2021
ANNUAL REPORT
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2021
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, 2021
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 000-29480
HERITAGE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Washington
(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(s)
Name of each exchange on which registered
HFWA
NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ☒ No ☐
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 has filed a report on and attestation to its management's assessment of the effectiveness of its
internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C 7262(b)) by the registered public accounting
firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2021, based on
the closing price of its common stock on such date, on the NASDAQ Global Select Market, of $25.02 per share, and 35,457,709 shares held
by non-affiliates was $887,151,879. The registrant had 35,105,779 shares of common stock outstanding as of February 14, 2022.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 2022 Annual Meeting of Shareholders are incorporated by reference into Part III of
this Annual Report on Form 10-K where indicated. The 2022 Proxy Statement will be filed with the U.S. Securities and Exchange Commission
within 120 days after the end of the fiscal year to which this report relates.
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
FORM 10-K
December 31, 2021
TABLE OF CONTENTS
GLOSSARY OF ACRONYMS, ABBREVIATIONS AND TERMS
CAUTIONARY NOTE REGARDING 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.
[RESERVED]
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
RESULTS OF OPERATIONS
AVERAGE BALANCES, YIELDS AND RATES PAID
NET INTEREST INCOME AND MARGIN OVERVIEW
PROVISION FOR CREDIT LOSSES OVERVIEW
NONINTEREST INCOME OVERVIEW
NONINTEREST EXPENSE OVERVIEW
INCOME TAX EXPENSE OVERVIEW
FINANCIAL CONDITION OVERVIEW
INVESTMENT ACTIVITIES OVERVIEW
LOAN PORTFOLIO OVERVIEW
ALLOWANCE FOR CREDIT LOSSES ON LOANS OVERVIEW
DEPOSITS OVERVIEW
STOCKHOLDERS' EQUITY OVERVIEW
LIQUIDITY AND CAPITAL RESOURCES
CRITICAL ACCOUNTING POLICIES
RECONCILIATIONS OF NON-GAAP MEASURES
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM (PCAOB ID: 173)
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION—DECEMBER 31, 2021 AND DECEMBER
31, 2020
CONSOLIDATED STATEMENTS OF INCOME—FOR THE YEARS ENDED DECEMBER 31, 2021, 2020
AND 2019
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME—FOR THE YEARS ENDED
DECEMBER 31, 2021, 2020 AND 2019
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY—FOR THE YEARS ENDED DECEMBER
31, 2021, 2020 AND 2019
CONSOLIDATED STATEMENTS OF CASH FLOWS—FOR THE YEARS ENDED DECEMBER 31, 2021,
2020 AND 2019
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, SIGNIFICANT ACCOUNTING
POLICIES AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
NOTE 2.
INVESTMENT SECURITIES
NOTE 3.
LOANS RECEIVABLE
NOTE 4. ALLOWANCE FOR CREDIT LOSSES ON LOANS
NOTE 5. OTHER REAL ESTATE OWNED
NOTE 6. PREMISES AND EQUIPMENT
NOTE 7. GOODWILL AND OTHER INTANGIBLE ASSETS
NOTE 8. DERIVATIVE FINANCIAL INSTRUMENTS
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 BENEFIT PLANS
NOTE 15. STOCKHOLDERS’ EQUITY
NOTE 16. FAIR VALUE MEASUREMENTS
NOTE 17. STOCK-BASED COMPENSATION
NOTE 18. CASH RESTRICTION
INCOME TAXES
NOTE 19.
NOTE 20. COMMITMENTS AND CONTINGENCIES
NOTE 21. REGULATORY CAPITAL REQUIREMENTS
NOTE 22. HERITAGE FINANCIAL CORPORATION (PARENT COMPANY ONLY)
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
ITEM 9.
ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9B. OTHER INFORMATION
ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS
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 AND 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.
ACL
AOCI
ASC
ASU
Bank
BOLI
CA Act
CARES Act
CECL
CECL Adoption
CMO
Company
Allowance for Credit Losses
Accumulated other comprehensive income (loss), net
Accounting Standards Codification
Accounting Standards Update
Heritage Bank
Bank owned life insurance
Consolidated Appropriations Act of 2021
Coronavirus Aid, Relief, and Economic Security Act of 2020
Current Expected Credit Loss
Bank's adoption on January 1, 2020 of FASB ASU 2016-13 Financial Instruments - Credit
Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended,
which replaces the incurred loss methodology with an expected loss methodology that is
referred to as the CECL methodology
Collateralized Mortgage Obligation
Heritage Financial Corporation and its subsidiaries
COVID Modifications
Loans with modifications made in compliance with the CARES Act, as amended, and related
regulatory guidance
COVID-19 Pandemic
Coronavirus Disease of 2019 Pandemic
CRE
DEI
DFI
Commercial real estate
Diversity, Equity, and Inclusion
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
FOMC
Form 10-K
GAAP
LIBOR
LIHTC
NMTC
MBS
OCC
PCD
PCI
Plan
PPP
Proxy Statement
Related Party
ROU
Federal Home Loan Bank of Des Moines
Federal Open Market Committee within the Federal Reserve System
Company's Annual Report on Form 10-K
U.S. Generally Accepted Accounting Principles
London Interbank Offering Rate
Low-Income Housing Tax Credit partnerships
New Market Tax Credits
Mortgage-backed security
Office of the Comptroller of the Currency
Purchased Credit Deteriorated; loans purchased with evidence of credit deterioration since
origination for which it is probable that not all contractually required payments will be collected;
accounted for under FASB ASC 326
loans purchased with evidence of credit deterioration since
Purchased Credit
origination for which it is probable that not all contractually required payments will be collected;
accounted for under FASB ASC 310-30
Impaired;
Heritage Financial Corporation 401(k) Profit Sharing Plan and Trust
Paycheck Protection Program
Definitive proxy statement for the annual meeting of shareholders to be held on May 3, 2022
Certain directors, executive officers and their affiliates
Right-of-Use
4
SBA
SEC
SM
SOFR
SS
TDR
Small Business Administration
Securities and Exchange Commission
Special Mention
Secured Overnight Financing Rate
Substandard
Troubled debt restructured
Unfunded Commitments
Off-balance sheet credit exposures such as loan commitments, standby letters of credit,
financial guarantees, and other similar instruments
USDA
United States Department of Agriculture
CAUTIONARY NOTE REGARDING FORWARD 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.” The Company cautions readers not to place undue reliance on any forward-looking
statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on
information then actually known to the Company. The Company does not undertake and specifically disclaims any obligation to
revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the
date of such statements. These risks could cause our actual results for future periods to differ materially from those expressed in
any forward-looking statements by, or on behalf of, us, and could negatively affect the Company’s operating results and stock price
performance.
The COVID-19 Pandemic is adversely affecting us, our customers, counterparties, employees, and third-party service
providers, and the ultimate extent of the impacts on our business, financial position, results of operations, liquidity, and prospects
is uncertain. Deterioration in general business and economic conditions, including increases in unemployment rates, or turbulence
in domestic or global financial markets could adversely affect our revenues and the values of our assets and liabilities, reduce the
availability of funding, lead to a tightening of credit, and increase stock price volatility. In addition, changes to statutes, regulations,
or regulatory policies or practices as a result of, or in response to the COVID-19 Pandemic, could affect us in substantial and
unpredictable ways. Other factors that could cause or contribute to such differences include, but are not limited to:
•
the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes
in our ACL on loans and provision for credit losses on loans that may be affected by deterioration in the housing and CRE
markets, which may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our ACL on
loans no longer being adequate to cover actual losses, and require us to increase our ACL on loans;
changes in general economic conditions, either nationally or in our market areas;
changes in the levels of general interest rates, and the relative differences between short-term and long-term interest rates,
deposit interest rates, our net interest margin and funding sources;
risks related to acquiring assets in or entering markets in which we have not previously operated and may not be familiar;
fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in
our market areas;
results of examinations of us by the bank regulators, including the possibility that any such regulatory authority may, among
other things, initiate an enforcement action against the Company or our bank subsidiary which could require us to increase our
ACL on loans, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or
increase deposits, or impose additional requirements on us, any of which could affect our ability to continue our growth through
mergers, acquisitions or similar transactions and adversely affect our liquidity and earnings;
legislative or regulatory changes that adversely affect our business;
implementing regulations, changes in regulatory policies and principles, or the 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;
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;
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the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
adverse changes in the securities markets;
inability of key third-party providers to perform their obligations to us;
changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the FASB,
including additional guidance and interpretation on accounting issues and details of the implementation of new accounting
methods and as a result of the CARES Act and the CA Act; and
other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products
and services and the other risks detailed from time to time in our filings with the SEC including this Form 10-K.
ITEM 1.
Overview
BUSINESS
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 and single reportable segment, Heritage Bank.
Heritage Bank is headquartered in Olympia, Washington and conducts business from its 49 branch offices located
primarily along the I-5 corridor in western Washington and the greater Portland, Oregon area. We additionally have offices
located in central Washington, primarily in Yakima County. The deposits of the Bank are insured by the FDIC.
During the last two years, the Company consolidated 13 branches to create a more efficient branch footprint, reducing
the branch count to 49 at December 31, 2021 from 62 at December 31, 2019. The Bank integrated these locations into other
branches within its network. These actions were the result of the Bank’s increased focus on balancing physical locations and
digital banking channels, driven by increased customer usage of online and mobile banking and a commitment to improve digital
banking technology.
Our business consists primarily of commercial
lending and deposit relationships with small and medium sized
businesses and their owners in our market areas and attracting deposits from the general public. We also make real estate
construction and land development loans, consumer loans and residential real estate loans for sale or investment purposes on
residential properties located primarily in our market.
General Development of Business
During the last two years, the Bank participated in the SBA's PPP in accordance with the CARES Act and CA Act. The
CARES Act initially amended the SBA’s loan program, in which the Bank participates, to create a guaranteed, unsecured loan
program, the PPP, to fund payroll and operational costs of eligible businesses, organizations and self-employed persons during
the COVID-19 Pandemic. Through the conclusion of the program on May 31, 2021, the Bank had funded 7,184 SBA PPP loans
totaling $1.28 billion with an average loan size of $178,000. As of December 31, 2021, total funded SBA PPP loans decreased to
$145.8 million, net of unamortized net deferred fees of $4.9 million, due primarily to principal and interest forgiveness payments
from the SBA as the Bank began accepting and processing the forgiveness applications during the three months ended
December 31, 2020. During the years ended December 31, 2021 and 2020, SBA PPP loans provided an additional $32.1 million
and $19.5 million, respectively, of interest and fee income on loans.
A combination of new deposit relationships obtained in conjunction with the SBA PPP lending process and existing
impact to our deposit
customers maintaining higher cash balances due to the COVID-19 Pandemic also caused a material
balances, which increased $1.80 billion, or 39.2%, to $6.38 billion at December 31, 2021 from $4.58 billion at December 31,
2019 and cash balances, which increased $1.49 billion, or 654.0%, to $1.72 billion at December 31, 2021 from $228.6 million at
December 31, 2019, which was before the start of the COVID-19 Pandemic.
Business Strategy
Our business strategy is to be a commercial community bank, seeking deposits from our communities and making loans
to customers with local ties to our markets. We believe we have an innovative team providing financial services and focusing on
the success of our customers. We are committed to being the leading commercial community bank in the Pacific Northwest by
continuously improving customer satisfaction, employee empowerment, community investment and shareholder value. Our
commitment defines our relationships, sets expectations for our actions and directs decision-making in these four fundamental
areas. We will seek to achieve our business goals through the following strategies:
Expand geographically as opportunities present themselves. We are committed to continuing the controlled expansion
of our franchise through strategic acquisitions designed to increase our market share and enhance franchise value. We believe
that consolidation across the community bank landscape will continue to take place and further believe that, with our capital and
liquidity positions, our approach to credit management, and our extensive acquisition experience, we are well-positioned to take
advantage of acquisitions or other business opportunities in our market areas. In markets where we wish to enter or expand our
business, we will also consider opening de novo branches. In the past, we have successfully integrated acquired institutions and
opened de novo branches. We will continue to be disciplined and opportunistic as it pertains to future acquisitions and de novo
branching, focusing on the Pacific Northwest markets we know and understand.
Focus on asset quality. 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
6
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 and subject our
loans to periodic internal loan reviews.
Maintain a strong balance sheet. In addition to our focus on underwriting, we believe 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 $1.72 billion in cash and cash equivalents as of December 31, 2021. As of December 31, 2021, the
regulatory capital ratios of the 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 13.5%, 8.7%, 13.9% and 14.8%, respectively.
Focused deposit growth. Our strategic focus is to continuously grow deposits with emphasis on total relationship
banking with our business and retail customers. We continue to seek to increase our market share in the communities we serve
by providing exceptional customer service, focusing on relationship development with local businesses and strategic branch
expansion. Our primary focus is to maintain a high level of non-maturity deposits to internally fund our loan growth with a low
reliance on maturity (certificate) deposits. At December 31, 2021, our non-maturity deposits were 94.6% 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 non-maturity deposits while maintaining our focus on asset
quality. Our incentive systems are designed to achieve balanced, high quality asset growth while maintaining appropriate
mechanisms to reduce or eliminate incentive payments when appropriate. Our equity compensation programs and retirement
benefits are designed to build and encourage employee ownership at all
levels of the Company and we align employee
performance objectives with corporate growth strategies and shareholder value. We have a strong corporate culture, which is
supported by our commitment to internal development and promotion from within as well as the retention of management and
officers in key roles.
There have been no material changes to our business strategy during the years ended December 31, 2021 and 2020,
except for our participation in the SBA's PPP.
History
The Bank was established in 1927 as a federally-chartered mutual savings bank. In 1992, the Bank converted to a
state-chartered mutual savings bank under
the name Heritage Savings Bank. Through the mutual holding company
reorganization of the Bank and the subsequent conversion of the mutual holding company, the Bank became a stock savings
bank and a wholly-owned subsidiary of the Company effective August 1997. Effective September 1, 2004, Heritage Savings
Bank switched its charter from a state-chartered savings bank to a state-chartered commercial bank and changed its legal name
from Heritage Savings Bank to Heritage Bank. The following table lists major combinations completed by the Company:
Type of
Combination
Date of
Combination
Acquired Holding Company Name
Acquired Bank Name
Purchase
June 1998
North Pacific Bancorporation
North Pacific Bank
$
Purchase
Purchase
March 1999
Washington Independent
Bancshares, Inc.
Central Valley Bank
June 2006
Western Washington Bancorporation
Washington State Bank, N.A.
FDIC Assisted
August 2010
FDIC Assisted November 2010
n/a
n/a
n/a
Cowlitz Bank
Pierce Commercial Bank
Northwest Commercial Bank
Valley Community Bancshares, Inc.
Valley Bank
Washington Banking Company
Whidbey Island Bank
January 2013
July 2013
May 2014
Purchase
Purchase
Merger
Purchase
Purchase
January 2018
Puget Sound Bancorp, Inc.
Puget Sound Bank
July 2018
Premier Commercial Bancorp
Premier Community Bank
7
Total Assets
Acquired
(in millions)
85
61
57
345
211
65
237
1,657
571
387
Description of Business
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 provided that a minimum balance is maintained to avoid service
charges.
Certificate of Deposit Accounts. Deposits require a minimum deposit of $2,500 and have maturities ranging from three
months to five years. Jumbo certificate of deposit accounts are offered in amounts of $100,000 or more for terms of
seven days to one year.
Our personal checking accounts feature an array of benefits and options, including online banking, online statements,
mobile banking with mobile deposit, VISA debit cards and access to more than 37,000 surcharge free Automated Teller Machines
through the MoneyPass network.
We also offer investment advice through a Wealth Management department that provides objective advice from trusted
advisers.
Lending Activities
Our lending activities are conducted through the Bank. While our focus is on commercial business lending, we also
originate consumer loans, real estate construction and land development loans and residential real estate loans. Our loans are
originated under policies that are reviewed and approved annually by our Board of Directors. In addition, we have established
internal lending guidelines that are updated as needed. These policies and guidelines address underwriting standards, structure
and rate considerations, and compliance with laws, regulations and internal lending limits. We conduct post-approval reviews on
selected loans and routinely perform internal loan reviews of our loan portfolio to confirm credit quality, proper documentation
and compliance with laws and regulations. Loan repayments are considered one of the primary sources of funding for the Bank.
Commercial Business Lending
At December 31, 2021 we had $3.19 billion, or 83.7% of our loans receivable, in commercial business loans. We offer
different types of commercial business loans, including lines of credit, term equipment financing and term owner-occupied and
non-owner occupied commercial real estate loans. We also originate loans that are guaranteed by the U.S. SBA, for which the
Bank is a “preferred lender”, the U.S. Department of Agriculture and the Federal Agricultural Mortgage Corporation. Before
extending credit to a business, we review and analyze the borrower’s management ability, financial history, including cash flow of
the borrower and all guarantors, and the liquidation value of the collateral. Emphasis is placed on having a comprehensive
understanding of the borrower’s global cash flow and performing necessary financial due diligence.
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 covenant requirements typically range from 1.15 times to 1.25 times, depending on the type
of property. Actual debt service coverage is usually higher than required covenant thresholds, as loan sizing requires sensitized
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 residential real estate loans. Payments on
loans secured by commercial real estate properties are dependent on successful operation and management of the properties
and repayment of these loans may be affected by adverse conditions in the real estate market or the economy. We seek to
minimize these risks by determining the financial condition of the borrower and any tenants, the quality and value of the
collateral, and the management of the property securing the loan. We also generally obtain personal guarantees from the owners
of the collateral after a thorough review of personal financial statements. In addition, we review a majority of the individual loans
within our commercial real estate loan portfolio annually for various performance related criteria and stress-test loans for
potential changes in interest rates, occupancy and collateral values.
See also Item 1A. Risk Factors—Our loan portfolio is concentrated in loans with a higher risk of loss.
The Bank may enter into non-hedging interest rate swap contracts with commercial customers to accommodate their
business needs. For additional information, see Note (8) Derivative Financial Instruments of the Notes to Consolidated Financial
Statements included in Item 8. Financial Statements And Supplementary Data.
8
Residential Real Estate Loans, Originations and Sales
At December 31, 2021, residential real estate loans totaled $164.6 million, or 4.3% of our loans receivable. The majority
of our residential real estate loans are secured by single-family residences located in our primary market areas. Our underwriting
standards require that residential real estate loans generally are owner-occupied and do not exceed 80% of the lower of
appraised value at origination or cost of the underlying collateral. Terms typically range from 15 to 30 years. As part of our asset/
liability management strategy, we also sell originated residential real estate loans in the secondary market with no recourse and
servicing released.
Real Estate Construction and Land Development
At December 31, 2021, we had $226.9 million, or 5.9% of our loans receivable, in real estate construction and land
development loans, including residential construction loans and commercial and multifamily construction loans.
We originate residential construction loans for the construction of single-family custom homes (where the home owner
is the borrower). We also provide financing to builders for the construction of pre-sold homes and speculative residential
property. Because of the higher risks present in the residential construction industry, our lending to builders is limited to those
who have demonstrated a favorable record of performance and who are building in markets that management understands. We
further endeavor to limit our construction lending risk through adherence to strict underwriting guidelines and procedures.
Speculative construction loans are short term in nature and have a variable rate of interest. We require builders to have tangible
equity in each construction project; have prompt and thorough documentation of all draw requests; and we inspect the project
prior to paying any draw requests.
Commercial and multifamily construction loans also have a higher risk because of the construction element and lease-
up, if not pre-leased. As a result, this type of construction loan is made only to strong borrowers with sufficient equity into the
project and additional resources they can draw on if needed. The Bank performs due diligence to gain comfort that the
experience of the general contractor is sufficient to finish the project on budget and on time. Project feasibility is also important
and our lenders ensure the project is economically viable. Commercial and multifamily construction loans are monitored through
cost reviews, regulatory-compliant appraisals, sufficient equity, engineering inspections and controlled disbursements.
See also Item 1A. Risk Factors—Our loan portfolio is concentrated in loans with a higher risk of loss.
Consumer
At December 31, 2021, we had $232.5 million, or 6.1% of our loans receivable, in consumer loans. We originate
consumer loans and lines of credit that are both secured and unsecured.
During the three months ended March 31, 2020, we ceased indirect auto loan originations, which are classified as
consumer loans within loans receivable. These indirect consumer loans are secured by new and used automobile and
recreational vehicles and were originated indirectly by established and well-known dealers located in our market areas. In
addition, the indirect loans purchased were made to only prime borrowers. At December 31, 2021, we had $117.3 million, or
3.1% of our loans receivable, in indirect auto loans remaining, which is a decrease of 58.7% from $284.0 million as of December
31, 2019, which approximates the balance of indirect auto loans before the runoff of this portfolio started. The majority of our
remaining consumer loans are for relatively small amounts disbursed among many individual borrowers.
Supervision and Regulation
We are subject to extensive legislation, regulation, and supervision under federal law and the law of Washington State,
which are both primarily intended to protect depositors and the FDIC, and not shareholders. Additionally, the Consumer Financial
Protection Bureau is responsible for the implementation of the federal financial consumer protection and fair lending laws and
regulations and has authority to impose new requirements.
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 the Company and the Bank which is
qualified in its entirety by reference to the actual laws and regulations.
Heritage Financial Corporation
As a bank holding company registered with the Federal Reserve, we are subject to comprehensive regulation and
supervision by the Federal Reserve under the Bank Holding Company Act of 1956, as amended, 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 the 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.
9
Federal Reserve policy provides that a bank holding company is required to serve as a source of financial and
managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. 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.
As a bank holding company, we are required to obtain the prior approval of the Federal Reserve to acquire all, or
substantially all, of the assets of any other bank or bank holding company. Prior Federal Reserve approval is required for any
bank holding company to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding
company if, after such acquisition, the acquiring bank holding company would, directly or indirectly, own or control more than 5%
of any class of voting shares of the bank or bank holding company. In addition to the approval of the Federal Reserve, prior
approval may for such acquisitions also be necessary from other agencies including the DFI and agencies that regulate the
target.
Under the prompt corrective action provisions of the Federal Deposit Insurance Act, a bank holding company with an
undercapitalized subsidiary bank must guarantee, within limitations,
is required to be
implemented for its undercapitalized subsidiary bank. If an undercapitalized subsidiary bank fails to file an acceptable capital
restoration plan or fails to implement an accepted plan, the Federal Reserve may, among other restrictions, prohibit the bank
holding company or its undercapitalized subsidiary bank from paying any dividend or making any other form of capital distribution
without the prior approval of the Federal Reserve. Federal Reserve policy also provides that a bank holding company may pay
cash dividends only to the extent that the company’s net income for the past year is sufficient to cover both the cash dividend
and a rate of earnings retention that is consistent with the company’s capital needs, asset quality and overall financial condition.
the capital restoration plan that
Bank regulations also require bank holding companies and banks to maintain minimum capital ratios and capital
conservation buffer. For additional information, see “Capital Adequacy” below. In addition, under Washington corporate law, a
company generally may not pay dividends if, after that payment, the company would not be able to pay its liabilities as they
become due in the usual course of business or its total assets would be less than its total liabilities.
Any subsidiaries which we may control are considered “affiliates” of the Company within the meaning of the Federal
Reserve Act, and transactions between affiliates are subject to numerous restrictions. With some exceptions, we and our
subsidiaries are prohibited from tying the provision of various products or services, such as extensions of credit, to other
products or services offered by us, or our affiliates.
Heritage Bank
The Bank is a Washington state-chartered commercial bank, the deposits of which are insured by the FDIC, and is
subject to regulation by the FDIC and the DFI.
required reserves against deposits,
Applicable Federal and State statutes and regulations which govern a bank’s operations relate to minimum capital
requirements,
lending limits, mergers and consolidation,
borrowings, issuance of securities, payment of dividends, establishment of branches, privacy, anti-money laundering and other
aspects of its operations, among other things. The 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.
investments,
loans,
legal
The Bank is required to file periodic reports with the FDIC and is subject to periodic examinations and evaluations by
the FDIC and the DFI. Based upon these evaluations, the regulators may revalue the assets of an institution and require that it
establish specific reserves to compensate for the differences between the determined value and the book value of such assets.
These examinations must be conducted at least every 12 months.
The Bank pays dividends to the Company. The FDIC and the DFI also have the general authority to restrict capital
distributions by the Bank, including dividends paid by the Bank to the Company. Such restrictions are generally tied to the Bank’s
capital levels after giving effect to such distributions.
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, a comprehensive capital framework and rules for U.S. banking organizations approved by the Federal Reserve
Board and the FDIC in 2013.
Under these capital regulations, the minimum capital ratios are: (1) a common equity Tier 1 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. Common equity Tier 1 generally
consists of common stock; retained earnings; AOCI unless an institution elects to exclude AOCI from regulatory capital; and
certain minority interests; all subject to applicable regulatory adjustments and deductions. Tier 1 capital generally consists of
common equity Tier 1 and noncumulative perpetual preferred stock. Tier 2 capital generally consists of other preferred stock and
subordinated debt meeting certain conditions plus an amount of the allowance for credit losses up to 1.25% of risk-weighted
assets. Total capital is the sum of Tier 1 and Tier 2 capital.
In addition to the minimum common equity Tier 1, Tier 1, leverage ratio and total capital ratios, the Company and the
Bank must maintain a capital conservation buffer consisting of additional common equity Tier 1 capital greater than 2.5% above
10
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 common equity Tier 1 capital ratio of at least 6.5%, a leverage
ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 8%, a total risk-based capital ratio of at least 10% 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 Company’s and the Bank's required and actual capital levels as of December 31, 2021 are listed in Note (21)
Regulatory Capital Requirements of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements
And Supplementary Data.
Prompt Corrective Action
Federal statutes establish a supervisory framework for FDIC-insured institutions based on five capital categories: well
capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution’s
category depends upon where its capital levels are in relation to relevant capital measures. The well capitalized category is
described in the Capital Adequacy section above. An institution that is not well capitalized is subject to certain restrictions on
brokered deposits, including restrictions on the rates it can offer on its deposits. To be considered adequately capitalized, an
institution must have the minimum capital ratios described in the Capital Adequacy section above. Any institution which is neither
well capitalized nor adequately capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and
restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by a 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, 2021, the Company and the Bank met all minimum capital requirements and the most recent
regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. See
Note (21) Regulatory Capital Requirements of the Notes to Consolidated Financial Statements included in Item 8. Financial
Statements And Supplementary Data.
Classification of Loans
Federal regulations require the Bank to periodically evaluate the risks inherent in its loan portfolio. In addition, the 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 the Bank
and this insurance is backed by the full faith and credit of the United States government. As insurer, the FDIC imposes deposit
insurance assessments 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.
Deposit insurance assessments are 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 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 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
11
the reserve ratio is at least 1.35%. The Bank was awarded $1.2 million in small bank assessment credits of which $518,000 and
$726,000 was applied against quarterly FDIC assessments during the years ended December 31, 2020 and 2019, respectively.
Other Regulatory Developments
The following summarizes some of the significant federal legislation affecting banking in recent years.
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 includes regulatory relief for community banks regarding regulatory examination cycles, call reports, the
Volcker Rule (proprietary trading prohibitions), mortgage disclosures, risk weights for certain high-risk commercial real estate
loans and simplifies the regulatory capital rules for financial
institutions and their holding companies with total consolidated
assets of less than $10 billion by instructing the federal banking regulators to establish a Community Bank Leverage Ratio, which
became effective January 1, 2020. The new ratio is an optional framework that is designed to reduce regulatory burden by
removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations
that opt into the framework starting in the first quarter of 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 calculated as Tier 1
capital divided by average total consolidated assets, consistent with how banking organizations calculate their leverage ratio
under the current rules. As of December 31, 2021, the Company and the Bank had not elected to be subject to the Community
Bank Leverage Ratio.
CECL. The FASB issued a new accounting standard the Bank adopted 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 prior 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. Concurrent with enactment of the CARES Act, federal banking agencies issued an interim final rule that delays the
estimated impact on regulatory capital resulting from the adoption of CECL. The interim final rule provides banking organizations
that implement CECL before the end of 2020 the option to delay for two years the estimated impact of CECL on regulatory
capital relative to regulatory capital determined under the prior incurred loss methodology, followed by a three-year transition
period to phase out the aggregate amount of capital benefit provided during the initial two-year delay. The changes in the final
rule apply only to those banking organizations that elect the CECL transition relief provided under the rule. The Company and the
Bank elected this option.
See discussion of CECL Adoption in Note (1) Description of Business, Basis of Presentation, Significant Accounting
Policies and Recently Issued Accounting Pronouncements of the Notes to Consolidated Financial Statements included in Item 8.
Financial Statements And Supplementary Data
Website Access to Company Reports
We post publicly available reports required to be filed with the SEC on our website, www.hf-wa.com, as soon as
reasonably practicable after filing such reports. The required reports are available free of charge through our website.
Code of Ethics
We have adopted a Code of Ethics that applies to our principal 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 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 robust delivery channels for our products and services. We actively solicit deposit-related clients and compete for deposits
by offering depositors a variety of savings accounts, checking accounts, cash management and other services.
Human Capital
Demographics
As of December 31, 2021, the Bank employed 727 full-time and 40 part-time employees across Washington and
12
Oregon. None of these employees are represented by a collective bargaining agreement. During 2021, we hired 134 regular full-
time and part-time employees. Voluntary workforce turnover (rolling 12-month attrition) was 20.76% and our average tenure was
7.6 years. Our workforce was 72% female and 28% male, and women held 70% of the bank’s management roles (including
department supervisors and managers, as well as executive leadership). The average tenure of management was 10 years. The
ethnicity of our workforce was 77% White, 8% Asian, 6% Hispanic, 4% Two or More Races, 2% Black, and 3% other.
Our Culture and Our People
The Company's success depends on the success of its people. As a result, the Company is focused on enhancing
employee empowerment through human capital and talent management. Our strong culture was built upon adherence to a well-
defined company mission and values, which aligns employees across all levels of the Company to a common goal and enables
them to reach their full potential.
The Company views its employees as our most important assets, which makes training and professional development a
worthy investment. We offer an array of
learning opportunities through virtual and in-house courses via “Heritage Bank
University”, as well as sponsoring courses through external providers, such as Ken Blanchard Company, Washington Bankers
Association, Oregon Bankers Association and the Pacific Coast Banking School. We sponsor situational leadership training for
leaders that focuses on communication and employee engagement.
The Company strives to maintain an environment of open communication with access to senior management, which
includes quarterly all-employee virtual meetings, as well as New Employee Orientation hosted by the Chief Executive Officer. To
further enhance our “listening culture” and foster open communications, we utilize a pulse survey platform to provide employees
with a chance to share feedback directly with leadership throughout the year, including internal communications and COVID-19
Pandemic-related surveys. Survey results are shared with executive leadership and drive action planning. We also host
Celebrate Great, an active internal peer recognition platform, where managers and employees post appreciation and recognition
for co-workers and teams. The Company celebrates “Employee Appreciation Days” in the spring and fall which includes prizes,
games, employee recognition and in-person events hosted by executive management. During 2021, the Puget Sound Business
Journal recognized Heritage Bank as one of the Top 100 Best Workplaces in the Puget Sound.
In addition to vacation and sick leave, all employees receive at least eight hours of paid time each year specifically to
use for volunteer activities of their choice in the communities where they live and work.
COVID-19
The COVID-19 Pandemic has presented a unique challenge with regard to maintaining employee safety while
continuing successful operations. Currently, a portion of our employees are working remotely, however, substantially all
employees are expected to return to their go-forward working environments during the three months ended March 31, 2022. The
Company continues to monitor the situation and will continue to implement measures commensurate with guidance issued by the
Centers for Disease Control and state/local health authorities.
Diversity, Equity, and Inclusion
We recognize and appreciate the importance of creating an environment in which all employees feel valued, included,
and empowered to do their best work. We recognize that each employee's unique experiences, perspectives, and viewpoints add
value to our ability to be the leading commercial community bank in the Pacific Northwest.
The Company has a DEI plan, a Diversity Council and a DEI Officer who has been certified by the National Diversity
Council. The Company's Diversity Council is made up of a diverse group of employees that acts on behalf of the Company to
promote the diversity and inclusion process and works closely with senior leaders to ensure DEI initiatives align with the
Company's overall strategic goals and initiatives. Both our Chief Executive Officer and Senior Vice President Chief Human
Resources Officer serve as Executive Sponsors to the Company's Diversity Council. The Company's Diversity Council
is a
critical driver in fostering organizational change, establishing a dedicated focus on diversity, equity, and inclusion priorities. The
primary role of the Company's Diversity Council is to connect DEI activities to a broader, business-driven and results-oriented
strategy. Executive management and the Company's board of directors have received instructor-led, custom DEI training. In
addition, all employees receive ongoing diversity training.
The objectives of the Company's DEI plan include:
• Workforce Diversity: Recruit from a diverse, qualified group of potential applicants to secure a high-performing
workforce drawn from all segments of the communities we serve.
• Workplace Inclusion: Promote a culture that encourages collaboration, flexibility and fairness to enable individuals to
•
contribute to their full potential.
Sustainability: Develop structures and strategies to equip leaders with the ability to manage diversity, be accountable,
measure results, refine approaches on the basis of such data and foster a culture of inclusion.
Compensation and Benefits
We provide competitive compensation and benefit programs to aid us in attracting and retaining top talent in the very
competitive Puget Sound and Portland, Oregon job markets where many of our offices are located. These programs include
annual bonuses, equity, 401(k) Plan with an employer matching contribution, health insurance, transit passes, paid parking, and
paid time off.
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Executive Officers
The following table sets forth information with respect to executive officers of the Company at December 31, 2021:
Name
Age as of
December 31,
2021
Position
Has Served
the Company
or Bank Since
Jeffrey J. Deuel
Donald J. Hinson
Tony Chalfant
Bryan McDonald
Cindy Huntley
63 Chief Executive Officer of Heritage Financial
Corporation and Heritage Bank
60 Executive Vice President and Chief
Financial Officer of Heritage Financial
Corporation and Heritage Bank
60 Executive Vice President and Chief Credit
Officer of Heritage Financial
Corporation and Heritage Bank
50 Executive Vice President of Heritage
Financial Corporation and President
and Chief Operating Officer of Heritage
Bank
2010
2005
2018
2014
58 Executive Vice President and Chief Banking
1988
Officer of Heritage Bank
The business experience of each executive officer is set forth below.
Jeffrey J. 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. Prior to joining Heritage, Mr. Deuel 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.
Donald J. 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 degree in Accounting from Central Washington University
and a Bachelor's degree in Psychology from Western Washington University.
Tony Chalfant became Executive Vice President and Chief Credit Officer of Heritage Financial Corporation and Heritage
Bank in July 2020. Previously, Mr. Chalfant held the title of Senior Vice President and Deputy Chief Credit Officer of Heritage
Bank since July 2019. Prior to that, he served as a Regional Credit Officer since January 2018 when Heritage Bank acquired
Puget Sound Bank. Mr. Chalfant served as the Chief Credit Officer for Puget Sound Bank for 13 years. Prior to joining Puget
Sound Bank, Mr. Chalfant held commercial lending and leadership positions with U.S. Bank for 11 years. Mr. Chalfant started his
career with the U.S. Office of Comptroller of the Currency, working there for eight years. Mr. Chalfant obtained his Bachelor's
degree in Finance and Economics from Washington State University and is a graduate of the Pacific Coast Banking School.
Bryan McDonald is the President and Chief Operating Officer of Heritage Bank. Mr. McDonald was promoted to
Executive Vice President and Chief Operating Officer of Heritage Bank effective July 1, 2018 and then promoted to President
and Chief Operating Officer of Heritage Bank effective July 1, 2021. Mr. McDonald was promoted to Executive Vice President
and Chief Lending Officer as a result of the merger between Heritage Financial and Washington Banking Company effective May
1, 2014. Previously, with Whidbey Island Bank he held the position of President and Chief Executive Officer of Whidbey Island
Bank from January 2012 to May 2014. He joined Whidbey Island Bank in 2006 as Commercial Banking Manager and was
promoted to Chief Operating Officer in 2010. Mr. McDonald has extensive managerial experience in various sales, credit,
operations, commercial banking and residential real estate areas. Before joining the team at Whidbey Island Bank, he was
Snohomish and King County Business Group Manager where he was responsible for developing all aspects of Peoples Bank's
commercial banking operation in King and Snohomish County.
Cindy Huntley was appointed Executive Vice President and Chief Banking Officer in September of 2019. Cindy has
been with Heritage Bank since 1988 and previously served as a Director of Retail Banking since 2006 and a Senior Vice
President since 2004. During her tenure with Heritage, Ms. Huntley has held numerous positions including marketing, retail and
executive support positions. 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
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discussion of material risks that management believes are specific to our business. This discussion should not be viewed as an
all-inclusive list or in any particular order.
Risks Related to the COVID-19 Pandemic and Associated Economic Slowdown
The outbreak of COVID-19 has adversely affected certain industries in which our customers operate and may impair
their ability to fulfill their obligations to us. Further, the spread of the outbreak has disrupted banking and other
financial activity in the areas in which we operate, could lead to an economic recession or other additional severe
disruptions in the U.S. economy, and could potentially create business continuity issues for us.
The COVID-19 Pandemic continues to negatively impact economic and commercial activity and financial markets, both
globally and within the United States. In our market areas, stay-at-home orders, travel restrictions and closure of non-essential
business and similar orders imposed across the United States to restrict the spread of the COVID-19 Pandemic in 2020 resulted
in significant business and operational disruptions, including business closures, supply chain disruptions and significant layoffs
and furloughs. Although local
jurisdictions have subsequently lifted stay-at-home orders and moved to the opening of
businesses, worker shortages, vaccine and testing requirements, new variants of COVID-19 and other health and safety
recommendations have impacted the ability of businesses to return to pre-pandemic levels of activity and employment. While the
overall economy has improved, disruptions to supply chains continue and significant inflation has been seen in the market. If
these effects continue for a prolonged period or result in sustained economic stress or recession, many of the risk factors
identified in our Form 10-K could be exacerbated, including the following risks from the COVID-19 Pandemic, any of which could
have a material, adverse effect on our business, financial condition, liquidity and results of operations of the Company:
•
effects on key employees, including operational management personnel and those charged with preparing, monitoring
and evaluating our financial reporting and internal controls;
declines in demand for loans and other banking services and products, as well as a decline in the credit quality of our
loan portfolio owing to the effects of the COVID-19 Pandemic in the markets served by us;
if the economy is unable to remain open in an efficient manner, loan delinquencies, problem assets and foreclosures
may increase, resulting in increased charge-offs and reduced income;
collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;
our allowance for credit losses on loans may increase if borrowers experience financial difficulties, which will adversely
affect net income;
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments;
as long as the Federal Reserve Board’s target federal funds rate remains near 0%, the yield on assets may decline to a
greater extent than the decline in the cost of interest-bearing liabilities, reducing net interest margin and spread and
reducing net income;
higher operating costs, increased cybersecurity risks and potential loss of productivity as a result of an increase in the
number of employees working remotely;
increasing or protracted volatility in the price of the Company’s common stock, which may also impair our goodwill; and
risks to the capital markets that may impact the performance of our investment securities portfolio as well as limit our
access to capital markets and other funding sources.
Because there have been no comparable recent global pandemics that resulted in similar global impact, we do not yet
know the full extent of the COVID-19 Pandemic’s effects on our business, operations or the global economy as a whole. Any
future development will be highly uncertain and cannot be predicted, including the scope and duration of the pandemic, possible
future virus variants,
third party providers’ ability to support our
operations and any actions taken by governmental authorities and other third parties in response to the pandemic. The uncertain
future development of this crisis could materially and adversely affect our business, operations, operating results, financial
condition, liquidity or capital levels.
the effectiveness of our work-from-home arrangements,
Risks Related to our Business Strategy
Our strategy of pursuing acquisitions and de novo branching exposes us to financial and operational risks that could
adversely affect us.
We are pursuing a strategy of supplementing organic growth by acquiring other financial institutions or their businesses
that we believe will help us fulfill our strategic objectives and enhance our earnings. There are risks associated with this strategy,
however, including the following:
•
we may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks, businesses,
assets and liabilities we acquire. If these issues or liabilities exceed our estimates, our results of operations and
financial condition may be materially negatively affected;
higher than expected deposit attrition;
potential diversion of our management's time and attention;
prices at which acquisitions are made can fluctuate with market conditions. We have experienced times during which
acquisitions could not be made in specific markets at prices we considered acceptable and expect that we may continue
to experience this condition in the future;
the acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired
entity into our company to make the transaction economically successful. This integration process is complicated and
time consuming and can also be disruptive to the customers of the acquired business. If the integration process is not
conducted successfully and with minimal effect on the acquired business and its customers, we may not realize the
anticipated economic benefits of an acquisition within the expected time frame, and we may lose customers or
employees of the acquired business. We may also experience greater than anticipated customer losses even if the
•
•
•
•
•
•
•
•
•
•
•
•
•
15
•
•
•
•
•
income will
including one acquisition in 2006,
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 2021, we completed eight acquisitions or mergers,
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
increase following our acquisitions; however, we also expect our general and
administrative expenses and consequently our efficiency ratios may 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;
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 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; and
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.
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.
If appropriate opportunities present
We intend to pursue a growth strategy for our business. We regularly evaluate potential acquisitions and expansion
opportunities.
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.
to engage in selected acquisitions of
themselves, we expect
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.
Risks Related to our Lending Activities
Our loan portfolio is concentrated in loans with a higher risk of loss.
Repayment of our commercial business loans, consisting of commercial and industrial loans as well as owner-occupied
and non-owner occupied commercial real estate loans, is often dependent on the cash flows of the borrower, which may be
unpredictable, and the collateral securing these loans may fluctuate in value. We offer different types of commercial business
loans to a variety of businesses in industries such as real estate and rental and leasing, healthcare, accommodation and food
services, retail trade and construction. The primary types of commercial business loans offered are lines of credit, term
equipment financing and term real estate loans. We also originate loans that are guaranteed by the SBA and we are a “preferred
lender” of the SBA. Commercial business lending involves risks that are different from those associated with residential real
estate lending. Our commercial business loans are primarily made based on our assessment of the cash flow of the borrower
and secondarily on the underlying collateral provided by the borrower. The borrower's cash flow may be unpredictable, and
collateral securing these loans may fluctuate in value. Although these commercial business loans are often collateralized by
equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of default is often an
insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited
use, among other things. Accordingly, the repayment of commercial business loans depends primarily on the cash flow and
creditworthiness of the borrower and secondarily on the underlying collateral provided by the borrower. In addition, as part of our
commercial business lending activities, we originate agricultural loans. Payments on agricultural loans are typically dependent on
the profitable operation or management of the related farm property and the success of the farm may be affected by many
factors outside the control of the borrower, including adverse weather conditions that prevent the planting of a crop or limit crop
yields (such as hail, drought and floods), loss of livestock due to disease or other factors, declines in market prices for
agricultural products (both domestically and internationally), changes in the economy (such as tariffs) and the impact of
16
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, 2021, our commercial business loans totaled $3.19 billion, or 83.7% of our total loan portfolio, of which
$23.1 million, or 0.7%, were classified as nonaccrual at December 31, 2021. The majority of the nonperforming commercial
business loans were secured by real estate. Within commercial business loans, agricultural loans totaled $64.7 million, or 1.7%
of our total
loans
totaled $5.1 million, or 21.5% of nonaccrual loans at December 31, 2021.
loan portfolio and 2.0% of our commercial business loans at December 31, 2021. Nonaccrual agricultural
Our owner and non-owner occupied commercial real estate loans, which include multifamily 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 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 real estate loans also expose us to greater credit risk than loans secured by residential real estate because
the collateral securing these loans typically cannot be sold as easily as residential real estate. In addition, many of our
commercial 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 real estate loan, our holding period for the collateral typically
is longer than for residential real estate loans because there are fewer potential purchasers of the collateral. Additionally,
commercial 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 real estate loans, any resulting
charge-offs may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.
As of December 31, 2021, our owner and non-owner occupied commercial real estate loans totaled $2.42 billion, or
63.6% of our total loan portfolio, of which $12.8 million, or 0.5%, were classified as nonaccrual at December 31, 2021.
for the project based on an estimate of costs that will produce a future value at completion. Because of
Our real estate construction and land development loans are based upon estimates of costs and net operating income
and the related value associated with the completed project. These estimates may be inaccurate. Construction lending involves
additional risks when compared with permanent commercial and residential
lending because funds are advanced upon the
the
collateral
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 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 our borrowers are builders with 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.
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 borrower's ability to finance the project 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 added risk associated with identifying an end-tenant or end-purchaser for the finished
project. Land development loans also pose additional risk because of the lack of income being produced by the property and
potential illiquid nature of the collateral. These risks can be significantly impacted by supply and demand conditions.
As of December 31, 2021, our real estate construction and land development loans totaled $226.9 million, or 5.9% of
our total loan portfolio, of which $85.5 million, or 2.2% of our total loan portfolio, were residential construction and $141.3 million,
or 3.7% of our total loan portfolio, were commercial and multifamily construction. Within this category, $571,000, or 0.3% of our
total real estate construction and land development loans, were classified as nonaccrual at December 31, 2021.
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Our ACL on loans may prove to be insufficient to absorb losses in our loan portfolio.
Lending money is a substantial part of our business. Every loan carries a certain risk that it will not be repaid in
accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by,
among other things:
•
•
•
•
•
the cash flow of the borrower, guarantors and/or the project being financed;
the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
the character and creditworthiness of a particular borrower or guarantor;
changes in economic and industry conditions; and
the duration of the loan.
The ACL on loans is a valuation account that is deducted from the amortized cost of loans receivable to present the net
amount expected to be collected. Loans are charged-off
through the ACL on loans when management believes the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are recorded to the ACL on loans. The Bank records
the changes in the ACL on loans through earnings as a provision for credit losses on the Consolidated Statements of Income.
The determination of the appropriate level of ACL on loans inherently involves a high degree of subjectivity and requires
us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. If our
estimates are incorrect, the ACL on loans may not be sufficient to cover credit losses inherent in our loan portfolio, resulting in
the need for increases in our ACL on loans through the provision for credit losses. Management also recognizes that significant
new growth in loan segments and new loan products can result in loans segments comprised of unseasoned loans that may not
perform in a historical or projected manner and will increase the risk that our ACL on loans may be insufficient to absorb losses
without significant additional provisions.
Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of
additional problem loans and other factors, both within and outside of our control, may require an increase in the ACL on loans. If
current conditions in the housing and real estate markets weaken, we expect we will experience increased delinquencies and
credit losses. In addition, bank regulatory agencies periodically review our ACL on loans and may require an increase in the
provision for credit 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 ACL on loans, we will need additional
provisions to increase the ACL on loans.
If our ACL on loans is not sufficient to cover actual loan losses our earnings could decrease.
For the year ended December 31, 2021 we recorded a reversal of provision for credit loss on loans of $27.3 million
compared to a provision for credit loss on loans of $35.4 million for the year ended December 31, 2020 due primarily to changes
in forecasted economic conditions attributable to the COVID-19 Pandemic during each period. At December 31, 2021 our total
nonaccrual loans were $23.8 million, or 0.62% of loans receivable, compared to $58.1 million, or 1.30% of loans receivable, at
December 31, 2020. Generally, our nonaccrual loans reflect operating difficulties of individual borrowers, which may be the result
of current economic conditions.
General economic conditions tend to impact loan segments at varying degrees. At December 31, 2021, our commercial
and industrial loan portfolio represented 43.3% of our nonaccrual loans, which was the greatest percentage of any loan category,
as the borrowers are primarily business owners whose business results are influenced by current economic conditions. Owner-
occupied commercial real estate loans and non-owner occupied commercial real estate loans represented 34.4% and 19.6%,
respectively, of our nonaccrual loans at December 31, 2021.
Risks Related to Economic Conditions
The current economic condition in the market areas we serve may adversely impact our earnings and could increase
the credit risk associated with our loan portfolio.
Substantially all of our loans are to businesses and individuals in the states of Washington and Oregon. A decline in the
economies of our primary market areas of the Pacific Northwest in which we operate could have a material adverse effect on our
business, financial condition, results of operations and prospects. Weakness in the global economy has adversely affected many
businesses operating in our markets that are dependent upon international trade and it is not known how changes in tariffs being
imposed on international trade may also affect these businesses.
A deterioration in economic conditions in our market areas of the Pacific Northwest as a result of the COVID-19
Pandemic or other factors could result in the following consequences, any of which could have a materially adverse impact on
our business, financial condition and results of operations:
•
•
•
•
•
•
•
loan delinquencies, problem assets and foreclosures may increase;
we may increase our ACL on loans and provision for credit losses;
the sale of foreclosed assets may be slow;
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 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
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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.
Changes in the United States government and its agencies’ monetary or fiscal policies, including stimulus
enacted in response to the COVID-19 Pandemic, could adversely affect our results of operations and financial
condition.
Our earnings will be affected by domestic economic conditions and the monetary and fiscal policies of the United States
government and its agencies. The United States government and its agencies have an important impact on the operating results
of banks through their power to implement national monetary policy, among other things, in order to curb inflation, combat a
recession or react to impacts from the COVID-19 Pandemic. We cannot predict the nature or impact of future changes in such
monetary and fiscal policies, including stimulus enacted in response to the COVID-19 Pandemic.
Risks Related to Market Interest Rates
Fluctuating interest rates can adversely affect our profitability.
Our profitability is dependent to a large extent upon net interest income, which is the difference (or “spread”) between
the interest earned on loans,
investment securities and other interest earning assets and the interest paid on deposits,
borrowings, and other interest bearing liabilities. Because of the differences in maturities and repricing characteristics of our
interest earning assets and interest bearing liabilities, changes in interest rates do not produce equivalent changes in interest
income earned on interest earning assets and interest paid on interest bearing liabilities.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities.
Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and
investment securities and the amount of interest we pay on deposits and borrowings, but these changes could also affect (i) our
ability to originate and/or sell
loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, which could
negatively impact shareholders’ equity, and our ability to realize gains from the sale of such assets, (iii) our ability to obtain and
retain deposits in competition with other available investment alternatives, (iv) the ability of our borrowers to repay adjustable or
variable rate loans, and (v) the average duration of our investment securities portfolio and other interest earning assets. If the
interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other
investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely
affected if interest rates decrease as assets tend to reprice more quickly than liabilities. In a changing interest rate environment,
we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business,
financial condition and results of operations could be materially affected.
Interest rates are highly sensitive to many factors that are beyond our control, including general and forecasted
economic conditions reflected in the rates offered along the yield curve and the FHLB's fixed-rate advance index, and policies of
various governmental and regulatory agencies and, in particular, the Federal Reserve. In March 2020, in response to the
COVID-19 Pandemic, the FOMC lowered the target range for the federal funds rate 150 basis points to a range of 0.00% to
0.25%. The reduction in the targeted federal funds rate has resulted in a decline in overall interest rates which has negatively
impacted our net interest income. However, the FOMC has recently indicated it expects to increase rates starting in 2022. If the
FOMC increases the targeted federal funds rate, overall interest rates are expected to rise, which will positively impact our net
interest income, but 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 stated maturity date) has resulted in our interest bearing liabilities having a shorter duration than our
assets. We would incur a higher cost of funds to retain these deposits in a rising interest rate environment. If the interest rates
paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments,
our net interest income, and therefore earnings, could be adversely affected.
Changes in interest rates also affect the value of our interest earning assets and in particular our investment securities
portfolio. Generally,
fixed-rate investment securities fluctuates inversely with changes in interest rates.
Unrealized gains and losses on investment securities available for sale are reported as a separate component of equity, net of
tax. Decreases in the fair value of investment securities available for sale resulting from increases in interest rates could have an
adverse effect on stockholders’ equity.
the fair value of
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. For further discussion of how changes in interest rates could impact us and additional information about
our interest rate risk management, see Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
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Our investment securities portfolio may be negatively impacted by fluctuations in market value and interest rates.
Our investment securities portfolio may be impacted by fluctuations in market value, potentially reducing AOCI and/or
earnings. Fluctuations in market value may be caused by changes in market interest rates, rating agency actions in respect of
the securities, defaults by the issuer or with respect to the underlying securities, lower market prices for securities and limited
investor demand. Our investment securities portfolio is evaluated for estimated credit
losses and an ACL on investment
securities, as appropriate, is recorded as a contra asset on the financial statement of condition and a provision for credit loss on
investment securities through earnings. There can be no assurance that the declines in market value will not result in credit
losses, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.
Risks Related to Laws and Regulations
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or
sanctions and limit our ability to get regulatory approval of acquisitions.
The USA PATRIOT and Bank Secrecy Acts require financial
institutions to develop programs to prevent financial
institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are
obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These
rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open
new financial accounts. Failure to comply with these regulations could result in fines or sanctions and limit our ability to get
regulatory approval of acquisitions. 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 and could have a material adverse effect on our business, financial condition,
results of operations and growth prospects.
Risks Related to Operational Matters
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 the risk these vendors will not perform in accordance with contracted
arrangements under service level agreements. The failure of an external vendor to perform in accordance with contracted
arrangements under service level agreements because of changes in the vendor's organizational structure, financial condition,
level of support for existing products and services, 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 core
operating systems, our general
ledger and virtually all other aspects of our business. Our operations rely on the secure
processing, storage and transmission of confidential and other information in our computer systems and networks. Although we
take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems,
software and networks may be vulnerable to breaches, fraudulent or unauthorized access, denial or degradation of service
attacks, misuse, computer viruses, malware or other malicious code and cyber-attacks that could have a security impact. If one
or more of these events occur, this could jeopardize our or our customers' confidential and other information processed and
stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our
operations or the operations of our customers or counterparties. We may be required to expend significant additional resources
to modify our protective measures or to investigate and remediate vulnerabilities or other exposures and we may be subject to
litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us. We
could also suffer significant reputational damage.
Security breaches in our internet banking activities could further expose us to possible liability and damage our
reputation. 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/or controls that we use to prevent fraudulent transactions and to protect
data about us, our clients and underlying transactions. Any compromise of our security could deter customers from using our
internet banking services that involve the transmission of confidential information. We rely on standard internet security systems
to provide the security and authentication necessary to effect secure transmission of data. Although we have developed and
continue to invest in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and
periodically test our security, these precautions may not protect our systems from compromises or breaches of our security
measures and could result in losses to us or our customers, our loss of business and/or customers, damage to our reputation,
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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 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 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 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.
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.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
The Company and the Bank 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,
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
including adverse sentiment about
financial
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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 new ones may cause service interruptions, transaction
processing errors and system conversion delays and may cause us to fail to comply with applicable laws. There can be no
assurance that we will be able to successfully manage the risks associated with increased dependency on technology.
Risks Related to Accounting Matters
New or changing tax, accounting, and regulatory rules and interpretations could significantly impact strategic
initiatives, results of operations, cash flows, and financial condition.
The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to
protect the deposit insurance funds and consumers, not to benefit our stockholders. These regulations, along with the currently
existing tax, accounting, securities, insurance and monetary laws, regulations, rules, standards, policies and interpretations
control the methods by which financial
institutions conduct business, implement strategic initiatives and tax compliance and
govern financial reporting and disclosures. These laws, regulations, rules, standards, policies and interpretations are constantly
evolving and may change significantly over time. Any new regulations or legislation, change in existing regulation or oversight,
whether a change in regulatory policy or a change in a regulator's interpretation of a law or regulation, could have a material
impact on our operations, increase our costs of regulatory compliance and of doing business and adversely affect our profitability.
Regulatory authorities also have extensive discretion in connection with their supervisory and enforcement activities, including
the imposition of restrictions on the operation of an institution, the classification of assets by the institution and adequacy of an
institution's ACL. These bank regulators also have the ability to impose conditions in the approval of merger and acquisition
transactions.
If the goodwill we have recorded in connection with acquisitions becomes impaired, our earnings and capital could be
reduced.
Accounting standards require that we account for acquisitions or business combinations using the purchase method of
accounting. Under purchase accounting, if the purchase price of an acquired company exceeds the fair value of its net assets,
the excess is carried on the acquirer’s balance sheet as goodwill. In accordance with GAAP, our goodwill
is evaluated for
impairment on an annual basis or more frequently if events or circumstances indicate a potential
impairment exists. The
evaluation may be based on a variety of quantitative factors, including the quoted price of our common stock, market prices of
common stock of other banking organizations, common stock trading multiples, discounted cash flows and data from comparable
acquisitions. Additionally, we may perform a qualitative assessment that takes into consideration macroeconomic conditions,
industry and market conditions, cost or margin factors, and financial performance. Our evaluation of the fair value of goodwill
involves a substantial amount of judgment. If our judgment was incorrect, or if events or circumstances change, and an
impairment of goodwill was deemed to exist, we would be required to write down our goodwill resulting in a charge against
income, which could adversely affect our results of operations and financial condition, perhaps materially; however, it would have
no impact on our liquidity, operations or regulatory capital.
Other Risks Related to Our Business
We will be required to transition from the use of the London Interbank Offered Rate ("LIBOR") in the future.
FHLB advances, loans receivable, investment securities, subordinated debentures and trust preferred securities may be
indexed to LIBOR to calculate the interest rate. The continued availability of the LIBOR index is not guaranteed after 2021 and
LIBOR is scheduled to be eliminated entirely by June 2023. We cannot predict whether and to what extent banks will continue to
provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted. At this
time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR (with the exception of overnight
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repurchase agreements, which are expected to be based on SOFR). Uncertainty as to the nature of alternative reference rates
and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans,
and to a lesser extent securities in our portfolio, and may impact the availability and cost of hedging instruments and borrowings,
including the rates we pay on our trust preferred securities. The language in our LIBOR-based contracts and financial
instruments has developed over time and may have various events that trigger when a successor rate to the designated rate
would be selected. If a trigger is satisfied, contracts and financial instruments may give the calculation agent discretion over the
substitute index or indices for the calculation of interest rates to be selected. The implementation of a substitute index or indices
for the calculation of interest rates under our loan agreements with our borrowers or our borrowings may result in our incurring
significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute
index or indices and may result in disputes or litigation with clients and creditors over the appropriateness or comparability to
LIBOR of the substitute index or indices, which could have an adverse effect on our results of operations.
To mitigate the uncertainty surrounding the LIBOR transition, the Bank has been utilizing specific contract language in
new loan agreements that provides for changes in the index used to calculate the loan's interest rate. Additionally, effective
January 25, 2021, the Company agreed to adhere to the Interbank Offered Rate Fallbacks Protocol as published by the
International Swaps and Derivatives Association, Inc recommended by the Alternative Reference Rates Committee.
Decreased volumes and lower gains on sales of mortgage loans sold could adversely impact our noninterest income.
We originate and sell residential real estate loans, or mortgage loans. The related mortgage income is a significant
portion of our noninterest income. We generate gains on the sale of residential real estate loans pursuant to programs currently
offered by the Federal Home Loan Mortgage Corporation and other secondary market purchasers. Any future changes in these
purchase programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly
affect the activity of such entities could, in turn, materially adversely affect our results of operations. Further, in a rising or higher
interest rate environment, our originations of mortgage loans may decrease resulting in fewer loans that are available to be sold
to investors. This would result in a decrease in gain on loans, net and a corresponding decrease in noninterest income. In
addition, our results of operations are affected by the amount of noninterest expense associated with mortgage banking
activities, such as salaries and employee benefits; occupancy and equipment expense; data processing expense and other
operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that
we are unable to reduce expenses commensurate with the decline in mortgage loan originations.
Ineffective liquidity management could adversely affect our financial results and condition.
Effective liquidity management is essential to our business. We require sufficient liquidity to meet customer loan
requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash
commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry
or general financial market stress. An inability to raise funds through deposits, borrowings, the sale of loans or investment
securities and other sources could have a substantial negative effect on our liquidity. We rely on customer deposits and
borrowings from the FHLB and certain other wholesale funding sources to fund our operations. Deposit
flows and the
prepayment of loans and mortgage-related investment securities are strongly influenced by such external factors as the direction
of interest rates, whether actual or perceived, and the competition for deposits and loans in the markets we serve. Further,
changes to the FHLB's underwriting guidelines for wholesale borrowings or lending policies may limit or restrict our ability to
borrow and could therefore have a significant adverse impact on our liquidity. Although we have historically been able to replace
maturing deposits and borrowings if desired, we may not be able to replace such funds in the future if, among other things, our
financial condition, the financial condition of the FHLB or market conditions change. Our access to funding sources in amounts
adequate to finance our activities or on terms which are acceptable could be impaired by factors that affect us, the financial
services industry or the economy in general, such as a disruption in the financial markets or negative views and expectations
about the prospects for the financial services industry or deterioration in credit markets. Additional factors that could detrimentally
impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the
markets in which our deposits and loans are concentrated, negative operating results or adverse regulatory action against us.
Any decline in available funding in amounts adequate to finance our activities or on terms which are acceptable could adversely
impact our ability to originate loans, invest in securities, pay our expenses or fulfill obligations such as repaying our borrowings or
meeting deposit withdrawal demands, any of which could, in turn, have a material adverse effect on our business, financial
condition and results of operations.
Additionally, collateralized public funds are bank deposits of state and local municipalities. These deposits are required
to be secured by certain investment grade securities to ensure repayment, which on the one hand tends to reduce our contingent
liquidity risk by making these funds somewhat less credit sensitive, but on the other hand reduces standby liquidity by restricting
the potential liquidity of the pledged collateral. Although these funds historically have been a relatively stable source of funds for
us, availability depends on the individual municipality's fiscal policies and cash flow needs.
Societal responses to climate change could adversely affect our business and performance,
through impacts on our customers.
including indirectly
Concerns over the long-term impacts of climate change have led and will continue to lead to governmental efforts
around the world to mitigate those impacts. Consumers and businesses also may change their behavior on their own as a result
of these concerns. We and our customers will need to respond to new laws and regulations as well as consumer and business
preferences resulting from climate change concerns. We and our customers may face cost increases, asset value reductions and
operating process changes. The impact on our customers will likely vary depending on their specific attributes, including reliance
on or role in carbon intensive activities. Among the impacts to us could be a drop in demand for our products and services,
23
particularly in certain industry sectors. In addition, we could face reductions in creditworthiness on the part of some customers or
in the value of assets securing loans. Our efforts to take these risks into account in making lending and other decisions, including
by increasing our business with climate-friendly companies, may not be effective in protecting us from the negative impact of new
laws and regulations or changes in consumer or business behavior.
Risk Related to Holding Our Common Stock
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available
when it is needed or the cost of that capital may be very high; further, the resulting dilution of our equity may adversely
affect the market price of our common stock.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our
operations. At some point, we may need to raise additional capital to support our growth or replenish future losses. Our ability to
raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and
on our financial condition and performance. Accordingly, we cannot make assurances we will be able to raise additional capital, if
needed, on terms that are acceptable to us or at all. If we cannot raise additional capital when needed, our ability to further
expand our operations through internal growth and acquisitions could be materially impaired and our financial condition and
liquidity could be materially and adversely affected.
In addition, any additional capital we obtain may result in the dilution of the interests of existing holders of our common
stock. Further, if we are unable to raise additional capital when required by our bank regulators, we may be subject to adverse
regulatory action.
We rely on dividends from the Bank for substantially all of our revenue at the holding company level.
We are an entity separate and distinct from our subsidiary, the Bank, and derive substantially all of our revenue at the
holding company level in the form of dividends from that subsidiary. Accordingly, we are, and will be, dependent upon dividends
from the Bank to pay the principal of and interest on our indebtedness, to satisfy our other cash needs and to pay dividends on
our common stock. The Bank's ability to pay dividends is subject to its ability to earn net income and to meet certain regulatory
requirements. In the event the Bank is unable to pay dividends to us, we may not be able to pay dividends on our common stock.
Also, our right to participate in a distribution of assets upon a subsidiary's liquidation or reorganization is subject to the prior
claims of the subsidiary's creditors.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
The Company has no unresolved staff comments from the SEC as it relates to the Company's financial information as
reported in the Form 10-K.
ITEM 2.
PROPERTIES
The main office of the Company and the Bank is located in downtown Olympia, Washington. In addition, the Bank owns
back office locations in downtown Tacoma, Washington; Lynnwood, Washington and Burlington, Washington. The Bank's branch
network at December 31, 2021 was comprised of 49 branches located throughout Washington and Oregon following the
consolidation of 12 branches during the year ended December 31, 2021. In the opinion of management, all properties are
adequately covered by insurance, are in good state of repair and are adequate to meet our present and immediately foreseeable
needs.
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 our businesses.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable
PART II
ITEM 5.
ISSUER PURCHASES OF EQUITY SECURITIES
MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
Market Information
Our common stock is traded on the NASDAQ Global Select Market under the symbol HFWA.
Holders
At December 31, 2021, we had approximately 1,183 shareholders of record (not including the number of persons or
entities holding stock in nominee or street name through various brokerage firms) and 35,105,779 outstanding shares of
24
common stock.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
The following table sets forth information about the Company’s purchases of its outstanding common stock during the
quarter ended December 31, 2021:
Period
October 1, 2021— October 31, 2021
November 1, 2021— November 30, 2021
December 1, 2021— December 31, 2021
Total
Total
Number of
Shares
Purchased
Average
Price Paid
Per Share
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
Maximum Number of
Shares that May Yet Be
Purchased Under the
Plans or Programs
— $
—
64,730
64,730 $
—
—
23.03
23.03
9,822,889
9,822,889
9,886,773
802,188
802,188
738,304
Of the common shares repurchased by the Company between October 1, 2021 and December 31, 2021, 846 shares
represented the cancellation of stock to pay withholding taxes on vested restricted stock units. See Note (15) Stockholders'
Equity of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data for
additional information on publicly announced repurchase plans or programs.
Performance Graph
The following graph shows the five-year comparison of the total return to shareholders of the Company’s common stock
as compared to the NASDAQ Composite Index, the KBW NASDAQ Bank Index and the S&P U.S. SmallCap Banks Index during
the five-year period beginning December 31, 2016 and ending December 31, 2021. The graph assumes the value of the
investment in Company’s common stock and each index was $100 on December 31, 2016, and all dividends were reinvested.
Total return includes appreciation or depreciation in market value of the Company’s common stock as well as actual cash and
stock dividends paid to common shareholders. The NASDAQ Composite Index is a broad equity market index comprised of all
domestic and international common stocks listed on the Nasdaq Stock Market. During the year ended December 31, 2021, the
previously used SNL U.S. Bank NASDAQ Index was replaced by the KBW NASDAQ Bank Index on the S&P Global Market
Intelligence platform. The KBW NASDAQ Bank Index is and the previously used SNL U.S. Bank NASDAQ Index was a published
industry index comprised of banks and related holding companies listed on the NASDAQ Stock Market. The S&P U.S. SmallCap
Banks Index is also a published industry index, however, the index constituents are aligned within the same market capitalization
range as the Company and we will include the S&P U.S. SmallCap Banks Index in the future since it is more closely aligned with
holding companies and banks of our size.
Total Return Performance
l
e
u
a
V
x
e
d
n
I
300
250
200
150
100
.
Index
12/31/16
12/31/17
12/31/18
12/31/19
12/31/20
12/31/21
Period Ending
Heritage Financial Corporation
KBW NASDAQ Bank Index
NASDAQ Composite Index
S&P U.S. SmallCap Banks Index
2016
2017
2018
2019
2020
2021
Years Ended December 31,
Heritage Financial Corporation
$
100.00 $
122.28 $
120.65 $
118.22 $
101.59 $
109.59
NASDAQ Composite Index
KBW NASDAQ Bank Index
S&P U.S. SmallCap Banks Index
100.00
100.00
100.00
129.64
118.59
104.33
125.96
97.58
87.06
172.18
132.84
109.22
249.51
119.14
99.19
304.85
164.80
138.09
*Information for the graph was provided by S&P Global Market Intelligence.
25
ITEM 6.
[RESERVED]
ITEM 7.
OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
The following discussion is intended to assist in understanding the financial condition and results of operations of the
Company as of and for the year ended December 31, 2021. The information contained in this section should be read together
with the December 31, 2021 audited Consolidated Financial Statements and the accompanying Notes included in Item 8.
Financial Statements And Supplementary Data of this Form 10-K.
This section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021
and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Form
10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7
of the Company’s Form 10-K for the fiscal year ended December 31, 2020.
Overview
Heritage Financial Corporation is a bank holding company which primarily engages in the business activities of our
wholly-owned financial
institution subsidiary, Heritage Bank. We provide financial services to our local communities with an
ongoing strategic focus on our commercial banking relationships, market expansion and asset quality. The Company’s business
activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the
information set forth in this report relates primarily to the Bank’s operations.
Our business consists primarily of commercial lending and deposit relationships with small to medium sized businesses
and their owners in our market areas and attracting deposits from the general public. We also make real estate construction and
land development loans and consumer loans. We additionally originate for sale or for investment purposes residential real estate
loans on single family properties located primarily in our markets. During the three months ended March 31, 2020, we ceased
indirect auto loan originations, included in our consumer loan portfolio.
Our core profitability depends primarily on our net interest income. Net interest income is the difference between
interest income, which is the income that we earn on interest earning assets, comprised primarily of loans and investment
securities, and interest expense, which is the amount we pay on our interest bearing liabilities, consisting primarily of deposits.
Management manages the repricing characteristics of the Company's interest earning assets and interest bearing liabilities to
protect net interest income from changes in market interest rates and changes in the shape of the yield curve. Like most financial
institutions, our net interest income is significantly affected by general and local economic conditions, particularly changes in
market interest rates, and by governmental policies and actions of regulatory agencies. Net interest income is additionally
affected by changes in the volume and mix of interest earning assets, interest earned on these assets, the volume and mix of
interest bearing liabilities and interest paid on these liabilities.
Our net income is affected by many factors, including the provision for credit losses on loans. The provision for credit
losses on loans is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan
portfolio as well as prevailing economic and market conditions. Management believes that the ACL on loans reflects the amount
that is appropriate to provide for current expected credit losses in our loan portfolio based on our methodology.
Net income is also affected by noninterest income and noninterest expense. Noninterest income primarily consists of
service charges and other fees and other income. Noninterest expense consists primarily of compensation and employee
benefits, occupancy and equipment, data processing and professional services. Compensation and employee benefits consist
primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits.
Occupancy and equipment expenses are the fixed and variable costs of buildings and equipment and consists primarily of lease
expenses, depreciation charges, maintenance and utilities. Data processing consists primarily of processing and network
services related to the Bank’s core operating system, including the account processing system, electronic payments processing
of products and services, internet and mobile banking channels and software-as-a-service providers. Professional services
consists primarily of third-party service providers such as auditors, consultants and lawyers.
Results of operations may also be significantly affected by general and local economic and competitive conditions,
governmental policies and actions of regulatory authorities, especially changes resulting from the COVID-19 Pandemic and the
governmental actions taken to address it. Net income is also impacted by growth of operations through organic growth or
acquisitions.
COVID-19 Pandemic Response
The Company maintains its commitment to supporting its community and customers during the COVID-19 Pandemic
and remains focused on keeping its employees safe and the Bank running effectively to serve its customers. As of December 31,
2021, nearly all Bank branches are open with normal hours and substantially all employees are expected to return to their go-
forward working environments during the three months ended March 31, 2022. The Bank will continue to monitor branch access
and occupancy levels in relation to cases and close contact scenarios and follow governmental restrictions and public health
authority guidelines.
Branch Consolidation Plan
The Company reduced the branch count to 49 from 61 branches at December 31, 2020, including the consolidation of
26
eight branches during the three months ended March 31, 2021 and four branches in October 2021. The Company integrated
these locations into other branches within its network. These actions were the result of the Company’s increased focus on
balancing physical locations and digital banking channels, driven by increased customer usage of online and mobile banking and
a commitment to improve digital banking technology.
Results of Operations
Net income was $98.0 million, or $2.73 per diluted common share, for the year ended December 31, 2021 compared to
$46.6 million, or $1.29 per diluted common share, for the year ended December 31, 2020. Net income increased $51.5 million, or
110.5%, due primarily to a reversal of provision for credit losses of $29.4 million during the year ended December 31, 2021
compared to a provision for credit losses of $36.1 million for the same period in 2020.
The Company’s efficiency ratio was 62.09% for the year ended December 31, 2021 compared to 62.52% for the year
ended December 31, 2020.
Average Balances, Yields and Rates Paid
The following table provides relevant net interest income information for the periods indicated:
Year Ended December 31,
2021
Interest
Earned/
Paid
Average
Balance(1)
Average
Yield/
Rate
Average
Balance(1)
2020
Interest
Earned/
Paid
Average
Yield/
Rate
Average
Balance(1)
2019
Interest
Earned/
Paid
Average
Yield/
Rate
(Dollars in thousands)
$ 4,181,464
$189,832
4.54 % $ 4,335,564
$192,417
4.44 % $ 3,668,665
$189,515
5.17 %
846,892
17,492
158,968
1,193,724
3,899
1,608
2.07
2.45
0.13
731,378
17,541
152,447
315,847
3,659
703
2.40
2.40
0.22
827,822
23,045
135,245
98,153
3,396
1,894
2.78
2.51
1.93
Interest Earning Assets:
Loans receivable, net (2)(3)
Taxable securities
Nontaxable securities (3)
Interest earning deposits
Total interest earning assets
6,381,048
212,831
3.34 % 5,535,236
214,320
3.87 % 4,729,885
217,850
4.61 %
Noninterest earning assets
Total assets
745,202
$ 7,126,250
758,386
$ 6,293,622
681,193
$ 5,411,078
Interest Bearing Liabilities:
Certificates of Deposit
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 bearing
liabilities
Noninterest bearing demand
deposits
Other noninterest bearing
liabilities
Stockholders’ equity
$ 372,279
$
1,811
0.49 % $ 482,316
$
5,675
1.18 % $ 512,732
$
7,021
1.37 %
598,492
367
0.06
489,471
526
0.11
506,073
2,633
0.52
2,862,504
3,982
0.14
2,491,477
6,064
0.24
2,052,573
6,695
0.33
3,833,275
21,025
6,160
742
0.16
3.53
3,463,264
12,265
20,730
890
0.35
4.29
3,071,378
16,349
20,438
1,339
0.53
6.55
45,655
140
0.31
27,805
160
0.58
28,457
175
0.61
—
—
—
1,466
8
0.55
11,899
305
2.56
3,899,955
7,042
0.18 % 3,513,265
13,323
0.38 % 3,132,172
18,168
0.58 %
2,256,608
127,620
842,067
1,835,165
139,612
805,580
1,389,721
99,683
789,502
Total liabilities and stock-
holders’ equity
$ 7,126,250
Net interest income and spread
Net interest margin
$ 6,293,622
$ 5,411,078
$205,789
3.16 %
$200,997
3.49 %
$199,682
4.03 %
3.23 %
3.63 %
4.22 %
(1) Average balances are calculated using daily balances.
(2) Average loan receivable, net includes loans held for sale and loans classified as nonaccrual, which carry a zero yield. Interest
earned on loans receivable, net includes the amortization of net deferred loan fees of $28.4 million, $14.4 million and $776,000 for
the years ended December 31, 2021, 2020, and 2019, respectively.
(3) Yields on tax-exempt loans and securities have not been stated on a tax-equivalent basis.
27
Net Interest Income and Margin Overview
One of the Company's key sources of earnings is net interest income. There are several factors that affect net interest
income, including, but not limited to, the volume, pricing, mix and maturity of interest earning assets and interest bearing
liabilities; the volume of noninterest earning assets, noninterest bearing demand deposits, other noninterest bearing liabilities and
stockholders' equity; market interest rate fluctuations; and asset quality.
The following table provides the changes in net interest income due to changes in average asset and liability balances
(volume), changes in average rates (rate) and changes attributable to the combined effect of volume and interest rates allocated
proportionately to the absolute value of changes due to volume and changes due to interest rates:
Interest Earning Assets:
Loans receivable, net
Taxable securities
Nontaxable securities
Interest earning deposits
Total interest income
Interest Bearing Liabilities:
Certificates of deposit
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
Net interest income
2021 Compared to 2020
Increase (Decrease) Due to changes in
2020 Compared to 2019
Increase (Decrease) Due to changes in
Volume
Rate
Total
Volume
Rate
Total
(Dollars in thousands)
(Dollars in thousands)
$
(6,934) $
4,349 $
(2,585) $
31,716 $
(28,814) $
2,902
2,566
159
1,278
(2,615)
81
(373)
(49)
240
905
(2,515)
418
1,544
(2,989)
(155)
(2,735)
(2,931) $
1,442 $
(1,489) $
31,163 $
(34,693) $
(1,082) $
(2,782) $
(3,864) $
(399) $
(947) $
100
803
(179)
12
75
(4)
(259)
(159)
(84)
(2,023)
(2,885)
(5,926)
(160)
(95)
(4)
(2,082)
(6,105)
(148)
(20)
(8)
1,265
782
19
(4)
(157)
(1,896)
(4,866)
(468)
(11)
(140)
(5,504)
263
(1,191)
(3,530)
(1,346)
(2,107)
(631)
(4,084)
(449)
(15)
(297)
(96) $
(6,185) $
(6,281) $
640 $
(5,485) $
(4,845)
(2,835) $
7,627 $
4,792 $
30,523 $
(29,208) $
1,315
$
$
$
$
Net interest income increased $4.8 million, or 2.4%, to $205.8 million for the year ended December 31, 2021 compared
to $201.0 million for 2020 due primarily to the Bank decreasing deposit rates following decreases in short-term market interest
rates and secondarily due to an increase in the yield of loans receivable, net, predominately from higher amortization of deferred
SBA PPP loan fees recognized from forgiven SBA PPP loans and higher recoveries of interest and fees on loans classified as
nonaccrual. These factors increasing net interest income were offset partially by a decrease in average loans receivable, net and
a decrease in the yield on taxable securities.
Net interest margin decreased due primarily to the significant increase in low-yielding average interest earning deposits
to average total earning assets of 18.7% during the year ended December 31, 2021 compared to 5.7% for the same period in
2020, reducing the yield on interest earning assets for 2021.
The following table presents the loan yield and the impacts of SBA PPP loans and the incremental accretion on
purchased loans on this financial measure for the periods presented below:
Loan yield (GAAP)
Exclude impact from SBA PPP loans
Exclude impact from incremental accretion on purchased loans
Loan yield excluding SBA PPP loans and incremental accretion on purchased loans (non-
GAAP)
Year Ended December 31,
2021
2020
(Dollars in thousands)
4.54 %
(0.20)%
(0.07)%
4.44 %
0.16 %
(0.08)%
4.27 %
4.52 %
(1) For additional information, see the "Reconciliations of Non-GAAP Measures" section below.
28
Provision for Credit Losses Overview
The aggregate of the provision for credit losses on loans and the provision for credit losses on unfunded commitments
is presented on the Consolidated Statements of Income as the provision for credit losses. The ACL on unfunded commitments is
included on the Consolidated Statements of Financial Condition within accrued expenses and other liabilities.
The following table presents the provision for credit losses for the periods indicated:
Provision for credit losses on loans
Provision for credit losses on unfunded commitments
Provision for credit losses
Year Ended December 31,
2021
2020
(In thousands)
$
$
(27,298) $
(2,074)
(29,372) $
35,433
673
36,106
The reversal of provision for credit losses recognized during the year ended December 31, 2021 was due primarily to
improvements in forecasted economic indicators used to calculate credit losses during the year ended December 31, 2021
compared to the worsening of economic indicators during the year ended December 31, 2020 stemming from the onset of the
COVID-19 Pandemic.
Noninterest Income Overview
The following table presents the change in the key components of noninterest income for the periods indicated:
Year Ended December 31,
2021
2020
Change
% Change
(Dollars in thousands)
Service charges and other fees
$
17,597 $
16,228 $
Gain on sale of investment securities, net
Gain on sale of loans, net
Interest rate swap fees
Bank owned life insurance income
Gain on sale of other assets, net
Other income
29
3,644
661
2,520
4,405
5,759
1,518
5,044
1,691
4,319
955
7,474
Total noninterest income
$
34,615 $
37,229 $
1,369
(1,489)
(1,400)
(1,030)
(1,799)
3,450
(1,715)
(2,614)
8.4 %
(98.1)
(27.8)
(60.9)
(41.7)
361.3
(22.9)
(7.0)%
Noninterest income decreased due primarily to lower bank owned life insurance income as the year ended December
31, 2020 included the recognition of death benefits of $1.9 million and lower other income as last year included trust income of
$1.6 million, including a termination fee of $651,000 from the divestiture of our trust department. Additionally, noninterest income
was lower due to reduced gain on sale of investment securities due to fewer sales, a decrease in gain on sale of loans due
primarily to lower sales volume of secondary market mortgage loans and a decline in interest rate swap fees due to fewer
executions of interest rate swap contracts. Partially offsetting these decreases was an increase in gain on sale of other assets,
net for the year ended December 31, 2021, including a $2.7 million gain from the sale and leaseback of the Company's
headquarters in Olympia, Washington.
Noninterest Expense Overview
The following table presents changes in the key components of noninterest expense for the periods indicated:
Year Ended December 31,
2021
2020
Change
% Change
(Dollars in thousands)
Compensation and employee benefits
$
89,880 $
88,106 $
Occupancy and equipment
Data processing
Marketing
Professional services
State/municipal business and use tax
Federal deposit insurance premium
Other real estate owned, net
17,243
16,533
3,039
4,065
3,884
2,106
—
29
17,611
14,449
3,100
5,921
3,754
1,789
(145)
1,774
(368)
2,084
(61)
(1,856)
130
317
145
2.0 %
(2.1)
14.4
(2.0)
(31.3)
3.5
17.7
(100.0)
Year Ended December 31,
2021
2020
Change
% Change
(Dollars in thousands)
Amortization of intangible assets
Other expense
3,111
9,408
3,525
10,830
Total noninterest expense
$
149,269 $
148,940 $
(414)
(1,422)
329
(11.7)
(13.1)
0.2 %
Noninterest expense increased slightly due primarily to an increase in data processing expense as the Bank continues
to invest in technology. Additionally, noninterest expense increased due to compensation and employee benefits primarily as a
result of severance payments following a strategic reduction in force and an increase in accrual for incentive payments. The
increase in noninterest expense was offset partially by lower professional services expense due to costs incurred during the year
ended December 31, 2020 related to the launch of the new mobile and online commercial banking platform "Heritage Direct" last
year and secondarily due to the decrease in other expense from lower branch consolidation costs recognized during the year
ended December 31, 2021 compared to the same period in 2020.
Income Tax Expense Overview
The following table presents the income tax expense and related metrics and the change for the periods indicated:
Income before income taxes
Income tax expense
Effective income tax rate
Year Ended December 31,
2021
2020
Change
% Change
(Dollars in thousands)
$
$
120,507
22,472
$
$
53,180
6,610
$
$
67,327
15,862
18.6 %
12.4 %
6.2 %
126.6 %
240.0 %
50.0 %
Income tax expense and the effective income tax rate both increased due primarily to higher pre-tax income, which
decreased the impact of favorable permanent tax items such as tax-exempt investments, investments in bank owned life
insurance and low-income housing tax credits, and secondarily due to a provision in the CARES Act, which permitted the
Company to recognize a $1.0 million benefit from net operating losses related to prior acquisitions during the year ended
December 31, 2020. Additionally, the Bank's New Market Tax Credit was fully utilized during the seven year period ending
December 31, 2020 and the related entities were dissolved in May 2021. In 2021, the Bank formed HBCDE, LLC which was
certified as a Community Development Entity by the Department of the Treasury Community Development Financial Institutions
Fund in September 2021. The newly created entity is expected to commence funding eligible loans during the year ended
December 31, 2022 and apply for New Market Tax Credits in future years.
Financial Condition Overview
The table below provides a comparison of the changes in the Company's financial condition for the periods indicated:
December 31,
2021
December 31,
2020
Change
% Change
(Dollars in thousands)
Assets
Cash and cash equivalents
$
1,723,292 $
743,322 $
Investment securities available for sale, at fair value, net
894,335
802,163
Investment securities held to maturity, at amortized cost,
net
Loans held for sale
Loans receivable, net
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
383,393
1,476
—
4,932
3,773,301
4,398,462
79,370
7,933
120,196
14,657
183,543
9,977
240,939
85,452
6,661
107,580
19,418
193,301
13,088
240,939
979,970
92,172
383,393
(3,456)
(625,161)
(6,082)
1,272
12,616
(4,761)
(9,758)
(3,111)
—
131.8 %
11.5
100.0
(70.1)
(14.2)
(7.1)
19.1
11.7
(24.5)
(5.0)
(23.8)
—
$
7,432,412 $
6,615,318 $
817,094
12.4 %
30
Liabilities and Stockholders' Equity
Deposits
Junior subordinated debentures
Securities sold under agreement to repurchase
Accrued expenses and other liabilities
Total liabilities
Common stock
Retained earnings
Accumulated other comprehensive income, net
Total stockholders' equity
December 31,
2021
December 31,
2020
Change
% Change
(Dollars in thousands)
$
6,381,337 $
5,597,990 $
783,347
14.0 %
21,180
50,839
124,624
6,577,980
551,798
293,238
9,396
854,432
20,887
35,683
140,319
5,794,879
571,021
224,400
25,018
820,439
293
15,156
(15,695)
783,101
(19,223)
68,838
(15,622)
33,993
817,094
1.4
42.5
(11.2)
13.5
(3.4)
30.7
(62.4)
4.1
12.4 %
Total liabilities and stockholders' equity
$
7,432,412 $
6,615,318 $
Total assets increased due primarily to increases in cash and cash equivalents and total
investment securities due
primarily to the significant increase in total deposits, which is discussed in more detail in the "Deposit Activities Overview" section
below. The increase in total assets was offset partially by a decrease in loans receivable, net, which is discussed in more detail in
the "Lending Activities Overview" section below.
Investment Activities Overview
Our investment policy is established by the Company's 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 permits investment in
various types of liquid assets permissible under applicable regulations. Investment in non-investment grade bonds and stripped
mortgage-backed securities is not permitted under the policy.
The following table provides information regarding our investment securities at the dates indicated:
December 31, 2021
December 31, 2020
Balance
% of
Total
Balance
% of
Total
(Dollars in thousands)
Change
% Change
Investment securities available for sale, at fair value:
U.S. government and agency
securities
Municipal securities
Residential CMO and MBS
Commercial CMO and MBS
Corporate obligations
Other asset-backed securities
$
21,373
1.7 % $
45,660
5.7 % $
(24,287)
(53.2)%
221,212
306,884
315,861
2,014
26,991
17.3 %
24.0 %
24.7 %
0.2 %
2.1 %
209,968
201,872
303,746
11,096
29,821
26.2 %
25.2 %
37.9 %
1.4 %
3.6 %
11,244
105,012
12,115
(9,082)
(2,830)
5.4
52.0
4.0
(81.8)
(9.5)
Total
$
894,335
70.0 % $
802,163
100.0 % $
92,172
11.5 %
Investment securities held to maturity, at amortized cost:
U.S. government and agency
securities
Residential CMO and MBS
Commercial CMO and MBS
$
141,011
11.0 % $
24,529
217,853
1.9 %
17.1 %
Total
$
383,393
30.0 % $
—
—
—
—
— % $
141,011
100.0 %
—
—
24,529
217,853
100.0
100.0
— % $
383,393
100.0 %
Total investment securities
$ 1,277,728
100.0 % $
802,163
100.0 % $
475,565
59.3 %
Total investment securities increased due primarily to purchases of $756.4 million, offset partially by maturities, calls
and payments of investment securities of $255.9 million. Additionally, we transferred $244.8 million of investment securities
available for sale to investment securities held to maturity in order to mitigate market price volatility and its impact to AOCI within
stockholders' equity.
31
The following table provides the weighted average yield at December 31, 2021 calculated based upon the fair values of
our investment securities available for sale and held to maturity and excluding any income tax benefits of tax-exempt bonds:
In one year or less
After one year
through five years
After five years
through ten years
After ten years
Total
Fair
Value
Yield
Fair
Value
Yield
Fair
Value
Yield
Fair
Value
Yield
Fair
Value
Yield
Investment securities available for sale:
(Dollars in thousands)
U.S. government and agency
securities
Municipal securities
Residential CMO and MBS
Commercial CMO and MBS
Corporate obligations
Other asset-backed securities
$
—
— % $
1,493
3.01 % $
11,682
2.07 % $
8,198
2.32 % $
21,373
2.23 %
7,095
3.19
25,746
2.84
58,340
2.61
130,031
2.52
221,212
2.60
—
—
10,978
2.30
34,783
2.00
261,123
1.68
306,884
1.74
20,025
2.15
81,769
2.54
178,906
1.50
35,161
1.99
315,861
1.86
—
—
—
—
2,014
0.94
—
—
—
—
2,014
0.94
354
2.77
4,068
2.54
22,569
1.12
26,991
1.35
Total
$
27,120
2.42 % $ 122,354
2.56 % $ 287,779
1.82 % $ 457,082
1.93 % $ 894,335
1.99 %
Investment securities held to maturity:
U.S. government and agency
securities
Residential CMO and MBS
Commercial CMO and MBS
Total
$
$
Loan Portfolio Overview
Changes by loan type
—
—
—
—
— % $
—
—
— % $
—
—
—
—
— % $
68,014
1.95 % $
71,349
1.67 % $ 139,363
1.81 %
—
—
—
—
24,376
1.74
24,376
1.74
181,393
1.50
31,199
1.62
212,592
1.52
— % $ 249,407
1.62 % $ 126,924
1.67 % $ 376,331
1.64 %
The Bank originates a wide variety of loans with a focus on commercial business loans. The following table provides
information about our loan portfolio by type of loan at the dates indicated:
December 31, 2021
December 31, 2020
Amortized
Cost
% of Loans
Receivable
Amortized
Cost
% of Loans
Receivable
(Dollars in thousands)
Change
% Change
Commercial business:
Commercial and industrial
$
621,567
16.3 % $
733,098
16.4 % $ (111,531)
(15.2)%
SBA PPP
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Residential real estate
145,840
931,150
1,493,099
3,191,656
164,582
Real estate construction and land development:
Residential
Commercial and multifamily
Total real estate construction
and land development
Consumer
Total
85,547
141,336
226,883
232,541
3.8
24.4
39.2
83.7
4.3
2.2
3.7
5.9
6.1
715,121
856,684
1,410,303
3,715,206
122,756
78,259
227,454
305,713
324,972
16.0
19.2
31.5
83.1
2.7
1.8
5.1
6.9
7.3
(569,281)
(79.6)
74,466
82,796
(523,550)
41,826
7,288
(86,118)
(78,830)
(92,431)
8.7
5.9
(14.1)
34.1
9.3
(37.9)
(25.8)
(28.4)
$ 3,815,662
100.0 % $ 4,468,647
100.0 % $ (652,985)
(14.6)%
Loans receivable decreased due primarily to a decrease in SBA PPP loans as a result of forgiveness payments
received from the SBA in excess of SBA PPP originations and elevated prepayments of commercial and industrial
loans.
Additionally, the consumer loan portfolio decreased due partially to continued runoff of the indirect auto loan portfolio following
the cessation of this business line during the three months ended March 31, 2020. Offsetting these decreases was an increase in
CRE loans which includes the transfer of several completed projects from real estate construction and land development loans.
32
SBA Paycheck Protection Program
The Bank has supported its community and customers during the COVID-19 Pandemic through its participation in the
SBA's PPP. The SBA PPP ended on May 31, 2021.
The Bank earns 1% interest on these loans as well as a fee from the SBA to cover processing costs, which is amortized
over the life of the loan and recognized fully at payoff or forgiveness. The Bank began processing loan forgiveness applications
and receiving SBA PPP forgiveness payments during the three months ended December 31, 2020.
Composition of loans receivable by contractual maturity and interest type
The following table presents the amortized cost of
the loan portfolio by segment and contractual maturity at
December 31, 2021:
In one year or
less
After one year
through five
years
After five
years through
15 years
After 15 years
Total
(In thousands)
Commercial business:
Commercial and industrial
$
142,248 $
227,589 $
244,025 $
7,705 $
SBA PPP
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Residential real estate
5,921
21,919
78,879
248,967
—
Real estate construction and land development:
Residential
Commercial and multifamily
Total real estate construction
and land development
Consumer
Total
65,861
58,009
123,870
11,953
139,919
190,612
398,844
956,964
1,045
2,563
12,563
15,126
94,359
—
674,344
981,290
1,899,659
29,067
8,936
59,099
68,035
29,972
—
44,275
34,086
86,066
134,470
8,187
11,665
19,852
96,257
621,567
145,840
931,150
1,493,099
3,191,656
164,582
85,547
141,336
226,883
232,541
$
384,790 $
1,067,494 $
2,026,733 $
336,645 $
3,815,662
The following table presents the amortized cost of the loan portfolio by segment and interest rate type that are due after
one year at December 31, 2021:
Commercial business:
Commercial and industrial
SBA PPP
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Residential real estate (3)
Real estate construction and land development:
Residential
Commercial and multifamily
Total real estate construction and land development
Have
predetermined
interest
rates(1)
Have floating
or adjustable
interest
rates(1)
(In thousands)
$
317,892 $
161,427 $
139,919
453,836
589,292
1,500,939
119,966
8,181
39,457
47,638
—
455,395
824,928
1,441,750
44,616
11,505
43,870
55,375
Consumer
118,471
102,117
Total
479,319
139,919
909,231
1,414,220
2,942,689
164,582
19,686
83,327
103,013
220,588
Total
3,430,872
(1) Includes $2.2 million of real estate construction and land development loans with predetermined interest rates and
$329.2 million of commercial business loans with floating or adjustable interest rates 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 the one-month LIBOR plus a margin,
except for interest rate swap contracts on construction loans that earn fixed rates until the end of the construction
period and the variable rate swap becomes effective.
1,643,858 $
1,787,014 $
$
33
Loans classified as nonaccrual and performing TDR and nonperforming assets
The following table provides information about our nonaccrual loans, performing TDR loans and nonperforming assets
for the dates indicated:
Nonaccrual loans: (1)
Commercial business
Residential real estate
Real estate construction and land development
Consumer
Total nonaccrual loans
Other real estate owned
Total nonperforming assets
December 31,
2021
December 31,
2020
Change
% Change
(Dollars in thousands)
$
23,107
$
56,786
$
(33,679)
(59.3)%
47
571
29
23,754
—
23,754
184
1,022
100
58,092
—
58,092
(137)
(451)
(71)
(34,338)
(74.5)
(44.1)
(71.0)
(59.1)
—
n/a
(34,338)
(59.1)%
Accruing loans past due 90 days or more
$
293
$
— $
293
100.0 %
Credit quality ratios:
Nonaccrual loans to loans receivable
Nonaccrual loans to total assets
Performing TDR loans: (1)
Commercial business
Residential real estate
Real estate construction and land development
Consumer
0.62 %
0.32
1.30 %
0.88
(0.68)%
(0.56)
(52.3)%
(63.6)
$
57,142
$
49,403
$
358
450
1,160
188
1,926
1,355
7,739
170
(1,476)
(195)
15.7 %
90.4
(76.6)
(14.4)
Total performing TDR loans
11.8 %
59,110
(1) At December 31, 2021 and December 31, 2020, $1.4 million and $3.2 million of nonaccrual loans, respectively, and
52,872
6,238
$
$
$
$1.6 million and $1.9 million of performing TDR loans, respectively, were guaranteed by government agencies.
The following table provides the changes in nonaccrual loans during the periods indicated:
Year Ended December 31,
2021
2020
Change
% Change
(In thousands)
Balance, beginning of period
$
58,092 $
44,525 $
Additions to nonaccrual loan classification
1,495
33,024
Net principal payments and transfers to accruing
(14,786)
(19,857)
(1,190)
—
(6,463)
(11,033)
(1,691)
(270)
13,567
(31,529)
(8,323)
(8,824)
501
270
30.5 %
(95.5)
128.8
80.0
(29.6)
(100.0)
$
23,754 $
58,092 $
(34,338)
(59.1)%
status
Payoffs
Charge-offs
Transfer to OREO
Balance, end of period
The decrease in nonaccrual loans during the year ended December 31, 2021 was due primarily to payoffs, including a
payoff of an agricultural business relationship of $10.7 million, which was initially classified as nonaccrual during the three
months ended September 30, 2019, and the return to accrual status of an owner-occupied CRE relationship of $7.0 million. The
Bank recovered $1.5 million of interest and fees on loans related to the payoff of the agricultural business relationship.
Additionally, the volume of additions to the nonaccrual
loan classification decreased to $1.5 million during the year ended
December 31, 2021 compared to $33.0 million last year which contributed to the lower ending balance of loans classified as
nonaccrual. The decrease in nonaccrual loans improved the Bank's credit quality ratios.
34
Allowance for Credit Losses on Loans Overview
The following table provides information regarding changes in our ACL on loans for the years indicated:
At or For the Years Ended
December 31,
2021
2020
Change
% Change
(Dollars in thousands)
ACL on loans at the beginning of the period
$
70,185
$
36,171
$
34,014
Impact of CECL Adoption
Adjusted ACL on loans, beginning of period
Charge-offs:
Commercial business
Real estate construction and land development
Consumer
Total charge-offs
Recoveries:
Commercial business
Residential real estate
Real estate construction and land development
Consumer
Total recoveries
Net charge-offs
Provision for credit losses on loans
ACL on loans at the end of period
Credit quality ratios:
—
70,185
(1,276)
(1)
(669)
(1,946)
816
—
32
572
1,420
(526)
(27,298)
$
42,361
$
1,822
37,993
(3,751)
(417)
(1,454)
(5,622)
1,530
3
278
570
2,381
(3,241)
35,433
70,185
(1,822)
32,192
2,475
416
785
3,676
(714)
(3)
(246)
2
(961)
2,715
(62,731)
$
(27,824)
94.0 %
(100.0)
84.7
(66.0)
(99.8)
(54.0)
(65.4)
(46.7)
(100.0)
(88.5)
0.4
(40.4)
(83.8)
(177.0)
(39.6)%
ACL on loans to loans receivable
1.11 %
1.57 %
(0.46)%
(29.3)%
ACL on loans to loans receivable, excluding SBA
PPP loans (1)
ACL on loans to nonaccrual loans
1.15
1.87
178.33 %
120.82 %
(0.72)
57.51 %
(38.5)
47.6 %
Average balances outstanding during the period: (2)
Commercial business
Residential real estate
Real estate construction and land development
Consumer
Total
$ 3,540,728
$ 3,569,851
$
(29,123)
(0.8)%
123,875
301,532
271,834
131,171
303,591
384,134
(7,296)
(2,059)
(112,300)
(5.6)
(0.7)
(29.2)
$ 4,237,969
$ 4,388,747
$
(150,778)
(3.4)%
Net charge-offs (recoveries) during the period to average balances outstanding during the period:
Commercial business
Residential real estate
Real estate construction and land development
Consumer
0.01 %
0.06 %
(0.05)%
—
(0.01)
0.04
—
0.05
0.23
—
(0.06)
(0.19)
(83.3)%
n/a
(120.0)
(82.6)
Total
(85.7)%
(1) The ACL on loans does not include a reserve for SBA PPP loans as these loans are fully guaranteed by the SBA. See
(0.06)%
0.07 %
0.01 %
"Reconciliations of Non-GAAP Measures" section below.
(2) Average balances exclude the ACL on loans and loans held for sale, but include loans classified as nonaccrual.
The ACL on loans decreased due primarily to a reversal of provision for credit losses on loans recorded during the year
ended December 31, 2021 following improvements in the economic forecast used in the CECL model at December 31, 2021 as
compared to the economic forecast at December 31, 2020.
35
The following table presents the ACL on loans by loan portfolio segment at the indicated dates:
December 31, 2021
December 31, 2020
ACL on
loans
Percent of
Total (1)
ACL on
loans
Percent of
Total (1)
(Dollars in thousands)
Change
% Change
Commercial business
Residential real estate
Real estate construction and land
development
Consumer
$
33,049
83.7 % $
49,608
83.1 % $
(16,559)
1,409
5,276
2,627
4.3
5.9
6.1
1,591
13,092
5,894
2.7
6.9
7.3
(182)
(7,816)
(3,267)
(33.4)%
(11.4)
(59.7)
(55.4)
Total ACL on loans
42,361
(1) Represents the percent of loans receivable by loan category to loans receivable.
100.0 % $
70,185
$
100.0 % $
(27,824)
(39.6)%
Deposits Overview
The following table summarizes the Company's deposits at the dates indicated:
December 31, 2021
December 31, 2020
Balance
Percent of
Total
Balance
Percent of
Total
Change
% Change
(Dollars in thousands)
Noninterest demand deposits
$ 2,330,956
36.5 % $ 1,980,531
35.4 % $
350,425
17.7 %
Interest bearing demand deposits
Money market accounts
Savings accounts
Total non-maturity deposits
Certificates of deposit
Total deposits
1,946,605
1,120,174
640,763
6,038,498
342,839
30.5
17.6
10.0
94.6
5.4
1,716,123
962,983
538,819
5,198,456
399,534
30.7
17.2
9.6
92.9
7.1
230,482
157,191
101,944
840,042
13.4
16.3
18.9
16.2
(56,695)
(14.2)
$ 6,381,337
100.0 % $ 5,597,990
100.0 % $
783,347
14.0 %
Total deposits increased due primarily to proceeds from SBA PPP loans originated during the year ended December 31,
2021 which were deposited directly into the customers' deposit accounts.
Total deposits includes uninsured deposits of $2.68 billion and $2.17 billion at December 31, 2021 and 2020,
respectively, calculated in accordance with FDIC guidelines. The Bank does not hold any foreign deposits.
The following table provides the uninsured portion of certificates of deposit at December 31, 2021, by account, with a
maturity of:
Three months or less
Over three months through six months
Over six months through twelve months
Over twelve months
Total
Stockholders' Equity Overview
(In thousands)
$
$
10,264
24,102
11,542
5,623
51,531
The Company’s stockholders' equity to assets ratio was 11.5% as of December 31, 2021 and 12.4% as of
December 31, 2020. The following table provides the changes to stockholders' equity during the periods indicated:
Year Ended December 31,
2021
2020
Change
% Change
(In thousands)
Balance, beginning of period
$
820,439 $
809,311 $
Cumulative effect from change in accounting policy (1)
Net income
Dividends declared
—
98,035
(29,197)
(5,615)
46,570
(29,029)
11,128
5,615
51,465
(168)
1.4 %
(100.0)
110.5
0.6
36
Year Ended December 31,
2021
2020
Change
% Change
Other comprehensive income, net of tax
Repurchase of common stock
Other
(In thousands)
(15,622)
(22,889)
3,666
14,640
(19,119)
3,681
(30,262)
(3,770)
(15)
Balance, end of period
$
33,993
(1) Effective January 1, 2020, the Bank adopted ASU 2016-13, Financial Instruments - Credit Losses.
820,439 $
854,432 $
(206.7)
19.7
(0.4)
4.1 %
The Company repurchased 904,972 and 795,700 shares of its common stock under the Company's stock repurchase
plans during the year ended December 31, 2021 and 2020, respectively. The repurchases represented approximately 2.5% and
2.2% of the Company's stock outstanding at the beginning of each year.
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 26, 2022, the Company’s board of directors declared a regular quarterly dividend of $0.21 per common share payable
on February 23, 2022 to shareholders of record on February 9, 2022.
Liquidity and Capital Resources
The following table provides the material cash requirements and capital resources from known contractual and other
obligations and sources as of December 31, 2021:
One Year or
Less
Over One Year
Other (1)
(Dollars in thousands)
Total
Cash requirements:
Unfunded commitments - loans and letters of credits
$
1,125,960 $
— $
— $
1,125,960
Maturing certificates of deposit
Unfunded commitment of LIHTCs
Operating leases
Junior subordinated debentures
Non-maturity deposits
Securities sold under agreement to repurchase
290,497
10,648
4,750
—
—
—
52,342
30,835
26,571
25,000
—
—
—
—
—
—
342,839
41,483
31,321
25,000
6,038,498
6,038,498
50,839
50,839
Total cash requirements
$
1,431,855 $
134,748 $
6,089,337 $
7,655,940
Capital resources:
Unrestricted cash and cash equivalents
FHLB and FRB borrowing availability (2)
Unencumbered investment securities available for sale
Loans receivable scheduled repayments, by contractual
maturity date
Fed funds line borrowing availability
Investment securities held to maturity, by contractual
maturity date
$
1,713,474 $
— $
— $
1,713,474
1,113,208
737,454
—
—
384,790
215,000
3,430,872
—
—
367,331
—
—
—
—
—
1,113,208
737,454
3,815,662
215,000
367,331
Total capital resources
7,962,129
(1) Represents the undefined maturity of non-maturity deposits, including noninterest bearing demand deposits, interest
bearing demand deposits, money market accounts and savings accounts, and securities sold under agreement to
repurchase, which can generally both be withdrawn on demand.
3,798,203 $
4,163,926 $
— $
$
(2) Includes FHLB borrowing availability of $1.06 billion at December 31, 2021 based on pledged assets, however,
maximum credit capacity is 45% of the Bank's total assets one quarter in arrears or $3.26 billion.
We maintain sufficient cash and cash equivalents and investment securities to meet short-term liquidity needs and
actively monitor our long-term liquidity position to ensure the availability of capital resources for contractual obligations, strategic
loan growth objectives and to fund operations. Our funding strategy has been to acquire non-maturity deposits from our retail
accounts, acquire noninterest bearing demand deposits from our commercial customers and use our borrowing availability to
37
fund growth in assets. We may also acquire brokered deposits when the cost of funds is advantageous to other funding sources.
Borrowings may be used on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows
at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and
match the maturity of repricing intervals of assets. 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 so we adhere to internal management targets assigned to the loan to deposit ratio, liquidity ratio, net short-term non-
core funding ratio and non-core liabilities to total assets ratio to ensure an appropriate liquidity position.
The Company pays dividends to our shareholders and the primary source of the Company's liquidity is cash obtained
from dividends from the Bank. We expect to continue our current practice of paying quarterly cash dividends on our common
stock subject to our board of directors’ discretion to modify or terminate this practice at any time and for any reason without prior
notice. Our current quarterly common stock dividend rate is $0.21 per share, as approved by our board of directors, which we
believe is a dividend rate per share which enables us to balance our multiple objectives of managing and investing in the Bank
and returning a substantial portion of our cash to our shareholders. Assuming continued payment during 2022 at this rate of
$0.21 per share, our average total dividend paid each quarter would be approximately $7.4 million based on the number of our
current outstanding shares (which assumes no increases or decreases in the number of shares).
Management believes the capital sources are adequate to meet all reasonably foreseeable short-term and intermediate-
term cash requirements.
Critical Accounting Policies
Critical accounting estimates are those estimates made in accordance with generally accepted accounting principles
that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the
financial condition or results of operations of the registrant. The Company considers its critical accounting estimates to be as
follows:
ACL on Investment Securities
Investment securities issued by the U.S. government and its agencies are either explicitly or implicitly guaranteed by the
U.S. government, highly rated by major credit rating agencies and have a long history of no credit losses and therefore
management concluded any declines in fair value were attributable to changes in interest rates relative to where these
investments fall within the yield curve and individual characteristics. The remainder of investment securities available for sale
were issued by municipal or corporate issuers. Management examined the combination of credit ratings, at the individual security
level, and an analysis of historical defaults by credit rating for municipal and corporate securities since 1970 and determined the
probability and magnitude of loss was insignificant.
Management's reliance on credit ratings and an analysis of historical defaults is subjective and these historical inputs
may not be suitable predictors of future performance. Unanticipated changes in the credit ratings or the historical defaults could
have a significant impact on our financial condition and results of operations.
For additional information regarding the ACL on investment securities, see Note (1) Description of Business, Basis of
Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements and Note (2) Investment
Securities of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
ACL on Loans
Management's estimate of the ACL on loans relies on the identification, stratification and separate estimates of loss for
loans individually evaluated for loss and loans collectively evaluated for loss. The estimate of loss for loans collectively evaluated
for loss particularly involves a significant level of estimation uncertainty due to its complexity and quantity of inputs including:
management's determination of baseline loss rate multipliers based on a third-party forecast of economic conditions, an estimate
of the reasonable and supportable forecast period, an estimate of the baseline loss rate lookback period, an estimate of the
reversion period from the reasonable and supportable forecast period to the baseline loss rate, and an estimate of
the
prepayment rate and related lookback period. Additionally, management considers other qualitative risk factors to further adjust
the estimated ACL on loans through a qualitative allowance.
Management's estimates for these inputs are based on past events and current conditions, are inherently subjective,
and are susceptible to significant revision as more information becomes available. While management utilizes its best judgment
and information available to recognize credit losses on loans, future additions to the allowance may be necessary based on
declines in local and national economic conditions.
their
examination process, periodically review the Bank’s ACL on loans. Such agencies may require the Bank to make adjustments to
the allowance based on their judgments about information available to them at the time of their examinations. Unanticipated
changes in any of these inputs could have a significant impact on our financial condition and results of operations.
In addition, various regulatory agencies, as an integral part of
For additional information regarding the ACL on loans, its relation to the provision for credit losses, its risk related to
asset quality and lending activity, see Item 1A. Risk Factors—Our ACL on loans may prove to be insufficient to absorb losses in
our loan portfolio as well as Note (1) Description of Business, Basis of Presentation, Significant Accounting Policies and Recently
Issued Accounting Pronouncements and Note (4) Allowance for Credit Losses on Loans of the Notes to Consolidated Financial
Statements included in Item 8. Financial Statements And Supplementary Data.
38
ACL on Unfunded Commitments
The allowance methodology for unfunded commitments is similar to the ACL on loans, but additionally includes
considerations of the current utilization of the commitment, an estimate of the future utilization, an estimate of utilization of
construction loans prior to completion and an estimate of construction loan advance rates as determined appropriate by historical
commitment utilization and the Bank's estimates of future utilization given current economic forecasts. Unanticipated changes in
loss rates estimated in the ACL on loans, as utilized in the methodology for the ACL on unfunded commitments, or the expected
utilization of unfunded commitments could have a significant impact on our financial condition and results of operations.
For additional information regarding the ACL on unfunded commitments, see Note (1) Description of Business, Basis of
Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements and Note (20) Commitments and
Contingencies of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary
Data.
Goodwill
The Company performed its annual goodwill impairment test during the fourth quarter of 2021 and determined, based
on a qualitative assessment utilizing the Company's market capitalization, that it is more likely than not that the fair value of the
reporting unit exceeded the carrying value, such that the Company's goodwill was not considered impaired for the year ended
December 31, 2021. Changes in the economic environment, operations of the reporting unit or other adverse events, including
as a result of COVID-19, could result in future impairment charges which could have a material adverse impact on the
Company’s operating results.
For additional information regarding goodwill, see Note (1) Description of Business, Basis of Presentation, Significant
Accounting Policies and Recently Issued Accounting Pronouncements and Note (7) Goodwill and Other Intangible Assets of the
Notes to Consolidated Financial Statements included in Item 8. Financial Statements And Supplementary Data.
Reconciliations of Non-GAAP Measures
This Form 10-K contains certain financial measures not presented in accordance with GAAP in addition to financial
measures presented in accordance with GAAP. The Company has presented these non-GAAP financial measures in this Form
10-K because it believes that they provide useful and comparative information to assess trends in the Company’s performance
and asset quality and to facilitate comparison of its performance with the performance of its peers. These non-GAAP measures
have inherent limitations, are not required to be uniformly applied and are not audited. They should not be considered in isolation
or as a substitute for financial measures presented in accordance with GAAP, nor are they necessarily comparable to non-GAAP
performance measures that may be presented by other companies. Reconciliations of the GAAP and non-GAAP financial
measures are presented in the tables below.
The Company believes presenting loan yield excluding the effect of discount accretion on purchased loans is useful in
assessing the impact of acquisition accounting on loan yield as the effect of loan discount accretion is expected to decrease as
the acquired loans mature or roll off its balance sheet. Incremental accretion on purchased loans represents the amount of
interest income recorded on purchased loans in excess of the contractual stated interest rate in the individual loan notes due to
incremental accretion of purchased discount or premium. Purchased discount or premium is the difference between the
contractual loan balance and the fair value of acquired loans at the acquisition date, or as modified by the adoption of ASU
2016-13. The purchased discount is accreted into income over the remaining life of the loan. The impact of incremental accretion
on loan yield will change during any period based on the volume of prepayments, but it is expected to decrease over time as the
balance of the purchased loans decreases. Similarly, presenting loan yield excluding the effect of SBA PPP loans is useful in
assessing the impact of these special program loans that are anticipated to substantially decrease within a short time frame.
Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans:
Interest and fees on loans (GAAP)
Exclude SBA PPP loan interest and fees
Exclude incremental accretion on purchased loans
Adjusted interest and fees on loans (non-GAAP)
Average loans receivable, net (GAAP)
Exclude average SBA PPP loans
Adjusted average loans receivable, net (non-GAAP)
Year Ended December 31,
2021
2020
(Dollars in thousands)
$
189,832
$
192,417
(32,109)
(2,638)
(19,472)
(3,446)
$
155,085
$
169,499
$ 4,181,464
$ 4,335,564
(549,422)
(589,635)
$ 3,632,042
$ 3,745,929
Loan yield (GAAP)
Loan yield, excluding SBA PPP loans and incremental accretion on purchased loans (non-
GAAP)
4.54 %
4.44 %
4.27 %
4.52 %
39
The Company considers presenting the ratio of ACL on loans to loans receivable, excluding SBA PPP loans, to be a
useful measurement in evaluating the adequacy of the Company's ACL on loans as the balance of SBA PPP loans is significant
to the loan portfolio, and since SBA PPP loans are guaranteed by the SBA, the Company has not provided an ACL on loans for
SBA PPP loans.
December 31,
2021
December 31,
2020
(Dollars in thousands)
ACL on loans to loans receivable, excluding SBA PPP loans
Allowance for credit losses on loans
$
42,361
$
70,185
Loans receivable (GAAP)
Exclude SBA PPP loans
Loans receivable, excluding SBA PPP (non-GAAP)
$ 3,815,662
$ 4,468,647
145,840
715,121
$ 3,669,822
$ 3,753,526
ACL on loans to loans receivable (GAAP)
ACL on loans to loans receivable, excluding SBA PPP loans (non-GAAP)
1.11 %
1.15 %
1.57 %
1.87 %
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur market risk in
the normal course of business through our exposure to market interest rates, equity prices and credit spreads. Our primary
market risk is interest rate risk, which is the risk of loss of net interest income or net interest margin resulting from changes in
market interest rates. Interest rate risk results primarily from the traditional banking activities in which the Bank engages, such as
gathering deposits and extending loans. Many factors, including economic and financial conditions, movements in interest rates
and consumer preferences, affect the difference between the interest earned on our assets and the interest paid on our liabilities.
Management regularly reviews our exposure to changes in interest rates. Among the factors considered are changes in the mix
of interest earning assets and interest bearing liabilities, interest rate spreads and repricing periods. The risk committee of the
board of directors oversees market risk management, including the monitoring of risk measures and limits and policy guidelines,
for the amount of interest rate risk and its effect on net interest income and capital.
On July 27, 2017, the United Kingdom's Financial Conduct Authority, which regulates LIBOR, publicly announced that it
intends to stop persuading or compelling banks to submit LIBOR rates after 2021. The market transition away from LIBOR to an
alternative reference rates is complex and could have a range of adverse effects on our business, consolidated financial
condition and consolidated results of operations. For more information, see Item 1A. Risk Factors--Other Risks Related to Our
Business.
Neither we, nor the 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.
Net interest income simulation
An income simulation model is the primary tool we use to assess the direction and magnitude of changes in net interest
income resulting from changes in interest rates. Modeling the sensitivity of net interest income is highly dependent on numerous
assumptions incorporated into the modeling process. Key assumptions in the model include prepayment speeds on loans and
loans, deposits and
investment securities, decay rates on non-maturity deposits, and pricing on investment securities,
borrowings. In order to measure the interest rate risk sensitivity as of December 31, 2021, this simulation model uses a “no
balance sheet growth” assumption and assumes an instantaneous and sustained uniform change in market interest rates at all
maturities. These assumptions are inherently uncertain and, as a result, the net interest income projections should be viewed as
an estimate of the net interest income sensitivity at the time of the analysis. Actual results will differ from simulated results due to
timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among
other factors.
40
Based on the results of the simulation model, the following table presents the change in our net interest income as a
result of parallel rate shock scenarios for the presented periods after the dates shown:
December 31, 2021
December 31, 2020
Amount
% Change in
Net Interest
Income
Amount
% Change in
Net Interest
Income
(Dollars in thousands)
Modeled increase in market interest rates of 100 basis points
Increase in net interest income in Year 1
$
Increase in net interest income in Year 2
Modeled increase in market interest rates of 200 basis points
Increase in net interest income in Year 1
Increase in net interest income in Year 2
Modeled decrease in market interest rates of 100 basis points
Decrease in net interest income in Year 1
Decrease in net interest income in Year 2
21,554
28,307
40,762
53,779
(6,445)
(18,261)
11.8 % $
15.9
22.4
30.1
(3.5)
(10.2)
15,281
26,839
28,507
51,021
(3,014)
(7,034)
7.7 %
14.3
14.4
27.1
(1.5)
(3.7)
These scenarios are based on market interest rates as of the last day of a reporting period published by independent
sources that are actively traded in the open market. Given the overall level of market interest rates at December 31, 2021, we do
not believe that the results of the "Down 200" analysis provide meaningful output and therefore have been excluded. For the
"Down 100" scenario, the Bank's modeling assumption is that all deposit rates are floored to one or two basis points and new
loan production is recalibrated to incorporate a chosen net interest spread over index. The simulations used to manage market
risk are based on numerous assumptions regarding the effect of changes in interest rates on the timing and extent of reprice
characteristics, future cash flows and customer behavior. These assumptions are inherently uncertain and, as a result, the model
cannot precisely estimate net interest income or precisely predict the impact of higher or lower net interest income. Actual results
will differ from simulated results due to the timing, magnitude and frequency of interest rate changes as well as changes in
market condition, customer behavior and management strategies, among other factors.
41
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
Shareholders 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, 2021 and 2020, 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, 2021, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s
internal control over financial reporting as of December 31, 2021, 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, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the
three-year period ended December 31, 2021 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, 2021, based on criteria established in the 2013 Internal Control – Integrated Framework issued by COSO.
Change in Accounting Principle
As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for allowance
for credit losses effective January 1, 2020 due to the adoption of Financial Accounting Standards Board Accounting Standards
Codification No 326, Financial Instruments – Credit Losses (ASC 326). The Company adopted the new current expected credit
loss standard using the modified retrospective method such that prior period amounts are not adjusted and continue to be
reported in accordance with previously applicable generally accepted accounting principles.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over
financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the
accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on
the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our
audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States)
("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws
and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement,
whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material
respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of
the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures
included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also
included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the
overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk. 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
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.
the company; (2) provide reasonable assurance that
the assets of
42
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements
that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures
that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The
communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole,
and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on
the accounts or disclosures to which it relates.
Allowance for Credit Losses on Loans – Qualitative Allowance
As described in Note 1, “Description of Business, Basis of Presentation, Significant Accounting Policies and Recently
Issued Accounting Pronouncements” and Note 4, “Allowance for Credit Losses (“ACL”) on Loans” to the consolidated financial
statements, the Company’s consolidated allowance for credit losses on loans was $42.4 million at December 31, 2021 and
reversal of provision for credit losses on loans was $27.3 million for the year then ended. The ACL on loans evaluation is
inherently subjective, as it utilizes estimates that require a high degree of judgment relating to risk characteristics of loan
segments, macroeconomic variables used in forecasting, and other qualitative risk factors. Changes in these judgments and
estimates could have a material effect on the Company’s financial results.
The Company primarily uses a historic loss, open pool credit loss methodology to calculate the ACL on loans, which the
Company has applied to identified loan segments with similar risk characteristics. The allowance for collectively evaluated loans
is comprised of the baseline loss allowance, the macroeconomic allowance, and the qualitative allowance. The baseline loss
allowance begins with the baseline loss rates calculated using average quarterly historical
loss information for an economic
cycle. The baseline loss rates are applied to each loan's estimated cash flows over the life of the loan under the remaining life
method to determine the baseline loss estimate for each loan. The macroeconomic methodology incorporates a macroeconomic
sensitive model which calculates multipliers for each loan segment to account for the current and forecasted conditions that
adjust the baseline historical loss rates over a reasonable and supportable forecast period. Management also considers other
qualitative risk factors to further adjust the estimated ACL on loans through a qualitative allowance. These adjustments are
subjectively selected by management and are based on established metrics to estimate risk.
The subjective nature of the qualitative risk factor adjustments requires significant judgment by management both in the
selection of qualitative factors to apply, if any, and the magnitude of the adjustment once selected. The audit procedures over the
qualitative allowance utilized in management’s methodology involved especially challenging and subjective auditor judgment,
including the use of more experienced audit personnel. Therefore, we identified auditing the ACL qualitative allowance as a
critical audit matter.
Our audit procedures to address this critical audit matter primarily included the following:
•
Tested the operating effectiveness of controls over application of the macroeconomic sensitive model and related
factors including:
◦
The Company’s ACL committee’s review and approval of the qualitative risk factor adjustments used to derive
the qualitative allowance for the ACL on loans, and the relevance and reliability of the data used therein.
◦ Management’s controls over the completeness and accuracy of the data utilized in the qualitative allowance for
the ACL on loans.
•
Substantively tested management’s application of the macroeconomic sensitive model and related factors including:
◦
◦
◦
Evaluated the reasonableness of management’s judgments used in the determination of the qualitative risk
factor adjustments by loan segment and the resulting allocation to the qualitative allowance for the ACL on
loans.
Evaluated the reliability and relevancy of data used as a basis for the qualitative risk factor adjustments.
Tested the completeness and accuracy of the data utilized in management’s ACL methodology to derive the
qualitative allowance for the ACL on loans.
/s/ Crowe LLP
We have served as the Company's auditor since 2012.
Denver, Colorado
February 24, 2022
43
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except shares)
ASSETS
Cash on hand and in banks
Interest earning deposits
Cash and cash equivalents
Investment securities available for sale, at fair value, net (amortized cost of $883,832 and
$770,195, respectively)
Investment securities held to maturity, at amortized cost, net (fair value of $376,331 and $0,
respectively)
Total investment securities
Loans held for sale
Loans receivable
Allowance for credit losses on loans
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, respectively
Common stock, no par value, 50,000,000 shares authorized; 35,105,779 and
35,912,243 shares issued and outstanding, respectively
Retained earnings
Accumulated other comprehensive income, net
Total stockholders’ equity
Total liabilities and stockholders’ equity
December 31,
2021
December 31,
2020
$
61,377 $
1,661,915
1,723,292
91,918
651,404
743,322
894,335
802,163
383,393
1,277,728
1,476
—
802,163
4,932
3,815,662
4,468,647
(42,361)
(70,185)
3,773,301
4,398,462
—
79,370
7,933
120,196
14,657
183,543
9,977
240,939
—
85,452
6,661
107,580
19,418
193,301
13,088
240,939
$
$
7,432,412 $
6,615,318
6,381,337 $
5,597,990
21,180
50,839
124,624
6,577,980
20,887
35,683
140,319
5,794,879
—
—
551,798
293,238
9,396
854,432
571,021
224,400
25,018
820,439
$
7,432,412 $
6,615,318
See accompanying Notes to Consolidated Financial Statements.
44
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts and shares outstanding)
INTEREST INCOME:
Interest and fees on loans
Taxable interest on investment securities
Nontaxable interest on investment securities
Interest on interest earning deposits
Total interest income
INTEREST EXPENSE:
Deposits
Junior subordinated debentures
Other borrowings
Total interest expense
Net interest income
(Reversal of) provision for credit losses
Net interest income after (reversal of) provision for credit
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
Bank owned life insurance income
Gain on sale of other assets, net
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 share
Diluted earnings per share
Dividends declared per share
Year Ended December 31,
2021
2020
2019
$
189,832 $
192,417 $
17,492
3,899
1,608
17,541
3,659
703
189,515
23,045
3,396
1,894
212,831
214,320
217,850
6,160
742
140
7,042
205,789
(29,372)
12,265
890
168
13,323
200,997
36,106
16,349
1,339
480
18,168
199,682
4,311
235,161
164,891
195,371
17,597
16,228
18,712
29
3,644
661
2,520
4,405
5,759
1,518
5,044
1,691
4,319
955
7,474
330
2,424
1,232
2,160
246
7,358
34,615
37,229
32,462
89,880
17,243
16,533
3,039
4,065
3,884
2,106
—
3,111
9,408
149,269
120,507
22,472
88,106
17,611
14,449
3,100
5,921
3,754
1,789
(145)
3,525
10,830
148,940
53,180
6,610
$
$
$
$
98,035 $
46,570 $
2.75 $
2.73 $
0.81 $
1.29 $
1.29 $
0.80 $
87,568
17,644
13,022
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
Average number of basic shares outstanding
Average number of diluted shares outstanding
35,677,851
36,014,445
36,758,230
35,973,386
36,170,066
36,985,766
See accompanying Notes to Consolidated Financial Statements.
45
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 $(4,298), $4,506 and $4,834, respectively
Reclassification adjustment for net gain from sale of investment
securities available for sale included in income, net of tax of $(6),
$(330) and $(69), respectively
Amortization of net unrealized gain for the reclassification of
investment securities available for sale to held to maturity, net of
tax of $(35), $0 and $0, respectively
Other comprehensive (loss) income
Comprehensive income
Year Ended December 31,
2021
2020
2019
$
98,035 $
46,570 $
67,557
(15,472)
15,828
18,094
(23)
(1,188)
(261)
(127)
(15,622)
—
14,640
$
82,413 $
61,210 $
—
17,833
85,390
See accompanying Notes to Consolidated Financial Statements.
46
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except shares and per share amounts)
Year Ended December 31, 2021
Number of
common
shares
Common
stock
Retained
earnings
AOCI
Total
stockholders’
equity
35,912,243 $
571,021 $
224,400 $
25,018 $
820,439
Balance at December 31, 2020
Restricted stock units vested
Stock-based compensation expense
125,377
—
—
3,666
Common stock repurchased
(931,841)
(22,889)
Net income
Other comprehensive loss, net of tax
Cash dividends declared on common
stock ($0.81 per share)
—
—
—
—
—
—
—
—
—
98,035
—
—
—
—
—
(15,622)
—
3,666
(22,889)
98,035
(15,622)
(29,197)
—
(29,197)
Balance at December 31, 2021
35,105,779 $
551,798 $
293,238 $
9,396 $
854,432
Year Ended December 31, 2020
Number of
common
shares
Common
stock
Retained
earnings
AOCI
Total
stockholders’
equity
36,618,729 $
586,459 $
212,474 $
10,378 $
809,311
Balance at December 31, 2019
Cumulative effect from change in
accounting policy (1)
Restricted stock units vested
Exercise of stock options
Stock-based compensation expense
—
109,853
8,248
—
—
—
122
3,559
Common stock repurchased
(824,587)
(19,119)
Net income
Other comprehensive income, net of tax
Cash dividends declared on common
stock ($0.80 per share)
—
—
—
—
—
—
(5,615)
—
—
—
—
46,570
—
—
—
—
—
—
—
14,640
(5,615)
—
122
3,559
(19,119)
46,570
14,640
(29,029)
—
(29,029)
Balance at December 31, 2020
35,912,243 $
571,021 $
224,400 $
25,018 $
820,439
(1) Effective January 1, 2020, the Bank adopted ASU 2016-13, Financial Instruments - Credit Losses.
Balance at December 31, 2018
Cumulative effect from change in
accounting policy (1)
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
Cash dividends declared on common
stock ($0.84 per share)
Year Ended December 31, 2019
Number of
common
shares
Common
stock
Retained
earnings
AOCI
Total
stockholders’
equity
36,874,055 $
591,806 $
176,372 $
(7,455) $
760,723
—
61,964
3,901
—
(321,191)
—
—
—
—
—
58
3,231
(8,636)
—
—
—
(399)
—
—
—
—
67,557
—
—
—
—
—
—
—
17,833
(399)
—
58
3,231
(8,636)
67,557
17,833
(31,056)
—
(31,056)
Balance at December 31, 2019
36,618,729 $
586,459 $
212,474 $
10,378 $
809,311
(1) Effective January 1, 2019, the Bank adopted ASU 2016-02, Leases.
See accompanying Notes to Consolidated Financial Statements.
47
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, amortization and accretion
(Reversal of) provision for credit losses
Stock-based compensation expense
Amortization of intangible assets
Origination of mortgage loans held for sale
Proceeds from sale of mortgage loans held for sale
Bank owned life insurance income
(Gain) loss on sale of other real estate owned
Gain on sale of mortgage loans held for sale, net
Gain on sale of investment securities available for sale, net
Gain on sale of other assets, net
Impairment of assets held for sale
Impairment of ROU asset
Other
Net cash provided by operating activities
Cash flows from investing activities:
Loan repayments (originations), net
Maturities and repayments of investment securities available for sale
Maturities and repayments of investment securities held to maturity
Purchase of investment securities available for sale
Purchase of investment securities held to maturity
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
Purchases of bank owned life insurance
Proceeds from bank owned life insurance death benefit
Cash received from return of New Market Tax Credit equity method
investment
Capital contributions to low-income housing tax credit partnerships
Net cash provided (used) by investing activities
Year Ended December 31,
2021
2020
2019
$
98,035 $
46,570 $
67,557
(21,739)
(29,372)
3,666
3,111
(86,443)
93,543
(2,520)
—
(3,644)
(29)
(4,405)
145
160
19,022
69,530
699,107
254,668
1,255
(616,123)
(140,288)
1,248
(3,018)
—
—
10,556
—
(1,272)
65
(10,166)
—
9,642
(41,911)
163,763
(3,612)
36,106
3,559
3,525
(136,979)
142,624
(4,319)
(179)
(5,044)
(1,518)
(955)
630
655
(10,732)
70,331
(692,720)
264,223
—
14,113
4,311
3,231
4,001
(72,216)
70,397
(2,160)
227
(2,424)
(330)
(246)
102
117
5,810
92,490
(126,142)
242,348
—
(152,618)
(242,776)
—
55,030
(6,997)
—
1,290
2,407
2,560
(2,844)
554
(3,641)
1,324
—
(7,117)
(538,549)
—
43,962
(13,041)
3,562
864
1,664
18,032
(18,333)
96
(8,053)
—
—
(27,485)
(125,302)
48
Year Ended December 31,
2021
2020
2019
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 increase (decrease) 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 in cash and cash equivalents
Cash and cash equivalents at beginning of period
783,347
1,015,314
—
—
(28,937)
15,156
—
(22,889)
746,677
979,970
743,322
64,000
(64,000)
(28,859)
15,514
122
(19,119)
982,972
514,754
228,568
Cash and cash equivalents at end of period
$
1,723,292 $
743,322 $
150,274
445,800
(445,800)
(30,908)
(11,318)
58
(8,636)
99,470
66,658
161,910
228,568
Supplemental disclosures of cash flow information:
Cash paid for interest
Cash paid for income taxes, net of refunds
$
6,790 $
13,136 $
9,888
13,432
17,867
7,528
Supplemental non-cash disclosures of cash flow information:
Transfer of investment securities available for sale to held to maturity
244,778
—
—
Investment in low-income housing tax credit partnership and related
funding commitment
Loans received from return of New Market Tax Credit equity method
investment
ROU assets obtained in exchange for new operating lease liabilities
Transfers of properties classified as held for sale to prepaid expenses
and other assets from premises and equipment, net
Cumulative effect from change in accounting policy (1)
Transfer of bank owned life insurance to prepaid expenses and other
assets due to death benefit accrued, but not paid
29,551
15,596
13,966
3,556
—
—
10,237
46,677
—
1,265
3,243
7,175
2,672
—
1,505
1,533
29,754
209
Transfers of loans receivable to other real estate owned
—
(1) Effective January 1, 2020 and 2019, the Bank adopted ASU 2016-13, Financial Instruments - Credit Losses, and ASU
270 $
— $
$
2016-02, Leases, respectively.
See accompanying Notes to Consolidated Financial Statements.
49
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2021, 2020 and 2019
(1)
Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued
Accounting Pronouncements
(a) Description of Business
The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its
wholly-owned subsidiary, the Bank. The Bank is headquartered in Olympia, Washington and conducts business from its 49
branch offices located throughout Washington State and the greater Portland, Oregon area. The Bank’s business consists
primarily of commercial lending and deposit relationships with small and medium-sized businesses and their owners in its market
areas and attracting deposits from the general public. The Bank also makes real estate construction and land development
loans, consumer loans and originates first mortgage loans on residential properties primarily located in its market areas. The
Bank's deposits are insured by the FDIC.
(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. To prepare the audited Consolidated Financial
Statements in conformity with GAAP, management makes estimates and assumptions based on available information. These
estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided. 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. Material estimates that are particularly susceptible to significant change relate to management's estimate of the ACL
on investment securities, management's estimate of the ACL on loans, management's estimate of the ACL on unfunded
commitments, management's evaluation of goodwill
financial
instruments.
impairment and management's estimate of
the fair value of
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 year's net income or stockholders’ equity.
(c) Significant Accounting Policies
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and in banks and interest earning deposits due substantially from the
Federal Reserve Bank. Cash equivalents have a maturity of 90 days or less at the time of purchase.
Investment Securities
Investment securities for which the Bank has the positive intent and ability to hold to maturity are classified as held to
maturity and are carried at amortized cost. Investment securities held primarily for the purpose of selling in the near term are
classified as trading securities and are reported at fair value, with unrealized gains and losses included in income. Investment
securities not classified as held to maturity or trading are classified as available for sale and are reported at fair value with
unrealized gains and losses, net of income taxes, as a separate component of other comprehensive income. The Bank
determines the appropriate classification of investment securities at the time of purchase and reassesses the classification at
each reporting date. Any subsequent reassessment of classification and transfer of investment securities available for sale to
held to maturity are completed at the amortized cost basis plus or minus the amount of any remaining unrealized holding gain or
loss reported in AOCI of the individual investment securities available for sale. The unrealized holding gain or loss at the date of
the transfer continues to be recognized in AOCI, but that gain or loss is amortized over the remaining life of the security using the
interest method. When the Company acquires another entity, all investment securities are recorded at fair value and classified as
available for sale at the acquisition date.
Realized gains and losses on sales of investment securities are recorded on the trade date in gain on sale of
investment securities, net on the Consolidated Statements of Income and determined using the specific identification method.
Premiums and discounts on investment securities available for sale and held to maturity are amortized or accreted into income
using the interest method. An investment security available for sale or held to maturity is placed on nonaccrual status at the time
any principal or payments become more than 90 days delinquent and classified as past due after 30 days of nonpayment.
Interest accrued, but not received for an investment security classified as nonaccrual is reversed against interest income during
the period that the investment security is placed on nonaccrual status.
ACL on Investment Securities Available for Sale
Management evaluates the need for an ACL on investment securities available for sale on at least a quarterly basis, and
more frequently when economic or market conditions warrant such an evaluation. For investment securities available for sale in
50
an unrealized loss position, the Company first assesses whether it intends to sell or it is more likely than not that it will be
required to sell the security before the recovery of its amortized cost basis. If either of the criteria regarding intent or requirement
to sell is met, the security’s amortized cost basis is written down to fair value through a provision for credit loss against income.
For investment securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether the
decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the
extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and adverse
conditions specifically related to the security, among other factors. The credit loss is defined as the difference between the
present value of the cash flows expected to be collected and the amortized cost basis. If the present value of cash flows
expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL on investment securities available
for sale is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any
unrealized decline in fair value that has not been recorded through an ACL on investment securities available for sale is
recognized in other comprehensive income.
Accrued interest receivable on investment securities available for sale is excluded from the estimate of expected credit
losses. Changes in the ACL on investment securities available for sale are recorded as provision for credit losses expense.
Losses are charged against the ACL when management believes the uncollectability of an investment security available for sale
is confirmed or when either of the criteria regarding intent or requirement to sell is met.
ACL on Investment Securities Held to Maturity
The Company measures expected credit losses on investment securities held to maturity on a pooled, collective basis
by major investment security type with similar risk characteristics. A historical lifetime probability of default and severity of loss in
the event of default is derived or obtained from external sources and adjusted for the expected effects of reasonable and
supportable forecasts over the expected lives of the investment securities on those historical credit losses. Expected credit
losses on investment securities in the held to maturity portfolio that do not share similar risk characteristics with any of the pools
are individually measured based on net realizable value, or the difference between the discounted value of the expected future
cash flows, based on the original effective interest rate, and the recorded amortized cost basis of the investment securities.
Accrued interest receivable on investment securities held to maturity is excluded from the estimate of expected credit
losses. Changes in the ACL on investment securities held to maturity are recorded as provision for credit losses expense. Losses
are charged against the ACL when management believes the uncollectability of an investment security held to maturity is
confirmed.
Loans Held for Sale
Mortgage loans held for sale are carried at the lower of amortized cost or fair value. Any loan that management does
not have the intent and ability to hold for the foreseeable future or until maturity or payoff is classified as held for sale at the time
of origination, purchase, 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
Loans receivable includes loans originated, indirect loans purchased by the Bank and loans acquired in business
combinations that management has the intent and ability to hold for the foreseeable future or until maturity or payoff and is
reported at amortized cost. Amortized cost is the outstanding principal balance, net of purchased premiums and discounts and
net deferred loan origination fees and costs. Interest on loans is calculated using the interest method based on the daily balance
of the principal amount outstanding and is credited to interest income as earned. Accrued interest receivable for loans receivable
is reported within accrued interest receivable on the Consolidated Statements of Financial Condition. The Company's policies for
loans receivable generally do not differ by loan segments or classes unless specified in the following policies.
Acquired Loans:
Acquired loans are recorded at their fair value at acquisition date net of an ACL on loans expected to be incurred over
the life of the loan. The initial ACL on purchased loans is determined using the same methodology as originated loans. For non-
PCD loans, the initial ACL on loans is recorded through earnings as a provision for credit losses. For PCD loans, the initial ACL is
incorporated into the calculation of the fair value of net assets acquired on the merger date and the net of the PCD loan purchase
price and the initial ACL becomes the initial amortized cost basis. The difference between the initial amortized cost basis and the
par value of PCD loans is the noncredit discount or premium for PCD loans. The noncredit discount or premium for PCD loans
and both the noncredit and credit discount or premium for non-PCD loans are accreted through the interest and fees on loans
line item on the Consolidated Statements of Income over the life of the loan using the interest method for non-revolving credits or
the straight-line method, which approximates the effective interest method, for revolving credits. Any unrecognized discount or
premium for a purchased loan that is subsequently repaid in full is recognized immediately into income. Subsequent changes to
the ACL on loans for purchased loans are recorded through earnings as a provision for credit losses.
Delinquent Loans:
Loans are considered past due or delinquent when principal or interest payments are past due 30 days or more.
Delinquent loans may generally remain on accrual status between 30 days and 89 days past due.
The Bank did not designate loans with payment deferrals granted due to the COVID-19 Pandemic as past due during
their modification period in accordance with the CARES Act and related regulatory guidance.
51
Nonaccrual and Charged-off Loans:
Loans for which the accrual of interest has been discontinued are designated as nonaccrual
loans. 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. 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.
Due to the short-term nature of the forbearance and other relief programs we were offering as a result of the COVID-19
Pandemic, borrowers granted relief under these programs generally were not reported as nonaccrual during the deferral period.
Loans are generally charged off to their net realizable value if collection of the contractual principal or interest as
scheduled in the loan agreement is doubtful. Consumer loans are typically charged off no later than 90 days past due.
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 to the interest
rate, extension of the maturity date, delay in the timing of the regular payment or any other actions intended to minimize potential
losses. The Bank does not generally forgive principal as part of a TDR, but in those situations where principal is forgiven, the
entire amount of such principal forgiveness is immediately charged off to the extent not done so prior to the modification. The
Bank also considers insignificant delays in payments when determining if a loan should be classified as a TDR.
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.
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 generally continues to be reported as such until it is paid off or charged off.
During 2020, the CARES Act and regulatory agencies provided guidance around the modification of loans as a result of
the COVID-19 Pandemic and outlined, among other criteria, that short-term modifications made on a good faith basis to
borrowers who were current as defined by the CARES Act and related regulatory guidance prior to any relief are not TDRs. This
includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or
other delays in payment that are insignificant. Borrowers are considered current if they were less than 30 days past due on the
contractual payments as of December 31, 2019 under the CARES Act, which the Bank determined was the implementation date
of its modification program under related regulatory guidance. The CA Act extended relief offered under the CARES Act through
January 1, 2022 or 60 days after the end of the national emergency declared by the President, whichever is earlier. The Bank
elected to apply the temporary relief under the applicable guidance to certain eligible short-term modifications and did not classify
the modifications as TDRs for accounting or disclosure purposes. However, COVID Modifications whose payment deferral
exceeded 180 days following the loans' initial modification were classified as TDRs based on the Bank's internal policy.
Deferred Loan Origination Fees and Costs
Direct loan origination fees and costs on originated loans and premiums and discounts on acquired loans are deferred
and subsequently amortized or accreted as a yield adjustment over the expected life of
the loan without prepayment
considerations utilizing the interest method, except revolving loans for which the straight-line method is used. When a loan is
paid off prior to maturity, the remaining net deferred balance is immediately recognized into interest income. In the event loans
are sold, the unamortized net deferred balance is recognized as a component of the gain or loss on the sale of loans.
ACL on Loans
The ACL on loans is a valuation account that is deducted from the amortized cost of loans receivable to present the net
amount expected to be collected. Loans are debited against the ACL on loans when management believes the uncollectibility of
a loan balance is confirmed and subsequent recoveries, if any, are credited to the ACL on loans. The Bank records the changes
in the ACL on loans through earnings as a provision for credit losses on the Consolidated Statements of Income.
Management has adopted a historic loss, open pool CECL methodology to calculate the ACL on loans. Under this
methodology, loans are either collectively evaluated if they share similar risk characteristics, including performing TDR loans, or
individually evaluated if they do not share similar risk characteristics, including nonaccrual loans.
The allowance for individually evaluated loans is calculated using either the collateral value method, which considers
the likely source of repayment as the value of the collateral less estimated costs to sell, or the net present value method, which
considers the contractual principal and interest terms and estimated cash flows available from the borrower to satisfy the debt.
52
Nonaccrual TDR loans are individually evaluated for credit loss except the original interest rate is used to discount the expected
cash flows, not the rate specified in the restructuring.
the baseline loss allowance,
The allowance for collectively evaluated loans is comprised of
the macroeconomic
allowance and the qualitative allowance. The baseline loss allowance begins with the baseline loss rates calculated using the
Bank's average quarterly historical
loss information for an economic cycle. The Bank evaluates the historical period on a
quarterly basis with the assumption that economic cycles have historically lasted between 10 and 15 years. The baseline loss
rates are applied to each loan's estimated cash flows over the life of the loan under the remaining life method to determine the
baseline loss estimate for each loan. Estimated cash flows consider the principal and interest in accordance with the contractual
term of the loan and estimated prepayments. Contractual cash flows are based on the amortized cost and are adjusted for
balances guaranteed by governmental entities, such as SBA or USDA, resulting in the unguaranteed amortized cost. The
the following applies: 1)
contractual
management has a reasonable expectation at the reporting date that a TDR will be executed with an individual borrower or 2) the
extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally
cancellable by the Company. Prepayments are established for each segment based on rolling historical averages for the
segment, which management believes is an accurate representation of future prepayment activity. Management reviews the
adequacy of the prepayment assumption on a quarterly basis.
renewals and modifications unless either of
term excludes expected extensions,
the forecasted direction of
The macroeconomic allowance includes consideration of
the economic and business
environment and its likely impact on the estimated allowance as compared to the historical losses over the reasonable and
supportable time frame. Economic forecast models for the current period are uploaded to the model, which targets 16 forecasted
macroeconomic factors, such as unemployment rate, gross domestic product, housing price index, commercial real estate price
index, disposable income growth, mortgage rates and certain rate indices. Macroeconomic factor multipliers are determined
through regression analysis and applied to loss rates for each segment of loans with similar risk characteristics. Each of the
forecasted segment balances is impacted by a mix of these macroeconomic factors. Further, each of the macroeconomic factors
is utilized differently by segment, including the application of lagged factors and various transformations such as percent change
year over year. A macroeconomic sensitive model is developed for each segment given the current and forecasted conditions
and a macroeconomic multiplier is calculated for each forecast period considering the forecasted losses as compared to the
long-term average actual losses of the dataset. The impact of those macroeconomic factors on each segment, both positive or
negative, using the reasonable and supportable period, are added to the calculated baseline loss allowance. After the reasonable
and supportable period, forecasted loss rates revert to historical baseline loss levels over the predetermined reversion period on
a straight-lined basis.
The Bank’s ACL model also includes adjustments for qualitative factors, where appropriate. Since historical information
(such as historical net losses and economic cycles) may not always, by themselves, provide a sufficient basis for determining
future expected credit losses, the Bank periodically considers the need for qualitative adjustments to the ACL. The Bank has a
bias for minimal qualitative risk factors unless internal or external factors indicate otherwise. Qualitative adjustments may be
related to and include, but not limited to, factors such as: (i) management’s assessment of economic forecasts used in the model
and how those forecasts align with management’s overall evaluation of current and expected economic conditions, (ii)
organization specific risks such as credit concentrations, collateral or industry specific risks, regulatory risks, and external factors
that may ultimately impact credit quality, (iii) other limitations associated with factors such as underwriting changes, acquisition of
new portfolios, changes in portfolio segmentation, and (iv) management’s overall assessment of the adequacy of the ACL,
including an assessment of model data inputs used to determine the ACL. The Bank has established metrics to estimate the
qualitative risk factors by segment based on the identified risk.
In general, management's estimate of the ACL on loans uses relevant available information, from internal and external
sources, relating to past events, current conditions, and reasonable and supportable forecasts. The evaluation of ACL on loans is
inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
While management utilizes its best judgment and information available to recognize estimated losses on loans, future additions
to the allowance may be necessary based on further declines in local and national economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process, periodically review the Bank’s ACL on loans. Such agencies
may require the Bank to make adjustments to the allowance based on their judgments about information available to them at the
time of their examinations. The Company believes the ACL on loans is appropriate given all of the above considerations.
ACL on Unfunded Commitments
The Bank estimates expected credit losses on unfunded, off-balance sheet commitments over the contractual period in
which the Bank is exposed to credit risk from a contractual obligation to extend credit, unless the obligation is unconditionally
cancellable by the Bank.
The allowance methodology for unfunded commitments is similar to the ACL on loans, but additionally includes
considerations of the current utilization of the commitment and an estimate of the future utilization as determined appropriate by
historical commitment utilization and the Bank's estimates of future utilization given current economic forecasts.
The ACL for unfunded commitments is recorded in accrued expenses and other liabilities on the Consolidated
Statements of Financial Condition and changes are recognized through earnings in the provision for credit losses on the
Consolidated Statements of Income.
Mortgage Banking Operations
The Bank originates and sells certain residential real estate loans on a servicing-released basis. The Bank recognizes a
gain or loss on sale to the extent that the sale proceeds of the loan sold differs from the net book value at the time of sale.
53
Income from residential real estate loans brokered to other lenders is recognized into income on date of loan closing.
Commitments to fund residential real estate loans and commitments to subsequently sell residential real estate loans
are made during the period between the taking of the loan application and the closing of the loan. The timing of making these
commitments is dependent upon the timing of the borrower’s election to lock-in the mortgage interest rate and fees prior to loan
closing. The Company enters into forward commitments for the future delivery of residential real estate loans when interest rate
locks are entered into in order to hedge the interest rate risk resulting from its commitments to fund the loans. These sale
commitments are typically made on a best-efforts basis whereby the Bank is only obligated to sell the loan if the loan is approved
and closed by the Bank. Commitments to fund residential real estate loans to be sold into the secondary market and forward
commitments for the future delivery of these loans are accounted for as free-standing derivatives, however, the fair values of
these freestanding derivatives were not significant at December 31, 2021 or December 31, 2020.
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. A servicing asset is recorded at fair value upon sale which is estimated by discounting estimated net future
cash flows from servicing using discount rates that approximate current market rates and using estimated prepayment rates.
Subsequent to initial recognition, all classes of servicing rights are carried at the lower of amortized cost or fair value and are
amortized in proportion to and over the period of the estimated net servicing income. The servicing asset is reported within
prepaid expenses and other assets on the Consolidated Statements of Financial Condition.
For purposes of evaluating and measuring impairment, the fair value of servicing rights is measured using a discounted
estimated net future cash flow model as described above at least annually. Impairment is determined by stratifying rights into
groupings based on predominant risk characteristics including investor type, loan type and maturity and recognized through a
valuation allowance for an individual stratum to the extent fair value is less than the carrying amount. If the Company later
determines all or a portion of the impairment no longer exists for a particular stratum, a reduction of the allowance may be
recorded as an increase to income. Changes in valuation allowances are reported within other noninterest income on the
Consolidated Statements of Income.
In connection with the loan sales, the Bank typically makes representations and warranties about the underlying loans
conforming to specified guidelines. If the underlying loans do not conform to the specifications, the Bank may have an obligation
to repurchase the loans or indemnify the purchaser against any loss. The Bank believes the potential for material loss under
these arrangements was remote at December 31, 2021, December 31, 2020 and December 31, 2019.
Servicing fee income is recorded for fees earned for servicing loans and reported as other noninterest income on the
Consolidated Statements of Income. The fees are based on a contractual percentage of the outstanding principal and are
recorded as income when earned. The amortization of mortgage servicing rights is netted against servicing fee income. Late fees
and ancillary fees related to loan servicing were not material for the years ended December 31, 2021, 2020, and 2019.
A premium over the adjusted carrying value is received upon the sale of the guaranteed portion of a SBA or USDA loan.
The Bank's investment in an SBA or USDA loan is allocated among the sold and retained portions of the loan based on the
relative fair value of each portion at the time of loan origination, adjusted for payments and other activities. Because the portion
retained does not carry a SBA or USDA guarantee, part of the gain recognized on the sold portion of the loan is deferred and
amortized as a yield enhancement on the retained portion in order to obtain a market equivalent yield. The balance of the
deferred gain was immaterial at December 31, 2021, December 31, 2020 and December 31, 2019.
Other Real Estate Owned
Other real estate owned 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 against the ACL on loans. Physical possession of
residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of
foreclosure or when the borrower conveys all interest in the properly to satisfy the loan through completion of a deed in lieu of
foreclosure or 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, net on the Consolidated Statements of Income.
Premises and Equipment
Premises and equipment,
including leasehold improvements, are stated at cost
less accumulated depreciation.
lives of the assets or the lease period,
Depreciation is computed using the straight-line method over the estimated useful
whichever is shorter. The estimated useful
lives used to compute depreciation and amortization for buildings and building
improvements, including lease improvements, is 15 to 39 years; and for furniture, fixtures and equipment is three to seven years.
The Company reviews premises and equipment, including leasehold improvements, 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
54
investments made by the insurance company. The Company records BOLI at the cash surrender value adjusted for other
charges or other amounts due that are probable at settlement.
ACL on Accrued Interest Receivable
Accrued interest receivable on investment securities and loans receivable are excluded from their estimates of credit
losses. Additionally, no allowance has been established for accrued interest receivable on investment securities and loans
receivable as interest accrued, but not received, is reversed timely in accordance with the policies stated above.
Other Intangible Assets
Other intangible assets represent core deposit intangibles acquired in business combinations. The fair value of the core
deposit intangible stemming from any given business combination is based on the present value of the expected cost savings
attributable to the core deposit funding, relative to an alternative source of funding. The core deposit intangibles are amortized on
an accelerated basis following a pattern of the economic benefits of the core deposit intangible over an estimated useful life of
the deposit relationships acquired. The Company evaluates such identifiable intangibles for impairment annually or more
frequently if an indication of impairment exists.
Goodwill
The Company’s goodwill represents the excess of the purchase price over the fair value of net assets acquired in
certain mergers and acquisitions. Goodwill is assigned to the Bank and is evaluated for impairment at the Bank level (single
reporting unit) on an annual basis or more frequently if an indication of impairment exists between the annual tests.
For the goodwill
impairment assessment, the Company either assess qualitative factors to determine whether the
existence of events or circumstances leads to a determination that it is more-likely-than-not the fair value of the reporting unit is
less than its carrying value and a quantitative test is needed or opts to bypass the qualitative analysis and performs a
quantitative analysis only. The quantitative analysis requires the Company to make assumptions and judgments regarding the
fair value of the reporting unit. If the implied fair value of goodwill is less than the recorded goodwill, an impairment charge would
be recorded for the difference.
Income Taxes
The Company and 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 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 tax expense in the
Consolidated Statements of Income as the amounts are generally insignificant each year.
Operating Leases
The Company has only identified leases classified as operating leases. Operating leases are recorded as ROU assets
and ROU liabilities within prepaid expenses and other assets and accrued expenses and other liabilities, respectively, in the
Consolidated Statements of Financial Condition. ROU assets represent the Company's right to use an underlying asset for the
lease term and ROU liabilities represent the Company's obligation to make lease payments arising from the lease. Operating
lease ROU assets and ROU liabilities are recognized at the lease agreement commencement date based on the present value of
lease payments over the lease term. The lease term incorporates options to extend the lease when it is reasonably certain that
the Company will exercise that option. As the Company's leases typically do not provide an implicit rate; the Company uses its
incremental borrowing rate based on the information available at the operating lease commencement date in determining the
present value of lease payments. The operating lease ROU asset is further reduced by any lease pre-payments made and lease
incentives. The leases may contain various provisions for increases in rental rates based either on changes in the published
Consumer Price Index or a predetermined escalation schedule and such variable lease payments are recognized as lease
expense as they are incurred. The majority of the Company's leases include variable lease payments such as real estate taxes,
maintenance, insurance and other similar costs in addition to the base rent. Lease expense for lease payments is recognized on
a straight-line basis over the lease term.
The Company does not separate non-lease components from lease components and excludes operating leases with a
term of twelve months or less from being capitalized as ROU assets and ROU liabilities. The Company follows a policy to
capitalize lease agreements with total contractual lease payments of $25,000 or more. The Company does not account for any
leases at a portfolio level.
Stock-Based Compensation
The Company maintains a number of stock-based incentive programs, which are discussed in more detail in Note (17)
55
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 Consolidated Statements of Income as a component of income tax expense. The Company
reports the carrying value of the equity investments in the unconsolidated LIHTCs as prepaid expenses and other assets on the
Company’s Statements of Financial Condition.
The maximum exposure to loss in the LIHTCs is the amount of equity invested and credit extended by the Company.
Loans to these entities are underwritten in substantially the same manner as other loans and are secured. The Company has
evaluated the variable interests held by the Company in each LIHTC investment and determined the Company does not have
controlling financial interests in such investments and is not the primary beneficiary.
New Market Tax Credit Investments
Through May 2021, the Company held $25.0 million of qualified equity investments in three certified development
entities eligible to receive NMTC. The NMTC program provides federal tax incentives to investors to make investments in
distressed communities and promotes economic improvements through the development of successful businesses in these
communities. The NMTC is available to investors over a seven-year period and is subject to recapture if certain events occur
during such period. The Company is required to fund 85% of a tranche by a predetermined deadline to claim the entire tax credit.
The Company funded its tranche before the deadline.
The Company dissolved the NMTC investment during the year ended December 31, 2021 after gross tax credits related
to the Company's certified development entities totaling $9.8 million were utilized during the seven year period ending December
31, 2020. Prior to dissolution, the Company accounted for its NMTC on the equity method and reported the investment balance
in prepaid expenses and other assets on the Consolidated Statements of Financial Condition and the related investment income
was recognized in other income on the Consolidated Statements of Income.
Deferred Compensation Plans
The Company has a Deferred Compensation Plan and has entered into similar arrangements with certain executive
officers. Under the Deferred Compensation Plan, participants are permitted to elect to defer compensation and the Company has
the discretion to make additional contributions to the Deferred Compensation Plan on behalf of any participant based on a
number of factors. Such discretionary contributions are generally approved by the Compensation Committee of the Company's
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, as amended.
Additionally, in conjunction with the Company's merger with Premier Commercial Bancorp in 2018, the Company
assumed a Salary Continuation Plan. The Salary Continuation Plan is an unfunded non-qualified deferred compensation plan for
former Premier Commercial executive officers, some of which are current Company officers. Under the Salary
select
Continuation Plan,
the Company will pay each participant, or their beneficiary, specified amounts over specified periods
beginning with the individual's termination of service due to retirement subject to early termination provisions.
The Company’s obligation to make payments under the Deferred Compensation Plan and the Salary Continuation Plan
is a general obligation of the Company and is to be paid from the Company’s general assets. As such, participants are general
unsecured creditors of the Company with respect to their participation under both plans. The Company records a liability within
accrued expenses and other liabilities on the Consolidated Statements of Financial Condition and records compensation and
employee benefits expense on the Consolidated Statements of Income in a systematic and rational manner. Since the amounts
earned under the Deferred Compensation Plan are generally based on the Company’s annual performance, the Company
56
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
this calculation. Dividends and undistributed earnings allocated to
dividends are considered participating securities for
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 Company 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.
The Company is exposed to credit-related losses in the event of nonperformance by the counterparty to these
agreements. Credit risk for derivatives with the customer is controlled through the credit approval process, amount limits, and
monitoring procedures and is concentrated within our primary market areas. Credit risk for derivatives with third-parties is
concentrated among four well-known broker dealers.
Fee income related to interest rate swap derivative contract transactions is recorded in interest rate swap fees on the
Consolidated Statements of Income. The fair value of derivative positions outstanding is included in Prepaid expenses and other
assets and Accrued expenses and other liabilities in the Consolidated Statements of Financial Condition. The gains and losses
due to changes in fair value and all cash flows are included in Other income in the Consolidated Statements of Income, but
typically net to zero based on the identical back-to-back interest rate swaps unless a credit valuation adjustment is recorded to
appropriately reflect nonperformance risk in the fair value measurement. Various factors impact changes in the credit valuation
adjustments over time, including changes in the risk ratings of the parties to the contracts, as well as changes in market rates
and volatilities, which affect the total expected exposure of the derivative instruments.
Advertising Expenses
Advertising costs are expensed as incurred. Costs related to production of advertising are considered incurred when the
advertising is first used.
Provision for Credit Losses
The provision for credit losses as presented in the Consolidated Statements of Income includes the provision for credit
losses on loans, the provision for credit losses on unfunded commitments and the provision for credit losses on investment
securities.
Operating Segments
While the Company’s chief decision-makers monitor the revenue streams of
the various products and services,
operations are managed and financial performance is evaluated on a Company-wide basis 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. The Company's revenue derived from contracts with customers are generally presented in service charges
and other fees and other income on the Consolidated Statement of Income and includes the following:
•
Service Charges on Deposit Accounts: The Company earns fees from its deposit customers from a variety of deposit
products and services. Non-transaction based fees such as account maintenance fees and monthly statement fees are
considered to be provided to the customer under a day-to-day contract with ongoing renewals. Revenues for these non-
transaction fees are earned over the course of a month, representing the period over which the Company satisfies the
performance obligation. Transaction-based fees such as non-sufficient fund charges, stop payment charges and wire
fees are recognized at the time the transaction is executed as the contract duration does not extend beyond the service
performed.
• Wealth Management: 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
57
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 or Adopted Accounting Pronouncements
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 ROU asset and liability for all leases with a term greater than 12 months regardless of their classification. All
cash payments are 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 was effective for public entities for fiscal years beginning after December 15, 2018, including interim periods
within those fiscal years. The Company adopted the ASU on January 1, 2019 and elected an exclusion accounting policy for
lease assets and lease liabilities of leases with a term of twelve months or less. The adoption of this ASU resulted in the
recognition of operating lease ROU assets and liabilities of approximately $29.3 million and $30.2 million, respectively, in prepaid
expenses and other assets and accrued expenses and other liabilities in the Consolidated Statements of Financial Condition.
This change also resulted in a cumulative-effect adjustment to beginning retained earnings of $399,000, net of tax, under the
modified retrospective approach.
FASB ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial
Instruments, as amended by ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, and ASU 2020-02, was
originally issued in June 2016. This ASU replaced the incurred loss methodology with an expected loss methodology, which is
commonly referred to as the "CECL" methodology. The measurement of expected credit losses under the CECL methodology is
applicable to financial assets measured at amortized cost, including loans receivable. It also applies to off-balance sheet credit
exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments. In addition,
CECL Adoption made changes to the accounting for credit losses on investment securities available for sale. This ASU requires
financial assets measured at amortized cost basis to be presented at the net amount expected to be collected. For public
business entities, this ASU was effective for fiscal years beginning after December 15, 2019, including interim periods within
those fiscal years with early adoption permitted for fiscal years after December 15, 2018, and can be delayed under a provision
of the CARES Act until the end of the official health emergency declaration. The Company adopted ASU 2016-13 on January 1,
2020 using the modified retrospective method for all financial assets measured at amortized cost, investment securities available
for sale and unfunded commitments. At adoption, the Bank elected not to measure an ACL on accrued interest receivable on
loans receivable or accrued interest receivable on investment securities available for sale as Bank policy is to reverse interest
income for uncollectible accrued interest receivable balances in a timely manner. The Significant Accounting Policies section
above reflects the policies after adoption. The CECL Adoption had the following impacts:
Investment Securities
As of December 31, 2019, the Company only held investment securities available for sale, had no historical
charge-off or recovery history and did not have any investment securities available for sale outstanding at the adoption
date for which an other-than-temporary impairment was previously recorded. At the adoption date of ASU 2016-13, the
unrealized losses present in the portfolio of investment securities available for sale were primarily due to decreases in
market interest rates on floating rate investment securities since the purchase of the securities and the fair value of
these securities was expected to recover as the securities approach their maturity dates. The basis of management’s
conclusion was that at December 31, 2019, 83.5% of the investment securities were issued by or guaranteed by the
United States government or its agencies, 14.0% were issued and guaranteed by State and local governments and the
remainder of the portfolio was invested in at least investment-grade securities. As a result of the analysis, no ACL on
investment securities available for sale was recorded upon adoption.
Loan Receivable
ASU 2016-13 replaced the allowance for loan losses with the ACL on loans on the Consolidated Statements of
Financial Condition and replaced the related provision for loan losses with the provision for credit losses as presented
on the Consolidated Statements of Income, which now additionally includes the provision for credit losses on unfunded
commitments discussed below.
The adoption was completed in a specific order beginning with the transition of PCI loans to PCD loans. The
Bank elected to account for the PCD loans individually, terminating the pools of loans that were previously accounted
for under ASC 310-30. First, an ACL on loans was determined for each PCI loan. The ACL on PCI loans was added to
the loan's carrying amount to establish a PCD loan at its amortized cost basis. The difference between the outstanding
principal balance and the amortized cost basis of the PCD loan is a noncredit premium or discount, which is amortized
into interest income over the remaining life of the PCD loan. The PCI to PCD transition did not have an impact on
58
beginning retained earnings; however, it did have the effect of reducing the existing allowance for PCI loans by
$1.6 million under the CECL methodology as compared to the previous ASC 310-10 methodology.
Following the PCI to PCD transition, the Bank recorded a pretax increase to the ACL on loans of $3.4 million to
increase the reserve to the estimated credit losses at January 1, 2020 based on its CECL methodology as part of the
cumulative-effect adjustment to beginning retained earnings. The pretax increase to the ACL on loans of $3.4 million
and the reduction in ACL on loans due to the PCI to PCD transition of $1.6 million resulted in an increase in the ACL on
loans of $1.8 million at January 1, 2020. Upon adoption, the adjusted beginning balance of the ACL on loans as a
percentage of loans receivable was 1.01% as compared to 0.96% at December 31, 2019 under the prior incurred loss
methodology.
The PCI to PCD transition also resulted in a net discount of $4.3 million for PCD loans, or an increase in the
net discount for PCD loans of $1.6 million. Following the transition, the total net discount for purchased loans increased
to $10.0 million at January 1, 2020 compared to $8.4 million as of December 31, 2019.
Unfunded Commitments
ASU 2016-13 replaced the reserve for unfunded commitments with the ACL on unfunded commitments as
included in Accrued liabilities and other expenses on the Consolidated Statements of Financial Condition and replaced
the provision for unfunded commitments which was previously recorded in Other expense with the provision for credit
losses as presented on the Consolidated Statements of Income, which now additionally includes the provision for credit
losses on loans discussed above. Upon adoption, the Bank recorded a pretax increase in the beginning ACL on
unfunded commitments of $3.7 million.
Overall CECL Adoption Impact
The adoption of ASU 2016-13, including the above mentioned increase to the ACL on loans of $3.4 million and
the increase to the ACL on unfunded commitments of $3.7 million, resulted in a pretax cumulative-effect adjustment of
$7.1 million. The impact of this adjustment to beginning retained earnings on January 1, 2020 was $5.6 million, net of
tax.
FASB ASU 2020-04, Reference Rate Reform (Topic 848), as amended by ASU 2021-01, was issued in March 2020 and
provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects
of) reference rate reform on financial reporting. The amendments in this ASU are effective for all entities as of March 12, 2020
through December 31, 2022. The amendments are elective, apply to all entities, and provide optional expedients and exceptions
for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria
are met. The Bank’s interest rate swap-related transactions are the majority of the Company's LIBOR exposure. Effective
January 25, 2021, the Company adhered to the Interbank Offered Rate Fallbacks Protocol as published by the International
Swaps and Derivatives Association, Inc. and recommended by the Alternative Reference Rates Committee. The Company does
not expect this ASU to have a material impact on its business operations and the Condensed Consolidated Financial Statements.
(2)
Investment Securities
The Company’s investment policy is designed primarily to provide and maintain liquidity, generate a favorable return on
assets without incurring undue interest rate and credit risk and complement the Bank’s lending activities.
During the three months ended September 30, 2021, the Company reassessed and transferred, at fair value, $244.8
million of U.S. government and agency securities from the available for sale classification to the held to maturity classification.
The net unrealized after tax gain of $1.3 million remained in AOCI to be amortized over the remaining life of the securities,
offsetting the related amortization of discount or premium on the transferred securities. No gains or losses were recognized at
the time of the transfer.
There were no investment securities classified as trading at December 31, 2021 or December 31, 2020. There were no
investment securities classified as held to maturity at December 31, 2020.
(a) Investment Securities by Classification Type and Maturity
The following tables present the amortized cost and fair value of investment securities at the dates indicated and the
corresponding amounts of gross unrealized gains and losses, including the corresponding amounts of gross unrealized gains
and losses on investment securities available for sale recognized in AOCI:
Investment securities available for sale:
U.S. government and agency securities
Municipal securities
Residential CMO and MBS
Amortized
Cost
December 31, 2021
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(In thousands)
Fair Value
$
21,494 $
55 $
(176) $
213,158
307,366
8,908
2,111
(854)
(2,593)
21,373
221,212
306,884
59
Commercial CMO and MBS
Corporate obligations
Other asset-backed securities
Total
Investment securities held to maturity:
U.S. government and agency securities
Residential CMO and MBS
Commercial CMO and MBS
Total
$
$
$
Amortized
Cost
December 31, 2021
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(In thousands)
Fair Value
313,169
2,007
26,638
3,891
7
369
(1,199)
—
(16)
315,861
2,014
26,991
883,832 $
15,341 $
(4,838) $
894,335
141,011 $
120 $
(1,768) $
139,363
24,529
217,853
—
—
(153)
(5,261)
383,393 $
120 $
(7,182) $
24,376
212,592
376,331
Investment securities available for sale:
U.S. government and agency securities
Municipal securities
Residential CMO and MBS
Commercial CMO and MBS
Corporate obligations
Other asset-backed securities
Total
Amortized
Cost
December 31, 2020
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(In thousands)
$
44,713 $
947 $
— $
197,634
196,956
290,638
10,971
29,283
12,561
5,125
13,198
125
565
(227)
(209)
(90)
—
(27)
Fair
Value
45,660
209,968
201,872
303,746
11,096
29,821
$
770,195 $
32,521 $
(553) $
802,163
The amortized cost and fair value of investment securities at December 31, 2021, by contractual maturity, are set forth
below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay
obligations with or without call or prepayment penalties.
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 investment securities due at a single maturity
date
Mortgage-backed securities (1)
Securities Available for Sale
Securities Held to Maturity
Amortized
Cost
Fair Value
Amortized
Cost
Fair Value
$
7,009 $
7,095 $
(In thousands)
28,441
71,319
156,528
263,297
620,535
29,608
74,089
160,798
271,590
622,745
— $
—
68,210
72,801
141,011
242,382
—
—
68,014
71,349
139,363
236,968
Total
376,331
(1) Mortgage-backed securities, which have prepayment provisions, are not assigned to maturity categories due to
894,335 $
883,832 $
383,393 $
$
fluctuations in their payment speed.
There were no holdings of investment securities of any one issuer, other than the U.S. government and its agencies, in
an amount greater than 10% of stockholders’ equity at December 31, 2021 and December 31, 2020.
(b) Unrealized Losses on Investment Securities Available for Sale
The following tables show the gross unrealized losses and fair value of the Company’s investment securities available
for sale for which an ACL on investment securities available for sale has not been recorded, aggregated by investment category
60
and length of time the individual securities have been in a continuous unrealized loss position at the dates indicated:
December 31, 2021
Less than 12 Months
12 Months or Longer
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
(In thousands)
U.S. government and agency securities
$
14,828 $
(176) $
— $
— $
14,828 $
Municipal securities
Residential CMO and MBS
Commercial CMO and MBS
Other asset-backed securities
Total
Municipal securities
Residential CMO and MBS
Commercial CMO and MBS
Other asset-backed securities
Total
(c) ACL on Investment Securities
29,774
204,039
83,283
2,763
(619)
(2,470)
(1,161)
(9)
9,351
19,862
1,936
1,118
(235)
(123)
(38)
(7)
39,125
223,901
85,219
3,881
(176)
(854)
(2,593)
(1,199)
(16)
$
334,687 $
(4,435) $
32,267 $
(403) $
366,954 $
(4,838)
December 31, 2020
Less than 12 Months
12 Months or Longer
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
(In thousands)
$
10,264 $
(227) $
— $
— $
10,264 $
—
11,404
—
—
(29)
—
25,293
7,499
4,570
(209)
(61)
(27)
25,293
18,903
4,570
(227)
(209)
(90)
(27)
$
21,668 $
(256) $
37,362 $
(297) $
59,030 $
(553)
The Company evaluated investment securities available for sale as of December 31, 2021 and December 31, 2020 and
determined that any declines in fair value were attributable to changes in interest rates relative to where these investments fall
within the yield curve and individual characteristics. Management monitors published credit ratings for adverse changes for all
rated investment securities and none of these securities had a below investment grade credit rating as of both December 31,
2021 and December 31, 2020. In addition, the Company does not intend to sell these securities nor does the Company consider
it more likely than not that it will be required to sell these securities before the recovery of the amortized cost basis, which may be
upon maturity. Therefore, no ACL on investment securities available for sale was recorded as of December 31, 2021 and
December 31, 2020.
The Company also evaluated investment securities held to maturity for current expected credit losses. There were no
investment securities held to maturity classified as nonaccrual or past due as of December 31, 2021 and all were issued by the
U.S. government and its agencies and either explicitly or implicitly guaranteed by the U.S. government, highly rated by major
credit rating agencies and have a long history of no credit losses. Accordingly, the Company did not measure expected credit
losses on investment securities held to maturity since the historical credit loss information adjusted for current conditions and
reasonable and supportable forecasts results in an expectation that nonpayment of the amortized cost basis is zero. Therefore,
no ACL on investment securities held to maturity was recorded as of December 31, 2021.
(d) Realized Gains and Losses
The following table presents the gross realized gains and losses on the sale of investment securities available for sale
for the years ended December 31, 2021, December 31, 2020 and December 31, 2019:
Gross realized gains
Gross realized losses
Net realized gains
Year ended December 31,
2021
2020
2019
$
$
(In thousands)
29 $
—
29 $
1,537 $
(19)
1,518 $
558
(228)
330
61
(e) Pledged Securities
The following table summarizes the amortized cost and fair value of investment securities that are pledged as collateral
for the following obligations at December 31, 2021 and December 31, 2020:
December 31, 2021
Fair
Value
Amortized
Cost
December 31, 2020
Fair
Value
Amortized
Cost
(In thousands)
Washington and Oregon state public deposits
$
128,216 $
130,217 $
119,652 $
124,228
Federal Reserve Bank credit facility
Securities sold under agreement to repurchase
Other securities pledged
Total
(f) Accrued Interest Receivable
61,057
59,887
56,419
59,674
59,655
55,633
—
38,630
29,665
—
39,945
30,717
$
305,579 $
305,179 $
187,947 $
194,890
Accrued interest receivable excluded from the amortized cost on investment securities available for sale totaled $3.5
million and $3.6 million at December 31, 2021 and December 31, 2020, respectively. Accrued interest receivable excluded from
the amortized cost on investment securities held to maturity totaled $1.1 million at December 31, 2021.
No amounts of accrued interest receivable on investment securities available for sale or held to maturity were reversed
against interest income on investment securities available for sale during the years ended December 31, 2021, 2020, and 2019.
(3)
Loans Receivable
The Bank originates loans in the ordinary course of business and has also acquired loans through mergers and
acquisitions. Accrued interest receivable was excluded from disclosures presenting the Bank's amortized cost of loans receivable
as it was deemed insignificant.
(a) Loan Origination/Risk Management
The Bank categorizes the individual loans in the total loan portfolio into four segments: commercial business; residential
real estate; real estate construction and land development; and consumer. Within these segments are classes of loans for which
management monitors and assesses credit risk.
The Bank 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,
loan
concentrations of credit, loan delinquencies and nonperforming and criticized loans. The Bank also conducts internal
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.
The amortized cost of loans receivable, net of ACL on loans at December 31, 2021 and December 31, 2020 consisted
of the following portfolio segments and classes:
Commercial business:
Commercial and industrial
SBA PPP
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Residential real estate
Real estate construction and land development:
Residential
Commercial and multifamily
Total real estate construction and land development
Consumer
Loans receivable
62
December 31,
2021
December 31,
2020
(In thousands)
$
621,567 $
145,840
931,150
1,493,099
3,191,656
164,582
85,547
141,336
226,883
232,541
733,098
715,121
856,684
1,410,303
3,715,206
122,756
78,259
227,454
305,713
324,972
3,815,662
4,468,647
Allowance for credit losses on loans
Loans receivable, net
Balances included in the amortized cost of loans receivable:
Unamortized net discount on acquired loans
Unamortized net deferred fee
December 31,
2021
December 31,
2020
(In thousands)
(42,361)
(70,185)
$
3,773,301 $
4,398,462
$
$
(3,938) $
(7,952) $
(6,575)
(15,458)
A discussion of the risk characteristics of each loan portfolio segment is as follows:
Commercial Business:
There are four significant classes of loans in the commercial business portfolio segment 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.
SBA PPP. The Bank began originating SBA PPP loans following the enactment of the CARES Act in April 2020. SBA
PPP loans are fully guaranteed by the SBA, intended for businesses impacted by the COVID-19 Pandemic and designed to
provide near term relief to help small businesses sustain operations. These loans have either a two-year or five-year maturity
date and earn interest at 1%. The Bank also earns a fee based on the size of the loan, which is recognized over the life of the
loan.
Owner-occupied and non-owner occupied CRE. The Bank originates CRE 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. CRE 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 some common risk characteristics with owner-occupied CRE loans and non-owner
occupied CRE loans. However, owner-occupied CRE loans are generally considered to have a slightly lower risk profile as we
typically have the guarantee of the owner-occupant and can underwrite risk using the complete financial information on the entity
that occupies the property.
Residential Real Estate:
The majority of the Bank’s residential real estate loans are secured by one-to-four family residences located in its
primary market areas. The Company’s underwriting standards require that residential real estate loans maintained in the portfolio
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 Bank sells a portion of originated residential real estate
loans in the secondary market.
Real Estate Construction and Land Development:
The Bank originates construction loans for residential and for commercial and multifamily properties. The residential
construction loans generally include construction of custom single-family homes whereby the home owner is the borrower. The
Bank also provides financing to builders for the construction of pre-sold residential homes and, in selected cases, to builders for
the construction of speculative single-family residential property. Substantially all construction loans are short-term in nature and
priced with variable rates of interest. Construction lending can involve a higher level of risk than other types of lending because
funds are advanced partially based upon the value of the project, which is uncertain prior to the project’s completion. Because of
the uncertainties inherent in estimating construction costs as well as the market value of a completed project and the effects of
governmental regulation of real property, the Bank’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 Bank’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 Bank until permanent financing is obtained. These loans are
closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate
repayment being dependent upon successful completion of the construction project, market interest rate changes, government
63
regulation of real property, general economic conditions and the availability of long-term financing.
Consumer:
The Bank originates consumer loans and lines of credit that are both secured and unsecured. The underwriting process
for these loans ensures a qualifying primary and secondary source of repayment. Underwriting standards for home equity loans
are significantly influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage
of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. To
monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. The majority of
consumer loans are for relatively small amounts disbursed among many individual borrowers which reduces the overall credit
risk for this segment. To further reduce the risk, trend reports are reviewed by management on a regular basis.
The Bank also purchased indirect consumer loans. These indirect consumer loans were secured by new and used
automobile and recreational vehicles and were originated indirectly by established and well-known dealers located in our market
areas. In addition, the indirect loans purchased were made to only prime borrowers. The Bank ceased indirect auto loan
originations in March 2020.
(b) Concentrations of Credit
Most of the Bank’s lending activity occurs within its primary market areas which are concentrated along the I-5 corridor
from Whatcom County to Clark County in Washington State and Multnomah County and Washington County in Oregon, as well
as other contiguous markets and represents a geographic concentration. Additionally, our loan portfolio is concentrated in
loans, including commercial business loans and commercial and multifamily real estate construction and land
commercial
development loans. Commercial loans are generally viewed as having more inherent risk of default than residential real estate
loans or other consumer loans. Also, the commercial loan balance per borrower is typically larger than that for residential real
estate loans and consumer loans, implying higher potential losses on an individual loan basis.
(c) Credit Quality Indicators
As part of the on-going monitoring of the credit quality of the Bank’s loan portfolio, management tracks certain credit
quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified loans, (iii) net charge-offs,
(iv) nonperforming loans, (v) past due status and (vi) the general economic conditions of the United States of America, and
specifically the states of Washington and Oregon. The Bank 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” and include loans with negligible to above average, but
acceptable, risk. These borrowers generally have strong to acceptable capital levels and consistent earnings
and debt service capacity. Loans with the higher grades within the “Pass” 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. 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" ("SM") loans and is intended to highlight loans deemed by
management to have some elevated risks that deserve management's close attention. Loans with this grade
show signs of deteriorating profits and capital and the borrower might not be strong enough to sustain a major
setback. The borrower is typically higher than normally leveraged and outside support might be modest and
likely illiquid. The loan is at risk of further credit decline unless active measures are taken to correct the
situation.
Grade 8: This grade includes “Substandard” ("SS") loans in accordance with regulatory guidelines, which the
Company has determined have a high credit risk. These loans also have well-defined weaknesses and are
characterized by the distinct possibility that
the deficiencies are not
corrected. The borrower may have shown serious negative trends in financial ratios and performance. Such
loans may be dependent upon collateral liquidation, a secondary source of repayment or an event outside of
the normal course of business.
the Bank will sustain some loss if
Grade 9: This grade includes “Doubtful” loans in accordance with regulatory guidelines and the Bank 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 been partially charged off for the amount considered
uncollectible.
Grade 10: This grade includes “Loss” loans in accordance with regulatory guidelines and the Bank 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.
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 and scheduled loan reviews. For consumer loans, the Bank
follows the FDIC’s Uniform Retail Credit Classification and Account Management Policy for subsequent classification in the event
of payment delinquencies or default. Typically, an individual loan grade will not be changed from the prior period unless there is a
64
specific indication of credit deterioration or improvement. Credit deterioration is evidenced by delinquency, direct communications
with the borrower or other borrower information that becomes known to management. Credit improvements are evidenced by
known facts regarding the borrower or the collateral property.
Loan grades relate to the likelihood of losses in that the higher the grade, the greater the loss potential. Loans with a
pass grade may have some estimated inherent losses, but to a lesser extent than the other loan grades. The SM loan grade is
transitory in that the Bank is waiting on additional information to determine the likelihood and extent of the potential loss. The
likelihood of loss for SM graded loans, however, is greater than Watch graded loans because there has been measurable credit
deterioration. Loans with a SS grade are generally accrual loans at risk of being classified as nonaccrual loans and includes all of
our loans classified as nonaccrual. For Doubtful and Loss graded loans, the Bank is almost certain of the losses and the
outstanding principal balances are generally charged off to the realizable value.
Regulatory agencies provided guidance regarding credit risk ratings, delinquency reporting and nonaccrual status for
loans adversely impacted by the COVID-19 Pandemic. The Bank has and will continue to exercise judgment in determining the
risk rating for impacted borrowers and will not automatically adversely classify credits that have been affected by the COVID-19
Pandemic. The Bank did not designate loans with payment deferrals granted due to the COVID-19 Pandemic as past due
because of the deferral. Due to the short-term nature of the forbearance and other relief programs the Bank was offering as a
result of the COVID-19 Pandemic, borrowers granted relief under these programs were generally not reported as nonaccrual
during the deferral period.
The following table presents the amortized cost of loans receivable by risk grade as of December 31, 2021 and
December 31, 2020:
December 31, 2021
Term Loans
Amortized Cost Basis by Origination Year
2021
2020
2019
2018
2017
Prior
(In thousands)
Revolving
Loans
Converted
to Term
Loans (1)
Revolving
Loans
Loans
Receivable
Commercial business:
Commercial and industrial
$ 95,960 $ 100,193 $ 94,657 $ 54,707 $ 28,558 $ 77,294 $ 127,651 $
1,035 $ 580,055
326
1,443
884
1,287
5,998
5,912
1,425
2,809
2,223
2,526
2,401
6,907
2,048
4,402
353
568
15,658
25,854
97,729
102,364
106,567
58,941
33,307
86,602
134,101
1,956
621,567
Pass
SM
SS
Total
SBA PPP
Pass
139,253
6,587
—
—
—
—
Owner-occupied CRE
Pass
SM
SS
182,742
90,609
188,380
73,714
66,039
273,518
264
—
—
1,332
3,079
—
7,521
3,787
3,937
3,014
16,724
16,418
Total
183,006
91,941
191,459
85,022
72,990
306,660
Non-owner occupied CRE
Pass
SM
SS
187,860
185,650
244,863
149,090
144,896
499,486
—
—
—
—
5,674
—
—
15,482
3,379
—
2,400
54,319
Total
187,860
185,650
250,537
152,469
160,378
556,205
Total commercial business
—
—
—
—
—
—
—
—
—
—
145,840
72
—
—
72
875,074
31,525
24,551
931,150
— 1,411,845
—
—
23,556
57,698
— 1,493,099
Pass
SM
SS
605,815
383,039
527,900
277,511
239,493
850,298
127,651
1,107
3,012,814
590
1,443
884
2,619
14,751
5,912
8,946
9,975
21,642
5,540
21,525
77,644
2,048
4,402
353
568
70,739
108,103
Total
607,848
386,542
548,563
296,432
266,675
949,467
134,101
2,028
3,191,656
Residential real estate
Pass
SS
85,089
27,090
23,295
—
—
—
Total
85,089
27,090
23,295
5,672
—
5,672
6,141
16,891
—
404
6,141
17,295
Real estate construction and land development:
Residential
Pass
44,892
23,728
12,266
2,921
389
1,351
—
—
—
—
—
—
—
164,178
404
164,582
—
85,547
65
December 31, 2021
Term Loans
Amortized Cost Basis by Origination Year
2021
2020
2019
2018
2017
Prior
Commercial and multifamily
Pass
SM
SS
56,448
41,616
34,117
5,794
—
—
—
571
68
—
—
—
Total
56,448
42,187
34,185
5,794
Total real estate construction and land development
710
—
—
710
1,379
213
420
2,012
Pass
SM
SS
101,340
65,344
46,383
8,715
1,099
2,730
—
—
—
571
68
—
—
—
—
—
213
420
Total
101,340
65,915
46,451
8,715
1,099
3,363
Revolving
Loans
Converted
to Term
Loans (1)
Revolving
Loans
Loans
Receivable
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
120
17
137
140,064
281
991
141,336
225,611
281
991
226,883
229,589
2,952
232,541
Consumer
Pass
SS
1,286
15,737
46,041
29,819
15,068
13,026
108,492
—
181
657
476
542
1,043
36
Total
1,286
15,918
46,698
30,295
15,610
14,069
108,528
Loans receivable
Pass
SM
SS
Total
793,530
491,210
643,619
321,717
261,801
882,945
236,143
1,227
3,632,192
590
1,443
884
3,371
14,819
6,569
8,946
10,451
21,642
6,082
21,738
79,511
2,048
4,438
353
585
71,020
112,450
$ 795,563 $ 495,465 $ 665,007 $ 341,114 $ 289,525 $ 984,194 $ 242,629 $
2,165 $3,815,662
(1) Represents the loans receivable balance at December 31, 2021 which was converted from a revolving loan to an
amortizing loan during the year ended December 31, 2021.
December 31, 2020
Term Loans
Amortized Cost Basis by Origination Year
2020
2019
2018
2017
2016
Prior
(In thousands)
Revolving
Loans
Converted
to Term
Loans (1)
Revolving
Loans
Loans
Receivable
Commercial business:
Commercial and industrial
Pass
SM
SS
$ 118,971 $ 127,919 $ 70,766 $ 44,231 $ 37,658 $ 95,958 $ 121,440 $
819 $ 617,762
14,430
2,199
9,162
11,835
Total
135,600
148,916
10,878
3,416
85,060
4,171
9,348
5,700
1,052
3,579
7,651
11,790
15,484
57,750
44,410
107,188
148,714
814
3,827
5,460
60,524
54,812
733,098
SBA PPP
Pass
715,121
—
—
—
—
—
Owner-occupied CRE
Pass
SM
SS
89,224
167,095
6,146
—
4,540
—
94,830
16,386
114
Total
95,370
171,635
111,330
80,138
11,231
7,320
98,689
74,902
254,864
5,464
3,313
12,105
29,012
83,679
295,981
Non-owner-occupied CRE
Pass
SM
SS
197,548
173,153
148,830
172,438
240,614
406,817
—
—
1,979
—
357
3,623
2,448
—
6,210
35,455
3,539
17,292
Total
197,548
175,132
152,810
174,886
282,279
427,648
Total commercial business
—
—
—
—
—
—
—
—
—
—
715,121
—
—
—
—
761,053
55,872
39,759
856,684
— 1,339,400
—
—
14,533
56,370
— 1,410,303
Pass
SM
1,120,864
468,167
314,426
296,807
353,174
757,639
121,440
20,576
15,681
27,621
17,850
17,374
19,223
11,790
819
814
3,433,336
130,929
66
SS
2,199
11,835
7,153
16,668
39,820
53,955
15,484
3,827
150,941
Total
1,143,639
495,683
349,200
331,325
410,368
830,817
148,714
5,460
3,715,206
Residential real estate
Pass
SS
30,141
41,829
15,730
10,362
7,322
16,825
—
—
—
59
—
488
Total
30,141
41,829
15,730
10,421
7,322
17,313
Real estate construction and land development:
Residential
Pass
SS
33,801
36,697
—
—
Total
33,801
36,697
Commercial and multifamily
2,725
—
2,725
1,097
1,926
3,023
Pass
SM
SS
27,423
151,020
38,682
5,660
67
572
1,011
450
—
—
—
—
Total
28,062
152,481
38,682
5,660
Total real estate construction and land development
971
—
971
689
—
—
689
1,042
—
1,042
1,407
29
444
1,880
Pass
SM
SS
61,224
187,717
41,407
67
572
1,011
450
—
—
Total
61,863
189,178
41,407
6,757
—
1,926
8,683
1,660
2,449
—
—
29
444
1,660
2,922
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
Consumer
Pass
SS
43,742
77,083
53,195
30,559
13,443
34
404
684
648
420
Total
43,776
77,487
53,879
31,207
13,863
Loans receivable
15,453
1,319
16,772
87,547
78
87,625
315
48
363
122,209
547
122,756
76,333
1,926
78,259
224,881
1,107
1,466
227,454
301,214
1,107
3,392
305,713
321,337
3,635
324,972
Pass
SM
SS
1,255,971
774,796
424,758
344,485
375,599
792,366
208,987
1,134
4,178,096
20,643
2,805
16,692
12,689
27,621
7,837
17,850
19,301
17,374
40,240
19,252
56,206
11,790
15,562
814
132,036
3,875
158,515
Total
$1,279,419 $ 804,177 $ 460,216 $ 381,636 $ 433,213 $ 867,824 $ 236,339 $
5,823 $4,468,647
(1) Represents the loans receivable balance at December 31, 2020 which was converted from a revolving loan to an
amortizing loan during the year ended December 31, 2020.
(d) Nonaccrual Loans
The following table presents the amortized cost of nonaccrual loans for the dates indicated:
December 31, 2021
Nonaccrual
without ACL
Nonaccrual
with ACL
Total
Nonaccrual
(In thousands)
$
6,454 $
3,827 $
3,036
1,273
10,763
—
—
—
5,138
3,379
12,344
47
571
29
10,281
8,174
4,652
23,107
47
571
29
$
10,763 $
12,991 $
23,754
Commercial business:
Commercial and industrial
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Residential real estate
Real estate construction and land development:
Commercial and multifamily
Consumer
Total
67
Commercial business:
Commercial and industrial
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Residential real estate
Real estate construction and land development:
Commercial and multifamily
Consumer
Total
December 31, 2020
Nonaccrual
without ACL
Nonaccrual
with ACL
Total
Nonaccrual
(In thousands)
$
22,039 $
9,208 $
4,693
3,424
30,156
67
572
31
13,700
3,722
26,630
117
450
69
$
30,826 $
27,266 $
31,247
18,393
7,146
56,786
184
1,022
100
58,092
The following table presents the reversal of interest income on loans due to the write-off of accrued interest receivable
upon the initial classification of loans as nonaccrual loans and the interest income recognized due to payment in full of previously
classified nonaccrual loans during the following periods:
Commercial business:
Commercial and industrial
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Residential real estate
Real estate construction and land development:
Residential
Commercial and multifamily
Total real estate construction and land
development
Consumer
Total
December 31, 2021
December 31, 2020
Interest
Income
Reversed
Interest
Income
Recognized
Interest
Income
Reversed
Interest
Income
Recognized
(In thousands)
$
(10) $
2,295 $
(95) $
—
—
(10)
—
—
—
—
(1)
117
601
3,013
—
71
—
71
52
(238)
(208)
(541)
(2)
—
(11)
(11)
(1)
434
89
67
590
2
—
—
—
47
$
(11) $
3,136 $
(555) $
639
For the years ended December 31, 2021 and 2020, no interest income was recognized subsequent to a loan’s
classification as nonaccrual, except as indicated in the tables above due to payment in full.
(e) Past due loans
The Bank performs an aging analysis of past due loans using policies consistent with regulatory reporting requirements
with categories of 30-89 days past due and 90 or more days past due. The amortized cost of past due loans as of December 31,
2021 and December 31, 2020 were as follows:
30-89 Days
90 Days
or Greater
Total Past
Due
Current
Loans
Receivable
December 31, 2021
(In thousands)
Commercial business:
Commercial and industrial
$
1,858 $
6,821 $
8,679 $
612,888 $
SBA PPP
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
223
2,397
—
4,478
293
112
—
7,226
516
2,509
—
11,704
145,324
928,641
1,493,099
3,179,952
621,567
145,840
931,150
1,493,099
3,191,656
68
Residential real estate
Real estate construction and land development:
Residential
Commercial and multifamily
Total real estate construction
and land development
Consumer
Total
30-89 Days
90 Days
or Greater
Total Past
Due
Current
Loans
Receivable
December 31, 2021
420
792
3,474
4,266
1,026
10
—
571
571
—
(In thousands)
430
164,152
164,582
792
4,045
4,837
1,026
84,755
137,291
222,046
231,515
85,547
141,336
226,883
232,541
$
10,190 $
7,807 $
17,997 $
3,797,665 $
3,815,662
30-89 Days
90 Days or
Greater
Total Past
Due
Current
Loans
Receivable
December 31, 2020
(In thousands)
Commercial business:
Commercial and industrial
$
4,621 $
8,082 $
12,703 $
720,395 $
SBA PPP
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Residential real estate
Real estate construction and land development:
Residential
Commercial and multifamily
Total real estate construction
and land development
—
991
412
6,024
765
—
2,225
2,225
1,407
—
403
1,970
10,455
16
—
—
—
30
—
1,394
2,382
16,479
781
—
2,225
2,225
1,437
715,121
855,290
1,407,921
3,698,727
121,975
78,259
225,229
303,488
323,535
733,098
715,121
856,684
1,410,303
3,715,206
122,756
78,259
227,454
305,713
324,972
$
10,421 $
10,501 $
20,922 $
4,447,725 $
4,468,647
Consumer
Total
There was one SBA PPP loan 90 days or more past due that was still accruing interest as of December 31, 2021 with
an amortized cost of $293,000. There were no loans 90 days or more past due that were still accruing interest as of
December 31, 2020.
(f) Collateral-dependent Loans
The type of collateral securing loans individually evaluated for credit losses and for which the repayment was expected
to be provided substantially through the operation or sale of the collateral as of December 31, 2021 and December 31, 2020
were as follows, with balances representing the amortized cost of the loan classified by the primary collateral category of each
loan if multiple collateral sources secure the loan:
CRE
Farmland
December 31, 2021
Residential
Real Estate
(In thousands)
Other
Total
Commercial business:
Commercial and industrial
$
1,499 $
4,362 $
1,036 $
245 $
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Real estate construction and land development:
Commercial and multifamily
3,035
1,273
5,807
571
—
—
4,362
—
—
1,036
—
—
Total
$
6,378 $
4,362 $
1,036 $
—
—
245
—
245 $
7,142
3,035
1,273
11,450
571
12,021
69
CRE
Farmland
December 31, 2020
Residential
Real Estate
(In thousands)
Other
Total
Commercial business:
Commercial and industrial
$
1,893 $
18,738 $
584 $
1,405 $
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Residential real estate
Real estate construction and land development:
Commercial and multifamily
4,693
3,424
10,010
—
572
—
—
—
18,738
—
—
—
—
—
584
67
—
30
—
—
1,405
—
—
—
22,620
4,693
3,424
30,737
67
572
30
$
10,582 $
18,738 $
681 $
1,405 $
31,406
Consumer
Total
There have been no significant changes to the collateral securing loans individually evaluated for credit losses and for
which repayment was expected to be provided substantially through the operation or sale of the collateral during the year ended
December 31, 2021, except changes due to additions or removals of loans in this classification.
(g) Troubled Debt Restructured Loans
Loans that were modified as TDR loans are set forth in the following tables for the periods indicated:
Year Ended December 31,
2021
2020
2019
Number of
Contracts
Amortized
Cost (1) (2)
Number of
Contracts
Amortized
Cost (1) (2)
(Dollars in thousands)
Number of
Contracts
Amortized
Cost (1) (2)
Commercial business:
Commercial and industrial
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Residential real estate
Real estate construction and land development:
Residential
Commercial and multifamily
Total real estate construction
and land development
Consumer
31 $
7
4
42
1
—
1
1
22
9,710
16,565
17,640
43,915
178
—
450
450
511
75 $
14
9
98
1
4
1
5
48
36,118
19,326
25,728
81,172
22
1,926
450
2,376
1,198
44 $
31,122
4
4
52
—
1
—
1
12
1,695
2,208
35,025
—
237
—
237
157
Total
35,419
(1) Number of contracts and amortized cost represent loans which have balances as of period end, net of subsequent
payments after modifications. Certain TDR loans may have been paid-down or charged-off during the years ended
December 31, 2021, 2020 and 2019.
152 $
45,054
84,768
65 $
66 $
(2) As the Bank did not forgive any principal or interest balance as part of the loan modifications, the Bank’s amortized
cost in each loan at the date of modification (pre-modification) did not change as a result of the modification (post-
modification).
The Bank had an ACL on loans of $3.1 million, $7.5 million and $1.0 million at December 31, 2021, December 31, 2020,
and December 31, 2019, respectively, related to these TDR loans which were restructured during the year ended December 31,
2021, 2020 and 2019, respectively.
The unfunded commitment to borrowers related to TDR loans was $5.7 million and $2.6 million at December 31, 2021
and December 31, 2020, respectively.
70
The following tables present loans that were modified in a TDR and subsequently defaulted within twelve months from
the modification date during the periods indicated:
Year Ended December 31,
2021
2020
2019
Number of
Contracts (1)
Amortized
Cost (1)
Number of
Contracts (1)
Amortized
Cost (1)
(Dollars in thousands)
Number of
Contracts (1)
Amortized
Cost (1)
6 $
1,379
—
—
—
—
4 $
2
2
2,136
1,369
1,811
13 $
12,854
3
1
1,142
52
Commercial business:
Commercial and industrial
Owner-occupied CRE
Non-owner occupied CRE
Total
14,048
(1) Number of contracts and amortized cost represent TDR loans which have balances as of period end, net of
subsequent payments after modifications. Certain TDR loans may have been paid-down or charged-off during the
years ended December 31, 2021, 2020 and 2019.
17 $
1,379
5,316
8 $
6 $
During the years ended December 31, 2021, 2020, and 2019, six, eight and 11 TDR loans defaulted because each was
past its modified maturity date and the borrower had not subsequently repaid the credits. The Bank chose not to further extend
the maturity date on these TDR loans. The remaining six TDR loans for the year ended December 31, 2019 defaulted because
the borrower was more than 90 days delinquent on their scheduled loan payments. The Bank had an ACL on loans for these
TDR loans which defaulted during the related years of $111,000, $229,000, and $88,000 at December 31, 2021, 2020, and 2019.
(h) Related Party Loans
In the ordinary course of business, the Company has granted loans to certain directors, executive officers and their
affiliates. Activity in related party loans during the periods indicated was as follows:
Balance outstanding at the beginning of year
Principal additions
Principal reductions
Balance outstanding at the end of year
Year Ended December 31,
2021
2020
2019
(In thousands)
7,694 $
8,144 $
—
(572)
199
(649)
7,122 $
7,694 $
$
$
8,367
—
(223)
8,144
The Company had $255,000 and $545,000 of unfunded commitments to related parties and all related party loans were
performing in accordance with the underlying loan agreements as of December 31, 2021 and December 31, 2020.
(i) Residential Real Estate Loan Sales
The Bank originates residential real estate loans; a portion of which are sold on the secondary market. The Bank does
not retain servicing on loans sold in the secondary market. At December 31, 2021 and December 31, 2020, the balance of loans
held for sale was $1.5 million and $4.9 million, respectively.
The following table presents information concerning the origination and sale of the Bank's residential real estate loans
and the gains from their sale during the periods indicated:
Originated (1)
Sold
Gain on sale of loans, net (2)
Year Ended December 31,
2021
2020
2019
(In thousands)
$
190,734 $
191,207 $
150,030
89,899
3,644
137,580
5,044
68,238
2,159
(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.
71
(j) Commercial Loan Sales, Servicing, and Commercial Servicing Asset
Details of loans serviced for others are as follows:
December 31,
2021
December 31,
2020
Loans serviced for others with participating interest, gross loan balance
Loans serviced for others with participating interest, participation balance owned by Bank (1)
7,088
(1) Included in the balance of loans receivable on the Consolidated Statements of Financial Condition.
(In thousands)
$
30,852 $
32,131
7,842
The Company recognized $320,000, $423,000 and $532,000 of servicing income for the years ended December 31,
2021, 2020 and 2019, respectively.
The Company's servicing asset at December 31, 2021 and December 31, 2020 was $343,000 and $583,000,
respectively. There was no valuation allowance on the Company's servicing asset as of December 31, 2021 and December 31,
2020.
(k) Accrued interest receivable on loans receivable
Accrued interest receivable on loans receivable totaled $10.1 million and $15.8 million at December 31, 2021 and
December 31, 2020, respectively. It is excluded from the calculation of the ACL on loans as interest accrued, but not received, is
reversed timely.
(4)
Allowance for Credit Losses on Loans
Effective January 1, 2020, the Bank adopted ASU 2016-13. CECL Adoption replaced the allowance for loan losses with
the ACL on loans and replaced the related provision for loan losses with the provision for credit losses on loans.
The baseline loss rates used to calculate the ACL on loans at December 31, 2021 utilized the Bank's average quarterly
historical loss information from December 31, 2012 through the balance sheet date. There were no changes to this assumption
during the year ended December 31, 2021. The Bank believes the historic loss rates are viable inputs to the current CECL model
as the Bank's lending practice and business has remained relatively stable throughout the periods. While the Bank's assets have
grown, the credit culture has stayed relatively consistent.
Prepayments included in the CECL model at December 31, 2021 were based on the 48-month rolling historical
averages for each segment, which management believes is an accurate representation of future prepayment activity. There were
no changes to this assumption during the year ended December 31, 2021.
The reasonable and supportable period and subsequent reversion period used in the CECL model was five quarters
and two quarters at December 31, 2021. There were no changes to these assumptions during the year ended December 31,
2021. Management believes forecasts beyond this seven quarter time period tend to diverge in economic assumptions and may
be less comparable to actual future events. As the length of the reasonable and supportable period increases, the degree of
judgment involved in estimating the allowance increases.
During the year ended December 31, 2021, the ACL on loans decreased $27.8 million, or 39.6%, due primarily to a
reversal of provision for credit losses on loans of $27.3 million. The reversal of provision for credit losses was primarily driven by
improvements in the economic forecast used in the CECL model at December 31, 2021 as compared to the forecast used in the
CECL model at December 31, 2020.
The ACL on loans at December 31, 2021 and December 31, 2020 did not include a reserve for SBA PPP loans as these
loans are fully guaranteed by the SBA.
A summary of the changes in the ACL on loans during the years ended December 31, 2021, December 31, 2020 and
December 31, 2019 is as follows:
Balance at the beginning of the year
Impact of CECL Adoption
Balance at the beginning of the year, as adjusted
Charge-offs
Recoveries of loans previously charged-off
(Reversal of) provision for credit losses on loans
Balance at the end of the year
$
42,361 $
70,185 $
72
2021
Year Ended December 31,
2020
(In thousands)
2019
$
70,185 $
36,171 $
35,042
—
70,185
(1,946)
1,420
(27,298)
1,822
37,993
(5,622)
2,381
35,433
—
35,042
(4,989)
1,807
4,311
36,171
The following tables detail the activity in the ACL on loans by segment and class for the periods indicated:
Year Ended December 31, 2021
Beginning
Balance
Charge-offs
Recoveries
(In thousands)
Reversal of
Provision for
Credit Losses
Ending Balance
Commercial business:
Commercial and industrial
$
30,010 $
(917) $
791 $
(12,107) $
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Residential real estate
Real estate construction and land development:
Residential
Commercial and multifamily
Total real estate construction
and land development
9,486
10,112
49,608
1,591
1,951
11,141
13,092
5,894
(359)
—
(1,276)
—
—
(1)
(1)
(669)
25
—
816
—
32
—
32
572
(2,741)
(1,251)
(16,099)
(182)
(679)
(7,168)
(7,847)
(3,170)
$
70,185 $
(1,946) $
1,420 $
(27,298) $
Consumer
Total
17,777
6,411
8,861
33,049
1,409
1,304
3,972
5,276
2,627
42,361
Year Ended December 31, 2020
Beginning
Balance
Impact of
CECL
Adoption
Beginning
Balance,
as Adjusted Charge-offs Recoveries
(In thousands)
Provision
(Reversal of
Provision)
for Credit
Losses
Ending
Balance
Commercial business:
Commercial and industrial
$
11,739 $
(1,348) $
10,391 $
(3,616) $
1,513 $
21,722 $
30,010
Owner-occupied CRE
Non-owner occupied CRE
Total commercial
business
Residential real estate
4,512
7,682
23,933
1,458
452
(2,039)
(2,935)
1,471
4,964
5,643
20,998
2,929
Real estate construction and land development:
1,455
(571)
884
(135)
—
(3,751)
—
—
Residential
Commercial and
multifamily
Total real estate
construction and
land development
Consumer
Unallocated
1,605
7,240
8,845
(417)
3,060
6,821
899
6,669
(2,484)
(899)
9,729
4,337
—
(417)
(1,454)
—
17
—
1,530
3
278
—
278
570
—
4,640
4,469
30,831
(1,341)
9,486
10,112
49,608
1,591
789
1,951
2,713
11,141
3,502
2,441
—
13,092
5,894
—
Total
$
36,171 $
1,822 $
37,993 $
(5,622) $
2,381 $
35,433 $
70,185
The following table details activity in the allowance for loan losses by segment and class for the period indicated:
Beginning
Balance
Charge-offs
Recoveries
Provision for
Loan Losses
Ending Balance
Year Ended December 31, 2019
(In thousands)
Commercial business:
Commercial and industrial
$
11,343 $
(2,692) $
166 $
2,922 $
Owner-occupied CRE
Non-owner occupied CRE
Total commercial business
Residential real estate
4,898
7,470
23,711
1,203
—
—
(2,692)
(60)
73
50
441
657
—
(436)
(229)
2,257
315
11,739
4,512
7,682
23,933
1,458
Beginning
Balance
Charge-offs
Recoveries
Provision for
Loan Losses
Ending Balance
Year Ended December 31, 2019
Real estate construction and land development:
Residential
Commercial and multifamily
Total real estate construction
and land development
Consumer
Unallocated
Total
1,240
954
2,194
6,581
1,353
(133)
—
(133)
(2,104)
—
637
—
637
513
—
(289)
651
362
1,831
(454)
1,455
1,605
3,060
6,821
899
$
35,042 $
(4,989) $
1,807 $
4,311 $
36,171
(5)
Other Real Estate Owned
Changes in other real estate owned during the periods indicated were as follows:
Year Ended December 31,
2021
2020
2019
(In thousands)
Balance at the beginning of the year
Additions
Proceeds from dispositions
Gain (loss) on sale, net
Valuation adjustment
Balance at the end of the year
$
$
— $
—
—
—
—
841
270
(1,290)
179
—
— $
— $
$
1,983
—
(864)
(227)
(51)
841
At December 31, 2021, there were no consumer mortgage loans secured by residential real estate properties (included
in Loans receivable on the Consolidated Statements of Financial Position) for which formal foreclosure proceedings were in
process.
(6)
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,
2021
December 31,
2020
(In thousands)
$
19,973 $
65,550
23,815
109,338
29,968
$
79,370 $
21,599
71,653
26,341
119,593
34,141
85,452
Total depreciation expense on premises and equipment was $5.3 million, $5.5 million and $4.7 million for the years
ended December 31, 2021, 2020 and 2019, respectively.
(7)
Goodwill and Other Intangible Assets
(a) Goodwill
The Company’s goodwill represents the excess of the purchase price over the fair value of net assets acquired in the
following mergers: Premier Commercial Bancorp and Puget Sound Bancorp in 2018; Washington Banking Company in 2014;
Valley Community Bancshares in 2013; Western Washington Bancorp in 2006 and North Pacific Bank in 1998. The Company’s
goodwill is assigned to the Bank and is evaluated for impairment at the Bank level (reporting unit). There were no additions to
goodwill during the years ended December 31, 2021, 2020, and 2019.
At December 31, 2021, the Company’s analysis concluded the fair value of the reporting unit exceeded the carrying
value so the Company's goodwill was not considered impaired. Similarly, no goodwill impairment charges were recorded for the
years ended December 31, 2020 and 2019. Even though there was no goodwill impairment at December 31, 2021, changes in
74
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 core deposit intangible acquired in business combinations with estimated useful lives
of ten years. There were no additions to goodwill during the years ended December 31, 2021, 2020, and 2019 and the estimated
aggregate amortization expense related to other intangible assets for future years as of December 31, 2021 is as follows, in
thousands:
2022
2023
2024
2025
2026
Thereafter
Total
$
$
2,750
2,435
1,640
1,173
1,006
973
9,977
(8)
Derivative Financial Instruments
The following table presents the notional amounts and estimated fair values of derivatives:
December 31, 2021
December 31, 2020
Notional
Amounts
Estimated Fair
Value
Notional
Amounts
Estimated Fair
Value
(In thousands)
322,726 $
15,219 $
308,126 $
25,740
Non-hedging interest rate derivatives:
Interest rate swap asset (1)
Interest rate swap liability (1)
(26,162)
322,726
(1) The estimated fair value of derivatives with customers was $9.8 million and $25.4 million as of December 31, 2021
and December 31, 2020, respectively. The estimated fair value of derivatives with third-parties was $(9.8) million and
$(25.9) million as of December 31, 2021 and December 31, 2020, respectively.
(15,286)
308,126
Generally, the gains and losses of the interest rate derivatives offset due to the back-to-back nature of the contracts.
However, the settlement values of the Bank's net derivative assets with customers were increased by $355,000 and reduced by
$422,000 as of December 31, 2021 and December 31, 2020, respectively, due to the recognition of a credit valuation adjustment.
A credit valuation adjustment was not recorded on the Bank's net derivative assets as of December 31, 2019.
(9)
Deposits
Deposits consisted of the following:
Noninterest demand deposits
Interest bearing demand deposits
Money market accounts
Savings accounts
Total non-maturity deposits
Certificates of deposit
Total deposits
December 31, 2021
December 31, 2020
Amount
Percent
Amount
Percent
(Dollars in thousands)
$
2,330,956
36.5 % $
1,980,531
35.4 %
1,946,605
1,120,174
640,763
6,038,498
342,839
30.5
17.6
10.0
94.6
5.4
1,716,123
962,983
538,819
5,198,456
399,534
30.7
17.2
9.6
92.9
7.1
$
6,381,337
100.0 % $
5,597,990
100.0 %
Deposit accounts overdrawn and reclassified to loans receivable were $216,000 and $187,000 as of December 31,
2021 and December 31, 2020. Accrued interest payable on deposits was $53,000 and $73,000 as of December 31, 2021 and
December 31, 2020, respectively and is included in accrued expenses and other liabilities in the Consolidated Statements of
Financial Condition.
75
Interest expense, by category, was as follows:
Interest bearing demand deposits
Money market accounts
Savings accounts
Certificates of deposit
Total interest expense
Year Ended December 31,
2021
2020
2019
(In thousands)
2,497 $
3,234 $
1,485
367
1,811
2,830
527
5,674
3,940
2,754
2,634
7,021
6,160 $
12,265 $
16,349
$
$
Scheduled maturities of certificates of deposit for future years as of December 31, 2021 are as follows, in thousands:
2022
2023
2024
2025
2026
Total
$
290,497
32,608
9,072
4,531
6,131
$
342,839
Certificates of deposit issued in denominations equal to or in excess of $250,000 totaled $100.0 million and $123.1
million as of December 31, 2021 and December 31, 2020, respectively.
Deposits received from related parties as of December 31, 2021 and December 31, 2020 totaled $8.8 million and
$6.3 million, respectively.
(10)
Junior Subordinated Debentures
As part of the acquisition of Washington Banking Company on May 1, 2014, the Company assumed trust preferred
securities and junior subordinated debentures with a total fair value of $18.9 million at the merger date. At December 31, 2021
and December 31, 2020, the balance of the junior subordinated debentures, net of unaccreted discount, was $21.2 million and
$20.9 million, respectively.
Washington Banking Master Trust, a Delaware statutory business trust, was a wholly owned subsidiary of
the
Washington Banking Company created for the exclusive purposes of issuing and selling capital securities and utilizing sale
proceeds to acquire junior subordinated debentures issued by the Washington Banking Company. During 2007, the Trust
issued $25.0 million of trust preferred securities with a 30-year maturity, callable after the fifth year. The trust preferred securities
have a quarterly adjustable rate based upon the three-month 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, 2021 and December 31, 2020 was 1.77% and
1.80%, respectively. The weighted average rate of the junior subordinated debentures for the years ended December 31, 2021,
2020 and 2019 was 3.53%, 4.29% and 6.55%, respectively. The weighted average rate includes the accretion of the discount
established at the merger date which is amortized over the life of the trust preferred securities.
The junior subordinated debentures are the sole assets of the Trust and payments under the junior subordinated
debentures are the sole revenues of the Trust. All of the common securities of the Trust are owned by the Company. The
Company has fully and unconditionally guaranteed the capital securities along with all obligations of the Trust under the trust
agreements. For financial reporting purposes, the Company's investment in the Master Trust is accounted for under the equity
method and is included in prepaid expenses and other assets on the 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
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. 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 (2) Investment Securities.
76
The following table presents the balance of the Company's securities sold under agreement to repurchase obligations
by class of collateral pledged at the dates indicated:
U.S. Treasury and U.S. Government-sponsored agencies
Residential CMO and MBS
Commercial CMO and MBS
Total
(12)
(a) FHLB
Other Borrowings
December 31,
2021
December 31,
2020
(In thousands)
4,914 $
4,134
41,791
50,839 $
—
7,388
28,295
35,683
$
$
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, 2021, the Bank maintained a credit facility with the FHLB with available borrowing capacity of
$1.06 billion. At December 31, 2021 and December 31, 2020 the Bank had no FHLB advances outstanding.
Advances from the FHLB may be collateralized by FHLB stock owned by the Bank, deposits at the FHLB, certain
commercial and residential real estate loans, investment securities 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 five correspondent banks to purchase federal funds totaling $215.0 million as of
December 31, 2021. The lines generally mature annually or are reviewed annually. As of December 31, 2021 and December 31,
2020, 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 $57.0 million as
of December 31, 2021. There were no borrowings outstanding as of December 31, 2021 and December 31, 2020. Any advances
on the credit facility would be secured by either investment securities or certain types of the Bank's loans receivable.
(d) Related Party Borrowings
The Company did not have any borrowings from related parties as of December 31, 2021 or December 31, 2020.
(13)
Leases
The Company's noncancelable operating lease agreements relate to certain banking offices, back-office operational
facilities, office equipment and sublease agreements. The majority of the leases contain renewal options and provisions for
increases in rental rates based on an agreed upon index or predetermined escalation schedule. As of December 31, 2021 and
December 31, 2020, the Company’s operating lease ROU asset was $27.6 million and $18.0 million, respectively, and the related
operating lease ROU liability was $28.8 million and $19.3 million, respectively. The Company does not have any leases
designated as finance leases.
On December 30, 2021, the Company sold its Olympia, Washington headquarters campus for total proceeds of
$5.4 million resulting in a net gain of $2.7 million. Contemporaneously with the closing of the sale, the Company entered into two
leases pursuant to which the Company leased back the first and second floors of the main building for an initial annual rent of
$227,000, subject to annual escalations of 3% over the lease terms. The leases are being accounted for as operating leases and
have initial lease terms of ten and five years for the first and second floor, respectively, and both leases additionally provide the
Company with two five-year options to extend. The new operating leases were incorporated into the required disclosures below.
The table below summarizes the information about our leases during the periods or at period end presented:
Operating lease cost
Short-term lease cost
Variable lease cost
77
Year Ended December 31,
2021
2020
(In thousands)
$
4,758
$
4,717
49
947
49
967
Sublease income
Total net lease cost during the period
Operating cash used for amounts included in the measurement of lease liabilities during the
period
ROU assets obtained in exchange for lease liabilities during the period
$
$
(24)
5,730
5,004
13,966
$
$
(55)
5,678
4,881
1,265
Weighted average remaining lease term of operating leases, in years, at period end
Weighted average discount rate of operating leases, at period end
7.1
2.32 %
7.2
3.12 %
The following table presents the lease payment obligations as of December 31, 2021 as outlined in the Company’s
lease agreements for each of the next five years and thereafter, in thousands:
2022
2023
2024
2025
2026
Thereafter
Total lease payments
Implied interest
ROU liability
$
$
4,750
4,844
4,614
4,480
3,930
8,703
31,321
(2,480)
28,841
(14)
Employee Benefit Plans
(a) 401(k) Plan
The Company provides its eligible employees with a Plan,
including funding certain Plan costs as incurred. All
employees may participate in the Plan commencing with the first of the month following the start of employment or concurrent to
their hire date if starting the first of the month. Participants may contribute a portion of their salary, which is matched by the
Company at 50%, not to be greater than 3% of eligible compensation, up to Internal Revenue Service limits. All participants are
100% vested in all accounts at all times. Employer matching contributions for the years ended December 31, 2021, 2020 and
2019 were $1.7 million, $1.7 million and $1.6 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, 2021, 2020 and 2019, the Company made no employer profit sharing contributions.
(b) Employment Agreements
The Company has entered into contracts with certain senior officers that provide benefits under certain conditions
following termination without cause 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
the changes in the Deferred
opportunity to defer current compensation. The following table presents a summary of
Compensation Plan during the periods indicated:
Balance outstanding at the beginning of the year
Employer contributions
Interest credited
Benefits Paid
Balance outstanding at the end of the year
(d) Salary Continuation Plan
Year Ended December 31,
2021
2020
2019
(In thousands)
4,101
$
4,244 $
3,654
634
78
(959)
207
128
(478)
443
147
—
3,854
$
4,101 $
4,244
$
$
In conjunction with the Company's merger with Premier Commercial Bancorp in 2018, the Company assumed an
unfunded deferred compensation plan for select former Premier Commercial executive officers, some of which are current
78
Company officers. The following table presents a summary of the changes in the salary continuation plan during the periods
indicated:
Obligation, at the beginning of the year
Benefits paid
Expenses incurred
Obligation, at the end of the year
(15)
Stockholders’ Equity
(a) Earnings Per Common Share
Year Ended December 31,
2021
2020
2019
(In thousands)
4,162
$
4,334 $
(536)
209
(460)
288
3,835
$
4,162 $
$
$
4,600
(554)
288
4,334
The following table illustrates the calculation of weighted average shares used for earnings per common share
computations for the periods indicated:
Net income:
Net income
Dividends and undistributed earnings allocated to participating
securities (1)
Net income allocated to common shareholders
Basic:
Year Ended December 31,
2021
2020
2019
(In thousands, except shares)
$
$
98,035 $
46,570 $
67,557
—
(7)
(57)
98,035 $
46,563 $
67,500
Weighted average common shares outstanding
35,677,851
36,018,627
36,789,244
Restricted stock awards
—
(4,182)
(31,014)
Total basic weighted average common shares outstanding
35,677,851
36,014,445
36,758,230
Diluted:
Basic weighted average common shares outstanding
Effect of potentially dilutive common shares (2)
35,677,851
36,014,445
36,758,230
295,535
155,621
227,536
Total diluted weighted average common shares outstanding
35,973,386
36,170,066
36,985,766
Potentially dilutive shares that were excluded from the computation of
diluted earnings per share because to do so would be anti-dilutive (3)
7,043
137,093
1,501
(1) Represents dividends paid and undistributed earnings allocated to unvested restricted stock awards.
(2) Represents the effect of the assumed exercise of stock options and vesting of restricted stock awards and units.
(3) Anti-dilution occurs when the exercise price of a stock option or the unrecognized compensation cost per share of a
restricted stock award or unit exceeds the market price of the Company’s stock.
(b) Dividends
The timing and amount of cash dividends paid on the Company's common stock depends on the Company’s earnings,
capital requirements, financial condition and other relevant factors. Dividends on common stock from the Company depend
substantially upon receipt of dividends from the Bank, which is the Company’s predominant source of income.
The following table summarizes the dividend activity during the most recent three year period:
Declared
Cash Dividend per Share
Record Date
Paid Date
January 23, 2019
April 24, 2019
July 24, 2019
October 23, 2019
October 23, 2019
January 22, 2020
April 29, 2020
July 22, 2020
October 21, 2020
$0.18
$0.18
$0.19
$0.19
$0.10
$0.20
$0.20
$0.20
$0.20
February 7, 2019
February 21, 2019
May 8, 2019
August 8, 2019
November 7, 2019
November 7, 2019
February 6, 2020
May 13, 2020
August 5, 2020
May 22, 2019
August 22, 2019
November 21, 2019
November 21, 2019
*
February 20, 2020
May 27, 2020
August 19, 2020
November 4, 2020
November 18, 2020
79
January 27, 2021
April 21, 2021
July 21, 2021
October 20, 2021
* Denotes a special dividend.
$0.20
$0.20
$0.20
$0.21
February 10, 2021
February 24, 2021
May 5, 2021
August 4, 2021
May 19, 2021
August 18, 2021
November 3, 2021
November 17, 2021
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
1,512,600 shares, under the eleventh stock repurchase plan. On March 12, 2020, the Company's board of directors authorized
the repurchase of up to 5% of the Company's outstanding common shares, or 1,799,054 shares, under the twelfth stock
repurchase plan after all shares under the eleventh stock repurchase plan had been repurchased. The number, timing and price
of shares repurchased under the twelfth stock repurchase plan will depend on business and market conditions and other factors,
including opportunities to deploy the Company's capital.
The following table provides total repurchased shares and average share prices under the applicable plans for the
periods indicated:
Eleventh Stock Repurchase Plan
Repurchased shares
Stock repurchase average share price
$
—
— $
639,922
292,712
1,512,600
23.95 $
26.50 $
21.69
Year Ended December 31,
2021
2020
2019
Plan Total(1)
Twelfth Stock Repurchase Plan
Repurchased shares
904,972
155,778
—
1,060,750
Stock repurchase average share price
$
(1) Represents shares repurchased and average price per share paid during the duration of each plan.
24.43 $
20.34 $
— $
23.83
In addition to the stock repurchases under a stock repurchase plan,
the Company repurchases shares to pay
withholding taxes on the vesting of restricted stock awards and units. The following table provides total shares repurchased to
pay withholding taxes during the periods indicated:
Repurchased shares to pay withholding taxes
26,869
28,887
Stock repurchase to pay withholding taxes average share price
$
29.10 $
21.57 $
28,479
30.83
(d) Issuance of Common Stock
Common stock was issued during the years ended December 31, 2020 and 2019 related to the exercise of stock
options as further described in Note (17) Stock-Based Compensation.
Year Ended December 31,
2021
2020
2019
(16)
Fair Value Measurements
Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or
most advantageous market for the asset or liability in an orderly transaction between market participants at 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,
80
discounted cash flow models and similar techniques using unobservable inputs, and not based on market exchange, dealer, or
broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value
assigned to such assets or liabilities.
(a) Recurring and Nonrecurring Basis
The Company used the following methods and significant assumptions to measure the fair value of certain assets on a
recurring and nonrecurring basis:
Investment Securities:
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). Investment security valuations are obtained from third-party pricing services.
Collateral-Dependent Loans:
Collateral-dependent loans are identified for the calculation of the ACL on loans. The fair value used to measure credit
loss for this type of loan is commonly based on recent real estate appraisals which are generally obtained at least every 18
months or earlier if there are changes to risk characteristics of the underlying loan. These appraisals may utilize a single
valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are
routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and
income data available. The Bank also incorporates an estimate of cost to sell the collateral when the sale is probable. Such
adjustments may be significant and result in a Level 3 classification of the inputs for determining fair value. Non-real estate
collateral may be valued using an appraisal, net book value based on the borrower’s financial statements or aging reports,
adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the
valuation and management’s expertise and knowledge of the customer and customer’s business (Level 3). Individually evaluated
loans are analyzed for credit loss on a quarterly basis and the ACL on loans is adjusted as required based on the results.
Appraisals on collateral-dependent loans are performed by certified general appraisers for commercial properties or
certified residential appraisers for residential properties whose qualifications and licenses have been reviewed and verified by the
Bank. Once received, the Bank's internal appraisal department reviews and approves the assumptions and approaches utilized
in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or
industry-wide statistics.
Derivative Financial Instruments:
The Bank obtains broker or dealer quotes to value its interest rate derivative contracts, which use valuation models
using observable market data as of the measurement date (Level 2), and incorporates credit valuation adjustments to reflect
nonperformance risk in the measurement of fair value (Level 3). Although the Bank has determined that the majority of the inputs
used to value its interest rate swap derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments
associated with its derivatives utilize Level 3 inputs, such as borrower risk ratings, to evaluate the likelihood of default by itself
and its counterparties. As of December 31, 2021 and December 31, 2020, the Bank assessed the significance of the impact of
the credit valuation adjustment on the overall valuation of its interest rate swap derivatives and determined the credit valuation
adjustment was not significant to the overall valuation of its interest rate swap derivatives. As a result, the Bank has classified its
interest rate swap derivative valuations in Level 2 of the fair value hierarchy.
Branches held for sale:
Branches held for sale are recorded at fair value less costs to sell when transferred from premises and equipment, net
to prepaid expenses and other assets on the Consolidated Statements of Financial Condition with any valuation adjustment
recorded within other noninterest expense on the Consolidated Statements of Income. The fair value of branches held for sale is
determined based on a real estate appraisal or broker price opinion. Adjustments are routinely made in the appraisal and broker
price opinion process by independent appraisers and commercial real estate brokers, respectively, to adjust for differences
between the comparable sales and income data available. Such adjustments are usually significant and typically result in Level 3
classification of the inputs for determining fair value. Additionally, the fair value of branches held for sale can be adjusted based
on executed agreements of sale to be completed at a future date.
Recurring Basis
The following tables summarize the balances of assets and liabilities measured at fair value on a recurring basis at the
dates indicated:
December 31, 2021
Total
Level 1
Level 2
Level 3
(In thousands)
Assets
Investment securities available for sale:
U.S. government and agency securities
$
21,373 $
— $
21,373 $
—
81
Municipal securities
Residential CMO and MBS
Commercial CMO and MBS
Corporate obligations
Other asset-backed securities
Total investment securities available for sale
Equity security
Derivative assets - interest rate swaps
Liabilities
December 31, 2021
Total
Level 1
Level 2
Level 3
(In thousands)
221,212
306,884
315,861
2,014
26,991
894,335
240
15,219
—
—
—
—
—
240
—
221,212
306,884
315,861
2,014
26,991
894,335
—
15,219
Derivative liabilities - interest rate swaps
$
15,286 $
— $
15,286 $
December 31, 2020
Total
Level 1
Level 2
Level 3
(In thousands)
Assets
Investment securities available for sale:
U.S. government and agency securities
$
45,660 $
— $
45,660 $
Municipal securities
Residential CMO and MBS
Commercial CMO and MBS
Corporate obligations
Other asset-backed securities
Total investment securities available for sale
Equity security
Derivative assets - interest rate swaps
Liabilities
209,968
201,872
303,746
11,096
29,821
802,163
131
25,740
—
—
—
—
—
—
131
—
209,968
201,872
303,746
11,096
29,821
802,163
—
25,740
Derivative liabilities - interest rate swaps
$
26,162 $
— $
26,162 $
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
Nonrecurring Basis
The Company may be required to measure certain financial assets and liabilities at fair value on a nonrecurring basis.
These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual
assets.
The following tables below represent assets measured at fair value on a nonrecurring basis at the dates indicated:
Basis(1)
Total
Level 1
Level 2
Level 3
Fair Value at December 31, 2021
(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial
$
1,911 $
1,049 $
— $
— $
Owner-occupied CRE
Total commercial business
Real estate construction and land development:
Commercial and multifamily
Total
Prepaid expenses and other assets:
Branch held for sale (2)
Total assets measured at fair value on
a nonrecurring basis
613
2,524
991
3,515
189
1,238
534
1,772
698
698
—
—
—
—
—
—
—
—
—
—
$
4,213 $
2,470 $
— $
— $
2,470
82
1,049
189
1,238
534
1,772
698
(1) Basis represents the outstanding principal balance of collateral-dependent loans and the carrying value of the branch
held for sale.
(2) In December 2021, one branch was written down to its net realizable value concurrent with the signing of an
agreement for sale at a future date.
Basis(1)
Total
Level 1
Level 2
Level 3
Fair Value at December 31, 2020
(In thousands)
Collateral-dependent loans:
Commercial business:
Commercial and industrial
$
1,305 $
1,289 $
— $
— $
1,289
Prepaid expenses and other assets:
Branch held for sale (2)
Total assets measured at fair value on
1,330
1,330
—
—
1,330
a nonrecurring basis
2,619
(1) Basis represents the outstanding principal balance of collateral-dependent loans and the carrying value of the branch
2,619 $
2,635 $
— $
— $
$
held for sale.
(2) In October 2020, one branch was reclassified as held for sale in accordance with ASC 360-10. As part of the transfer,
the branch was written down to its net realizable value at that time.
The following table represents the net (loss) gain recorded in earnings as a result of nonrecurring fair value adjustments
recorded during the periods indicated:
Collateral-dependent loans:
Commercial business:
Commercial and industrial
Owner-occupied CRE
Total commercial business
Real estate construction and land development:
Commercial and multifamily
Prepaid expenses and other assets:
Branch held for sale
Net loss from nonrecurring fair value adjustments
Year ended December 31,
2021
2020
2019
(In thousands)
$
(691) $
(8) $
(359)
(1,050)
(38)
—
(8)
—
(145) $
(1,233) $
$
(630) $
(638) $
(78)
—
(78)
—
—
(78)
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 the dates indicated:
Fair
Value
Valuation
Technique(s)
December 31, 2021
Unobservable Input(s)
(Dollars in thousands)
Range of Inputs; Weighted
Average
Collateral-dependent loans $
1,772 Market approach
Adjustment for differences
between the comparable sales
35.0% - (11.0%); 13.8%
Branch held for sale
$
698 Market approach Sale agreement
Not applicable
Fair
Value
Valuation
Technique(s)
Collateral-dependent loans $
1,289 Market approach
Branch held for sale
$
1,330 Market approach
December 31, 2020
Unobservable Input(s)
(Dollars in thousands)
Adjustment for differences
between the comparable sales
Adjustment for differences
between the comparable sales
Range of Inputs; Weighted
Average
0.6% - (40.1%); (24.1%)
140.7% - (40.3%); 33.2%
83
(b) Fair Value of Financial Instruments
for most of
Broadly traded markets do not exist
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 Company’s financial
instruments;
therefore,
The following tables present the carrying value amount of the Company’s financial instruments and their corresponding
estimated fair values at the dates indicated:
Carrying
Value
December 31, 2021
Fair Value Measurements Using:
Fair Value
Level 1
Level 2
Level 3
(In thousands)
Financial Assets:
Cash and cash equivalents
$
1,723,292 $
1,723,292 $
1,723,292 $
— $
Investment securities available for sale
Investment securities held to maturity
Loans held for sale
Loans receivable, net
Accrued interest receivable
Derivative assets - interest rate swaps
Equity security
Financial Liabilities:
Non-maturity deposits
Certificates of deposit
Securities sold under agreement to
repurchase
Junior subordinated debentures
Accrued interest payable
Derivative liabilities - interest rate
swaps
894,335
383,393
1,476
894,335
376,331
1,527
3,773,301
3,849,602
14,657
15,219
240
14,657
15,219
240
—
—
—
—
14
—
240
894,335
376,331
1,527
—
4,582
15,219
—
$
6,038,498 $
6,038,498 $
6,038,498 $
— $
342,839
344,025
—
344,025
50,839
21,180
73
15,286
50,839
18,750
73
15,286
50,839
—
33
—
—
—
19
15,286
—
—
—
—
3,849,602
10,061
—
—
—
—
—
18,750
21
—
Carrying
Value
December 31, 2020
Fair Value Measurements Using:
Fair Value
Level 1
Level 2
Level 3
(In thousands)
Financial Assets:
Cash and cash equivalents
$
743,322 $
743,322 $
743,322 $
— $
Investment securities available for sale
Loans held for sale
Loans receivable, net
Accrued interest receivable
Derivative assets - interest rate swaps
Equity security
Financial Liabilities:
Non-maturity deposits
Certificates of deposit
Securities sold under agreement to
repurchase
Junior subordinated debentures
802,163
4,932
802,163
5,156
4,398,462
4,556,862
19,418
25,740
131
19,418
25,740
131
—
—
—
2
—
131
802,163
—
—
3,648
25,740
—
$
5,198,456 $
5,198,456 $
5,198,456 $
— $
399,534
402,701
—
402,701
35,683
20,887
35,683
18,500
35,683
—
—
—
—
—
5,156
4,556,862
15,768
—
—
—
—
—
18,500
84
Carrying
Value
December 31, 2020
Fair Value Measurements Using:
Fair Value
Level 1
Level 2
Level 3
(In thousands)
Accrued interest payable
Derivative liabilities - interest rate
swaps
94
94
26,162
26,162
42
—
33
26,162
19
—
(17)
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 various types of stock-based compensation. As of December 31, 2021,
shares remaining available for future issuance under the Equity Plan totaled 522,228.
(a) Stock Option Awards
Stock options generally vested ratably over three years and expired five years after they become exercisable or vested
ratably over four years and expired ten years from date of grant. All outstanding stock options were exercised during the year
ended December 31, 2020. The intrinsic value from options exercised during the years ended December 31, 2020 and 2019 was
$61,000 and $60,000, respectively. The cash proceeds from options exercised during the years ended December 31, 2020 and
2019 were $122,000 and $58,000, respectively.
The following table summarizes the stock option activity during the periods indicated:
Outstanding at December 31, 2018
Exercised
Outstanding at December 31, 2019
Exercised
Forfeited or expired
Outstanding at December 31, 2020
(b) Restricted Stock Awards
Shares
Weighted-
Average
Exercise Price
12,558 $
(3,901)
8,657
(8,248)
(409)
— $
14.77
14.77
14.77
14.77
14.77
—
Restricted stock awards generally had a four-year cliff vesting or four-year ratable vesting schedule. The remaining
restricted stock awards vested during the year ended December 31, 2020. For the years ended December 31, 2020 and 2019,
the Company recognized compensation expense related to restricted stock awards of $76,000 and $440,000, respectively, and a
related tax benefit of $17,000 and $93,000, respectively. The vesting date fair value of restricted stock awards that vested during
the years ended December 31, 2020 and 2019 was $442,000 and $1.3 million, respectively.
The following table summarizes the restricted stock award activity for the periods indicated
Nonvested at December 31, 2018
Vested
Forfeited
Nonvested at December 31, 2019
Vested
Nonvested at December 31, 2020
(c) Restricted Stock Units
Weighted-
Average Grant
Date Fair
Value
Shares
66,033 $
(43,148)
(2,178)
20,707
(20,707)
— $
17.28
17.07
18.32
17.59
17.59
—
Restricted stock units generally vest ratably over three years and are subject to service conditions in accordance with
each award agreement.
Performance-based restricted stock units have a three-year cliff vesting schedule, participate in dividends and are
additionally subject to performance-based vesting. The conditions of the grants allow for an actual payout ranging between
no payout and 150% of target. The payout level is calculated based on the percentile level of the market condition, which is the
ratio of the Company's total shareholder return and the ratio of the Company's return on average assets over the performance
period in relation to the performance of these metrics of a predetermined peer group. The fair value of each performance-based
85
restricted stock unit, inclusive of the market condition, was determined using a Monte Carlo simulation and will be recognized
over the vesting period. The Monte-Carlo simulation model uses the same input assumptions as the Black-Scholes model;
however, it also further incorporates into the fair value determination the possibility the market condition may not be satisfied.
Compensation costs related to these awards are recognized regardless of whether the market condition is satisfied, provided the
requisite service has been provided.
The Company used the following assumptions to estimate the fair value of performance-based restricted share units
granted for the periods indicated:
Shares issued
Expected Term in Years
Weighted-Average Risk Free Interest Rate
Weighted Average Fair Value
Correlation coefficient
Range of peer company volatilities
Range of peer company correlation coefficients
Company volatility
Company correlation coefficient
Year Ended December 31,
2021
14,347
2020
15,200
2019
14,396
2.9
0.3 %
2.8
1.1 %
2.8
2.5 %
24.49
23.50
30.06
ABA NASDAQ
Community
Bank Index
ABA NASDAQ
Community
Bank Index
ABA NASDAQ
Community
Bank Index
31.4%-136.4% 18.1%-107.6%
19.9%-75.4%
34.1%-94.8%
16.1%-90.2%
34.5%-90.7%
40.2 %
90.1 %
23.2 %
80.5 %
23.9 %
79.9 %
Expected volatilities in the model were estimated using a historical period consistent with the performance period of
approximately three years. The risk-free interest rate was based on the United States Treasury rate for a term commensurate
with the expected life of the grant.
For the years ended December 31, 2021, 2020 and 2019, the Company recognized compensation expense related to
restricted stock units of $3.7 million, $3.5 million, and $2.8 million respectively, and a related tax benefit of $802,000, $757,000,
and $589,000, respectively. As of December 31, 2021, the total unrecognized compensation expense related to non-vested
restricted stock units was $5.0 million and the related weighted-average period over which the compensation expense is
expected to be recognized is approximately 2.0 years. The vesting date fair value of the restricted stock units that vested during
the year ended December 31, 2021, 2020 and 2019 was $3.6 million, $2.4 million and $2.0 million, respectively.
The following table summarizes the unit activity for the periods indicated:
Nonvested at December 31, 2018
Granted
Vested
Forfeited
Nonvested at December 31, 2019
Granted
Vested
Forfeited
Nonvested at December 31, 2020
Granted
Vested
Forfeited
Nonvested at December 31, 2021
(18)
Cash Restriction
Weighted-
Average Grant
Date Fair
Value
Units
179,185 $
126,598
(64,173)
(8,070)
233,540
200,972
(109,853)
(8,543)
316,116
147,944
(125,377)
(23,669)
315,014 $
28.94
31.89
29.25
30.25
30.41
23.61
29.21
28.07
26.57
25.70
26.84
27.20
26.01
The Bank had restricted cash included in interest earning deposits of $9.8 million and $25.9 million as of December 31,
2021 and December 31, 2020, respectively, relating to collateral required on interest rate swaps from third-parties as discussed
in Note (8) Derivative Financial Instruments. The Bank does not have a collateral requirement with customers.
86
(19)
Income Taxes
Income tax expense is substantially due to Federal income taxes as the provision for the state of Oregon income taxes
is insignificant and the state of Washington does not charge an income tax in lieu of a business and occupation tax. Income tax
expense consisted of the following for the periods indicated:
Current tax expense
Deferred tax expense (benefit)
Income tax expense
Year Ended December 31,
2021
2020
2019
(In thousands)
20,896 $
15,186 $
1,576
(8,576)
22,472 $
6,610 $
$
$
12,504
984
13,488
The CARES Act, among other things, permitted net operating loss carryovers and carrybacks to offset 100% of taxable
income for taxable years beginning before 2021. In addition, the CARES Act allowed net operating loss carrybacks incurred in
2018, 2019 and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid
income taxes. During the year ended December 31, 2020, the Company recorded a tax benefit from net operating loss carryback
related to prior acquisitions of $967,000.
The effective tax rate was 18.6% for the year ended December 31, 2021 compared to an effective tax rate of 12.4%
and 16.6% for the years ended December 31, 2020 and 2019, respectively. The increase in the effective tax rate during the year
ended December 31, 2021 was due primarily to the change in income before income taxes earned between the periods,
including an increase in annual pre-tax income for the year ended December 31, 2021 which decreased the impact of favorable
permanent tax items such as tax-exempt investments, investments in bank owned life insurance and low-income housing tax
credits. The following table presents the reconciliation of income taxes computed at the Federal statutory income tax rate of 21%
to the actual effective rate for the periods indicated:
Year Ended December 31,
2021
2020
2019
(In thousands)
Income tax expense at Federal statutory rate
$
25,307 $
11,168 $
State tax, net of Federal tax benefit
Tax-exempt instruments
Federal tax credits and other benefits (1)
Effects of BOLI
Tax benefit of CARES Act carryback
Other, net
960
(1,929)
(1,630)
(474)
—
238
359
(1,785)
(1,928)
(827)
(967)
590
17,020
357
(1,745)
(1,961)
(368)
—
185
Income tax expense
13,488
(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.
Gross tax credits related to the Company's NMTC totaling $9.8 million were utilized during the seven year period
ended December 31, 2020.
22,472 $
6,610 $
$
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 credit losses
Accrued compensation
Stock compensation
Market discount on purchased loans
Foregone interest on nonaccrual loans
Net operating loss carryforward acquired
ROU lease liability
Other deferred tax assets
Total deferred tax assets
87
December 31,
2021
December 31,
2020
(In thousands)
$
9,756 $
15,883
3,480
689
944
967
186
6,257
1,156
23,435
2,988
642
1,062
1,456
207
4,161
160
26,559
Deferred tax liabilities:
Deferred loan fees, net
Premises and equipment
FHLB stock
Goodwill and other intangible assets
New market tax credit
Junior subordinated debentures
ROU lease asset
Net unrealized gains on investment securities
Other deferred tax liabilities
Total deferred tax liabilities
Deferred tax asset, net
December 31,
2021
December 31,
2020
(In thousands)
(1,838)
(2,436)
(572)
(1,659)
—
(991)
(5,995)
(2,537)
(181)
(2,643)
(2,680)
(569)
(2,186)
(2,048)
(1,050)
(3,879)
(6,805)
(264)
(16,209)
$
7,226 $
(22,124)
4,435
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized. A valuation allowance is required to be recognized for the portion of
the deferred tax asset that will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation
of future taxable income during the periods in which those temporary differences become deductible. As of December 31, 2021,
based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred
tax assets are deductible, management expects to realize the benefits of these deductible differences.
At December 31, 2021 and December 31, 2020, the Company had a net operating loss carryforward of $888,000 and
$986,000, respectively, and do not expire. The Company is limited to the amount of the net operating loss carryforward that it can
deduct each year under Section 382 of the Internal Revenue Code. Due to sufficient earnings history and other positive
evidence, management has not recorded a valuation allowance on the net operating loss carryforward as of December 31, 2021
and December 31, 2020.
As of December 31, 2021 and December 31, 2020, the Company had an insignificant amount of unrecognized tax
benefits, none of which would materially affect its effective tax rate if recognized. The Company does not anticipate that the
amount of unrecognized tax benefits will significantly increase or decrease in the next 12 months. The amount of interest and
penalties accrued as of December 31, 2021 and December 31, 2020 and recognized during the years ended December 31,
2021, 2020 and 2019 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, 2021, the Company had a
taxable temporary difference of approximately $2.8 million that arose before 1988 (base-year amount). In accordance with FASB
ASC 740, an estimated deferred tax liability of $588,000 has not been recognized for the temporary difference. Management
does not expect this temporary difference to reverse in the foreseeable future.
The Company and its Bank subsidiary file a United States consolidated federal income tax return and an Oregon State
income tax return, and the tax years subject to examination by the Internal Revenue Service are the years ended December 31,
2021, 2020, 2019 and 2018.
(20)
Commitments and Contingencies
(a) Commitments to Extend Credit
In the ordinary course of business, the Bank may enter into various types of transactions that include commitments to
extend credit that are not included in its Consolidated Financial Statements. The Bank applies the same credit standards to these
commitments as it uses in all
its lending activities and has included these commitments in its lending risk evaluations. The
majority of the commitments presented below are variable rate. Loan commitments can be either revolving or non-revolving. The
Bank’s exposure to credit and market risk under commitments to extend credit
these
commitments.
is represented by the amount of
The following table presents outstanding commitments to extend credit, including letters of credit, at the dates indicated:
Commercial business:
Commercial and industrial
Owner-occupied CRE
88
December 31,
2021
December 31,
2020
(In thousands)
$
570,156 $
640,018
2,252
3,488
Non-owner occupied CRE
Total commercial business
Real estate construction and land development:
Residential
Commercial and multifamily
Total real estate construction and land development
Consumer
December 31,
2021
December 31,
2020
(In thousands)
7,487
579,895
51,838
209,217
261,055
285,010
18,396
661,902
52,453
127,821
180,274
263,249
Total outstanding commitments
$
1,125,960 $
1,105,425
The following table details the activity in the ACL on unfunded commitments during the periods indicated:
Balance, beginning of period
Impact of CECL Adoption
Adjusted balance, beginning of period
(Reversal of) provision for credit losses on unfunded commitments
Balance, end of period
(b) Variable Interests - Low Income Housing Tax Credit Investments
Year Ended December 31,
2021
2020
2019
(In thousands)
4,681 $
306 $
—
4,681
(2,074)
3,702
4,008
673
2,607 $
4,681 $
$
$
306
—
306
—
306
The carrying values of investments in unconsolidated LIHTCs were $116.3 million and $96.4 million as of December 31,
2021 and December 31, 2020, respectively. During the years ended December 31, 2021, 2020 and 2019 the Company
recognized tax benefits of $11.4 million, $7.5 million and $5.7 million, respectively, and proportional amortization of $9.7 million,
$6.5 million and $5.0 million, respectively.
Total unfunded contingent commitments related to the Company’s LIHTC investments totaled $41.5 million and $53.8
million at December 31, 2021 and December 31, 2020, respectively. The Company expects to fund LIHTC commitments of $10.6
million during the year ended December 31, 2022 and $23.6 million during the year ended December 31, 2023, with the
remaining commitments of $7.3 million funded by December 31, 2035. There were no impairment losses on the Company’s
LIHTC investments during the years ended December 31, 2021, 2020 or 2019.
(c) Variable Interests - New Market Tax Credit Investments
The Company dissolved the NMTC investment during the year ended December 31, 2021 after gross tax credits related
to the Company's certified development entities totaling $9.8 million were utilized during the seven year period ending December
31, 2020. The equity method balance of the NMTC investment was $25.2 million at December 31, 2020. The Company
recognized related investment income of $247,000, $694,000 and $701,000 during the years ended December 31, 2021, 2020
and 2019, respectively.
(21)
Regulatory Capital Requirements
requirements established by the FDIC. The Federal Reserve capital
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
the FDIC
capital
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 Consolidated Financial Statements and
operations. Management believes as of December 31, 2021, the Company and the Bank meet all capital adequacy requirements
to which they are subject.
requirements generally parallel
89
As of December 31, 2021 and December 31, 2020, the most recent regulatory notifications categorized the Bank as
well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that
notification that management believes have changed the Bank's categories.
Minimum
Requirements
Well-
Capitalized
Requirements
Actual
$
%
$
%
$
%
(Dollars in thousands)
As of December 31, 2021:
The Company consolidated
Common equity Tier 1 capital to risk-
weighted assets
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
As of December 31, 2020:
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
$ 200,525
4.5 %
285,791
267,367
356,489
200,408
285,657
267,210
356,280
4.0
6.0
8.0
4.5
4.0
6.0
8.0
$ 203,314
4.5 %
256,216
271,086
361,448
203,112
256,051
270,815
361,087
4.0
6.0
8.0
4.5
4.0
6.0
8.0
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A $ 600,390
13.5 %
N/A
N/A
N/A
621,570
621,570
660,209
8.7
13.9
14.8
13.8
8.6
13.8
14.7
9.0
12.8
14.0
12.5
8.8
12.5
13.7
$ 289,478
6.5 %
615,820
357,071
356,280
445,350
5.0
8.0
10.0
615,820
615,820
654,459
N/A $ 555,644
12.3 %
N/A
N/A
N/A
576,531
576,531
633,061
$ 293,383
6.5 %
563,630
320,064
361,087
451,359
5.0
8.0
10.0
563,630
563,630
620,124
As of December 31, 2021 and December 31, 2020, the capital measures reflect the revised CECL capital transition
provisions adopted by the Federal Reserve and the FDIC that allowed us the option to delay for two years an estimate of CECL’s
effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year
transition period starting January 1, 2022 until December 31, 2024.
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, 2021, the capital conservation buffer was 6.8%
and 6.7% for the Company and the Bank, respectively.
90
(22)
Heritage Financial Corporation (Parent Company Only)
Following are the condensed financial statements of the Parent Company.
HERITAGE FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
Condensed Statements of Financial Condition
ASSETS
Cash and cash equivalents
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
HERITAGE FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
Condensed Statements of Income
December 31,
2021
December 31,
2020
(In thousands)
$
$
$
$
3,513 $
869,862
2,608
9,736
828,426
4,469
875,983 $
842,631
21,180 $
371
854,432
875,983 $
20,887
1,305
820,439
842,631
INTEREST INCOME:
Interest on interest earning deposits
INTEREST EXPENSE:
Junior subordinated debentures
Net interest expense
NONINTEREST INCOME:
Dividends from subsidiary bank
Equity in undistributed income of subsidiary bank
Other income
Total noninterest income
NONINTEREST EXPENSE:
Professional services
Other expense
Total noninterest expense
Income before income taxes
Income tax benefit
Net income
Year Ended December 31,
2021
2020
2019
(In thousands)
$
30 $
16 $
57
742
(712)
46,000
57,058
117
103,175
394
5,430
5,824
96,639
(1,396)
890
(874)
39,000
12,685
5
51,690
495
5,172
5,667
45,149
(1,421)
$
98,035 $
46,570 $
1,339
(1,282)
47,000
25,186
39
72,225
517
4,395
4,912
66,031
(1,526)
67,557
91
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:
Equity in undistributed income of subsidiary bank
Stock-based compensation expense
Net change in other assets and other liabilities
Net cash provided by operating 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 (decrease) increase in cash and cash equivalents
Cash and cash equivalents at the beginning of year
Cash and cash equivalents at the end of year
Year Ended December 31,
2021
2020
2019
(In thousands)
$
98,035 $
46,570 $
67,557
(57,058)
3,666
960
45,603
(12,685)
3,559
(1,333)
36,111
(25,186)
3,231
763
46,365
(28,937)
(28,859)
(30,908)
—
(22,889)
(51,826)
(6,223)
9,736
122
(19,119)
(47,856)
(11,745)
21,481
$
3,513 $
9,736 $
58
(8,636)
(39,486)
6,879
14,602
21,481
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
ITEM 9.
DISCLOSURE
None
ITEM 9A.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our disclosure controls and procedures are designed to ensure that information the Company must disclose in its
reports filed or submitted under the Exchange Act, is recorded, processed, summarized, and reported on a timely basis. Our
management has evaluated, with the participation and under the supervision of our Chief Executive Officer and Chief Financial
Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the
Exchange Act) as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that, as of such date, the Company’s disclosure controls and procedures are effective in
ensuring that information relating to the Company, including its consolidated subsidiaries, required to be disclosed in reports that
it files under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the
SEC’s rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and
Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting
(a) Management’s report on internal control over financial reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial
reporting. The Company’s internal control system is designed to provide reasonable assurance to our management and the
board of directors regarding the preparation and fair presentation of published financial statements. Nonetheless, all internal
control systems, no matter how well designed, have inherent limitations. Even systems determined to be effective as of a
particular date can provide only reasonable assurance with respect to financial statement preparation and presentation and may
not eliminate the need for restatements.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as
of December 31, 2021. In making this assessment, management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission in the 2013 Internal Control—Integrated Framework. Based on our assessment, we
believe that, as of December 31, 2021, 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, 2021, and their report is included in Item 8. Financial Statements And Supplementary
Data.
92
(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
ITEM 9C.
DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS
Not applicable
PART III
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning directors of the registrant is incorporated by reference to the section entitled “Proposal 1 -
Election of Directors” of our Proxy Statement.
For information regarding the executive officers of the Company, see Item 1. Business—Executive Officers.
The required information with respect to compliance with Section 16(a) of the Exchange Act is incorporated by
reference to the section entitled “Security Ownership of Certain Beneficial Owners and Management” of the Proxy Statement.
The Company has adopted a written Code of Ethics that applies to our directors, officers and employees. The Code of
Ethics can be accessed electronically by visiting the Company’s website at www.hf-wa.com 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, Trevor D. Dryer, Jeffery S. Lyon, Gragg E.
Miller, and Anthony B. Pickering, all of whom are considered “independent” as defined by the SEC. Our board of directors has
determined Mrs. Gavin meets the definition of a financial expert as determined by the requirements of the SEC.
ITEM 11.
EXECUTIVE COMPENSATION
Information concerning executive and director compensation and certain matters regarding participation in the
Company’s Compensation Committee required by this item is incorporated by reference to the headings “Executive
Compensation,” “Director Compensation,” “Report of
the Proxy
Statement.
the Compensation Committee,” and "CEO Pay Ratio" of
ITEM 12.
STOCKHOLDER MATTERS
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
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, 2021, 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
Number of
securities
remaining
available for
future issuance
under equity
compensation
plans
—
315,014
—
522,228
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.
93
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 12 of our 13 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 AND 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.
Exhibit No. Description of Exhibit
3.1 Amended and Restated Articles of Incorporation
3.2 Amendment to Amended and Restated Articles of Incorporation
3.3 Amended and Restated Bylaws of the Company
4.1 Form of Certificate of Company's Common Stock (3)
4.2 Description of Capital Stock of Capital Stock (1)
10.1* Annual Incentive Compensation Plan
10.2* Amended 2014 Omnibus Equity Plan
10.3* 2014 Omnibus Equity Plan
10.4* Form of Performance-Based Restricted Stock Unit Award Agreement
under the Heritage Financial Corporation 2014 Omnibus Equity Plan
10.5* Form of Restricted Stock Unit Award Agreement under the Heritage
Financial Corporation 2014 Omnibus Equity Plan
10.6* Employment Agreement by and between Heritage and Jeffery J. Deuel
10.7* Deferred Compensation Plan and Participation Agreement by and
between Heritage and Jeffrey J. Deuel
Incorporated by Reference
Form
Exhibit
Filing Date/
Period End
Date
8-K
3.1(B)
05/18/2010
S-14A
8-K
S-1/A
-
03/18/2011
3.3
06/30/2020
-
10/29/1997
10-K
8-K
10.5
99.2
03/09/2017
02/01/2017
DEF 14A
-
06/11/2014
8-K
99.4
02/01/2017
8-K
8-K
99.3
10.1
02/01/2017
07/01/2019
8-K
10.6
09/07/2012
10.8* Deferred Compensation Plan and Participation Agreement - Addendum by
and between Heritage and Jeffrey J. Deuel
8-K
10.2
12/22/2016
10.9* Deferred Compensation Plan and Participation Agreement - Addendum by
and between Heritage and Jeffrey J. Deuel
10.10* Employment Agreement by and between Heritage and Donald J. Hinson
10.11* Deferred Compensation Plan and Participation Agreement by and
between Heritage and Donald J. Hinson
10-Q
10-Q
10.15
11/06/2019
10.22
11/06/2019
8-K
10.7
09/07/2012
10.12* Deferred Compensation Plan and Participation Agreement - Addendum by
and between Heritage and Donald J. Hinson
8-K
10.3
12/22/2016
10.13* Deferred Compensation Plan and Participation Agreement - Addendum by
and between Heritage and Donald J. Hinson
10.14* Employment Agreement by and between Heritage and Bryan McDonald
10.15* Deferred Compensation Plan and Participation Agreement by and
between Heritage and Bryan D. McDonald
10-Q
10-Q
10.16
11/06/2019
10.33
11/06/2019
10-K
10.16
03/11/2015
94
10.16* Deferred Compensation Plan and Participation Agreement - Addendum by
and between Heritage and Bryan D. McDonald
8-K
10.4
12/22/2016
10.17* Deferred Compensation Plan and Participation Agreement - Addendum by
and between Heritage and Bryan D. McDonald
10-Q
10.27
11/06/2019
10.18* Addendum to Employment Agreement - Bryan D. McDonald
8-K
10.1
07/06/2021
10.19* Employment Agreement by and between Heritage and Cindy Huntley
10-Q
10.35
11/06/2019
10-Q
10-Q
10-Q
10-Q
8-K
10.36
11/06/2019
10.37
11/06/2019
10.17
08/06/2015
10.34
05/09/2019
10.1
06/30/2020
8-K
10.3
06/30/2020
10-Q
10.34
05/05/2021
10.20* Deferred Compensation Plan and Participation Agreement by and
between Heritage and Cindy Huntley
10.21* Employment Agreement by and between Heritage and William Glasby
10.22* Form of Split Dollar Agreements
10.23* Form of First Amendment to Split Dollar Agreements
10.24* Employment Agreement by and between Heritage and Tony Chalfant
10.25* Deferred Compensation Plan and Participation Agreement by and
between Heritage and Tony Chalfant
10.26* Form of Split Dollar Agreement, dated May 3, 2021, by and between
Heritage Bank and Tony Chalfant
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)
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.
95
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 24, 2022.
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 24, 2022.
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 of directors.
Brian S. Charneski
John A. Clees
Trevor D. Dryer
Kimberly T. Ellwanger
Deborah J. Gavin
Gail B. Giacobbe
Jeffrey S. Lyon
Gragg E. Miller
Anthony B. Pickering
Frederick B. Rivera
Brian L. Vance
Ann Watson
/S/
JEFFREY J. DEUEL
Jeffrey J. Deuel
Attorney-in-Fact
February 24, 2022
96
BOARD OF DIRECTOCC RS
Brian S. Charneski
President, L&E Bottling Company
John A. Clees
Attorney, Worth Law Group
Jeffrff ey J. Deuel
President & Chief Executive Offiff cer
Trevor D. Dryer
Director, Co-Founder and CEO,
Carbon Title
Kimberly T. Ellwanger
Retired Senior Director of Corporate
Affairs
Microsoftff Corporation
and Associate General Counsel,
ff
Deborah J. Gavin
Retired Vice President of Finance and
Controller, The Boeing Company
Gail B. Giacobbe
General Manager, Customer Success
Engineering, Microsoftff Corporation
Jeffrff ey S. Lyon
Chairman, Kidder Mathews
Gragg E. Miller
Retired Principal Managing Broker,
Coldwell Banker Bain
Anthony B. Pickering
Former Owner, Max Dale’s
Restaurant and Stanwood Grill
Frederick B. Rivera
Executive Vice President and
General Counsel, Seattle Mariners
Brian L. Vance
Chairman of the Board
Retired Chief Executive Offiff cer
Ann Watson
Chief Operating Offiff cer,
Cascadia Capital, LLC
201 5th Avenue SW
Olympia, WA 98501
360.943.1500 | 800.455.6126
Jeffrff ey J. Deuel
President & Chief Executive Offiff cer
Bryan D. McDonald
Executive Vice President
Donald J. Hinson
Executive Vice President
Chief Financial Offiff cer
Kaylene M. Lahn
Senior Vice President
Corporate Secretary
SHAREHOLDER INFORMATION
AA
TRANSFER AGENT
The annual meeting will be held virtually
Tuesday, May 3, 2022 at 9:00 a.m.
All shareholders are invited to attend.
rr
NASDAQ: HFWA | WWW.HF -WA.COM
Computershare
P.O. Box 505000
Louisville, KY 40233
Phone: 800.962.4284
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