family residential
Total real estate construction
and land development
Consumer
Total TDR loans
19,200
(1) Number of contracts and outstanding principal balance represent loans which have balances as of period end as certain
22,495
35,422
53
36
65
$
$
$
loans may have been paid-down or charged-off during the years ended December 31, 2019, 2018 and 2017.
(2) Includes subsequent payments after modifications and reflects the balance as of period end. As the Bank did not forgive
any principal or interest balance as part of the loan modification, the Bank’s recorded investment in each loan at the
date of modification (pre-modification) did not change as a result of the modification (post-modification), except when
the modification was the initial advance on a one-to-four family residential real estate construction and land development
loan under a master guidance line. There were no advances on these types of loans during the years ended December
31, 2019, 2018 and 2017.
The table above includes 17, 18, and 12 loans for the years ended December 31, 2019, 2018, and 2017,
respectively, that were previously reported as TDR loans. The Bank typically grants shorter extension periods to
continually monitor these TDR loans despite the fact that the extended date might not be the date the Bank expects
sufficient cash flow from these borrowers. The Bank does not consider these modifications a subsequent default of a
TDR as new loan terms, specifically new maturity dates, were granted. Of the remaining first-reported TDR loans, the
concessions granted largely consisted of maturity extensions, interest rate modifications or a combination of both. The
potential losses related to TDR loans are considered in the period the loan was first reported as a TDR loan and are
adjusted, as necessary, in the current period based on more recent information. The Bank had a related specific
valuation allowance of $1.0 million, $2.3 million, and $1.8 million at December 31, 2019, 2018, and 2017, respectively,
related to these TDR loans.
99
Loans that were modified during the previous twelve months that subsequently defaulted during the years
ended December 31, 2019, 2018 and 2017 are included in the following table:
Year Ended December 31,
2019
2018
2017
Number of
Contracts
Recorded
Investment (1)
Number of
Contracts
Recorded
Investment (1)
Number of
Contracts
Recorded
Investment (1)
(Dollars in thousands)
13 $
12,856
5 $
1,890
1 $
283
3
1
17
—
—
—
17 $
1,142
52
14,050
—
—
—
14,050
1
—
6
2
2
—
65
—
1,955
665
665
—
1
—
2
2
2
1
80
—
363
938
938
7
8 $
2,620
5 $
1,308
Commercial business:
Commercial and industrial
Owner-occupied commercial
real estate
Non-owner occupied
commercial real estate
Total commercial business
Real estate construction and land
development:
One-to-four family residential
Total real estate
construction and land
development
Consumer
Total
(1) Number of contracts and outstanding principal balance represent loans which have balances as of period end as certain
loans may have been paid-down or charged-off during the years ended December 31, 2019, 2018 and 2017.
During the years ended December 31, 2019, 2018, and 2017, six, one, and one TDR loans defaulted because
the borrower was more than 90 days delinquent on their scheduled loan payments. The remaining 11, seven and four
TDR loans defaulted because each was past its modified maturity date and the borrower has not subsequently repaid
the credits. The Bank has chosen not to further extend the maturity date on these loans. The Bank had a specific
valuation allowance of $88,000, $260,000, and $1,000 at December 31, 2019, 2018, and 2017, respectively, related
to the TDR loans which defaulted during the related year ends.
(h) Purchased Credit Impaired Loans
The Company acquired certain loans and designated them as PCI loans, which are accounted for under FASB
ASC 310-30. There were no PCI loans acquired in the Premier and Puget Mergers.
100
The following table reflects the outstanding principal balance and recorded investment of the PCI loans at
December 31, 2019 and December 31, 2018:
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 PCI loans
December 31, 2019
December 31, 2018
Outstanding
Principal
Recorded
Investment
Outstanding
Principal
Recorded
Investment
(In thousands)
$
4,439 $
4,925
7,028
16,392
3,095
2,367 $
4,914
5,491
12,772
3,579
6,319 $
7,830
8,685
22,834
3,169
—
—
—
1,463
—
—
—
1,762
67
188
255
2,203
$
20,950 $
18,113 $
28,461 $
3,433
7,215
7,059
17,707
3,315
380
43
423
3,462
24,907
On the acquisition dates, the amount by which the undiscounted expected cash flows of the PCI loans exceeded
the estimated fair value of the loan is the “accretable yield.” The accretable yield is then measured at each financial
reporting date and represents the difference between the remaining undiscounted expected cash flows and the current
carrying value of the PCI loans.
The following table summarizes the accretable yield on the PCI loans for the years ended December 31, 2019,
2018 and 2017:
Balance at the beginning of the year
Accretion
Disposal and other
Reclassification from nonaccretable difference
Balance at the end of the year
(i) Related Party Loans
Year Ended December 31,
2019
2018
(In thousands)
2017
$
$
9,493 $
(1,936)
(1,600)
884
11,224 $
(2,674)
(2,871)
3,814
6,841 $
9,493 $
13,860
(3,471)
(2,758)
3,593
11,224
In the ordinary course of business, the Company has granted loans to certain directors, executive officers and
their affiliates. Activity in related party loans for the years ended December 31, 2019, 2018 and 2017 was as follows:
Balance outstanding at the beginning of year
Elimination of outstanding loan balance due to
change in related party status
Principal additions
Principal reductions
Balance outstanding at the end of year
$
$
101
Year Ended December 31,
2019
2018
2017
(In thousands)
8,367 $
8,460 $
19,917
—
—
(223)
8,144 $
—
211
(304)
8,367 $
(10,930)
—
(527)
8,460
The Company had $557,000 and $592,000 of unfunded commitments to related parties as of December 31,
2019 and 2018, respectively. The Company did not have any borrowings from related parties at December 31, 2019
or 2018.
(j) Mortgage Banking Activities
The Bank originates one-to-four family residential loans. A portion of these loans are sold on the secondary
market. The Bank does not retain servicing on loans sold in the secondary market. At December 31, 2019 and 2018,
the balance of loans held for sale was 5.5 million and 1.6 million, respectively.
The following table presents information concerning the origination and sale of the Bank's one-to-four family
residential loans and the gains from the sale of loans as a result of the Bank's mortgage banking activities:
One-to-four family residential loans:
Originated (1)
Sold
Gain on sale of loans, net (2)
Year Ended December 31,
2019
2018
2017
(In thousands)
$
150,030 $
121,998 $
68,238
2,159
76,834
2,403
144,066
113,786
3,412
(1) Includes loans originated for sale in the secondary market or for the Bank's loan portfolio.
(2) Excludes net gains on sales of SBA and other loans.
The Bank may additionally make commitments to fund one-to-four family residential loans (interest rate locks)
to be sold into the secondary market. The contractual amounts of commitments to sell and fund with off-balance sheet
risk at December 31, 2019 and 2018 were as follows:
Commitments to sell mortgage loans
Commitments to fund mortgage loans (at interest rates approximating
market rates) for portfolio or for sale:
Fixed rate
Variable or adjustable rate
Total commitments to fund mortgage loans
December 31, 2019
December 31, 2018
$
$
$
(In thousands)
8,815 $
15,509 $
3,111
18,620 $
3,910
6,593
1,008
7,601
The fair values of freestanding derivatives related to the commitments to fund mortgage loans and sell at
locked interest rates were not significant at December 31, 2019 or 2018.
(k) Commercial Loan Sales, Servicing, and Commercial Servicing Asset
Details of loans serviced are as follows:
December 31, 2019
December 31, 2018
(In thousands)
Loans serviced for others with participating interest, gross loan
balance
$
40,616 $
Loans serviced for others with participating interest, participation
balance owned by Bank (1)
9,850
54,335
12,715
(1) Included in the balances of total loans receivable, net on the Company's Consolidated Statements of Financial
Condition.
The Company recognized $459,000, $506,000 and $467,000 of servicing income for the years ended
December 31, 2019, 2018 and 2017, respectively.
102
The Company's servicing asset at December 31, 2019 was $361,000. The activity and balances for the years
ended December 31, 2018 and 2017 was not significant.
Fair value for the annual impairment analysis was determined using discount rates ranging from 10.0% to
12.8% and prepayment speeds from 11.5% to 19.7%. There was no valuation allowance as of December 31, 2019,
2018, and 2017.
(5)
Allowance for Loan Losses
The allowance for loan losses is maintained at a level deemed appropriate by management to provide for
probable incurred credit losses in the loan portfolio.
A summary of the changes in the allowance for loan losses during the years ended December 31, 2019, 2018
and 2017 is as follows:
Balance at the beginning of the year
Charge-offs
Recoveries of loans previously charged-off
Provision for loan losses
Balance at the end of the year
2019
Year Ended December 31,
2018
(In thousands)
2017
$
$
35,042 $
(4,989)
1,807
4,311
36,171 $
32,086 $
(3,605)
1,432
5,129
35,042 $
31,083
(4,838)
1,621
4,220
32,086
The following table details the activity in the allowance for loan losses disaggregated by segment and class
for the year ended December 31, 2019:
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
Unallocated
Balance at
Beginning of
Year
Charge-offs
Recoveries
(In thousands)
Provision for
Loan Losses
Balance at
End of Year
$
11,343 $
(2,692) $
166 $
2,922 $
11,739
4,898
7,470
23,711
1,203
1,240
954
2,194
6,581
1,353
—
—
(2,692)
(60)
(133)
—
(133)
(2,104)
—
50
441
657
—
637
—
637
513
—
(436)
4,512
(229)
2,257
315
(289)
651
362
1,831
(454)
4,311 $
7,682
23,933
1,458
1,455
1,605
3,060
6,821
899
36,171
Total
$
35,042 $
(4,989) $
1,807 $
103
The following table details the allowance for loan losses disaggregated on the basis of the Company's
impairment method as of December 31, 2019:
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
Unallocated
Total
Loans
Individually
Evaluated
for
Impairment
Loans
Collectively
Evaluated
for
Impairment
Total
Allowance
for Loan
Losses
PCI Loans
(In thousands)
$
1,372 $
9,772 $
426
146
1,944
56
—
—
—
143
—
3,558
7,064
20,394
1,316
1,296
1,527
2,823
6,327
899
595
528
472
1,595
86
159
78
237
351
—
$
11,739
4,512
7,682
23,933
1,458
1,455
1,605
3,060
6,821
899
$
2,143 $
31,759 $
2,269
$
36,171
The following table details the recorded investment balance of the loan receivables disaggregated on the basis
of the Company’s impairment method as of December 31, 2019:
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
Loans
Individually
Evaluated
for
Impairment
Loans
Collectively
Evaluated
for
Impairment
PCI Loans
Total Gross
Loans
Receivable
(In thousands)
$
43,818 $
805,649 $
2,367
$
851,834
6,336
6,330
795,359
1,279,771
4,914
5,491
806,609
1,291,592
56,484
2,880,779
12,772
2,950,035
216
128,293
3,579
132,088
237
104,673
—
171,777
237
554
276,450
404,312
$
57,491 $ 3,689,834 $
—
—
—
104,910
171,777
276,687
1,762
18,113
406,628
$ 3,765,438
104
The following table details the activity in the allowance for loan losses disaggregated by segment and class
for the year ended December 31, 2018:
Balance at
Beginning of
Year
Charge-offs
Recoveries
(In thousands)
Provision for
Loan Losses
Balance at
End of Year
Commercial business:
Commercial and industrial
$
9,910 $
(1,250) $
901 $
1,782 $
11,343
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
Unallocated
Total
3,992
8,097
21,999
1,056
862
1,190
2,052
6,081
898
32,086 $
$
(1)
(149)
(1,400)
(45)
—
—
—
(2,160)
—
7
—
908
—
11
—
11
513
—
900
4,898
(478)
2,204
192
367
(236)
131
2,147
455
7,470
23,711
1,203
1,240
954
2,194
6,581
1,353
(3,605) $
1,432 $
5,129 $
35,042
The following table details the allowance for loan losses disaggregated on the basis of the Company's
impairment method as of December 31, 2018:
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
Unallocated
Total
Loans
Individually
Evaluated
for
Impairment
Loans
Collectively
Evaluated
for
Impairment
Total
Allowance
for Loan
Losses
PCI Loans
(In thousands)
$
2,607 $
1,142
7,913 $
3,063
206
3,955
76
—
—
—
139
—
6,630
17,606
1,015
1,040
875
1,915
5,965
1,353
$
823
693
634
2,150
112
200
79
279
477
—
11,343
4,898
7,470
23,711
1,203
1,240
954
2,194
6,581
1,353
$
4,170 $
27,854 $
3,018
$
35,042
105
The following table details the recorded investment balance of the loan receivables disaggregated on the basis
of the Company’s impairment method as of December 31, 2018:
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:
Loans
Individually
Evaluated
for
Impairment
Loans
Collectively
Evaluated
for
Impairment
PCI Loans
Total Gross
Loans
Receivable
(In thousands)
$
22,642 $
827,531 $
3,433 $
853,606
5,816
6,276
766,783
1,291,128
7,215
7,059
779,814
1,304,463
34,734
2,885,442
17,707
2,937,883
279
98,169
3,315
101,763
One-to-four family residential
899
101,451
380
102,730
Five or more family residential and commercial
properties
Total real estate construction and land
development
Consumer
Total
—
112,687
43
112,730
899
527
214,138
391,556
423
3,462
215,460
395,545
$
36,439 $ 3,589,305 $
24,907 $ 3,650,651
The following table details the activity in the allowance for loan losses disaggregated by segment and class
for the year ended December 31, 2017:
Balance at
Beginning of
Year
Charge-offs
Recoveries
(In thousands)
Provision for
Loan Losses
Balance at
End of Year
Commercial business:
Commercial and industrial
$
10,968 $
(859) $
792 $
(991) $
9,910
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
Unallocated
Total
155
—
947
2
202
—
202
470
—
1,755
344
1,108
69
419
(169)
250
2,401
392
3,992
8,097
21,999
1,056
862
1,190
2,052
6,081
898
(4,838) $
1,621 $
4,220 $
32,086
3,661
(1,579)
—
(2,438)
(30)
(556)
—
(556)
(1,814)
—
7,753
22,382
1,015
797
1,359
2,156
5,024
506
31,083 $
$
106
(6)
Other Real Estate Owned
Changes in other real estate owned during the years ended December 31, 2019, 2018 and 2017 were as
follows:
Balance at the beginning of the year
Additions
Additions from acquisitions
Proceeds from dispositions
(Loss) gain on sale, net
Valuation adjustment
Balance at the end of the year
Year Ended December 31,
2019
2018
2017
(In thousands
$
1,983 $
— $
—
—
(864)
(227)
(51)
434
1,796
(198)
—
(49)
$
841 $
1,983 $
754
32
—
(930)
144
—
—
At December 31, 2019, there was no other real estate owned that was the result of foreclosure and obtaining
physical possession of residential real estate properties. At December 31, 2019, there were no consumer mortgage
loans secured by residential real estate properties (included in the one-to-four family residential loans in Note (4) Loans
Receivable) for which formal foreclosure proceedings were in process.
(7)
Premises and Equipment
A summary of premises and equipment is as follows:
Land
Buildings and building improvements
Furniture, fixtures and equipment
Total premises and equipment
Less: Accumulated depreciation
Premises and equipment, net
December 31, 2019
December 31, 2018
$
$
(In thousands)
22,003 $
72,810
26,354
121,167
33,279
87,888 $
22,954
69,315
25,354
117,623
36,523
81,100
Total depreciation expense on premises and equipment was $4.7 million, $4.4 million and $3.9 million for the
years ended December 31, 2019, 2018 and 2017, respectively.
(8)
Goodwill and Other Intangible Assets
(a) Goodwill
The Company’s goodwill represents the excess of the purchase price over the fair value of net assets acquired
in the following mergers: Premier Commercial Bancorp on July 2, 2018; Puget Sound Bancorp on January 16, 2018;
Washington Banking Company on May 1, 2014; Valley Community Bancshares on July 15, 2013; Western Washington
Bancorp in 2006 and North Pacific Bank in 1998. The Company’s goodwill is assigned to the Bank and is evaluated
for impairment at the Bank level (reporting unit).
107
The following table presents the change in goodwill for the periods indicated:
Balance at the beginning of the period
Additions as a result of acquisitions (1)
Balance at the end of the period
(1) See Note (2) Business Combinations
Year Ended December 31,
2019
2018
2017
(In thousands)
$
$
240,939 $
119,029 $
119,029
—
121,910
—
240,939 $
240,939 $
119,029
At December 31, 2019, the Company’s step-one analysis concluded that the reporting unit’s fair value of the
reporting unit exceeded the carrying value, such that the Company's goodwill was not considered impaired. Similarly,
no goodwill impairment charges were required, or recorded, for the years ended December 31, 2018 and 2017. Even
though there was no goodwill impairment at December 31, 2019, changes in the economic environment, operations
of the reporting unit or other adverse events could result in future impairment charges which could have a material
impact on the Company’s operating results.
(b) Other Intangible Assets
Other intangible assets represent CDI acquired in business combinations. The useful life of the CDI was
estimated to be ten years for the acquisitions of Premier Commercial Bancorp, Puget Sound Bancorp, Washington
Banking Company, and Valley Community Bancshares, and was estimated to be five years for the acquisition of
Northwest Commercial Bank.
The following table presents the change in other intangible assets for the periods indicated:
Balance at the beginning of the year
Additions as a result of acquisitions (1)
Amortization
Balance at the end of the year
(1) See Note (2) Business Combinations
Year Ended December 31,
2019
2018
2017
(In thousands)
20,614 $
6,088 $
—
(4,001)
18,345
(3,819)
16,613 $
20,614 $
$
$
7,374
—
(1,286)
6,088
The estimated aggregate amortization expense related to these intangible assets for future years is as follows:
Year Ending December 31,
(In thousands)
$
$
3,525
3,111
2,750
2,435
1,640
3,152
16,613
2020
2021
2022
2023
2024
Thereafter
108
(9)
Deposits
Deposits consisted of the following:
Noninterest demand deposits
Interest bearing demand deposits
Money market accounts
Savings accounts
Total non-maturity deposits
Certificate of deposit accounts
Total deposits
December 31, 2019
December 31, 2018
Amount
Percent
Amount
Percent
(Dollars in thousands)
$
1,446,502
31.6% $
1,362,268
30.7%
1,348,817
753,684
509,095
4,058,098
524,578
29.4
16.4
11.2
88.6
11.4
1,317,513
765,316
520,413
3,965,510
466,892
29.7
17.3
11.8
89.5
10.5
$
4,582,676
100.0% $
4,432,402
100.0%
Accrued interest payable on deposits was $160,000 and $144,000 as of December 31, 2019 and 2018,
respectively and is included in accrued expenses and other liabilities in the Consolidated Statements of Financial
Condition.
Interest expense, by category, was as follows:
Interest bearing demand deposits
Money market accounts
Savings accounts
Certificate of deposit accounts
Total interest expense
2019
Year Ended December 31,
2018
(In thousands)
2017
$
$
3,940 $
2,754
2,634
7,021
2,728 $
1,654
2,056
3,959
16,349 $
10,397 $
1,812
682
1,311
2,244
6,049
Scheduled maturities of certificates of deposit for future years are as follows:
2020
2021
2022
2023
2024
Thereafter
Year Ending December 31,
(In thousands)
$
$
440,996
29,151
26,386
19,976
8,043
26
524,578
Certificates of deposit issued in denominations equal to or in excess of $250,000 totaled $182.9 million and
$146.2 million as of December 31, 2019 and 2018, respectively.
Deposits received from related parties as of December 31, 2019 and 2018 totaled $6.9 million and $6.1 million,
respectively.
(10)
Junior Subordinated Debentures
As part of the acquisition of Washington Banking Company on May 1, 2014, the Company assumed trust
preferred securities and junior subordinated debentures with a total fair value of $18.9 million at the merger date. At
December 31, 2019 and December 31, 2018, the balance of the junior subordinated debentures, net of unaccreted
discount, was 20.6 million and 20.3 million, respectively.
Washington Banking Master Trust, a Delaware statutory business trust, was a wholly-owned subsidiary of the
Washington Banking Company created for the exclusive purposes of issuing and selling capital securities and utilizing
109
sale proceeds to acquire junior subordinated debentures issued by the Washington Banking Company. During 2007,
the Trust issued $25.0 million of trust preferred securities with a 30-year maturity, callable after the fifth year. The trust
preferred securities have a quarterly adjustable rate based upon the three-month LIBOR plus 1.56%. On the merger
date, the Company acquired the Trust, which retained the Washington Banking Master Trust name, and assumed the
performance and observance of the covenants under the indenture related to the trust preferred securities.
The adjustable rate of the trust preferred securities at December 31, 2019 was 3.47%. The following table
presents the weighted average rate of the junior subordinated debentures for the periods indicated periods:
Weighted average rate (1)
Year Ended
December 31,
2019
2018
2017
6.55%
6.27%
5.11%
(1) The weighted average rate includes the accretion of the discount established at the merger date which is
amortized over the life of the trust preferred securities.
The junior subordinated debentures are the sole assets of the Trust and payments under the junior subordinated
debentures are the sole revenues of the Trust. All of the common securities of the Trust are owned by the Company.
Heritage has fully and unconditionally guaranteed the capital securities along with all obligations of the Trust under
the trust agreements. For financial reporting purposes, the Company's investment in the Master Trust is accounted
for under the equity method and is included in prepaid expenses and other assets on the Company's Consolidated
Statements of Financial Condition. The junior subordinated debentures issued and guaranteed by the Company and
held by the Master Trust are reflected as liabilities on the Company's Consolidated Statements of Financial Condition.
(11)
Securities Sold Under Agreement to Repurchase
The Company utilizes securities sold under agreement to repurchase with one day maturities as a supplement
to funding sources. Securities sold under agreement to repurchase are secured by pledged investment securities
available for sale. Under the securities sold under agreement to repurchase, the Company is required to maintain an
aggregate market value of securities pledged greater than the balance of the securities sold under agreement to
repurchase. The Company is required to pledge additional securities to cover any declines below the balance of the
securities sold under agreement to repurchase. For additional information on the total value of investment securities
pledged for securities sold under agreement to repurchase see Note (3) Investment Securities.
The following table presents the Company's securities sold under agreement to repurchase obligations by
class of collateral pledged at the dates indicated:
December 31, 2019
December 31, 2018
U.S. Treasury and U.S. Government-sponsored agencies
Mortgage-backed securities and collateralized mortgage
obligations (1):
Residential
Commercial
Total securities sold under agreement to repurchase
$
(1) Issued and guaranteed by U.S. Government-sponsored agencies.
(12)
(a) FHLB
Other Borrowings
$
(In thousands)
— $
4,878
9,335
17,274
31,487
8,452
11,717
20,169 $
The FHLB functions as a member-owned cooperative providing credit for member financial institutions.
Advances are made pursuant to several different programs. Each credit program has its own interest rate and range
of maturities. Limitations on the amount of advances are based on a percentage of the Bank's assets or on the FHLB’s
assessment of the institution’s creditworthiness. At December 31, 2019, the Bank maintained a credit facility with the
FHLB with available borrowing capacity of $945.2 million. The Bank had no FHLB advances outstanding at
December 31, 2019 and December 31, 2018.
110
The following table sets forth the details of FHLB advances during and as of the years ended December 31,
2019 and 2018:
FHLB Advances:
Average balance during the year
Maximum month-end balance during the year
Weighted average rate during the year
Weighted average rate at the end of year
December 31, 2019
December 31, 2018
(In thousands)
$
$
11,898
90,700
$
$
2.57%
n/a
33,913
154,500
1.98%
n/a
Advances from the FHLB are collateralized by a blanket pledge on FHLB stock owned by the Bank, deposits
at the FHLB, certain one-to-four single family residential loans or other assets, investment securities which are
obligations of or guaranteed by the United States or other assets. In accordance with the pledge agreement, the
Company must maintain unencumbered collateral in an amount equal to varying percentages ranging from 100% to
160% of outstanding advances depending on the type of collateral.
(b) Federal Funds Purchased
The Bank maintains advance lines with Wells Fargo Bank, US Bank, The Independent Bankers Bank, Pacific
Coast Bankers’ Bank, and JP Morgan Chase to purchase federal funds of up to $140.0 million as of December 31,
2019. The lines generally mature annually or are reviewed annually. As of December 31, 2019 and 2018, there were
no federal funds purchased.
(c) Credit Facilities
The Bank maintains a credit facility with the Federal Reserve Bank with available borrowing capacity of $73.1
million as of December 31, 2019. There were no borrowings outstanding as of December 31, 2019 or 2018. Any
advances on the credit facility would have to be first secured by the Bank's investment securities or loans receivable.
(13)
Leases
On January 1, 2019, the Company adopted ASU 2016-02, Leases, as further explained in Note (1) Description
of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements.
As of December 31, 2019, the Company’s lease ROU asset and related lease ROU liability were $23.0 million
and $24.2 million, respectively. The Company does not have leases designated as finance leases.
The table below summarizes the net lease cost recognized during the periods presented:
Operating lease cost
Variable lease cost
Sublease income
Total net lease cost
Year Ended
December 31,
2019
(In thousands)
4,950
$
876
(71)
$
5,755
111
The tables below summarize other information related to the Company's operating leases during the periods
presented:
Cash paid for amounts included in the measurement of lease liabilities
ROU assets obtained in exchange for lease liabilities, excluding adoption impact
Weighted average remaining lease term of operating leases, in years
Weighted average discount rate of operating leases
Year Ended
December 31,
2019
(In thousands)
4,858
$
$
1,505
December 31,
2019
8.07
3.27%
The following table outlines lease payment obligations as outlined in the Company’s lease agreements for
each of the next five years, as of December 31, 2019, and thereafter in addition to a reconcilement to the Company’s
ROU liability at the date indicated:
2020
2021
2022
2023
2024
Thereafter
Total lease payments
Implied interest
ROU liability
Year Ending
December 31,
(In thousands)
4,842
$
3,630
3,207
3,167
2,810
10,046
27,702
(3,484)
24,218
$
As of December 31, 2019, the Company entered into a $7.7 million lease agreement to renew, restructure
and add additional leased space at one of its branch locations commencing on January 1, 2021 and is not included
in the lease payment obligations table above. The new agreement will replace a lease included in the table above that
will terminate on December 31, 2020.
For comparative purposes as of December 31, 2018, the estimated future minimum annual rental commitments
under noncancelable leases having an original or remaining term of more than one year as calculated prior to applying
the modified retrospective method of ASU 2016-02 implementation were as follows:
Year Ending
December 31,
(In thousands)
4,766
$
4,251
2,477
1,704
1,568
1,788
$
16,554
2020
2021
2022
2023
2024
Thereafter
112
Rental expense of leased premises and equipment was $6.1 million and $3.8 million for the years
ended December 31, 2018 and 2017, respectively, which was included in occupancy and equipment expense on the
Company's Consolidated Statements of Income.
(14)
Employee Benefit Plans
(a) 401(k) Plan
The Company provides its eligible employees with a 401(k) plan. The Company funds certain Plan costs as
incurred.
The Plan includes the Company’s salary savings 401(k) plan for its employees. All employees hired may
participate in the Plan the first of the month following employment. Participants may contribute a portion of their salary,
which is matched by the Company at 50%, not to be greater than 3% of eligible compensation, up to Internal Revenue
Service limits. All participants are 100% vested in all accounts at all times. Employer matching contributions for the
years ended December 31, 2019, 2018 and 2017 were $1.6 million, $1.4 million and $1.1 million, respectively.
The Plan may make profit sharing and discretionary contributions which are completely discretionary.
Participants are eligible for profit sharing contributions upon credit of 1,000 hours of service during the plan year, the
attainment of 18 years of age, and employment on the last day of the year. Employees are 100% vested in profit
sharing contributions at all times. For the years ended December 31, 2019, 2018 and 2017, the Company made no
employer profit sharing contributions.
(b) Employment Agreements
The Company has entered into contracts with certain senior officers that provide benefits under certain
conditions following termination without cause, and/or following a change in control of the Company.
(c) Deferred Compensation Plan
The Company has 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. A summary of the changes in the deferred compensation plan during the
years ended December 31, 2019, 2018 and 2017 is as follows:
Balance outstanding at the beginning of the year
Employer contributions
Interest credited
Balance outstanding at the end of the year
(d) Split-Dollar Life Insurance Benefit Plan
Year Ended December 31,
2019
2018
2017
(In thousands)
$
$
3,654 $
2,844 $
2,192
443
147
713
97
567
85
4,244 $
3,654 $
2,844
In conjunction with the Washington Banking Merger, the Company assumed the split-dollar life insurance
benefit plan previously maintained by Washington Banking. Life insurance policies are maintained for current or former
officers of the Bank or former Washington Banking officers that are subject to split-dollar life insurance agreements,
which continue after the participant's employment and retirement. All participants are fully vested in their split-dollar
life insurance benefits. The accrued benefit liability for the split-dollar life insurance agreements represents the present
value of the future death benefits payable to the participants' beneficiaries.
The split-dollar life insurance projected benefit obligation is included in accrued expenses and other liabilities
on the Company's Consolidated Statements of Financial Condition. As of December 31, 2019 and 2018, the carrying
value of the obligation was $200,000 and $268,000, respectively.
(e) Salary Continuation Plan
In conjunction with the Premier Merger in 2018, the Company assumed an unfunded deferred compensation
plan for select former Premier Commercial executive officers, some of which are current Heritage officers. Under this
salary continuation plan, the Company will pay each participant, or their beneficiary, specified benefits over specified
periods beginning with the individual's termination of service due to retirement subject to early termination provisions.
113
A liability is accrued for the obligation under this plan. A summary of the changes in the salary continuation plan during
the years ended December 31, 2019 and 2018 are as follows:
Balance outstanding at the beginning of the year
Balance acquired in Premier Merger
Benefits paid
Expenses incurred
Balance outstanding at the end of the year
(15)
Commitments and Contingencies
(a) Commitments to Extend Credit
Year Ended December 31,
2019
2018
(In thousands)
4,600 $
—
(554)
288
4,334 $
—
4,718
(529)
411
4,600
$
$
In the ordinary course of business, the Company may enter into various types of transactions that include
commitments to extend credit that are not included in the Consolidated Financial Statements. The Company applies
the same credit standards to these commitments as it uses in all its lending activities and has included these
commitments in its lending risk evaluations. The majority of the commitments presented below are variable rate. The
Company’s exposure to credit and market risk under commitments to extend credit is represented by the amount of
these commitments.
The following table presents outstanding commitments to extend credit, including letters of credit, at the dates
indicated:
December 31, 2019
December 31, 2018
(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
$
600,324 $
17,193
35,573
653,090
—
75,066
230,343
305,409
253,860
Total outstanding commitments
$
1,212,359 $
568,215
13,065
13,621
594,901
—
59,772
95,535
155,307
239,822
990,030
(b) Variable Interests - Low Income Housing Tax Credit Investments
The carrying value of investments in unconsolidated LIHTCs were $92.7 million and $50.9 million as
of December 31, 2019 and 2018, respectively. During the years ended December 31, 2019, 2018, and 2017 the
Company recognized tax benefits of $5.7 million, $2.4 million and $2.9 million, respectively, and proportional
amortization of $5.0 million, $3.1 million and $2.2 million, respectively.
Total unfunded contingent commitments related to the Company’s LIHTC investments totaled $50.7 million
and $31.5 million at December 31, 2019 and 2018, respectively. The Company expects to fund LIHTC commitments
of $7.0 million during the year ended December 31, 2020 and $36.4 million during the year ended December 31, 2021,
with the remaining commitments of $7.3 million paid by December 31, 2034. There were no impairment losses on the
Company’s LIHTC investments during the years ended December 31, 2019, 2018 or 2017.
114
(c) Variable Interests - New Market Tax Credit Investments
The equity method balance of the NMTC investment was $25.4 million and $25.7 million at December 31,
2019 and December 31, 2018, respectively. The Company recognized related investment income of $701,000,
$708,000 and $735,000 during the years ended December 31, 2019, 2018 and 2017, respectively. Gross tax credits
related to the Company's certified development entities totaling $9.8 million are available through December 31, 2020.
There were no impairment losses on the Company’s NMTC investments during the years ended December 31, 2019,
2018, or 2017.
(16)
Derivative Financial Instruments
The Company has entered into certain interest rate swap contracts that are not designated as hedging
instruments. The following table presents the notional amounts and estimated fair values of interest rate derivative
contracts outstanding at December 31, 2019 and December 31, 2018:
December 31, 2019
December 31, 2018
Notional
Amounts
Estimated
Fair Value
Notional
Amounts
Estimated
Fair Value
(In thousands)
$
221,436 $
8,318 $
171,798 $
5,095
Non-hedging interest rate derivatives
Interest rate swap asset (1)
Interest rate swap liability (1)
(5,095)
(1) The estimated fair value of derivatives with customers was $8,051 and $(1,643) as of December 31, 2019 and
December 31, 2018, respectively. The estimated fair value of derivatives with third parties was $(8,051) and $1,643 as
of December 31, 2019 and December 31, 2018, respectively.
221,436
171,798
(8,318)
(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, 2019, 2018 and 2017:
Net income:
Net income
Dividends and undistributed earnings allocated to participating
securities(1)
Net income allocated to common shareholders
Basic:
Year Ended December 31,
2019
2018
2017
(In thousands)
$
$
67,557 $
53,057 $
41,791
(57)
(223)
(293)
67,500 $
52,834 $
41,498
Weighted average common shares outstanding
Restricted stock awards
36,789,244
35,281,408
29,937,400
(31,014)
(87,405)
(179,581)
Total basic weighted average common shares outstanding
36,758,230
35,194,003
29,757,819
Diluted:
Basic weighted average common shares outstanding
Effect of potentially dilutive common shares(2)
36,758,230
35,194,003
29,757,819
227,536
177,587
91,512
Total diluted weighted average common shares outstanding
(1) Represents dividends paid and undistributed earnings allocated to nonvested restricted stock awards.
(2) Represents the effect of the assumed exercise of stock options and vesting of restricted stock awards and units.
35,371,590
36,985,766
29,849,331
Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive.
Anti-dilution occurs when the exercise price of a stock option or the unrecognized compensation cost per share of a
restricted stock award exceeds the market price of the Company’s stock. For the year ended December 31, 2019,
there were 1,501 anti-dilutive shares outstanding, respectively. For the years ended December 31, 2018 and 2017,
there were no anti-dilutive shares outstanding.
115
(b) Dividends
The timing and amount of cash dividends paid on the Company's common stock depends on the Company’s
earnings, capital requirements, financial condition and other relevant factors. Dividends on common stock from the
Company depend substantially upon receipt of dividends from the Bank, which is the Company’s predominant source
of income.
The following table summarizes the dividend activity for the years ended December 31, 2019, 2018 and 2017:
Declared
January 25, 2017
April 25, 2017
July 25, 2017
October 25, 2017
October 25, 2017
January 24, 2018
April 25, 2018
July 24, 2018
October 24, 2018
October 24, 2018
January 23, 2019
April 24, 2019
July 24, 2019
October 23, 2019
October 23, 2019
Cash Dividend per Share
$0.12
$0.13
$0.13
$0.13
$0.10
$0.15
$0.15
$0.15
$0.17
$0.10
$0.18
$0.18
$0.19
$0.19
$0.10
Record Date
February 9, 2017
May 10, 2017
Paid Date
February 23, 2017
May 24, 2017
August 10, 2017
August 24, 2017
November 8, 2017
November 22, 2017
November 8, 2017
November 22, 2017
*
February 7, 2018
February 21, 2018
May 10, 2018
August 9, 2018
May 24, 2018
August 23, 2018
November 7, 2018
November 21, 2018
November 7, 2018
November 21, 2018
*
February 7, 2019
February 21, 2019
May 8, 2019
August 8, 2019
May 22, 2019
August 22, 2019
November 7, 2019
November 21, 2019
November 7, 2019
November 21, 2019
*
* Denotes a special dividend.
The FDIC and the Washington State Department of Financial Institutions, Division of Banks have the authority
under their supervisory powers to prohibit the payment of dividends by the Bank to the Company. Additionally, current
guidance from the Federal Reserve provides, among other things, that dividends per share on the Company’s common
stock generally should not exceed earnings per share, measured over the previous four fiscal quarters. Current
regulations allow the Company and the Bank to pay dividends on their common stock if the Company’s or the Bank’s
regulatory capital would not be reduced below the statutory capital requirements set by the Federal Reserve and the
FDIC.
(c) Stock Repurchase Program
The Company has had various stock repurchase programs since March 1999. On October 23, 2014, the
Company's Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common shares,
or approximately 1,513,000 shares, under the eleventh stock repurchase plan. The number, timing and price of shares
repurchased will depend on business and market conditions, and other factors, including opportunities to deploy the
Company's capital.
Since the inception of the eleventh plan, the Company has repurchased 872,678 shares at an average share
price of $20.03. During the year ended December 31, 2019, 292,712 shares were repurchased with an average share
price of $26.50. No shares were repurchased under this plan during the years ended December 31, 2018 and 2017.
116
In addition to the stock repurchases under a plan, the Company repurchases shares to pay withholding taxes
on the vesting of restricted stock awards and units. The following table provides repurchased shares for the periods
indicated:
Year Ended December 31,
2019
2018
2017
Repurchased shares to pay withholding taxes (1)
Stock repurchase to pay withholding taxes average share price
28,479
53,256
$
30.83 $
31.99 $
29,429
25.01
(1) During the year ended December 31, 2018, the Company repurchased 26,741 shares related to the withholding taxes
due on the accelerated vesting of the restricted stock units of Puget Sound which were converted to Heritage common
stock shares with an average share price of $31.80 under the terms of the Puget Sound Merger. See Note (2) Business
Combinations.
(d) Issuance of Common Stock
In conjunction with the Premier Merger effective on July 2, 2018 and the Puget Sound Merger effective on
January 16, 2018, Heritage issued 2,848,579 and 4,112,258 shares, respectively, of the Company's common stock at
the merger date share price of $34.85 and $31.80, respectively, for a fair value of $99.3 million and $130.8 million,
respectively.
In addition, common stock was issued during the years ended December 31, 2019, 2018, and 2017 related
to the exercise of stock options and issuance of restricted stock awards as further described in Note (20) Stock-Based
Compensation.
(18)
Accumulated Other Comprehensive Income (Loss)
The changes in AOCI, all of which are due to changes in the fair value of available for sale securities and are
net of tax, during the years ended December 31, 2019, 2018 and 2017 are as follows:
Balance of AOCI at the beginning of the year
$
(7,455) $
(1,298) $
(2,606)
December 31,
2019
December 31,
2018
December 31,
2017
(In thousands)
Other comprehensive income (loss) before
reclassification
Amounts reclassified from AOCI for gain on sale of
investment securities included in net income
Net current period other comprehensive income
(loss)
ASU 2016-01 and 2018-02 Implementations
Balance of AOCI at the end of the year
(19)
Fair Value Measurements
18,094
(5,956)
1,530
(261)
(108)
(4)
17,833
—
(6,064)
(93)
$
10,378 $
(7,455) $
1,526
(218)
(1,298)
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.
117
(a) Recurring and Nonrecurring Basis
The Company used the following methods and significant assumptions to measure the fair value of certain
assets on a recurring and nonrecurring basis:
Investment Securities Available for Sale:
The fair values of all investment securities are based upon the assumptions that market participants would
use in pricing the security. If available, fair values of investment securities are determined by quoted market prices
(Level 1). For investment securities where quoted market prices are not available, fair values are calculated based on
market prices on similar securities (Level 2). For investment securities where quoted prices or market prices of similar
securities are not available, fair values are calculated by using observable and unobservable inputs such as discounted
cash flows or other market indicators (Level 3). Security valuations are obtained from third party pricing services for
comparable assets or liabilities.
Impaired Loans:
At the time a loan is considered impaired, its impairment is measured based on either the present value of
expected future cash flows discounted at the loan’s effective interest rate, the observable market price, or the fair
market value of the collateral (less costs to sell) if the loan is collateral-dependent. Impaired loans for which impairment
is measured using the discounted cash flow approach are not considered to be measured at fair value because the
loan’s effective interest rate is generally not a fair value input, and for the purposes of fair value disclosures, the fair
value of these loans are measured commensurate with non-impaired loans. If the Company utilizes the fair market
value of the collateral method, the fair value used to measure impairment 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 independent
appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are
usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate
collateral may be valued using an appraisal, net book value based on the borrower’s financial statements, or aging
reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the
time of the valuation and management’s expertise and knowledge of the client and client’s business (Level 3). Impaired
loans are evaluated on a quarterly basis and impairment is adjusted accordingly.
Other Real Estate Owned:
Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when
acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value
less costs to sell. Fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single
valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments
are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable
sales and income data available. Such adjustments are usually significant and typically result in Level 3 classification
of the inputs for determining fair value.
Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified
general appraisers for commercial properties or certified residential appraisers for residential properties whose
qualifications and licenses have been reviewed and verified by the Company. Once received, the Company reviews
the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with
independent data sources such as recent market data or industry-wide statistics. On a quarterly basis, the Company
compares the actual selling price of collateral that has been liquidated to the most recent appraised value to determine
what additional adjustment should be made to the appraisal value to arrive at fair value.
118
Derivative Financial Instruments:
The Company obtains broker or dealer quotes to value its interest rate derivative contracts, which use valuation
models using observable market data as of the measurement date (Level 2).
Recurring Basis
The following tables summarize the balances of assets and liabilities measured at fair value on a recurring
basis as of December 31, 2019 and December 31, 2018:
Assets
Investment securities available for sale:
U.S. Treasury and U.S. Government-sponsored
agencies
Municipal securities
Mortgage backed securities and collateralized
mortgage obligations:
Residential
Commercial
Corporate obligations
Other asset-backed securities
Total investment securities available for
sale
Equity security
Derivative assets - interest rate swaps
Liabilities
Derivative liabilities - interest rate swaps
December 31, 2019
Total
Level 1
Level 2
Level 3
(In thousands)
$
105,223 $
— $
105,223 $
133,014
339,608
327,095
24,194
23,178
952,312
148
8,318
—
—
—
—
—
148
—
133,014
339,608
327,095
24,194
23,178
952,312
—
8,318
$
8,318 $
— $
8,318 $
December 31, 2018
Total
Level 1
Level 2
Level 3
(In thousands)
Assets
Investment securities available for sale:
U.S. Treasury and U.S. Government-sponsored
agencies
Municipal securities
Mortgage backed securities and collateralized
mortgage obligations:
Residential
Commercial
Corporate obligations
Other asset-backed securities
Total investment securities available for
sale
Equity security
Derivative assets - interest rate swaps
Liabilities
Derivative liabilities - interest rate swaps
$
101,603 $
15,936 $
85,667 $
158,864
331,602
333,761
25,563
24,702
976,095
114
5,095
—
—
—
—
—
15,936
114
—
158,864
331,602
333,761
25,563
24,702
960,159
—
5,095
$
5,095 $
— $
5,095 $
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
There were no transfers between Level 1 and Level 2 during the years ended December 31, 2019 and 2018.
119
Nonrecurring Basis
The Company may be required to measure certain financial assets and liabilities at fair value on a nonrecurring
basis. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-
downs of individual assets.
The following tables below represent assets measured at fair value on a nonrecurring basis at December 31,
2019 and December 31, 2018 and the net losses recorded in earnings during years ended December 31, 2019 and
2018:
Fair Value at December 31, 2019
Basis(1)
Total
Level 1
Level 2
(In thousands)
Level 3
Net Losses
Recorded in
Earnings
During
the Year Ended
December 31,
2019
Impaired loans:
Commercial and industrial
$ 4,111 $ 3,380 $ — $ — $ 3,380 $
Total assets measured at fair value
on a nonrecurring basis
$ 4,111 $ 3,380 $ — $ — $ 3,380 $
78
78
(1) Basis represents the unpaid principal balance of impaired loans.
Fair Value at December 31, 2018
Basis(1)
Total
Level 1
Level 2
Level 3
(In thousands)
Net Losses
Recorded in
Earnings
During
the Year Ended
December 31,
2018
Impaired loans:
Commercial business:
Commercial and industrial
Non-owner occupied commercial real estate
Total commercial business
Consumer
$ 117 $ 107 $ — $ — $ 107 $
—
— 1,102
1,102
1,378
1,495
9
1,209
7
—
—
— 1,209
—
7
Total assets measured at fair value
on a nonrecurring basis
$ 1,504 $ 1,216 $ — $ — $ 1,216 $
(1) Basis represents the unpaid principal balance of impaired loans.
10
150
160
8
168
The following tables present quantitative information about Level 3 fair value measurements for financial
instruments measured at fair value on a non-recurring basis at December 31, 2019 and December 31, 2018:
Fair
Value
Valuation
Technique(s)
Impaired loans
$
3,380 Market approach
December 31, 2019
Unobservable Input(s)
(Dollars in thousands)
Adjustment for differences
between the comparable
sales
Range of Inputs; Weighted
Average
173.5% - (18.5%); 36.8%
120
Impaired loans
Fair
Value
Valuation
Technique(s)
$
1,216 Market approach
December 31, 2018
Unobservable Input(s)
(Dollars in thousands)
Adjustment for differences
between the comparable
sales
Range of Inputs; Weighted
Average
10.4% - (37.3%); (10.9%)
(b) Fair Value of Financial Instruments
Because broadly traded markets do not exist for most of the Company’s financial instruments, the fair value
calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are
subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications;
therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and
may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses
in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates
of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value
calculations presented herein do not represent, and should not be construed to represent, the underlying value of the
Company.
The following tables present the carrying value amount of the Company’s financial instruments and their
corresponding estimated fair values at December 31, 2019 and December 31, 2018:
Carrying
Value
December 31, 2019
Fair Value Measurements Using:
Fair Value
Level 1
Level 2
Level 3
(In thousands)
Financial Assets:
Cash and cash equivalents
Investment securities available for
sale
Loans held for sale
Total loans receivable, net
Accrued interest receivable
Derivative assets - interest rate swaps
Equity security
Financial Liabilities:
Noninterest deposits, interest
bearing demand deposits,
money market accounts and
savings accounts
Certificate of deposit accounts
Securities sold under agreement to
repurchase
Junior subordinated debentures
Accrued interest payable
Derivative liabilities - interest rate
swaps
—
—
5,704
3,791,557
10,699
—
—
—
—
—
20,000
40
—
$
228,568 $
228,568 $
228,568 $
— $
952,312
5,533
3,731,708
14,446
8,318
148
952,312
5,704
3,791,557
14,446
8,318
148
—
—
—
79
—
148
952,312
—
—
3,668
8,318
—
— $
529,679
—
—
64
8,318
$ 4,058,098 $ 4,058,098 $ 4,058,098 $
529,679
524,578
—
20,169
20,595
199
20,169
20,000
199
8,318
8,318
20,169
—
95
—
121
—
—
N/A
—
—
—
—
—
—
20,500
47
—
December 31, 2018
Fair Value Measurements Using:
Carrying Value
Fair Value
Level 1
Level 2
Level 3
(In thousands)
$
161,910 $
161,910 $
161,910 $
— $
976,095
976,095
15,936
960,159
6,076
1,555
N/A
1,605
3,619,118
15,403
3,613,076
15,403
5,095
114
5,095
114
N/A
—
—
68
—
114
N/A
1,605
5,095
—
—
3,613,076
4,091
11,244
Financial Assets:
Cash and cash equivalents
Investment securities available for
sale
Federal Home Loan Bank stock
Loans held for sale
Total loans receivable, net
Accrued interest receivable
Derivative assets - interest rate
swaps
Equity security
Financial Liabilities:
Noninterest deposits, interest
bearing demand deposits,
money market accounts and
savings accounts
$
3,965,510 $ 3,965,510 $ 3,965,510 $
— $
Certificate of deposit accounts
466,892
470,222
—
470,222
Securities sold under agreement to
repurchase
Junior subordinated debentures
Accrued interest payable
Derivative liabilities - interest rate
swaps
31,487
20,302
191
31,487
20,500
191
5,095
5,095
31,487
—
63
—
—
—
81
5,095
(20)
Stock-Based Compensation
On July 24, 2014, the Company's shareholders approved the Equity Plan that provides for the issuance of
1,500,000 shares of the Company's common stock in the form of stock options, stock appreciation rights, stock awards
(which includes restricted stock units, restricted stock awards, performance units, performance shares or bonus shares)
and cash incentive awards. The Company issues new shares of common stock to satisfy share option exercises and
restricted stock awards. As of December 31, 2019, shares remain available for future issuance under the Equity Plan
totaled 838,932.
(a) Stock Option Awards
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. For the years ended December 31, 2019, 2018
and 2017, the Company did not recognize any compensation expense or related tax benefit related to stock options
as all of the compensation expense related to the outstanding stock options had been previously recognized. The
intrinsic value from options exercised during the years ended December 31, 2019, 2018 and 2017 was $60,000,
$202,000 and $161,000, respectively. The cash proceeds from options exercised during the years ended December
31, 2019, 2018 and 2017 were $58,000, $132,000 and $164,000, respectively.
122
The following table summarizes the stock option activity for the years ended December 31, 2019, 2018 and
2017:
Outstanding at December 31, 2016
Exercised
Forfeited or expired
Outstanding at December 31, 2017
Exercised
Forfeited or expired
Outstanding at December 31, 2018
Exercised
Outstanding, vested and expected to vest and
exercisable at December 31, 2019
(b) Restricted Stock Awards
Weighted-
Average
Remaining
Contractual
Term
(In years)
Aggregate
Intrinsic
Value
(In
thousands)
Weighted-
Average
Exercise Price
13.77
Shares
37,495 $
(12,662)
(1,602)
23,231
(9,842)
(831)
12,558
(3,901)
12.97
13.76
14.21
13.45
14.77
14.77
14.77
8,657 $
14.77
0.40 $
117
Restricted stock awards granted generally have a four-year ratable vesting schedule. For the years ended
December 31, 2019, 2018 and 2017 the Company recognized compensation expense related to restricted stock awards
of $440,000, $907,000 and $1.4 million, respectively, and a related tax benefit of $93,000, $191,000 and $488,000,
respectively. As of December 31, 2019, the total unrecognized compensation expense related to non-vested restricted
stock awards was $76,000 and the related weighted average period over which the compensation expense is expected
to be recognized is approximately 0.21 years. The vesting date fair value of the restricted stock awards that vested
during the years ended December 31, 2019, 2018 and 2017 was $1.3 million, $2.2 million and $2.9 million, respectively.
The following table summarizes the restricted stock award activity for the years ended December 31, 2019,
2018 and 2017:
Nonvested at December 31, 2016
Vested
Forfeited
Nonvested at December 31, 2017
Vested
Forfeited
Nonvested at December 31, 2018
Vested
Forfeited
Nonvested at December 31, 2019
(c) Restricted Stock Units
Weighted-
Average Grant
Date Fair
Value
Shares
261,296 $
(113,479)
(10,418)
137,399
(67,877)
(3,489)
66,033
(43,148)
(2,178)
20,707 $
16.80
16.55
16.80
17.00
16.74
16.92
17.28
17.07
18.32
17.59
During 2017, the Company began issuing RSU and PRSU, collectively called "units." RSUs granted generally
vest ratably over three years. PRSUs granted generally have a three-year cliff vesting schedule. Additionally, PRSU
grants participate in dividends and may be subject to performance-based vesting as well as other approved vesting
conditions. The number of shares actually delivered pursuant to the PRSUs depends on the performance of the
Company's Total Shareholder Return and Return on Average Assets over the performance period in relation to the
performance of the common stock of a predetermined peer group. The conditions of the grants allow for an actual
payout ranging between no payout and 150% of target. The payout level is calculated based on actual performance
achieved during the performance period compared to a defined peer group. The fair value of such PRSUs allocable
to the performance of the Company's Total Shareholder Return was determined using a Monte Carlo simulation and
123
will be recognized over the subsequent three-years. The Monte-Carlo simulation model uses the same input
assumptions as the Black-Scholes model; however, it also further incorporates into the fair value determination the
possibility that the market condition may not be satisfied. Compensation costs related to these awards are recognized
regardless of whether the market condition is satisfied, provided that the requisite service has been provided.
Expected volatilities in the model were estimated using a historical period consistent with the performance
period of approximately three years. The risk-free interest rate was based on the United States Treasury rate for a
term commensurate with the expected life of the grant. The Company used the following assumptions to estimate the
fair value of PRSUs granted for the periods indicated:
Shares issued
Expected Term in Years
Weighted-Average Risk Free Interest Rate
Weighted Average Fair Value
Correlation coefficient
Year ended December 31,
2019
2018
2017
7,198
2.84
2.47%
5,550
2.84
2.39%
$
30.06
$
27.69
$
6,089
2.85
1.40%
24.39
ABA NASDAQ
Community Bank
Index
ABA NASDAQ
Community Bank
Index
ABA NASDAQ
Community Bank
Index
Range of peer company volatilities
19.9% - 75.4%
19.0% - 51.4%
17.8%-63.1%
Range of peer company correlation coefficients
34.5% - 90.7%
28.2% - 94.3%
8.2%-89.8%
Heritage volatility
Heritage correlation coefficient
23.9%
79.9%
22.3%
76.4%
21.8%
75.9%
For the years ended December 31, 2019, 2018, and 2017 the Company recognized compensation expense
related to the units of $2.8 million, $1.8 million, and $712,000 respectively, and a related tax benefit of $589,000,
$387,000, and $249,000 respectively. As of December 31, 2019, the total unrecognized compensation expense related
to non-vested units was $4.4 million and the related weighted-average period over which the compensation expense
is expected to be recognized is approximately 2.02 years. The vesting date fair value of the units that vested during
the year ended December 31, 2019 was $2.0 million. There were no PRSUs that vested during the years end
December 31, 2019, 2018, and 2017.
The following table summarizes the unit activity for the years ended December 31, 2019, 2018, and 2017:
Nonvested at December 31, 2016
Granted
Forfeited
Nonvested at December 31, 2017
Granted
Vested
Forfeited
Nonvested at December 31, 2018
Granted
Vested
Forfeited
Nonvested at December 31, 2019
124
Weighted-
Average Grant
Date Fair
Value
Units
— $
92,356
(1,812)
90,544
125,633
(32,375)
(4,617)
179,185
126,598
(64,173)
(8,070)
233,540 $
—
25.31
25.35
25.31
30.62
25.44
27.82
28.94
31.89
29.25
30.25
30.41
(21)
Cash Requirement
The Company is required to maintain an average reserve balance with the Federal Reserve Bank or maintain
such reserve balance in the form of cash. The required reserve balance at December 31, 2019 and December 31,
2018 was $17.1 million and $9.2 million, respectively, and was met by holding cash and maintaining an average balance
with the Federal Reserve Bank.
(22)
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, 2019, 2018 and 2017 consisted
of the following:
Current tax expense
Deferred tax expense
Income tax expense
Year Ended December 31,
2019
2018
2017
(In thousands)
$
$
12,504 $
9,866 $
984
1,372
13,488 $
11,238 $
12,171
6,185
18,356
A reconciliation of the Company's effective income tax rate with the Federal statutory income tax rate for the
years ended December 31, 2019, 2018 and 2017 of 21%, 21% and 35% is as follows:
Year Ended December 31,
2019
2018
2017
(In thousands)
Income tax expense at Federal statutory rate
$
17,020 $
13,710 $
Tax-exempt instruments
Non-deductible acquisition costs
Federal tax credits and other benefits (1)
Effects of BOLI
Revaluation of net deferred tax assets
Other, net
Income tax expense
(1,745)
—
(1,961)
(368)
—
542
$
13,488 $
(1,879)
336
(515)
(330)
—
(84)
11,238 $
21,051
(3,212)
210
(1,510)
(531)
2,568
(220)
18,356
(1) Federal tax credits are provided for under the NMTC and LIHTC programs as described in Note (1) Description of
Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements.
The Tax Act amended the Internal Revenue Code to reduce tax rates and modify policies, credits, and
deductions for individuals and businesses. For businesses, the Tax Act reduced the corporate federal tax rate from a
maximum of 35% to a flat 21% rate. The corporate tax rate reduction was effective January 1, 2018. The Tax Act
required a revaluation the Company’s deferred tax assets and liabilities to account for the future impact of lower
corporate tax rates and other provisions of the legislation. As a result of the Company's revaluation, the net deferred
tax asset was reduced through an increase to the provision for income tax during the year ended December 31, 2017.
125
The following table presents major components of the deferred income tax asset (liability) resulting from
differences between financial reporting and tax basis:
Deferred tax assets:
Allowance for loan losses
Accrued compensation
Stock compensation
Net unrealized losses charged to other comprehensive income on securities
Market discount on purchased loans
Foregone interest on nonaccrual loans
Net operating loss carryforward acquired
Other Real Estate Owned
ROU lease liability
Other deferred tax assets
Total deferred tax assets
Deferred tax liabilities:
Deferred loan fees, net
Premises and equipment
FHLB stock
Goodwill and other intangible assets
Federal tax credits
Junior subordinated debentures
Other deferred tax liabilities
ROU lease asset
Net unrealized gains recognized in other comprehensive income on securities
December 31,
2019
December 31,
2018
(In thousands)
$
7,389 $
3,058
904
—
621
914
228
—
5,227
134
18,475
(3,328)
(2,510)
(569)
(2,807)
(1,781)
(1,113)
(239)
(4,956)
(2,753)
6,941
3,379
769
2,070
1,054
811
336
754
—
364
16,478
(3,333)
(1,819)
(569)
(3,526)
(1,457)
(1,176)
(540)
—
—
Total deferred tax liabilities
Deferred tax (liability) asset, net
(20,056)
$
(1,581) $
(12,420)
4,058
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not
that some portion or all of the deferred tax assets will not be realized. A valuation allowance is required to be recognized
for the portion of the deferred tax asset that will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in which those temporary differences
become deductible. As of December 31, 2019, 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, 2019 and 2018, the Company had a net operating loss carryforward of $1.1 million and $1.6
million, respectively, that will begin to expire in 2024. The Company is limited to the amount of the net operating loss
carryforward that it can deduct each year. A tax planning strategy has been developed that management believes will
enable the Company to deduct all of the net operating loss carryforwards prior to the expiration date. Based on these
estimates, management has not recorded a valuation allowance as of December 31, 2019 and 2018.
As of December 31, 2019 and 2018, 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, 2019 and 2018 and for the years ended December 31, 2019, 2018
and 2017 were immaterial.
The Company has qualified under provisions of the Internal Revenue Code to compute income taxes after
deductions of additions to the bad debt reserves when it was registered as a Savings Bank. At December 31, 2019,
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 $588,000 has not been recognized
126
for the temporary difference. Management does not expect this temporary difference to reverse in the foreseeable
future.
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, 2019, 2018, 2017 and 2016.
(23)
Regulatory Capital Requirements
The Company is a bank holding company under the supervision of the Federal Reserve Bank. Bank holding
companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company
Act of 1956, as amended, and the regulations of the Federal Reserve. Heritage Bank is a federally insured institution
and thereby is subject to the capital requirements established by the FDIC. The Federal Reserve capital requirements
generally parallel the FDIC requirements. Failure to meet minimum capital requirements can initiate certain mandatory,
and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on
the Company’s consolidated financial statements and operations. Management believes as of December 31, 2019,
the Company and the Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2019 and December 31, 2018, the most recent regulatory notifications categorized the
Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events
since that notification that management believes have changed the Bank's categories.
Minimum
Requirements
Well-
Capitalized
Requirements
Actual
$
%
$
%
$
%
(Dollars in thousands)
N/A $ 541,154
11.5%
N/A
N/A
N/A
N/A
N/A
561,749
N/A
561,749
N/A
598,226
304,803
263,984
375,142
6.5
5.0
8.0
538,560
538,560
538,560
468,927
10.0
575,037
10.6
12.0
12.8
11.5
10.2
11.5
12.3
As of December 31, 2019:
The Company consolidated
Common equity Tier 1 capital to
risk-weighted assets
Tier 1 leverage capital to
average assets
Tier 1 capital to risk-weighted
assets
Total capital to risk-weighted
assets
Heritage Bank
Common equity Tier 1 capital to
risk-weighted assets
Tier 1 leverage capital to
average assets
Tier 1 capital to risk-weighted
assets
Total capital to risk-weighted
assets
$ 211,110
4.5%
212,578
281,479
375,306
211,017
211,187
281,356
375,142
4.0
6.0
8.0
4.5
4.0
6.0
8.0
127
As of December 31, 2018:
The Company consolidated
Common equity Tier 1 capital to
risk-weighted assets
Tier 1 leverage capital to
average assets
Tier 1 capital to risk-weighted
assets
Total capital to risk-weighted
assets
Heritage Bank
Common equity Tier 1 capital to
risk-weighted assets
Tier 1 leverage capital to
average assets
Tier 1 capital to risk-weighted
assets
Total capital to risk-weighted
assets
$ 197,189
4.5%
201,920
262,918
350,558
197,004
203,339
262,671
350,229
4.0
6.0
8.0
4.5
4.0
6.0
8.0
N/A $ 510,618
11.7%
N/A
N/A
N/A
N/A
N/A
530,920
N/A
530,920
N/A
566,268
284,561
254,174
350,229
6.5
5.0
8.0
513,993
513,993
513,993
437,786
10.0
549,341
10.5
12.1
12.9
11.7
10.1
11.7
12.5
Under applicable capital requirements both the Company and the Bank are required to have a common equity
Tier 1 capital ratio of 4.5%, a Tier 1 leverage ratio of 4.0%, a Tier 1 risk-based ratio of 6.0% and a total risk-based ratio
of 8.0%. Both the Company and the Bank are also required to maintain a capital conservation buffer consisting of
common equity Tier 1 capital above 2.5% of minimum risk based capital ratios to avoid restrictions on certain activities
including payment of dividends, stock repurchases and discretionary bonuses to executive officers. At December 31,
2019, the capital conservation buffer was 4.8% and 4.3% for the Company and the Bank, respectively.
(24)
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,
2019
December 31,
2018
(In thousands)
$
$
$
$
21,481 $
806,717
2,281
14,602
764,097
2,520
830,479 $
781,219
20,595 $
20,302
573
809,311
830,479 $
194
760,723
781,219
ASSETS
Cash and interest earning deposits
Investment in subsidiary bank
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Junior subordinated debentures
Other liabilities
Total stockholders’ equity
Total liabilities and stockholders’ equity
128
HERITAGE FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
Condensed Statements of Income
INTEREST INCOME:
Interest and dividends on interest earning deposits and other
assets
Total interest income
INTEREST EXPENSE:
Junior subordinated debentures
Total interest expense
Net interest expense
NONINTEREST INCOME:
Dividends from subsidiary bank
Equity in undistributed income of subsidiary bank
Other income
Total noninterest income
NONONTEREST EXPENSE:
Professional services
Other expense
Total noninterest expense
Income before income taxes
Income tax benefit
Year Ended December 31,
2019
2018
2017
(In thousands)
$
57 $
57
7 $
7
44
44
1,339
1,339
(1,282)
47,000
25,186
39
72,225
517
4,395
4,912
66,031
(1,526)
1,263
1,263
(1,256)
30,000
29,258
22
59,280
3,063
3,833
6,896
51,128
(1,929)
1,014
1,014
(970)
23,000
21,755
—
44,755
768
3,726
4,494
39,291
(2,500)
41,791
Net income
$
67,557 $
53,057 $
129
HERITAGE FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
Condensed Statements of Cash Flows
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash provided by
operating activities:
Year Ended December 31,
2019
2018
2017
(In thousands)
$
67,557 $
53,057 $
41,791
Equity in undistributed income of subsidiary bank
(25,186)
(29,258)
3,231
763
46,365
—
—
2,744
1,735
28,278
1,782
1,782
(21,755)
2,103
(1,925)
20,214
—
—
(30,908)
(25,791)
(18,305)
58
(8,636)
(39,486)
6,879
14,602
133
(1,704)
(27,362)
2,698
11,904
21,481 $
14,602 $
164
(737)
(18,878)
1,336
10,568
11,904
— $
230,043 $
—
228,261
—
—
$
$
Stock-based compensation expense
Net change in other assets and liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Net cash received from acquisitions
Net cash provided by investing activities
Cash flows from financing activities:
Common stock cash dividends paid
Proceeds from exercise of stock options
Repurchase of common stock
Net cash used in financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at the beginning of year
Cash and cash equivalents at the end of year
Supplemental non-cash disclosures of cash flow information:
Common stock issued for business combinations
Capital contribution of net assets acquired in business
combinations to Bank
130
(25)
Selected Quarterly Financial Data (Unaudited)
Results of operations on a quarterly basis were as follows:
Year Ended December 31, 2019
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
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
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
$
$
$
$
$
$
(Dollars in thousands, except per share amounts)
53,807 $
54,884 $
55,216 $
4,019
49,788
920
48,868
7,429
36,525
19,772
3,220
4,680
50,536
1,367
49,169
7,564
37,547
19,186
3,202
4,641
50,243
466
49,777
8,458
36,719
21,516
3,621
16,552 $
0.45 $
15,984 $
17,895 $
0.43 $
0.49 $
0.45
0.18
0.43
0.18
0.48
0.19
53,943
4,828
49,115
1,558
47,557
9,011
35,997
20,571
3,445
17,126
0.47
0.47
0.29
Year Ended December 31, 2018
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
(Dollars in thousands, except per share amounts)
43,247 $
54,606 $
46,669 $
2,410
40,837
1,152
39,685
7,548
36,747
10,486
1,399
9,087 $
0.27 $
0.27
0.15
2,928
43,741
1,750
41,991
7,575
35,706
13,860
2,003
3,480
51,126
1,065
50,061
8,050
39,461
18,650
3,146
11,857 $
0.35 $
15,504 $
0.42 $
0.35
0.15
0.42
0.15
54,884
3,595
51,289
1,162
50,127
8,445
37,273
21,299
4,690
16,609
0.45
0.45
0.27
ITEM 9.
FINANCIAL DISCLOSURE
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
None
ITEM 9A.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our disclosure controls and procedures are designed to ensure that information the Company must disclose
in its reports filed or submitted under the Exchange Act, is recorded, processed, summarized, and reported on a timely
131
basis. Our management has evaluated, with the participation and under the supervision of our CEO and 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, 2019. In making this assessment, management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission in the 2013 Internal Control—Integrated
Framework. Based on our assessment, we believe that, as of December 31, 2019, the Company’s internal control
over financial reporting is effective based on these criteria.
Crowe LLP, an independent registered public accounting firm, has audited the effectiveness of our internal
control over financial reporting as of December 31, 2019, and their report is included in Item 8. Financial Statements
And Supplementary Data.
(b) Attestation report of the registered public accounting firm.
See Item 8. Financial Statements And Supplementary Data.
(c) Changes in internal control over financial reporting.
There were no significant changes in the Company’s internal control over financial reporting during the fourth
quarter of the period covered by this Form 10-K that materially affected, or are reasonably likely to materially affect,
the Company’s internal control over financial reporting.
ITEM 9B.
OTHER INFORMATION
None
PART III
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning directors of the registrant is incorporated by reference to the section entitled “Proposal
1 - Election of Directors” of our 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 sections entitled “Security Ownership of Certain Beneficial Owners and Management” and "Section
16(a) Beneficial Ownership Reporting Compliance" of the Proxy Statement.
The Company has adopted a written Code of Ethics that applies to our directors, officers and employees. The
Code of Ethics can be accessed electronically by visiting the Company’s website at www.hf-wa.com in the section
titled Overview: Governance Documents.
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 Deborah J. Gavin, chair of the committee, Brian S.
Charneski, John A. Clees and Gragg E. Miller, all of whom are considered “independent” as defined by the SEC. Our
132
Board of Directors has determined that Mrs. Gavin 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 “Director
Compensation," “Report of the Compensation Committee,” “Executive Compensation,” and "CEO Pay Ratio" of the
Proxy Statement.
ITEM 12.
RELATED STOCKHOLDER MATTERS
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
Information concerning security ownership of certain beneficial owners and management is incorporated by
reference to the section entitled “Security Ownership of Certain Beneficial Owners and Management” of the Proxy
Statement.
The following table summarizes the consolidated activity within the Company’s stock-based compensation
plans as of December 31, 2019, all of which were approved by shareholders.
Number of
securities
to be issued
upon vesting
of restricted
stock awards
Number of
securities
to be issued
upon vesting
of restricted
stock units
Number of
securities
to be issued
upon exercise
of
outstanding
options
Weighted-
average
exercise
price of
outstanding
options
Number of
securities
remaining
available for
future
issuance
under equity
compensation
plans
20,707
233,540
8,657
$14.77
838,932
Plan Category
Equity compensation plans, all
of which are approved by
security holders
ITEM 13.
CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information concerning certain relationships and related transactions is incorporated by reference to the
sections entitled “Meetings and Committees of the Board of Directors" and Corporate Governance” of the Proxy
Statement.
Our common stock is listed on the NASDAQ Global Select Market. In accordance with NASDAQ requirements,
at least a majority of our directors must be independent directors. The Board of Directors has determined that 9 of our
11 directors are independent.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
Information concerning principal accounting fees and services is incorporated by reference to the section
entitled “Proposal 3 - Ratification of the Appointment of Independent Registered Public Accounting Firm” in the Proxy
Statement.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as a part of this report:
PART IV
(1) Financial Statements: The Consolidated Financial Statements are included in Part II. Item 8. Financial
Statements And Supplementary Data.
(2) Financial Statements Schedules: All schedules are omitted because they are not required or applicable,
or the required information is shown in the Consolidated Financial Statements or Notes.
(3) Exhibits: Included in schedule below.
133
Exhibit
No.
Description of Exhibit
Incorporated by Reference
Filing
Date/
Period
End Date
Form Exhibit
2.1 Agreement and Plan of Merger with Puget Sound Bancorp, Inc
8-K
2.1
7/27/17
2.2 Agreement and Plan of Merger with Premier Commercial Bancorp,
Inc
3.1 Amended and Restated Articles of Incorporation
3.2 Amended and Restated Bylaws of the Company
4.1
Form of Certificate of Heritage's Common Stock (3)
10.1* Annual Incentive Compensation Plan
10.3* Amended 2014 Omnibus Equity Plan
10.4*
2014 Omnibus Equity Plan
8-K
8-K
8-K
2.1
3/9/2018
3.1(B)
5/18/10
3.2
10/3/16
S-1/A
-
10/29/97
10-K
8-K
DEF
14A
10.5
99.2
3/9/17
2/1/17
-
6/11/14
10.5* Form of Nonqualified Stock Option Award Agreement under the
Heritage Financial Corporation 2014 Omnibus Equity Plan
8-K
99.6
2/1/17
10.6* Form of Nonqualified Stock Option Award Agreement under the
Heritage Financial Corporation 2014 Omnibus Equity Plan
10-Q
10.8
8/8/14
10.7* Form of Restricted Stock Award Agreement under the Heritage
Financial Corporation 2014 Omnibus Equity Plan
8-K
99.7
2/1/17
10.8* Form of Restricted Stock Award Agreement under the Heritage
Financial Corporation 2014 Omnibus Equity Plan
10-Q
10.9
8/8/14
10.9* Form of Performance-Based Restricted Stock Unit Award Agreement
under the Heritage Financial Corporation 2014 Omnibus Equity Plan
(4)
8-K
99.4
2/1/17
10.10* Form of Restricted Stock Unit Award Agreement under the Heritage
Financial Corporation 2014 Omnibus Equity Plan
10-Q
10.10
8/8/14
10.11* Form of Restricted Stock Unit Award Agreement under the Heritage
Financial Corporation 2014 Omnibus Equity Plan
8-K
99.3
2/1/17
10.12* Form of Cash Incentive Award Agreement under the Heritage
Financial Corporation 2014 Omnibus Equity Plan
8-K
99.8
2/1/17
10.13* Form of Incentive Stock Option Award Agreement under the Heritage
Financial Corporation 2014 Omnibus Equity Plan
8-K
99.5
2/1/17
10.14* Transitional Employment Agreement by and between Heritage and
Brian L. Vance
10.15* Employment Agreement by and between Heritage and Jeffery J.
Deuel
8-K
10.1
7/10/18
8-K
10.1
7/1/19
10.16* Deferred Compensation Plan and Participation Agreement by and
between Heritage and Jeffrey J. Deuel
8-K
10.6
9/7/12
10.17* Deferred Compensation Plan and Participation Agreement -
Addendum by and between Heritage and Jeffrey J. Deuel
8-K
10.2
12/22/16
10.18* Deferred Compensation Plan and Participation Agreement -
Addendum by and between Heritage and Jeffrey J. Deuel
10.19* Employment Agreement by and between Heritage and Donald J.
Hinson
10-Q
10.15
11/6/19
10-Q
10.22
11/6/19
10.20* Deferred Compensation Plan and Participation Agreement by and
between Heritage and Donald J. Hinson
8-K
10.7
9/7/12
134
10.21* Deferred Compensation Plan and Participation Agreement -
Addendum by and between Heritage and Donald J. Hinson
8-K
10.3
12/22/16
10.22* Deferred Compensation Plan and Participation Agreement -
Addendum by and between Heritage and Donald J. Hinson
10.23* Employment Agreement by and between Heritage and David A.
Spurling
10-Q
10.16
11/6/19
10-Q
10.24
11/6/19
10.24* Deferred Compensation Plan and Participation Agreement by and
between Heritage and David A. Spurling
8-K
10.2
1/6/14
10.25* Deferred Compensation Plan and Participation Agreement Addendum
by and between Heritage and David A. Spurling
8-K
10.1
12/22/15
10.26* Deferred Compensation Plan and Participation Agreement -
Addendum by and between Heritage and David A. Spurling
8-K
10.5
12/22/16
10.27* Deferred Compensation Plan and Participation Agreement -
Addendum by and between Heritage and David A. Spurling
10.28* Employment Agreement by and between Heritage and Bryan
McDonald
10-Q
10.23
11/6/19
10-Q
10.33
11/6/19
10.29* Deferred Compensation Plan and Participation Agreement by and
between Heritage and Bryan D. McDonald
10-K
10.16
3/11/15
10.30* Deferred Compensation Plan and Participation Agreement -
Addendum by and between Heritage and Bryan D. McDonald
8-K
10.4
12/22/16
10.31* Deferred Compensation Plan and Participation Agreement -
Addendum by and between Heritage and Bryan D. McDonald
10-Q
10.27
11/6/19
10.32* Employment Agreement by and between Heritage and Cindy Huntley
10-Q
10.35
11/6/19
10.33* Deferred Compensation Plan and Participation Agreement by and
between Heritage and Cindy Huntley
10-Q
10.36
11/6/19
10.34* Employment Agreement by and between Heritage and William
Glasby
10-Q
10.37
11/6/19
10.35* Form of Split Dollar Agreements, dated August 3, 2015, by and
between Heritage and Brian L. Vance, Jeffrey J. Deuel, Donald J.
Hinson, Bryan D. McDonald and David A. Spurling
10-Q
10.17
8/6/15
10.36* Form of First Amendment to Split Dollar Agreements dated August 3,
2015 by and between Heritage and Brian L. Vance, Jeffrey J. Deuel,
Donald J. Hinson, Bryan D. McDonald and David Spurling
10-Q
10.34
5/9/19
14.0 Code of Ethics and Conduct Policy (2)
21.0 Subsidiaries of the Company (1)
23.0 Consent of Independent Registered Public Accounting Firm (1)
24.0 Power of Attorney (1)
31.1 Certification of Principal Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 (1)
31.2 Certification of Principal Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 (1)
32.1 Certification of Principal Executive Officer and Principal Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)
101.INS XBRL Instance Document (1)
101.SCH XBRL Taxonomy Extension Schema Document (1)
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document (1)
135
101.DEF XBRL Taxonomy Extension Definition Linkbase Document (1)
101.LAB XBRL Taxonomy Extension Label Linkbase Document (1)
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document (1)
*Indicates management contract or compensatory plan or arrangement.
(1) Filed herewith.
(2) Registrant elects to satisfy Regulation S-K §229.406(c) by posting its Code of Ethics on its website at www.HF-
WA.com in the section titled Overview: Governance Documents.
(3) Exhibit not previously filed in electronic format.
ITEM 16.
FORM 10-K SUMMARY
None.
136
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on February 28, 2020.
SIGNATURES
HERITAGE FINANCIAL CORPORATION
(Registrant)
/S/ JEFFREY J. DEUEL
Jeffrey J. Deuel
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by
the following persons on behalf of the registrant and in the capacities indicated on February 28, 2020.
Principal Executive Officer:
/S/ JEFFREY J. DEUEL
Jeffrey J. Deuel
President and Chief Executive Officer
Principal Financial Officer:
/S/ DONALD J. HINSON
Donald J. Hinson
Executive Vice President and Chief Financial Officer
Jeffrey J. Deuel, pursuant to a power of attorney that is being filed with the Form 10-K, has signed this report
as attorney in fact for the following directors who constitute a majority of the Board.
Brian S. Charneski
John A. Clees
Stephen A. Dennis
Kimberly T. Ellwanger
Deborah J. Gavin
Jeffrey S. Lyon
Gragg E. Miller
Anthony B. Pickering
Brian L. Vance
Ann Watson
/S/ JEFFREY J. DEUEL
Jeffrey J. Deuel
Attorney-in-Fact
February 28, 2020
137
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BOARD OF DIRECTORS
Brian S. Charneski
President, L&E Bottling Company
John A. Clees
Attorney, Worth Law Group
Stephen A. Dennis
Retired President and Chief Executive
Officer of Quadrant Homes
Jeffrey J. Deuel
President and Chief Executive Officer,
Heritage Financial Corporation and
Heritage Bank
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
Jeffrey S. Lyon
Chairman and Chief Executive Officer,
Kidder Mathews
Gragg E. Miller
Retired Principal Managing Broker
of Coldwell Banker Bain
Anthony B. Pickering
Former Owner of Max Dale’s
Restaurant and Stanwood Grill
Brian L. Vance
Executive Chairman
Heritage Financial Corporation
Ann Watson
Chief Operating Officer,
Cascadia Capital, LLC
and
Heritage Bank
201 5th Avenue SW
Olympia, WA 98501
360.943.1500 | 800.455.6126
HERITAGE FINANCIAL CORPORATION
HERITAGE BANK
Jeffrey J. Deuel
President & Chief Executive Officer
Bryan D. McDonald
Executive Vice President
Chief Operating Officer
Donald J. Hinson
Executive Vice President
Chief Financial Officer
Kaylene M. Lahn
Senior Vice President
Corporate Secretary
SHAREHOLDER INFORMATION
The annual meeting will be held Monday,
May 4, 2020, at 10:00 a.m. at the DoubleTree
by Hilton, Olympia, WA.
All shareholders are invited to attend.
NASDAQ: HFWA | WWW.HF -WA.COM
TRANSFER AGENT
Computershare
250 Royall Street
Canton, MA 02021
Phone: 800.962.4284
www.computershare.com